The Social Dimension of Carbon Trading: Contrasting Economic Perspectives

This is part of a series of think pieces reflecting on the importance of bringing the social dimension back into discussions about green economy and sustainable development.

This think piece combines insights from ecological economics, critical institutional economics and property economics with neoclassical environmental economics to offer an alternative theoretical interpretation of carbon markets. From this heterodox perspective, carbon trading is seen as an institutional innovation created for meeting both the interests and constraints of the industrial capitalist mode of development.

Pascal van Griethuysen is senior lecturer in evolutionary economics and sustainable development at the Graduate Institute of International and Development Studies, Geneva, Switzerland.


This think piece sheds some light on the social dimensions of climate politics by combining and contrasting different economic perspectives on carbon trading. I argue that the neoclassical foundations of standard environmental economics constitute too narrow an analytical framework for an adequate conceptualization of the relationships between carbon trading, social equity and ecological sustainability. Environmental economics could therefore gain in being combined with alternative economic perspectives if the social dimensions of carbon trading are to be addressed more comprehensively. Ecological economics, critical institutional economics and property economics could widen the analytical framework of carbon trading.

The neoclassical interpretation of carbon trading

Carbon trading as an economic instrument for achieving a reduction in emissions—and therefore for lowering the rate of climate change—has emerged from neoclassical economic textbooks. This perspective considers the market to be an efficient system of resource allocation as long as external processes have internal, monetary counterparts. Having recognized that pollution indicates situations of market failures, neoclassical economists have tried to incorporate them into the internal logic of market mechanisms and property rights. While Pigou (1920) proposed state intervention to make the polluter pay for external costs, Coase (1960) recommended extending the market’s scope by establishing property rights to environmental resources. According to Coase (1960), bargaining between owners would then ensure that the level of pollution—which he sees as a peculiar type of factor of production—would be optimal. Dales (1968) suggested that the level of pollution should be set by the government on the basis of ecological considerations. Market transactions would then react to this artificial scarcity and allocate emission permits efficiently. This led to the conceptualization of cap-and-trade, which was further adapted to carbon emissions by Tietenberg (1985), among others, before being implemented at the international level in the current climate regime.

Ecological economics and industrial dependence

Ecological economics, as elaborated by Georgescu-Roegen (1971), sheds a very different light on the issue of carbon trading. Focusing on the biophysical dimension of economic activities, ecological economics pinpoints the entropic nature of the economic process, that is, the fact that economic processes inevitably transform high-quality resources to lower quality wastes (Georgescu-Roegen 1971). This is of particular relevance for industrial activities, where CO₂ emissions are an output just as unavoidable as the input of fossil energy. Unlike biotic resources and renewable energy, fossil fuels can provide a continuous energy flow which allows the full use of economic resources such as land, labour and equipment (Steppacher 2008). Moreover, fossil fuels have the power to sustain a process of exponential economic growth which confers to the industrial mode of production a clear-cut competitive advantage over any other production process that relies on a discontinuous flow of energy and matter, such as that coming from biotic and other renewable resources. This helps to explain the growing strategic dependence by industry on controlling CO₂ emissions which are, after all, the thermodynamic counterpart of fossil energy use itself.

But this industrial power also has weaknesses. Because of their finite nature, fossil fuels will only allow exponential economic growth for a historically limited time, and with grave environmental consequences. In parallel, competitive processes fed by a finite amount of scarce resources increases the risk of conflict among resource-dependent competitors. Control over fossil energy becomes more and more strategic, not only for economic sectors whose core business depends directly on non-renewable energy extraction, transformation and distribution, but for the industrial process as a whole. Today’s technological dependence on fossil fuels—and, therefore, upon creating CO₂ emissions—is of a systemic nature.

Given the strategic nature of CO₂ emissions control, it is no surprise that the institutions that have emerged out of the climate governance process rest on the rationale of economic competition. The ecological differences between fossil fuel and biotic resources, however, mean that the carbon emitted from fossil energy combustion and the carbon that is exchanged between biotic resources and their ecosystems are fundamentally different. This biophysical incommensurability in turn suggests that establishing carbon as an exchange currency out of heterogeneous ecological processes—as is the approach of current carbon trading schemes—is scientifically invalid. Substituting the reduction of fossil carbon emissions with the creation of carbon offset schemes that do not alleviate, and often aggravate, the overall ecological burden is also environmentally dangerous. Above all, it shows the irresponsibility of making profitable activities out of such fictitious substitution.

Neoinstitutional economics and the moulding of institutional conditions

Neoinstitutional economics criticizes the neoclassical bias toward market mechanisms and private property regimes. In this perspective, markets are always delineated by a set of conventions and entitlements that establish a predictable structure for changes in ownership over resources. What is required is a structured set of rules and sanctions that result in social order (Bromley 1989). As in the neoclassical model, the definition of rights is crucial. However, formal rights derive from law and necessarily imply a correlate: if Alpha has a right, Beta faces the duty of respecting Alpha’s right (Bromley 1989). Consequently, property comes with a legal relationship of both exclusivity and exclusion, and institutional exclusion is a matter of organized power. This reciprocal and exclusionary nature of property rights is central to understanding the social impacts of setting allowances for carbon emissions—creating new exclusive rights necessarily implies creating new exclusions. Therefore, besides the establishment of new rights and trading schemes, the climate regime creates new social conflicts, notably between private businesses and local communities.

The private costs that economic agents are legally bound to bear, and the social costs that may be transferred to third parties, are largely determined by formal institutional conditions (Kapp 1950). Thus, institutional conditions are at the core of economic agents’ choices and behaviours (Bromley 1989). This explains why firms pursue multiple strategies that include political, technological, organizational, financial and public relations components. Given the growing strategic importance of CO₂ emissions control for firms, their engagement toward favourable institutional modalities appears not only rational but, indeed, imperative.

Property economics and capitalization

Property economics criticizes the standard economic interpretation of property rights for having failed to recognize the capitalist potential of property, that is, the capacity for proprietors to engage their property into capitalization processes (Heinsohn and Steiger 1996). This capitalist potential rests on the creation of formal transferrable property titles that confers an economic security to their holders, which can be engaged to securitize the creation of a monetary capital (Heinsohn and Steiger 1996). Moreover, the earning capacity of engaging property in a capitalization process becomes an additional income stream to the concrete, material exploitation of the property itself. This allows for the cumulative enrichment of proprietors, since a higher material yield usually implies a higher earning capacity through capitalization, which can itself be invested in increasing material productivity, creating a cycle of accumulation.

Property economics highlights the exclusive nature of carbon credits and the earning potential of such financial instruments. Although emission allowances do not constitute genuine property titles (the allocation of allowances is redefined on an annual basis), the temporary security they provide to their holders over future activity and income is sufficient to constitute a basis for economic growth. In making explicit the potential to capitalize on cap-and-trade schemes, property economics sheds some light on why carbon trading has gained so much support from business and finance. It also reveals the spontaneous character of financial practices that have emerged out of primary carbon markets, and draws attention to the speculative nature of financial practices that might dwarf the primary trading market, as well as the lack of a regulatory framework for carbon finance.

Conclusion

Perhaps, as Spash (2010:189) states, “the most worrying aspect of the [emission trading scheme] debate is the way in which an economic model bearing little relationship to political reality is being used to justify the creation of complicated new financial instruments and a major new commodity market”. By providing an alternative theoretical interpretation of carbon markets in terms of exclusive rights, capitalization processes and institutional economic strategies, this think piece aims to establish a more adequate appraisal of such a complex reality.

While neoclassical environmental economics considers carbon trading to be a reliable instrument for reducing CO₂ emissions at the lowest possible cost, ecological economics reveals that the strategic nature of controlling CO₂ emissions goes hand in hand with fossil energy use, as well as the ecological peril inherent in making the trading of carbon commodities profitable. Critical institutional economics points to the exclusionary nature of carbon allowances or credits, as well as to the ways that institutional conditions favouring the control of CO₂ emissions are shaped by powerful economic agents. Property economics argues that granting exclusive carbon rights increases the potential of firms to capitalize by securing future incomes, and addresses the relation between exclusive carbon rights and carbon finance. Altogether, alternative economic perspectives consider carbon trading an institutional innovation created for meeting both the interests and constraints of the industrial capitalist mode of development.

References

Bromley, D.W. 1989. Economic Interests and Institutions: The Conceptual Foundation of Public Policy. Basil Blackwell. Oxford.

Coase, R. 1960. “The problem of social cost.” Journal of Law and Economics, Vol. 3, pp. 1–44.

Dales, J.H. 1968. Pollution, Property and Prices: An Essay in Policy-Making Decisions. Toronto Press. Toronto.

Georgescu-Roegen, N. 1971. The Entropy Law and the Economic Process. Harvard University Press, Cambridge, MA.

Heinsohn, G. and O. Steiger. 1996. Eigentum, Zins und Geld: Ungelöste Rätsel der Wirtschaftswissenschaft. Rowohlt, Reinbek bei Hamburg.

Kapp, K.W. 1950. The Social Cost of Private Enterprise. Harvard University Press, Cambridge, MA.

Pigou, A.C. 1920. The Economics of Welfare. Macmillan, London.

Spash, C. 2010. “The brave new world of carbon trading.” New Political Economy, Vol. 15, No. 2, pp. 169–195.

Steppacher, R. 2008. “Property, mineral resources and ‘sustainable development.’”, In O. Steiger (ed.), Property Economics: Property Rights, Creditor’s Money and the Foundations of the Economy. Metropolis-Verlag, Marburg.

Tietenberg, T.H. 1985. Emissions Trading, An Exercise in Reforming Pollution Policy. Resources for the Future, Washington, DC.