26Smith School of Enterprise and the EnvironmentSmith

EnvironmentSmith School of Enterprise and the Environment27Chapter 5: Next StepsPricing CarbonIt is generally agreed that one of the most useful tools in inducing action on mitigating emissions is the pricing of GHG emissions. While by itself pricing will not be sufficient to tackle climate change, it is nonetheless a key part of climate policy. The need to price environmental externalities is a basic lesson from environmental economics. It sends a signal to the marketplace that governments are serious in taking action on climate change, incentivises reductions in emissions, and draws attention to the cost-effectiveness of investment in low carbon infrastructure [48]. Importantly, a high price incentivises the research, innovation, wealth creation chain, developing new energy efficient and low carbon technologies for the market. Setting a global price on CO2 emissions would clearly prevent carbon leakage. There are three main ways of pricing CO2: CO2 taxes, CO2 trading, and implicit pricing via regulations and standards. Each of the three approaches has different advantages and disadvantages, and all three are likely to be used in some form at some level of government. Regulation and Standards-Based PoliciesThese include efficiency standards for various goods, vehicle fuel-economy standards and best-available control technology standards. While undoubtedly a useful mechanism, there are several drawbacks to using a regulation and standards approach to reducing emissions. For example, regulatory standards are very often only applied to new, rather than existing, equipment Chapter 5which limits the opportunity for near-term reduction. Emissions would also therefore be dependent on the rate of capital stock turnover. Importantly, increasing the cost of new stock without affecting that of the existing stock means that incentives are created to continue using the old, higher CO2-emitting stock, thereby delaying emissions reductions [49]. Furthermore, in terms of cost-effectiveness, standards and regulatory approaches cannot compete with CO2 trading. CO2 Taxes and TradingTaxes and trading in the economists' idealised world would provide the same results as each other [50]. However, idealised conditions seldom occur. Taxes will fix the CO2 price but leave the quantity of emissions uncertain and trading fixes quantity but leaves price uncertain. Setting taxes too low would lead emissions to overshoot their target. A globally agreed CO2 tax therefore would offer less certainty than CO2 trading in meeting a desired target. By the same logic CO2 trading can lead to much more price uncertainty and volatility than taxes which, in a world where businesses prefer clear and stable signals for decision-making and investment, is not ideal. In either case, achieving a significant reduction in emissions requires a real commitment from governments: if the CO2 caps for the trading process are insufficient, the CO2 trading price will be too low to induce effective action; and the argument for governments imposing lower taxes than needed is even stronger. It is worth noting that the UK Government, noting the need to incentivise utilities to invest in low carbon infrastructure, has decided to introduce a floor to the CO2 price.Next Steps