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Putting A Price on Carbon: Nations Opt For Market-Based Solutions

Xueman Wang's picture

 Curt Carnemark/World Bank

Climate change is a threat to global development and to poverty alleviation. And yet, reducing greenhouse gas emissions is proving difficult because all players in an economy contribute to the problem. To make a difference, we must reduce our emissions in a coordinated manner.

This is no easy task. So where do we go from here?

One approach involves pricing the “externalities” that are contributing to climate change. Pricing externalities into the costs of production is nothing new. A classic textbook example is the paper mill that sits upstream from a fishing village.

Discharge from the mill pollutes the river, diminishing the fishermen’s catch. The mill freely uses the water of the river in its production of paper, but does not pay for the damage of the negative externality that it causes. To remedy the situation, regulations can be put in place to stop waste from going into the river – or the mill can pay a fine equivalent to the loss of the fishermen’s revenue.

The latter is an example of an externality priced into the cost of production. The same can be done to combat climate change.

In this case, carbon emissions are the externality that must be priced. Doing so provides a cost-effective and efficient means to drive down greenhouse gas emissions as the cost of such pollution goes up.

An efficient instrument that can deliver

Approaches that lead to a price on carbon fall into two camps: explicit and implicit.

Explicit carbon pricing means that every ton of carbon dioxide (CO2) that’s emitted into the atmosphere is priced. Explicit carbon pricing tools include carbon taxes, emissions trading systems, emission crediting mechanisms, and payments for emission reductions.

Implicit carbon pricing, on the other hand, prices the energy content of a fuel used in production – rather than the CO2 from that fuel. Energy-efficiency regulations, for example, can lead to an implicit price on carbon.

At the Partnership for Market Readiness meeting held this week in Mexico City, several countries presented plans involving both explicit and implicit carbon pricing.

As part of its green economy strategy, Mexico announced that it is exploring an emissions trading scheme within the energy sector. This comes in addition to the tax on carbon-intensive fuels that the country introduced in January.

China, the second-largest economy and the world’s biggest emitter, has launched emissions trading pilots that cover 250 million people and one-third of the Chinese economy.

The European Union has proposed a structural reform for its emissions-trading scheme, which continues to be a main flagship for achieving the EU’s proposed 40-percent reduction by 2030.

South Africa plans to introduce a delayed carbon tax in early 2016 that will cover the most of the country’s emissions-intensive sectors.

Thailand proposed an energy performance certificate scheme as a precursor to an eventual emissions trading scheme, and Colombia announced it’s exploring a performance standard for its public transportation system.

This growing momentum for such country actions is encouraging.

Today, 70 percent of global emissions are regulated, and of that, about one-third is regulated through an explicit pricing mechanism. An estimated 40 countries and 20 subnational jurisdictions are considering or implementing explicit carbon pricing tools. These countries account for about 21 percent of global emissions.

As countries begin to construct their 2030, 2040, and 2050 greenhouse gas mitigation scenarios, identifying a package of effective and cost-efficient policies that includes carbon pricing measures must be part of the answer.

The Partnership for Market Readiness can help. This week, we announced support for analytical work that would help nations integrate such measures their post-2020 mitigation scenarios.

In the not-too-distant future, we believe the world will finally embrace efforts to price carbon. It will be a critical step in our race to slow climate change and for our work to end global poverty.

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