When meddling makes matters worse

When economists speak about climate change risk, they use a lens of externalities — when exchanges between two parties have consequences that spill over onto third parties.

These externalities are labelled negative when these spillovers hurt third parties.

Greenhouse gas emissions resulting from economic activity constitute a negative externality, as producers and consumers in any exchange don’t pay the full social cost of their actions (present or future). This, economists argue, is a form of market failure.

Economists then propose corrective policies for governments. A good example is the carbon tax. Because it raises the price of pollution, it internalizes the externality.

The discussion generally ends with how further government interventions will internalize the externality.

However, are there margins where greater reliance on markets and scaling back government intervention would constitute a superior course of action? Did prior government actions make the problem larger, making it more accurate to speak of government failure?

This possibility is rarely discussed in the sphere of public affairs.

Yet consider the example of highways in Quebec. In the 1970s, the province removed all tolls on highways. By doing so, it reduced the cost of using an automobile and thus encouraged traffic jams, which are associated with greater levels of air pollution (in addition to the cost in time to commuters).

A move back to road-pricing would reduce greenhouse gas emissions and help mitigate climate change.

While this example suggests that this government failure is ubiquitous, it doesn’t speak to the contribution of government failures to the overall problem.

While valid, this argument may only explain a small portion of the problem of climate change. Thus, most of the efforts should come from policies such as new regulations and/or a carbon tax.

But that would be incorrect.

Consider fossil fuel subsidies. In countries representing roughly one-third of the world’s population, gasoline prices are reduced to artificially low levels.

Because consumption is greater at these lower levels, the governments of these countries (including India, China, Iran, Algeria, Venezuela and Egypt) must spend public funds to pay for the greater consumption.

The downside is that the incentives to invest in energy-saving technologies and to use energy more parsimoniously are weakened. The result is greater levels of greenhouse gas emissions and conventional air pollutants.

In the early 1990s, some economists began to point to the importance of this effect. A World Bank study suggested that eliminating those subsidies in the 1980s would have reduced emissions by five to nine per cent.

In a more recent report, the Organization for Economic Co-operation and Development found that the immediate abolition of these subsidies would reduce emissions by 10 per cent. And the International Monetary Fund found that, if the subsidies were eliminated, emissions of carbon dioxide would fall by 4.5 billion tons, representing 13 per cent of total emissions.

The potential reduction in the OECD study is enough to do a seventh of the effort needed to accomplish the ambitious objective of stabilizing greenhouse gas emissions concentrations at 450 parts per million (thus limiting climate change to below 2 C).

Alone, this policy packs quite a punch. And it seriously suggests that government meddling with market processes exacerbated the problem.

Imagine all the other policies and compare their effects to the impact of fossil fuel subsidies. Even if each policy is individually small, their sum may amount to much more.

So maybe it’s time to consider each of these small pebbles. This might open the road to a more modest, but more efficient, set of environmental policies that rely on the idea that before doing anything, it’s best to stop doing what makes things worse.

Vincent Geloso is a senior fellow at the Fraser Institute.

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