Making the best out of second-best climate policies

Economists like Prof Avinash Dixit and Dani Rodrik often say second best is the best. We always hope for the best economic outcomes which is not really possible. By focusing on the best of the second best, is as good.

Olli Rehn Governor of the Bank of Finland says the same in this speech:

While street demonstrations and citizen activism play an important role in pressing for more ambitious climate action, what we need in terms of public policy is consistent, systemic and rational policy solutions to achieve effective concrete results.

Systemic in the sense that they need to cover and bite in energy production, transport fuels and manufacturing industries widely. Rational in the sense that they need to lean on insights based on theory and evidence – “In science we trust”. Economics can provide such insights on which policies actually work.

Based on economics and policy analysis, there are three essential and widely accepted requirements for an effective climate policy.

The first is efficiency, which implies that we should design policy action so that we get the biggest emission reductions for a buck.

The second requirement is that climate policy needs to be fair. The cost of transition needs to be evenly shared, and in such a way that also takes into account historical responsibility for emissions.

Thirdly, the policy needs to address the free-rider problem by ensuring that everyone has an incentive to take part in the system. Since climate change is a truly global problem, it implies by definition that we need solutions that in the end have a global scope. Free-riding and carbon leakage would simply erode the work of even the best of students.

Based on these three requirements, the first-best solution to limiting CO2 emissions would be a global carbon tax. Many economists have expressed their support for such a solution.1

In order to be effective, a global carbon tax would need to be complemented with a border carbon adjustment to avoid countries undermining the system by not signing up to it.

When theories are put into practice, however, policymakers face the complexity of the real world. The sense of urgency on climate action seems to vary from country to country across the global arena. Second-best solutions are therefore necessary as medium-term transitional measures, whether we like it or not. We have prominent regional and national initiatives, based on international treaties, in place that aim at effective climate change mitigation.


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