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The Carbon Price Solution

The net-zero transition requires the rapid development at scale of new technologies, energy-efficient infrastructure, and carbon capture and storage. A carbon price, together with the elimination of fossil-fuel subsidies, would give investors powerful incentives to finance these and other imperatives.

SAN MATEO, CALIFORNIA – The quest for carbon neutrality has begun in earnest. More than 70 countries, including the world’s biggest polluters, have set net-zero targets for carbon dioxide emissions, with hundreds of cities, companies, and investors committing to complementary strategies. But a successful net-zero transition will require a fundamental transformation of the real economy. Russia’s invasion of Ukraine, which has roiled global energy markets, has reawakened concern with energy independence. Now is the time to put a price on carbon as it is essential to drive the shift from our current overwhelming dependence on fossil fuels.

By allocating society’s savings, financial markets shape the economy. Investors’ choices depend on two factors: information and incentives. It is only when investors have both that financial markets can do what they do the best: allocate capital toward its best and highest use.

To understand this dynamic, consider the evolution of investors’ understanding of risk, an ambiguous concept until 1952, when Harry Markowitz defined it as volatility, which has mathematical properties and is thus quantifiable. In 1964, William F. Sharpe built on this contribution to create his capital asset pricing model, which describes the relationship between systematic risk and expected returns, thereby putting a price on market risk. Together, Markowitz and Sharpe revolutionized how investors analyze investment risks and opportunities and thus how financial markets allocate capital.

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