Eiffel Tower in Paris

The Right Incentives for a Low-Carbon Future

The climate agreement that world leaders reached in Paris last month was a major victory, but it is just the first step. Policymakers now must figure out how to implement it – no easy feat, especially given that rising costs for conventional energy cannot be counted on to propel the necessary shift toward a low-carbon future.

BERLIN – The climate agreement that world leaders reached in Paris last month has been widely celebrated for establishing the ambitious target of limiting the increase in global temperature to well below 2º Celsius above pre-industrial levels. But the agreement is just one step, albeit an important one. Policymakers now must figure out how to achieve this goal – no easy feat, especially given that, contrary to the conventional wisdom, steadily rising costs for conventional energy cannot be counted on to propel the necessary shift toward a low-carbon future.

At first glance, the logic of negative economic incentives seems sound. If, say, driving a gas-guzzling car becomes more expensive, people will presumably be less likely to do it. But the impact of changing fuel prices is partial and delayed. While drivers may purchase a more fuel-efficient car in the long run, they are more likely, in the shorter run, to reduce other kinds of consumption to offset the rise in cost. When it comes to resolving a problem as urgent as climate change, Keynes’s famous dictum – “In the long run, we are all dead” – clearly applies.

Moreover, even if consumers did respond efficiently, fossil-fuel prices are dictated largely by heavily financialized markets, which tend to be extremely volatile. The sharp decline in oil prices over the last 18 months is a case in point. Not only have oil prices themselves failed to spur a reduction in consumption; they have undermined incentives to develop alternative energy sources. Investing in, say, solar power may have seemed worthwhile when oil cost $100 per barrel, but it looked a lot less appealing when the price dropped below $50.

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