Global carbon pricing has a bright future

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Greetings. Covid-19 has not gone away, as I can personally testify. Whatever number wave is currently washing over London has put me out of action, so today’s newsletter is shorter than what you may be used to (and perhaps that is a good thing? Let me know!). Wherever you are, I hope you are well and in good health. Thanks to my colleague Georgina Quach who has supplied today’s reading recommendations.

Another thing that has not gone away is the pressure for carbon pricing to achieve the decarbonisation of our economies. That may sound odd in a week when Britain’s Conservatives are circling their wagons against a supposed war on motorists and the European centre-right is generally positioning itself around a message of net zero, but not if it costs too much. But there it is. The EU’s carbon border adjustment mechanism (CBAM) began coming into effect at the start of this month — the bloc’s economy commissioner assures non-EU companies that they will be treated the same way as local ones — and the IMF, ahead of its annual meetings next week, has published new arguments for carbon pricing.

It has been a couple of years since IMF head Kristalina Georgieva started banging the drum for a global floor on carbon prices. Despite the political allergy to anything smacking of carbon taxes in the IMF’s most influential member state, it once looked like the campaign could gain some traction. At the time, it could be cleverly analogised with the international corporate tax reform, a central pillar of which was a global floor on corporate tax rates. Even the US has shown interest in forming a “carbon club” in steel, which would come with the political gain of keeping high-emission Chinese steel out of America.

The IMF has now developed a new argument, one that will stick in the throat of the centre-right political strategists trying to win voters over with economic arguments. In its new Fiscal Monitor report, the IMF estimates the effects on fiscal sustainability of climate policy packages that rely only on spending and subsidies, and those that also make emitters pay through a tax or price on carbon. The results are sizeable: the choice is between raising debt-to-GDP ratios by 10 to 15 percentage points (with carbon taxes) or about 50 (without them)! The sting in the tail is that if you delay a carbon tax, your long-term public debt situation will get worse.

The trick, of course, is to make carbon pricing politically palatable. But there are a lot of ways to help the politics. The IMF’s 2021 proposal set out a system of a floor on carbon tax equivalents — ie countries could choose whether to make emitters pay via taxes, carbon pricing, or regulations. And in presentations of the proposals, the IMF has put forward illustrations where poorer countries get to have lower price floors than richer ones. In this regard, it is significant — and not sufficiently noticed — that the leaders assembled at the Africa Climate Summit last month called for a global carbon taxation regime, including on fossil fuel trade, shipping and aviation.

If anything, we need carbon pricing a lot more today than just a few years ago. The sorry truth is that the economic incentives for investing in the energy transformation we need have worsened significantly, both because of cost increases and higher interest rates. Case in point: the tight monetary policy adopted by most advanced-economy central banks (except Japan’s) has hit the prospects of renewable energy companies.

One political economy argument for a global carbon pricing regime is that without one, unilateral initiatives will proliferate — because no economy that is serious about climate change will want its industries simply to migrate to other economies that don’t care about the planet. The EU’s CBAM is surely only the start, and its mere existence strengthens the incentives for the bloc’s trading partners to implement equivalent carbon pricing systems of their own (which will exempt them from the border tax). Look at the UK for a cautionary tale: since its emissions trading scheme has decoupled from the EU’s, UK carbon prices have fallen to less than half of EU ones.

But for UK exporters to the EU, that is no cost saving: they will have to pay the EU’s CBAM to make up for the lower domestic carbon price. That tax revenue will go to the EU rather than the UK exchequer. A fine way to shoot yourself in the foot, you may say. The bigger point is clear: affordability is going to require making emitters pay more, not less.

Other readables

• “China’s population is being transformed, on multiple dimensions,” writes Martin Wolf in his latest of a series of columns on China. This week, he asks whether policy reforms by Beijing can help manage the consequences of its dramatic demographic shift.

• Will Bidenomics help the US Democrats win another term in office? In the latest instalment of a three-part podcast series, Gideon Rachman speaks to Adam Posen, president of the Peterson Institute for International Economics, who explains what he perceives to be the shortcomings of President Joe Biden’s economic policies. Listen here.

• Greece is grappling with the destructive impact of Storm Daniel on one of its most recognisable exports: feta cheese.

• Global migration has long been a personal interest of mine (Georgina) so I thought I’d take the opportunity to showcase a couple of brilliant podcasts that take a step back from news and lead with interesting multidisciplinary research: this one from Cornell University’s Eleanor Paynter, and this one hosted by Lancaster University’s Michaela Benson.

Join us on October 11 for an exclusive webinar — hosted by the Financial Times and Nikkei — to explore the macroeconomic trends in Japan and assess their impact on the recent rally in the Japanese stock market. Register here for free.