Point 4. The rules of the system (incentives, punishments, constraints).

Places to Intervene in the System

4. The rules of the system (incentives, punishments, constraints).

“The rules of the system define its scope, boundaries, degrees of freedom. Constitutions are strong social rules. Physical laws such as the second law of thermodynamics are absolute rules if we understand them correctly. Laws, punishments, incentives, and informal social agreements are progressively weaker rules.”  Extracts from Dona Meadows Paper.

Considering climate change challenge, we need to foster cooperation by all societal and market players using the rules of the system. It is the carrot and sticks approach to create cooperation by the participants in the economy. I mean by cooperation is reduction of burning Fossil Fuels. Carrot, in terms of price increase for actions that promote burning fossil fuels, sticks in terms of carbon subsidies for actions that promote reduced dependency on fossil fuels. Sticks in terms of carbon taxes or fees, and cap-and -trade system for organizations and carrots in terms of exchange benefit that rewards the economy player who reduces dependency on burning fossil fuels. The combination of carrots and sticks policies creates the most optimum cooperation in humans.

Figure 1

With negative externalities of burning fossil fuels (the economic damage caused by anthropogenic carbon emissions) being in the spotlight, we need to remind ourselves that there can exist other kinds of externality, including positive externalities. A positive externality is a spillover benefit that is enjoyed by a third party (the company’s executives and the investors) who does not pay for the benefit (not paying for the pollution). What creates a positive externality is called a merit good. A merit good is a good or service that provides significant benefits for people who do not pay (such as the companies that do not pay for pollution they have caused). Right now, the process without Carbon Taxes, or Fees or Cap-and-Trade incentives the polluters to pollute more, hence enhancing a positive feedback loop of “burn baby burn.”

In 64 jurisdictions' worldwide where carbon tax or cap-and-trade is in effect, there is no or very limited alternative mechanism to incentivize the polluters. This way corporations will logically lobby for no carbon taxes or carbon pricing mechanisms such as cap-and-trade and ask for more concessions from governments for less taxes, cap-and-trade, regulations, transparency, and accountability (bidding time). This creates the Net Zero Mission creep that we are currently experiencing. That is because there are penalties but no incentives. We all know that incentives work better than penalties. Pollution taxes alone are far from ideal for addressing systemic risks because taxes do not attract enough social and political cooperation. Without any incentives built in the system, we are going to continue to have mission creep in 2024, 2025, 2030, etc.

Figure 2

 There is an alternative way of adding carrots to the equation that would produce more effective results. The alternative method works by adding a carbon reduction reward mechanism that serves as a carrot. There is a huge investment outlay that is required to move us from Mission Creep to Carbon emissions reduction that the world (by the world I mean voters, governments, corporations, etc.) is not willing to pay right now. So, a new thought is needed here. Let us consider the possibility that the market failure in carbon (i.e., the inability of the world to reduce carbon emissions as of today) is partly the result of the system of fiat money creation, which is a debt-based system of money creation called ‘bank credit’. If this debt-based system is a driving force for encouraging continuous profits, higher profits, and economic growth, then it appears reasonable to conclude that the market failure in carbon is worsened by debt accumulation because this amplifies the profit motive resulting in unsustainable economic activity such as fossil fuel extraction and dirty consumption. This market failure assumes that the actions of polluters are self-motivated when it is often the case that producers and consumers have limited choices because they are somewhat like ‘cogs in a wheel’, where the wheel is metaphorical for an economy that has a growth bias and a rising appetite for profits and energy. Without addressing this systematic failure in the system, there will be no incentive to transition out of fossil fuels. Who is going to pay for the huge outlays of funds to create real trajectory to reward clean energy, clean business, and carbon removal.

Figure 3

We need a new term to describe this systemic impact of the economy of carbon emissions. We call this impact a ‘systemic externality ‘. By definition, the systemic externality is the hidden cost of the role the global economic system plays in perpetuating and worsening the market failure in carbon. Given that global economic systems are metaphorically speaking writing the ‘rules of the game,’ it is posited here that the cost of correcting the systemic externality. The main culprit here is the elites that meet in Davos Global Economic Forum each year. They are the ones who practically write the rules. The rest of us, individuals, producers, manufacturers, and municipalities, and local governments are just “a cog in the wheel” market players. This system externality should not be imposed on the “cog in the wheel” market participants because those market actors are not responsible for making the rules (I would exclude from this either the Global 250 corporations or the SDG2000 responsible for 50% of the global GDP).

This suggests that we address the whole situation with a carbon pricing matrix that prices in the carbon emissions risks and funds it. The proposed carbon pricing matrix is a combination of laws that govern carbon taxes, carbon subsidies, and cap-&-trade schemes, and carbon reward system that is controlled by central banks. It is a novel idea, but it has a lot going on for it. The idea to incentivize all sectors of the society to endorse it, the voters, the elected officials, industry captains, the 1% elites, to give it enough credence to make it work. That way has an optimum mix of carrots and sticks to incentivize moving in the right direction.

The systemic externality concept is relatively complex and unorthodox because it proposes that risk management requires a new kind of financial ‘carrot’ — the carbon reward — and a bold new social principle based on the notion of preventative insurance, as explained below. We need a global mechanism (trade system) that incentivizes actors that would benefit people and the planet. We can use the leverage in laws, regulations, and rules, to provide enough incentives to corporations to drive efficiencies, and provide penalties for not being efficient, and put constraints on the system in terms of the cap-and-trade as well as the carbon reward mechanism. It is a novel idea but nonetheless, it has potential to deliver better outcomes than the current system of sticks only (Carbon tax or Cap-&-Trade). If you add Carbon subsidy and carbon reward methodology, you will get a better functioning global economic system that incentivizes corporations to work towards solutions to the climate change mess.

This Carbon Risk Reward mechanism, termed as Preventative insurance differs from conventional insurance that is typically used to insure private property against flood, fire, and theft. Preventative insurance is proposed at the global level to defend against irreversible catastrophic damages to common pool resources. These resources are irreplaceable, and they cannot be compensated if irreversibly damaged or lost. The cost of correcting the political gridlock, institutional barriers, and financial barriers to effective and scalable climate action may be considered an insurance levy, under the preventative insurance principle. Important, is that this levy will not result in any direct financial costs for citizens, businesses, or governments—on the basis that the levy will be managed using monetary policy.

Reference for the blog is made to the work of Dr.

Delton Chen of the Global Carbon Reward Organization.