31 May 2023

Why markets fail on fossil fuel pollution, heralding an era of climate disruption

For more than 30 years, policy-makers have believed, and relied on, market mechanisms to respond to rapidly rising fossil fuel emissions and a heating planet. They have failed, and an era of climate disruption is now upon us. This post is an extract on "Markets and disruption" from a recent article, "Reclaiming 'Climate emergency'", published (in English) in a special issue on emergencies of the Slovenian journal Filozofski vestnik in March 2023.

by David Spratt

Markets crave stability and fear disruption. Yet the world is entering an era of instability and uncertainty driven in part by climate-related financial risks, preventing the market generation of reliable prices. Energy markets provide just one example. 

In 2011, Paul Gilding concluded that it was an illusion to think the contradictions can be resolved within the current economic frame and that disruption and chaos was now inevitable as system failure occurs. Five years earlier, Nicholas Stern had said that "paths requiring very rapid emissions cuts are unlikely to be economically viable" and disruptive because “it is difficult to secure emission cuts faster than about 1% per year except in instances of recession.”

Analyst Alex Steffen concludes that:

It is no longer possible to achieve [an] orderly transition, to combine action at the scale and speed we need with a smooth transition and a minimum of disruption [...] We are not now capable of designing a future that works in continuity with our existing systems and practices while producing emissions reductions and sustainability gains fast enough to avoid truly dire ecological harm. This is an option that no longer exists.

And the risk intelligence company Verisk Maplecroft assesses that "there is ‘no longer any realistic chance’ for an orderly transition for global financial markets because political leaders will be forced to rely on ‘handbrake’ policy interventions to cut emissions.”

So, when all is said and done, the choice is social collapse and economic disruption due to the failure to act fast enough, or economic disruption as a necessary consequence of emergency-level fast change. There is no third way.

Yet climate policymaking has been built on two foundational pillars: a bedrock assumption that change should be slow and incremental in a manner that not does disrupt growth or inhibit the market, or leave capital stranded; and that levers for change should be market-focused, thus the emphasis on such mechanisms as carbon prices, tradeable offsets, tax credits, new markets for carbon capture and storage with or without bioenergy, and even commodifying nature. This is reflected in IPCC reports and the preferred net-zero-2050 scenarios of central bankers and the fossil fuel industry.

The major fossil fuel producers and nations have ensured that their sector is not targeted by policymakers. The COP 21 Paris Agreement, for example, is almost devoid of substantive language on the cause of human induced climate change and contains no reference to “coal”, “oil”, “fracking”, “shale oil”, “fossil fuel” or “carbon dioxide”, nor to the words “zero”, “ban”, “prohibit” or “stop”. By way of comparison, the term “adaptation” occurs more than eighty times in 31 pages, although responsibility for forcing others to adapt is not mentioned, and both liability and compensation are explicitly excluded.

Instead, emphasis is given to speculative, but potentially highly-profitable, market-based solutions. There is no better example than most economy–energy–climate Integrated Assessment Models’ (IAMs) scenarios, which have come to dominate IPCC mitigation pathway reports and net-zero-2050 paths. They contort a path towards the Paris targets by — in the best Orwellian tradition — “overshooting” the target and then returning to it by century’s end through an undue reliance on bioenergy with carbon capture and storage (BECCS), a technological imaginary that would pay oil and gas producers to pump gigantic volumes of carbon dioxide into wells they have emptied of fossil fuels. The focus is on the “efficiency” of the market; in the IPCC’s most recent Working Group 3 report, the expression “cost-effectiveness” is mentioned 173 times. 

Depending on how modellers perceive the roots of the problem to be solved, they will “design the model structure, including possible instruments and relationships within the model accordingly […] Hence, the very structure of a model depends on the modeller’s beliefs about the functioning of society.” IAMs are based on faith in the efficacy and efficiency of market-driven change and so privilege particular pathways, and entice policymakers into thinking that the forecasts the models generate have some kind of scientific legitimacy. 

IAMs project only gradual physical changes, in which climates will “migrate” slowly, yet we are now in an era of physical disruption, cascades and fast change. The models, says financial analyst Spencer Glendon, quoting Thomas C. Schelling, “probably cannot project discontinuities because nothing goes into them that will produce drastic change. There may be phenomena that could produce drastic changes, but they are not known with enough confidence to introduce into the models.” Thus the very models that underpin climate policymaking are not fit for purpose.  

Mathematical models of the climate and the economy use quantifiable, probabilistic risk analysis to reduce complexity and high levels of uncertainty to numerical expressions and formulae, but cannot adequately express non-linear processes in the climate system. Schellnhuber describes a "probability obsession", which he says makes little sense in the most critical instances, in part because "we are in a unique situation with no precise historic analogue." 

Corporate and state climate policies and scenarios lack appropriate non-probabilistic risk-management approaches to both the physical and social risks, and exhibit an inadequate understanding of the high-end possibilities. Mostly, they are based on IPCC processes and methods, which are scientifically reticent and a poor basis for understanding the full range of potential outcomes.

Neo-classical economics assumes an idealised world of market participants operating with "perfect knowledge" to produce smooth change and optimal outcomes via efficient prices. If risk is quantifiable, then it can be priced, so that uncertainty is tamed by the market. But markets so far have been poor at recognising and pricing risks and suffer from the “tragedy of the horizon” and the “tragedy of the commons”: hence greenhouse gas emissions continue to rise at worst-case rates. 

The global economy relies on endless layers of systems that were built within the stable climate of the past, but “investing in an environment where tomorrow doesn’t look like today is very tricky,” as Dickon Pinner, a senior partner at global management consultants McKinsey, acknowledges. Pinner says that if investors do not change direction now, then governments will likely “have to pull that lever hard […] and I think that would cause a lot of massive, massive disruption.” 

Climate change is not a market optimisation problem, it’s a risk problem — the risk of the loss of capitalism — says Spencer Glendon. He also notes that the economics of climate change “will be seen as one of the worst mistakes humans have made.”

Thus the current, market-dominated approaches to managing climate risks are not efficacious, and another approach — that of state-led mobilisation — is necessary but barely on the agenda.