The purpose of the global financial system is to allocate the world’s savings to their most productive uses. When the system works properly, these savings are channeled into investments that raise living standards; when it malfunctions — as in recent years — savings are channeled into real-estate bubbles and environmentally harmful projects, including those said to exacerbate human-induced climate change.
Next year will be a turning point in the effort to create a global financial system that contributes to climate safety rather than climate ruin. In July, the world’s governments are set to meet in Addis Ababa to hammer out a new framework for global finance.
The meeting’s goal is to facilitate a financial system that supports sustainable development, meaning economic growth that is socially inclusive and environmentally sound. Five months later, in Paris, the world’s governments are expected to sign a new global agreement to control anthropogenic climate change and channel funds toward climate-safe energy generation, building on the progress achieved earlier this month in negotiations in Lima. There, too, finance will loom large.
Illustration: Mountain People
The basics are clear. Climate safety requires that all nations shift their energy generation systems away from coal, oil and gas and toward wind, solar, geothermal and other low-carbon sources. Nations should also test the feasibility of large-scale carbon capture and sequestration, which might enable the safe, long-term use of at least some fossil fuels. Instead, the global financial system has continued to pump hundreds of billions of US dollars per year into exploring and developing new fossil-fuel reserves, while directing very little toward capture and sequestration.
Many investments in new fossil-fuel reserves will lose money — lots of it — owing to the recent fall in world oil prices. And many of the fossil fuel reserves that companies are currently developing will eventually be “stranded” — left in the ground — as part of new global climate policies. The world has far more fossil-fuel resources than can be safely burned, given the theories of human-induced climate change.
Though market signals are not yet clear, this year’s more successful investors were those who sold their fossil-fuel holdings, thereby avoiding the crash in oil prices. Perhaps they were just lucky this year, but their divestment decision makes long-term sense, because it correctly anticipates the future policy shift away from fossil fuels and toward low-carbon power generation.
Several major pension funds and foundations in the US and Europe have recently made the move. They have wisely heeded the words of former BP chief executive John Browne, who recently said that climate change poses an “existential threat” to the oil industry.
More governments around the world are introducing carbon pricing to reflect the high social costs inherent in the continued use of fossil fuels. Every tonne of carbon dioxide that is emitted into the atmosphere by burning coal, oil or gas adds to long-term global warming, and therefore to the long-term costs that society is predicted to incur through droughts, floods, heat waves, extreme storms and rising sea levels.
While these future costs cannot be calculated with precision, recent estimates put the current social cost of each added tonne of atmospheric carbon dioxide at somewhere between US$10 and US$100, with the US government using a middle-range estimate of about US$40 per tonne to guide energy regulation.
Some nations, like Norway and Sweden, long ago introduced a tax on carbon dioxide emissions to reflect a social cost of about US$100 per tonne, or even higher. Many private companies, including major oil firms, have also recently introduced an internal accounting cost of carbon emissions to guide their decisions regarding fossil-fuel investments. Doing so enables companies to anticipate the financial consequences of future government regulations and taxation.
As more nations and companies introduce carbon pricing, the internal accounting cost of carbon emissions will rise, investments in fossil fuels will become less attractive and investments in low-carbon energy systems will become more appealing. The market signals of carbon dioxide taxation — or the cost of carbon dioxide emission permits — will help investors and money managers steer clear of new fossil-fuel investments. Carbon taxes also offer governments a crucial source of revenue for future investment in low-carbon energy sources.
With international oil prices dropping — by US$40 per barrel since the summer — this is an ideal time for governments to introduce carbon pricing. Rather than let the consumer price of oil fall by that amount, governments should put a carbon tax in place.
Consumers would still come out ahead. Because each barrel of oil emits about 0.43 tonnes of carbon dioxide, a carbon tax of, say, US$40 per tonne of carbon dioxide implies an oil tax of just US$17 per barrel. And, because oil prices have declined by more than triple the tax, consumers would continue to pay much less than they did just a few months ago.
Moreover, new revenues from carbon taxes would be a boon for governments. High-income nations have promised to help low-income peers invest in climate safety, both in terms of low-carbon energy provision and resilience against climate shocks. Specifically, they have promised US$100 billion in climate-related financing per year, starting in 2020, up from between US$25 billion and US$30 billion this year. New revenues from a carbon dioxide tax would provide an ideal way to honor that pledge.
The math is simple. High-income nations emitted about 16.3 billion tonnes of carbon dioxide this year — about half of all global emissions. If these nations earmarked just US$2 per tonne of carbon dioxide for global financing organizations like the new Green Climate Fund and the regional development banks, they would transfer about US$32.6 billion per year. By using part of that money to mobilize private-sector financing, the full US$100 billion of climate financing could be reached.
Both Big Oil and Big Finance have made major mistakes in recent years, channeling funds into socially destructive investments. Next year, these two powerful industries — and the world as a whole — can start to put things right. There is within reach the makings of a new global financial system that directs savings where they are urgently needed: sustainable development and climate safety, for this and future generations.
Jeffrey Sachs is a professor of sustainable development and health policy and management, as well as director of the Earth Institute at Columbia University. He is also special adviser to the UN secretary-general on the Millennium Development Goals.
Copyright: Project Syndicate
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