Using Market Forces to Protect the Environment
OpinionZEW President Achim Wambach on Emissions Trading
European emissions trading has effectively linked economics and climate protection for some time now. But the public seems to be unaware of its success. The German Federal Government’s climate cabinet should work to extend European emissions trading to the transport and heating sectors. The first step should be to introduce emissions markets in these sectors throughout Germany, argues Professor Achim Wambach, President of the economic research institute ZEW in Mannheim, in his latest opinion piece.
Economists typically create incentives using prices. For the father of Germany’s ‘social market economy’, Walter Eucken, the price system fulfils an essential function. Activities that have a negative impact on third parties must be ‘priced into’ the market. Such activities are common in the environmental sector. Loud aircraft pay higher take-off and landing fees, trucks pay a motorway toll because they cause greater wear to the roads, and the motor vehicle tax is linked to consumption. Similarly, economists have long called for the introduction of a CO2 price to reduce harmful emissions.
But environmentalists prefer targets and limits to prices. They believe that these measures are a more reliable strategy for ensuring goals are actually met. By way of example: Nitrogen dioxide concentrations cannot exceed an annual average limit of 40 micrograms per cubic meter of air volume, and automobile manufacturers must reduce the CO2 emissions of their new passenger cars by 37.5 per cent compared to 2021 by 2030. But limits such as these do not address how these goals will actually be met.
The EU ETS combines prices and limits
Emissions trading is an instrument for meeting emission reduction targets. About 11,000 facilities in the energy and industry sectors participate in the European Emissions Trading Scheme (EU ETS). The scheme serves the interests of both economists and environmentalists. Every company participating in the EU ETS must obtain CO2 licences for its emissions. If it has too few, then it has to buy more. So a facility pays a price for every tonne of CO2 it emits. Since the number of certificates is limited, the price is determined by market forces. The total amount of licenses is capped, and, by extension, total CO2 emissions are limited. If one company emits more CO2, then another has to emit less, and vice versa. The EU Commission has determined caps for the EU ETS sectors to achieve a reduction in CO2 emissions by 2030 of 43 per cent compared with 2005. Around 45 per cent of European emissions in 31 countries are currently included in the EU ETS. For the period after 2030, the EU will have to decide on new certificate numbers. These numbers are expected to be based on the EU’s climate targets for 2050. So does the EU ETS achieve the impossible by combining prices and limits?
To an extent, it does. But the public appears to have little appreciation for its success. Here are two examples. Coal will soon be phased out. But the public debate about the coal phase-out is highly emotional and contentious, in particular regarding the timing of the exit. From an economic and social point of view, there are compelling reasons to consider structural changes in coal-producing regions and to plan carefully for the post-coal period. Determining an exact exit date is secondary. Since electricity generated from coal is part of the EU ETS, reduced or increased emissions in this sector that result from an earlier or later coal exit will automatically be compensated for in other sectors or countries. A later coal exit would tend to make certificates more expensive, because the companies producing emissions would require more certificates in total. Higher certificate prices would in turn incentivise other emitters to reduce their emissions and the number of certificates they require, for example by investing in ‘cleaner’ technologies. Some have argued that an earlier coal exit could take additional certificates off the market, and as a result further reduce emissions. That may be true, but there are other ways to achieve the same goal without an earlier coal exit.
Extend emissions trading in Germany to the transport and heating sectors
Another example is the recent student protests at airports against frequent air travel. Media coverage of the protests report the quantities of CO2 emitted by air travel. In 2017, the average per capita consumption of CO2 in Germany was equivalent to around 20 round-trip flights from Frankfurt to Mallorca. But intra-European flights are part of the EU ETS. So more flights within Europe do not result in increased CO2 emissions. If there are more flights, then emissions must be reduced in other sectors. But intercontinental flights and flights to non-EU countries are not currently included in any emissions trading system.
In mid-September, the federal government’s climate cabinet will set out policies to meet climate targets, among them reducing CO2 emissions in 2030 by 55 per cent compared to 1990. There appears to be a consensus that a price should be put on CO2. Ideally these policies should also cover the transport and heating sectors, which currently do not participate in the EU ETS. But that would require the agreement of the European Council, which is unlikely at least in the short term.
As recommended by the Council of Economic Experts in its special report on climate policy, the first step should be to introduce emissions markets in these sectors throughout Germany. The consumption of petrol and diesel as well as heating powered by oil or gas would then be included in emissions trading. A ZEW study on new price models in the energy industry showed that prices for petrol, diesel, oil and natural gas would then probably rise, while those for electricity would fall.
The extension of emissions trading to sectors not currently covered should be combined with a publicity campaign to explain the interdependencies fostered by the emissions trade. If an individual or company emits more CO2, they require more certificates. Certificate prices then rise. As a result, emissions trading ensures that others emit less. The total quantity of certificates is capped to meet climate targets. Headlines like ‘The SUV boom’s harm to the environment’ would be a thing of the past.
This article first appeared in the newspaper ‘Rheinische Post’ on 10 September.
