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Climate change policies and opportunities, some lessons from Friedrich Hayek

July 8th, 2008 · No Comments

The G8 just stated it’s ambition to half the emission of greenhouse gases by.. 2050. We are not climate experts, but let’s review a few stylized facts.

1) Climate change is happening. This is highly probable, or so say the overwhelming majority

2) Climate change is at least part man-made. While we won’t argue with it (as we’re not qualified to do so), it seems to be the view of a large majority of scientist. The fact that much research trying to disprove it was financed by big oil companies like Exxon might be taken as further supporting evidence.

A few arguments seem pretty difficult to negate to us:

  • CO2 levels are rising in the atmosphere
  • It’s not difficult to link these to human endeavors like industry, transport, forest destroying..
  • It’s also no secret that CO2 is a greenhouse gas.

But this is as far as we feel comfortable with. So the stylized fact point to a high probability that the worlds climate is changing due, at least partly, to human endeavor. Now, what’s the right approach?

The first gut reaction to that G8 summit ambition could very well be, something like: “oh no, not another target far away into the future, instead of ambitious, feel-good targets far away into the future, we need workable policies now.”

You would be forgiven for arguing like that. Actions are costly now, involve big changes in the way we (the voters!) live, and their supposed beneficial effects are a generation or more away and difficult to assess, so usual politics is very ill equipped to deal with it, despite Al Gore.

Two arguments in the climate debate which come from the skeptics do make sense to us:

  • A cool, detached cost-benefit analysis could well point out that measures trying to slow climate change are more expensive than measures trying to soften it’s effects (building dikes, things like that)
  • Instead of large changes in our way of life, perhaps technological solutions have more to offer.

We also say the following: it might seem rational that such a big (in some predictions catastrophic) problem that spans the earth also needs a centralized, political solution. But we couldn’t disagree more. Like we argued above, politics is actually especially ill adapt to deal with these kinds of big problems.

And we have a potentially much more powerful tool to come up with solutions: the market. Friedrich Hayek, author of one of the most impressive economic papers of all time, his “The use of knowledge in Society”, written in 1945.

The central thesis is that markets are much better than central planning in situations where knowledge and information is relatively dispersed, which it is, especially in modern economies, as a result of specialization.

The trick is to enlist that knowledge for a greater goal. If you are a regular reader of this space, you might have realized that we do not share some of Hayek’s more radical sides, that states hardly have a role to play, and that the market is a solution for every problem (many of his followers are especially adept at arguing these things).

Markets also have problems, and, perhaps even more importantly for the present purposes, they can only function well in the right institutional environment, an insight which, although ever present latently, has only really bloomed in economic literature the last couple of decades.

(For the economist amongst you, although we think that particular Hayek article is amongst the very best in the history of economic achievements as a science, we would put others on a par, like that seminal article from Ronald Coase in the 1930s (The Nature of the Firm) in which he singlehandedly invents transaction cost economics).

Now, back to those emission targets. We understand why avid environmentalist will be disappointed. We’ve tried to explain why politics has such a hard time coming up with something better. But it’s actually not that bad, and here’s why:

If such targets become translated into several achievable and binding subtargets, much like mandatory fuel efficiencies we mentioned in another article, than they can be used as an instrument to enlist all the creativity and dispersed knowledge to come up with solutions, and the market also happens to be a pretty good mechanism for selecting the best of these.

Let people everywhere, armed with local and specialist knowledge and information, come up with solutions. Fund, if necessary (this is somthing no true Hayekian would dare to say), but translate these global targets into achievable targets and goals for innovators to work towards.

Mandatory fuel efficiency on an upwards scale is an excellent example of what we mean. It’s a pretty simple measure, but as a consequence, a multitude of car companies, research labs and alternative technologies are starting to think and work how to achieve that.

And a nice side effect for investors (who will play an essential role in financing all these potential solutions) is that a wave of new approaches, concepts, technologies will arrive which could be the next winner not only in the battle against climate change, but also on the markets.

Let the games begin!

Tags: Opinion