COP26 should stand out from carbon shock therapy
This is a guest article by Daniela Gabor, professor of economics and macrofinance at UWE Bristol, and of Isabella Weber, assistant professor of economics at the University of Massachusetts at Amherst and author of How China Escaped Shock Therapy, in which they support a market-based approach to reducing carbon emissions, could create more instability than it is worth.
If COP26 is to make significant progress, according to common wisdom, it must be around carbon prices. Big finance would like a global carbon price of $ 50 a tonne to be set at the meeting, which ends this week. Big companies are finally on board too. Business lobby groups recently argued that a global carbon price would encourage energy producers, industry, consumers and financial markets to switch to low-carbon technologies and activities. Global coordination at COP26 should mobilize reluctant countries (notably the US, China and India) to ensure that everyone faces the disciplinary hand of the market. COP26 is the last collective chance to trust the power of price signals.
Those of us who have experienced the transition from centrally planned economies have another name for the mantra “get the prices right and the market will deliver”. We know it as shock therapy. In the 1990s, shock therapists told governments in Eastern Europe and the former Soviet Union that their economies needed rapid structural change.
Public enterprises have had to give way to a large private sector. Shock therapy would subject them to market discipline by liberalizing the prices of previously state-controlled producer goods and ending cheap credit, subsidies, and tax breaks. Indeed, shock therapists insisted that only a strong dose of fiscal and monetary austerity would finally eliminate the “soft budget constraint,” that particular socialist affliction that kept low-paid state enterprises alive, immobilizing them. resources in the wrong areas. The aim was to reduce heavy industry.
The real test for governments to raise prices, shock therapists warned, was not just to stand firm when real wages fell, but to stick to tight credit policies even as bankruptcies. in the public sectors increased unemployment. It was a test of austerity, even committed governments would fail when the market provoked, quite predictably, social and economic upheaval. But the shock therapists had a formidable institutional apparatus to condition reluctant governments: the IMF and the World Bank. Formerly planned economies depended for crisis support on the Bretton Woods institutions, both firm believers to the power of price signals reinforced by macro austerity. Conservative economists at local central banks have successfully rallied to their cause.
Take a closer look behind the rhetoric of COP26, and you can see the carbon shock therapists coming. The price story seems oddly familiar: Carbon price hikes will allocate resources, real and financial, to the right sectors. Macro austerity may not be in the talk, but it is on the menu: after nearly two years of monetary and fiscal expansion linked to the pandemic, we are returning to calls for cuts in public funds.
Fetishists of fiscal discipline are (still) in the driver’s seat, and they don’t like the alternative to carbon shock therapy – massive green public investment under the keynesian motto “whatever we can really do we can afford”. Like the former shock therapists, their rejection is a political choice: state-led decarbonization would force central banks and the ministries of finance and industry to work together again after nearly 40 years of separation. It would actively involve central banks redirect private capital flows from investing in polluting activities to low-carbon activities. This would mean developing the public institutional capacity to quickly orient the private sector towards low-carbon activities, and to respond dynamically to the obstacles and unintended consequences of rising carbon prices.
It is a bit like how china escaped shock therapy: central planning institutions have maintained control over strategic aspects of the economic system, while creating new market dynamics experimentally and gradually. China used market signals but did not allow them to dictate the pace and direction of the transition.
Carbon shock therapy will not be applied everywhere. As the global momentum ostensibly concerns high-income countries, the historical polluters, the institutional apparatus of carbon shock therapy is rapidly transforming to target middle-income and poor countries. Once again, the countries most vulnerable to climate events and least responsible for the climate crisis will be the laboratory. Struggling with high external debt as a result of the pandemic and limited access to vaccines, they will have to look to the IMF and the World Bank for financial support.
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The IMF was one of the early advocates of global carbon pricing. His new climate change dashboard addresses the transition in terms of lost tax revenues and pricing fossil fuel emissions to a “socially efficient” level that would both reduce pollution and increase consumer tax revenues. However, it does not calculate the damage to local businesses caused by rising carbon prices or the implications for jobs and growth. The new IMF Climate Strategy, published in July 2021, presents carbon pricing as the only viable transition strategy. In 42 pages, he mentions carbon pricing 23 times, green industrial policy once and never green public investments. The shift towards carbon shock therapy is spelled out in its “green” conditional lending plans: IMF lending to countries in need will intensify experiences of reducing subsidies (fuel and energy), pricing carbon and boosting the economy. financial resilience.
The emphasis on carbon pricing makes the central bank a key local ally, recreating the institutional politics of shock therapy. Like its precursor, carbon shock therapy is inherently inflationary. Then countries were promised that free-floating exchange rates would strengthen price signals, but instead got higher inflation from weaker currencies, pushing central banks further into monetary austerity. Now, even if central banks refuse to selectively increase the cost of dirty credit (for high-carbon industries), monetary austerity may be needed to fight inflation due to carbon pricing.
Carbon shock therapists may not support green public investments, but they have reassuring climate finance a message. Countries can mobilize the trillions of dollars that global institutional investors like BlackRock want to invest in the low carbon transition. These investors have not come forward on a large scale because climate investments in poor countries are too risky relative to the returns. In addition to regulatory reforms, the key to unlocking private finance is the reduction of fiscal risks: countries should find fiscal resources to guarantee returns for private investors, including official development assistance.
The IMF’s new Resilience and Sustainability Fund can also be recruited to reallocate newly created Special Drawing Rights from high-income countries to global institutional investors, all in the name of reducing the risks of green private investments. The only area that will be immune to carbon shock therapy is private funding. Despite its devastating contribution to the climate crisis, via credit to polluters and greenwashing, is well known.
It is tempting to dismiss the growing calls for carbon pricing as an empty posture of entrenched interests that bet on the continued lack of political will. But poor and middle-income countries appear to be forced, once again, to subject their economies to chaotic structural transformation. What they really need are carefully designed macro-financial policies to adjust their productive structures.
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