The best climate policy puts carrots before sticks

It is widely recognized that the transition to a zero-carbon economy requires both carrots and sticks — incentives and penalties. Less appreciated is the importance of this sequence: carrots before sticks.

True, economists have long insisted that the only way to cut emissions of carbon dioxide and other greenhouse gases rapidly and at scale is to put a price on them. In a world where burning fossil fuels causes more damage than it adds in value to gross domestic product, each ton of coal or barrel of oil consumed ultimately destroys collective prosperity.

Calculations of these emissions’ social costs provide a guide to pricing them. Accounting for the full damages caused by each ton of carbon dioxide emitted, an appropriate price is well over $200. But that comes out to almost $2 per gallon (or 50 cents per liter) of gasoline at the pump, which helps to explain why, for example, neither Europe’s well-functioning carbon market (with prices of around $75 per ton) nor Germany’s own carbon tax covers gasoline to the extent needed. In Germany, where 80 million people own 40 million gasoline and diesel-powered cars, an adequately high tax would appear too punitive to pass political muster.

These calculations also explain why electric vehicles are such an important solution. The technology’s advantage lies in basic physics: EVs convert 90 percent of their power into distance, compared with just 20 percent for internal combustion engines. And similar efficiency ratios apply when comparing heat pumps to gas furnaces, induction stoves to gas stoves, and LEDs to the incandescent lightbulbs of yore.

Physics and economics trumped culture wars

Monika Schnitzer and Gernot Wagner

That last example is particularly instructive, since the transition to LEDs is already mostly complete. Given that incandescent bulbs were notoriously inefficient — converting 90 percent of power to heat instead of light — switching to LEDs has paid for itself many times over. But even this common-sense change required coordination to achieve scale, and to overcome barriers such as high upfront costs and landlords’ unwillingness to provide more efficient bulbs to tenants.

In the US, it started with the Energy Independence and Security Act of 2007, signed into law by President George W. Bush, which set new efficiency standards for household lightbulbs. That triggered a typical culture-war response, with the Republican congresswoman Michele Bachmann introducing the Light Bulb Freedom of Choice Act in 2008. Fortunately, her bill went nowhere, and nor did President Donald Trump’s attempts to abolish efficiency standards a decade later. LEDs had already taken over as the better, more efficient, and ultimately cheaper technology. Physics and economics trumped culture wars, and both consumers and the planet benefited as a result.

The transitions to EVs, heat pumps, induction stoves, and many other newer, better technologies are now following similar, and similarly rapid, trajectories. While the cost of coal power in inflation-adjusted terms has stayed roughly the same for more than 200 years, the costs of solar power and batteries have declined by more than 99 percent in the past 30 years alone. In fact, solar is now the cheapest source of electricity ever — yes, even accounting for the fact that the sun does not shine at night — and it is bound to become even cheaper. Sun, sand, and human innovation are all plentiful, leading to further economies of scale.

But, like LED adoption, rapid solar deployment requires coordination among households, utilities, regulators, industry, and those developing new technologies. After all, the goal is to have plug-in EVs charging when the sun shines, and powering the dishwasher or helping to stabilize the local grid when it does not.

Coordination is also needed to encourage purchases of solar panels and other technologies in the first place. When Germany launched its ambitious Energiewende (energy transition) in 2011, feed-in tariffs and other subsidies helped solar-panel manufacturers climb the learning curve and drive down costs. Solar manufacturers then decamped to China, however, which drove costs down further, but hurt German employment. And now, massive new US subsidies under the Inflation Reduction Act may lead more European clean-tech businesses to look to greener shores, this time across the Atlantic.

Sun, sand, and human innovation are all plentiful

Monika Schnitzer and Gernot Wagner

The proper response to these developments is not to give up on newer, more efficient technologies. It is to find other ways to manufacture and deploy them at home. The EU ban on sales of cars powered by internal combustion engines beginning in 2035 will help, as would a coordinated push to support adoption of heat pumps.

Backpedaling on these policies would be a big mistake. Europeans will need to devise creative solutions to subsidize the production and adoption of clean technologies. Electricity-market reforms that reward low-carbon power generation and thereby pass lower solar-power prices on to consumers are a good start. On EVs, heat pumps, and other more efficient products, targeted transition schedules ought to be part of the package. They provide investment certainty and balance carrots and sticks.

New York State, for example, has banned gas connections to most new buildings — a measure that Germany has yet to pass — thus gradually reducing its reliance on a fossil-fuel source while stopping short of taxing it. Minnesota, under the leadership of Gov. Tim Walz, now the Democratic candidate for the vice presidency, has similarly passed a law requiring utilities to achieve 60-80 percent carbon-free electricity by 2030, and 100 percent by 2040, up from around 50 percent today. The law is implemented with a flexible renewable portfolio standard, but it is still largely a stick. The carrot: $2 billion in clean-energy subsidies, as part of the state’s comprehensive action plan.

Not all goes so smoothly. Though Gov. Kathy Hochul’s long-awaited plan to introduce congestion pricing in New York City would have funded much-needed public-transit investments, it was seen as putting the stick before the carrot. In the event, she bowed to political pressure and abandoned the plan at the last minute.

The US is facing broader sequencing questions. Now that many of the Inflation Reduction Act subsidies have proven to be wildly popular, when is the right time to follow up the carrot with a stick? The expiration of the Trump tax cuts for the rich next year could be seen as an opportunity finally to start pricing carbon. Of course, all will depend on the outcome of November’s presidential election.

• Monika Schnitzer is Chair of Comparative Economics at the Ludwig-Maximilians-University of Munich and Chair of the German Council of Economic Experts. Gernot Wagner is a climate economist at Columbia Business School and the author, most recently, of ‘Geoengineering: The Gamble’ (Polity, 2021). Copyright: Project Syndicate, 2024.