Season 1, Episode 2
Arthur Cecil Pigou was a highly decorated professor of economics at Oxford University. He originated the principle of imposing a tax on production-related external effects – “externalities” in the jargon – that cause harm to the environment. Here’s how it works in an oft-cited example: If a chemical factory discharges its untreated wastewater into a river, then it impacts those who use the river – for recreation or as a source of irrigation, for example. This impairment to the quality of life of river users should then be factored in as a production cost of the chemical company’s goods, according to Pigou’s logic.
In this case, state intervention in market activities is also considered justified from the perspective of economic liberals: The negative external effect is given a price tag and the bill is sent to the polluter – here, the chemical company – in order to correct a market failure. Should the company’s management opt to invest in filtering equipment, the tax would be lifted and the water quality would be preserved. So much for Pigou’s concept and the “Pigouvian tax” named after him, invented in 1920.
In discussions about how to combat the existential – primarily environmental – threats of the present day, demands for consistent application of the polluter pays principle are voiced as often as the “Amen” in church. However, arguments that advocate putting a price on external impacts often act as a conversation killer when it comes to exploring different, innovative possibilities beyond free-market thinking. There is a widespread belief that all we need to do now is “internalize” the external impacts and this will effectively remedy our problems of economic production and overconsumption. And among adherents of economic liberalism, it is often the only corrective measure they consider acceptable in the context of an otherwise excellent self-regulating system.
It’s a seductive concept: simply organize markets such that environmental services are priced and thus made artificially scarce. In this way, their consumption is reflected in production costs, just as Pigou foresaw. This can be done by means of either incentive taxes or tradable emission rights, and it elegantly solves problems of excessive consumption or pollution. Many economists consider it even more elegant to move Pigouvian taxes in the direction of least-cost compensation. Here, it is not the polluter who pays, but rather those who make the cheapest offer to cover the external harms. For example, if Switzerland finances projects abroad to reduce carbon emissions instead of investing in climate measures at home, this reflects the logic of least-cost compensation.
It begs the question: if there is such a sleek, simple, market-compatible solution, why is it that – some 100 years after Pigou’s work – we are still so far from widespread internalization of external costs? According to World Bank calculations, 47 countries have introduced carbon pricing in national regulations to date – putting a price on just 23 per cent of global greenhouse gas emissions. In addition, implementation to date shows that the impact of this instrument falls far short of expectations. Meaning that the Paris climate targets are falling by the wayside.
And now back to the conversation killer. To prevent a substantive discussion about more effective incentive taxes or other ways of getting a grip on human-made environmental problems, conversations are often stifled by means of standard arguments. Here are a few samples from mainstream free-market thought – and some considerations that might be useful to counter them.
Take the example of the EU. In 2008, in the aftermath of the global financial crisis, the international community agreed to quickly launch emissions trading. The EU had been in the starting gates with its emissions trading scheme (EU ETS) since 2005, the World Bank and the International Monetary Fund supported the initiative, and even in the US a trading scheme based on the European example was discussed – though it failed in the Senate shortly thereafter. The EU ETS, however, was successfully introduced. Unfortunately, the low rate of taxation and generous allocation of free emission allowances to companies meant the instrument wasn’t very effective – quite the opposite, in fact: some companies could even sell their emission allowances for a profit without taking a single measure to reduce their own greenhouse gas emissions. And yet, the EU example still shows that changes can be made as long as there is enough political will.
Switzerland provides an illuminating example of how a relatively progressive system of incentive taxes can be politically dismantled beyond recognition. In 1990, against the background of accumulating ecological crises in the late 1980s and shortly before the Rio Earth Summit, the Swiss Federal Council submitted a proposal to increase the price of heating oil and petrol. The proposal was widely supported by the political mainstream and had been endorsed by prominent business associations.
The reversal came a few years later: An economic recession caused people’s will to act to fizzle out, and gloomy predictions about Swiss competitiveness led politicians to lose their courage. Under pressure from the oil lobby and the Autopartei (“Automobile Party”), which later merged with the SVP, or “Swiss People’s Party”, business associations did an about-turn. Years of efforts towards balancing the tax scheme came to nothing – and the pricing instrument was ultimately rejected at the ballot box in 2021, albeit narrowly. The Swiss magazine Die Republik has chronicled the true reasons for the failure of incentive taxes in Switzerland to date.
Bill Clinton’s famous quote always applies: “It’s the economy, stupid.” Introduction of a carbon tax is constantly accompanied by talk of declining economic growth – and stirs up corresponding fears. If the tax is set high – enabling it to actually impact emissions – there is a threat of harm to national economic growth. This is a scenario that (almost) every politician wants to avoid because – as Bill Clinton understood – it would jeopardize their re-election. As a consequence, taxes on emissions are set low. With that, the incentive to take emission-reducing measures is gone, and so carbon emissions rise unabated.
In other words, putting a price on carbon that accurately matches the magnitude of its external harms – and leads to emission reductions in line with the targets negotiated in international agreements – would be so severe that the national economy would collapse under normal circumstances. According to estimates, absorbing this would require an effort equal to Britain’s war mobilization in World War II.
In today’s political order, something similar to Churchill’s call for “blood, toil, tears and sweat” is not an option. On the other hand, allowing the situation to become even costlier – that is, by doing nothing – is beyond the pale. The viable path forward, then, lies somewhere in between. Smaller economic growth should no longer be treated as taboo. Meanwhile, joint creation of new, knowledge-based approaches could point the way forward. For example, we could lead an informed debate about which sectors and regions require growth, and where we, as citizens of a rich country with a high quality of life, have reached the limits to growth.
Problems of implementation are problems of measurability, many have concluded. After all, what is the cost of an environmental service like clean river water? How can you put a price tag on the extra effort that women farmers must make to obtain clean water from another source? What is the cost of quality of life? How do you calculate how much sleep is lost by the owner of a single-family home in the vicinity of an airport? How do you account for the fine dust particles produced by road and air traffic?
In truth, there are numerous methods available to calculate environmental costs. However, in the logic of neoclassical economics, they are scarcely practicable. The problem is that the definitions and boundaries that must be established are ultimately based on normative principles. Mainstream economists shy away from discussions of values, as they see economics as a hard science. And because they also claim that their science has authority over price-related issues, gridlock prevails.
The unprecedented prosperity of Western industrialized countries and massive reduction of poverty in emerging economies are based on continual economic growth, which is in turn based on cheap energy. Low energy prices enable poorer social strata to obtain a piece of the prosperity pie. Raising taxes on fossil fuels, goes the thinking, would specifically harm these poorer strata.
This argument is often employed by actors who are otherwise conspicuously absent when it comes to supporting measures against inequality. As evidence, they like to cite the 2018/2019 protests by the “yellow vests” in France, simultaneously raising concerns about democracy and the rise of right-wing authoritarian parties.
Meanwhile, there are now numerous studies showing how higher energy prices burden different income groups. They generally confirm greater net burdens on poorer households, especially in the areas of electricity and heating, and less pronouncedly regarding transportation costs. However, depending on the design of internalization policies, precisely these poorer groups can be supported in a targeted manner by compensating them with the tax revenues raised, such that they suffer no negative income effects on balance.
“No government intervention if possible” belongs to the standard repertoire of economic liberals. But “the market” doesn’t operate in a vacuum. There’s barely any discussion of the extensive subsidies built into our economic system, which frequently create bad incentives. Fossil-fuel subsidies, both in production and consumption, boost economic output and promote consumerism. For example, the OECD has identified over 700 measures that either directly subsidize fossil fuels or promote them via incentives. International air travel, for instance, not only benefits from an exemption from the petrol tax that every Swiss motorist pays at the pump, it is also largely exempt from the value added tax. And this is just the tip of the iceberg. In other areas, too – such as biodiversity – a closer look reveals enormous interventions that have become commonplace over the decades; yet another example are the large fisheries subsidies used by major fishing countries to promote cheap fuel.
A first fundamental step towards true costs would be the systematic elimination of subsidies for fossil fuels. They could be replaced by more courageous incentive programmes for climate protection measures, such as those currently under discussion in Switzerland.
“Pigou’s main concern was not to raise more government revenue, but rather to change behaviour,” say many observers. And that’s true. But the latter doesn’t work – at least not in the long term. Certain psychological wiring in our brains apparently prevents long-term behavioural change if it derives solely from external prodding rather than our own genuine conviction.
Without a doubt, major behavioural changes are needed in areas relevant to greenhouse gas emissions – such as transportation, energy use, consumption – in order for us to get on a green track regarding climate policy and sustainable development. If we only make superficial adjustments based on outside nudges, rather than because of our own conscious perception, we’ll always end up falling back into old patterns.
And this is where another scientific discipline offers insights. In contrast to economics, which, in a nutshell, attributes our choices to individual preferences, the discipline of psychology flips that logic: it is our choices that form our preferences. According to Dorsch’s Dictionary of Psychology, this so-called preference reversal phenomenon contradicts basic assumptions of the economic theory of Homo economicus.
Arthur Cecil Pigou would probably be disappointed with the results of his approach. The idea that it can make a significant contribution to reducing greenhouse gas emissions has largely remained theoretical.
But what can we learn from history? The most important lesson might be that incentive taxes are not a bad way of addressing our current crises – as long as they are designed more effectively than they have been so far. Their weak impact and our lack of learning call to mind the phenomenon of “implementation failures”: We try again and again, at best increasing the dose, without changing anything about the underlying approach.
It’s like when we’re waiting for an elevator that doesn’t come: Most people, myself included, press the elevator button like crazy, rather than simply taking the stairs. Or, to paraphrase Adrienne Buller, author of “The Value of a Whale: On the Illusions of Green Capitalism”, our obsession with cost–benefit calculations shapes our perspective on environmental and inequality crises and obscures our perception of more effective measures.
This leads to the second insight: The sciences – the plural is intentional, as not only economists bear responsibility – should step up their game. Namely, in the debate about diverse, uncertain, and incomplete knowledge. It is also up to the sciences to develop and test different possible solutions that need to be weighed up politically. These include approaches such as reducing working hours, new forms of producer–consumer relationships, or considering decisive divestment from harmful practices of the fossil age.
By contrast, stubborn adherence to and one-sided emphasis on market-friendly solutions prevents open, transparent, and public debate about the benefits of alternative courses of action. We are getting in our own way when it comes to substantial breakthroughs. Which we need. Fast.