The front page of the Financial Times today says: “Soaring oil prices risk recession”. The chief economist of the International Energy Agency, Fatih Birol, says that the high oil prices have the capacity to tip the global economy back into recession. He also said that every recession in industrialised countries since the second world war had been preceded by an oil price spike.
Sir Nicholas Stern argues in his book, The Economics of Climate Change, that a robust carbon price is required in order to prompt investors to invest into low-carbon technologies.
There’s something fishy here. It looks like one economist is saying that high energy prices cause recession and another is saying that high energy prices are needed to stimulate investment in a clean and shiny low-carbon future. It can’t really be both.
It looks like there must be some other conditions which would determine whether the consequence of high energy prices is recession or cleantech investment.
Before plugging on with carbon pricing, it might be useful to know what these conditions are and how they can be affected. It might even become evident that the relationship between carbon pricing and cleantech investment is much weaker than economists had assumed. That is: other factors, perhaps softer and less quantifiable factors, might be far more important.
Recession is a bogey word, but in this case it highlights something very important. It highlights that economists are not telling the full truth when they give their justifications for emissions trading schemes.
Look what happened next.
The guy in the corduroy suit and black-rimmed glasses is our friend Günther.
He had barged in on the conversation. “Economists like carbon markets because they mean that the government doesn’t have to wade in and make clumsy choices about technology. Governments have an appalling track record at the allocation of capital. So we prefer it if they let entrepreneurs and business people select which technologies to invest in.”
“Sounds good, Günther. So you give business a free hand to choose its own way of cutting emissions.”
“Exactly,” confirmed Günther. “We believe in not being prescriptive.”
“So you don’t mind how they cut emissions, as long as they are cut. That’s why you give them the freedom, right?” I just wanted to be sure.
“Yes, you have understood me precisely.” Günther even managed a superior smile.
“Ok. So you don’t mind how they cut emissions, as long as they cut emissions?”
“No, I don’t mind. That’s why we leave it to the market,” replied Günther.
“So the market cuts production, thereby reducing emissions. That’s ok, then?”
“Ja, why not?”
“And that happens because the economy has gone into recession.”
“Whaaaaat???” cried Günther, alarmed.
“Whoa, Günther. What’s up?”
“You said ‘recession’,” jabbered Günther.
“Sure, I did,” I replied.
“But we can’t have recession. It’s not allowed,” he gibbered.
“But you said you didn’t mind how the companies cut emissions. That’s why you have a market mechanism. The market has said: the best way to cut emissions is not to invest in wind farms but to invest in lower economic activity.”
“Yes but no but!” spluttered Günther. “We want wind farms, solar parks, shiny passive houses, hydroponic agricultural systems; we want meat to be grown synthetically in tubs without any methane emissions…oops-”
“But you said that you didn’t want to dictate technology choices,” I said to Günther, with a look of confusion on my face.
“Yes but no but,” continued Günther, his piggy eyes darting back and forth, his face puffed and red with excitement. “I didn’t mean it like that. We don’t want to dictate technologies and but we do want to dictate technologies. You see, it’s a special kind of policy, called, we-do-and-but-we-don’t. It’s a special policy to handle market failures.
“You see, we have the EU ETS to address market failures and then we have a we-do-and-but-we-don’t policy to address market failures in the policy to address market failures. It’s very … sophisticated; I wouldn’t really expect you to understand,” added Günther. He had downed a large glass of single malt and was recovering his composure.
“Not so quick, Günther!” I said, “It’s now become very clear to me. I could never understand why you kept saying that the carbon price is too low and you wanted to intervene in the market. You saw the price signal loud and clear that we will successfully keep emissions below the cap. But you weren’t happy with achieving the aims of the EU ETS, which was to keep emissions within the cap at the lowest cost. You wanted something else. You wanted your preferred technologies to be implemented. So when you said all that stuff about the theory behind cap and trade – about cutting emissions at the lowest cost and about not wanting to select technologies – you didn’t mean it at all.”
But Günther, not one to take responsibility, had loosened his tie with elephants on, and was already snoring away loudly on his leatherette settee.
In short: both Mr Birol and Sir Nicholas Stern are right. High carbon or energy prices will indeed result in both recession and investment in low-carbon technology. How come? Because they are the same thing: recession is the most effective and easiest-to-implement technology for low-carbon living. It just happens to be the option which they don’t want the market to choose.