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Climate change and why capitalism must price it in

Published 20 September 2021 in Sustainability ‚ÄĘ 4 min read

Anyone who demands that environmental damage should be priced into services and goods today is far from being a socialist. They are just canny, calculating capitalists. 

The forms of capitalism that prevail worldwide today have brought much progress to mankind, but at the cost of a fatal misconception: that the resources available in nature are practically free. The latest figures from the Intergovernmental Panel on Climate Change, published on 9 August, 2021, reveal the disastrous consequences of our actions:¬†the authors now expect global warming of about 3¬įC¬†by¬†the¬†mid-century. The¬†goals of the¬†2015¬†Paris Agreement¬†to¬†limit global warming to 2¬įC¬†or even 1.5¬įC will thus be missed by a wide margin.¬†Climate¬†scientists are therefore calling for¬†a reduction to¬†net-zero¬†C02¬†emissions,¬†alongside a reduction in the production of other greenhouse gases.¬†

Since the signing of the Framework Convention on Climate Change in 1992, political decision-makers, companies and individuals all over the world have repeatedly been warned by climate scientists about the dangers of global climate change. And although, especially in Switzerland, a generally growing environmental awareness can be observed, political promises or good intentions by companies and consumers have proven to be insufficient. Global CO2 emissions have increased by more than 50% per year since 1992 and experts expect further annual increases in the coming years.  

Critics rightly point out that emerging economies such as China and India are estimated to have quadrupled their emissions over this period. They and the USA are now the three countries with the highest emissions. But even countries in the western world often fail to meet their climate targets. Switzerland, for example, failed in its intention to reduce its greenhouse gas emissions by 20% by the end of 2020, compared with 1990 levels.

An iceburg from the Colombia Glacier. Photo taken from my sailboat in Prince William Sound, Alaska.
‚ÄúWe pay for road and rail infrastructure, but not for the¬†consequences of thawing permafrost, melting glaciers, mudslides¬†or flooding caused by extreme climate events resulting from global warming‚ÄĚ
- Karl Schmedders

From the perspective of economics, greenhouse gas emissions represent a so-called¬†¬†‚Äúexternality‚ÄĚ. In¬†economics,¬†externality¬†refers to¬†the¬†effects of the production or consumption of an economic good that are insufficiently reflected in the price of the good,¬†or not at all. For example, the production of cement generates large amounts of¬†CO2,¬†for which (most) producers in the world do not have to pay any taxes. Similarly, we emit¬†CO2¬†when we drive a gasoline or diesel engine car, without having to pay for the side effects of these emissions.¬†

These emissions contribute to global warming in the long run and thus have a negative impact on the quality of life of mankind, but their polluters do not pay for this damage. Take Switzerland for example: we pay for road and rail infrastructure, but not for the consequences of thawing permafrost, melting glaciers, mudslides or flooding caused by extreme climate events resulting from global warming. For this reason, economists also refer to the lack of pricing for such negative externalities as a market failure. This is what led to the gigantic overproduction of greenhouse gases worldwide in the first place. 

Now, there are two ways to correct this market failure. Either we build the cost of the consequences into the goods in question, i.e., adjust the market prices. For example, the aviation fuel kerosene is virtually tax-free today. This means that no consequential costs are priced into flights, which warm the climate and thus contribute to damage. One option, therefore, would be to tax kerosene ‚Äď on the one hand, fewer flights might be made, while on the other hand the tax revenues could be used to alleviate the damage. However, it still seems illusory that the global community will agree on such an approach.

So there is the second way: levying incentive taxes. Switzerland had planned to do this in the CO2 Act, for example with a flat-rate surcharge on airline tickets. However, the law was rejected this year. Apparently, the majority of Swiss residents are not yet ready to take this step. Yet the CO2 tax on heating oil has shown that steering actually works well; It has reduced CO2 emissions from heating in Switzerland between 1990 and 2020 by more than 30%. 

Whatever the citizens of a country decide, international pressure may well increase after the Intergovernmental Panel on Climate Change published its truly alarming figures and force countries to make certain goods more expensive. Switzerland would probably follow this step ‚Äúautonomously‚ÄĚ. It would be nicer if ‚Äď as a rich country ‚Äď it would set a good example and do it quickly and independently. We will by no means end up in socialism because of this. Instead, as ‚Äúgood capitalists‚ÄĚ we are merely adjusting prices to reflect the effective costs.

This article was originally published in German in the NZZ.  


Karl Schmedders - IMD Professor of Finance

Karl Schmedders

Professor of Finance at IMD

Karl Schmedders is Professor of Finance at IMD. In his research, he applies numerical solution techniques to complex economic and financial models, shedding light on relevant market issues and industry problems. He is also Director of IMD’s new online certification course for structured investment products in partnership with Swiss company Leonteq, teaches in the Advanced Management Concepts (AMC) and Executive MBA programs, and is an advisor on International Consulting Projects in the MBA program.


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