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The Green Paradox

Presseartikel von Hans-Werner Sinn, The World Financial Review, May – June 2012, S. 51

Despite policymakers’ efforts to promote alternative energy, impose emission controls on cars, and enforce tough energy efficiency standards for buildings, the relentlessly rising curve of CO2 output does not show the slightest downward turn. The author attributes this to the fact that policies thus far have only focused on curbing the demand for fossil fuel, while the supply side has been neglected. That is what causes the Green Paradox.

Throughout Europe and elsewhere, particularly in California, politicians are keen to curb consumption of fossil fuels. They are busily promoting alternative energy and more efficient cars. They forbid citizens to use traditional light bulbs, force them to buy expensive “green” electricity and biofuels, impose emission constraints on car engines, subsidize electric cars, impose tough norms on the insulation of buildings (forcing homeowners to wrap their buildings in wadding), and frighten their citizens by announcing that they will come up with even tighter measures in the future. These programs cost hundreds of billions, yet in many cases they achieve little or nothing. The technical fixes touted in the special reports that fill pages in our newspapers every other week stand in striking contrast to the reality of ever-increasing carbon emissions. The relentlessly rising curve of worldwide CO2 output does not deign to honor these efforts with even a kink, let alone a downturn.

The policies against global warming are often naïve and counterproductive, since they focus purely on demand, neglecting the supply side of the carbon markets. President Mahmoud Ahmadinejad of Iran, President Hugo Chávez of Venezuela, the Arabian oil sheikhs, Vladimir Putin’s oligarchs, and all the coal barons of this world simply do not figure in the policy programs. However, these resource owners are the real climate makers. By bringing fossil carbon back into the carbon cycle by way of supplying it to the markets, thus enlarging the stock of carbon dioxide in the atmosphere, they determine the speed of global warming and consequently hold the fate of humanity in their hands.

If the resource owners do not react to the demand cuts by curbing their supply, stubbornly extracting whatever they had planned to extract irrespective of the demand-reducing policy measures being taken in some parts of the Western world, Europe in particular, these measures are unavoidably ineffective. The reduction in demand will then simply lead to a lowering of fossil fuel prices, inducing firms and households in other parts of the world to consume the carbon that the "green" countries set free.

So the question is how the resource owners actually react to the price cuts induced by the demand restraint. At first glance one might suspect that the lower prices will reduce supply, as is the case with reproducible goods. However, unlike such goods, the prices of natural resources are not driven by cost, but by scarcity. In the case of oil and gas they are about seven times as large as the unit extraction and exploration costs, and with coal, they are more than twice as high.

Since resource owners plan to sell their resources at some stage, their supply decisions will depend more on the timing of the price cuts resulting from green policy measures rather than the size of such cuts. If the price cuts are similar in all periods of time relative to what would have occurred if no green policies had been implemented, resource owners will be indifferent and will not react to the green policies. If the price cuts are stronger in the present than in the future, they will postpone extraction in order to sell when prices are good. However, if the expected price cuts are announced to be stronger in the distant future than in the near future and the present, then they will try to anticipate their sales in a kind of preemptive move to avoid falling prey to the destruction of their markets implied by green policy measures. That is the Green Paradox: announced future reductions in carbon consumption may have the effect of accelerating climate change now.

Instead of mulling over which technical fixes could be applied to reduce CO2 emissions, policy makers should turn to the question of how to induce resource owners to leave more carbon underground.

This may have been a major reason why the prices of fossil fuels fell in real terms from 1980 to about 2000, even though China and India emerged as new consumers in the market. The green saber-rattling that occurred during that period was the equivalent to an announced expropriation of resource owners that induced them to avoid the expected wealth losses by selling their resources much faster than they would have done in the absence of any green policy measures.

Whatever the weight given to this argument, it is high time for environmental policy to shift its focus from the demand for fossil fuels to the supply of such fuels. Instead of mulling over for the thousandth time which technical fixes could be applied to reduce CO2 emissions, we should turn to the question of how to induce resource owners to leave more carbon underground. Unfortunately, that goal will not be easy to achieve with the policy tools that the industrialized countries have at their disposal. Uncoordinated idiosyncratic measures by single countries or by groups of countries (such as the European Union) may achieve nothing, other than inducing the resource owners to overextract.

However, the toolbox available to policy makers is not entirely empty. A swiftly introduced “Super-Kyoto” system, combining all consuming countries into a seamless demand cartel using a worldwide cap-and-trade system, may help. After all, already 30% of worldwide carbon emissions are subjected to a cap set by the Kyoto agreement of 2005, with the corresponding emission permits being traded among countries under the supervision of the United Nations. It should be possible to bring the remaining 70% on board.

The worldwide cap-and-trade system could be supported by the levying of source taxes on capital income, in order to spoil the resource owners’ appetite for financial assets. After all, when deciding on how much to extract in the present or in the future, they compare the rate of return on financial assets into which they could convert their sales revenues with the capital gains they would enjoy if they kept the resources underground. Taxing the returns to financial assets tilts their decisions towards leaving more carbon underground and enjoying the capital gains instead.

If mankind wishes to pursue the path to a worldwide cap-and-trade system, it is important that it do so quickly. Any delay is poison for the climate, not only because in the meantime emissions will continue unabated but also (and especially) because the piecemeal inclusion of additional countries would exacerbate the Green Paradox even further. If the number of countries accepting caps on their emissions increases only bit by bit, this will give rise to an increasingly larger proportion of the fossil-fuel market being destroyed, inducing the resource owners to counteract the worsening of their profit margins by speeding extraction. Paradoxically, the more successful the world climate summits are expected to be in gaining members to the worldwide demand cartel over the coming decades, the more rapidly the world’s climate will grow warm in the meantime. Only taking the resource owners by surprise, with an immediate completion of the consumer cartel that proceeds so rapidly that the resource owners no longer have time to react by accelerating the extraction of their resources, can bring about the desired effects. If this surprise effect is lost, everything may get worse instead of improving.

Only the horror of further warming of the atmosphere, in combination with the fact that the consumer countries will have to keep spending considerable parts of their real income for the acquisition of constantly dwindling amounts of carbon, can make the worldwide demand cartel attractive. So far, policymakers exhibit not the slightest glimmer of thinking about how they could influence the supply side of the carbon market. Hundreds of resolutions, laws, and promotion programs have been promulgated, all aimed at curbing the demand for fossil fuels, without one mention of the supply side. Half of the market for fossil fuels has simply been disregarded.

Until recently, even science hadn’t really paid attention to the supply side. Models of long-term fossil-fuel extraction didn’t concern themselves with the climate. Climate models, in turn, typically didn’t concern themselves with the extraction of such resources. The few exceptions were theoretical models that never made it into numerical climate-simulation models, let alone to the public policy debate. Only recently have scientists begun to explicitly model the supply side numerically, joining in the Green Paradox debate.

Precisely because I consider climate change one of the greatest problems humanity faces, I find this neglect profoundly disturbing. Thus, I hope that policymakers will read this article and the book it is based on.1 Those who learn to focus on the supply-side effects of their policies will shed their illusions and will support a climate policy that offers better chances of staving off disaster.

About the author
Hans-Werner Sinn is Professor of Economics and Public Finance at the University of Munich and President of the CESifo Group.
Author of Can Germany Be Saved? The Malaise of the World’s First Welfare State (MIT Press), Casino Capitalism (Oxford University Press) and other books.
He is a former president of the International Institute of Public Finance and a former chairman of the German Economic Association.

Note
1. H.W. Sinn, The Green Paradox. A Supply-Side Approach to Global Warming, The MIT Press, Cambridge, Mass., Feb 2012.

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