Since the Thatcher/Reagan reforms of the 1970s and 1980s and the collapse of the Soviet Union there has been an orthodox belief in favour of allowing pricing signals to guide markets. Prices serve a ‘discovery’ purpose, steering markets to produce what people want and providing incentives for innovation and change. This orthodoxy is once again under challenge. The goal of decarbonising the global economy and to achieve net zero carbon emissions by 2050 or 2060 is leading to a return of ‘command and control’ measures to guide economic choices. The direction is clear from the 'Roadmap' set out by the International Energy Agency in a report in May, 2021. We are likely to hear much more about command and control in November on the occasion of COP 26, the UN follow-up meeting to the 2016 Paris Agreement and the 1992 UN Framework Convention. This blog looks at the return of command and control.
Command and control
The essential feature of ‘command and control’ measures is that governments decide on what is good for the collective wellbeing of their societies and impose their choices on individuals, rather than allowing for the collective to be reflected in large part through the summation of the myriad of voluntary choices that individuals make for themselves in their daily lives.
The case for ‘command and control’ measures rests on the need to prevent a public harm occurring from the sum of individual decision making. The case has been illustrated in the COVID pandemic. It is politicians who have decided on curfews, lockdowns, the closure of bars and restaurants, mandated the wearing of face masks, forbidden social gatherings and imposed compulsory quarantine. Left to their own discretion, some individuals would no doubt have continued to gather in social spaces at all hours, patronised bars, travelled and mixed freely, many without face masks. Their behaviour would inevitably have led to higher infection rates with an accompanying higher level of mortality. In short, the sum of individual decisions would have led to a great collective harm.
It is this same basic belief that also propels command and control measures in the case of climate change. The assumption is that individual choices will lead to a great and possibly irreversible collective harm. The IEA 'Roadmap' notes that over half of the emissions reduction needed to achieve net zero by 2050 are directly linked to consumer choices. Thus, politicians are setting target dates for the mandatory phasing out of petrol/diesel driven forms of road transport, are imposing more stringent insulation standards in construction and housing, and are also imposing changes in domestic heating, cooking and cooling systems. The same IEA 'Roadmap' assumes that around 75% of emissions saved through behavioural change will result from choices that are regulated and mandated.
Market liberals are tempted to view this change in over-simplified terms and to see politically mandated change in direct opposition to voluntary changes brought about by the operation of market pricing. In practice, the relationship involves a more complex interchange of signalling.
Long term framework for individual decisions
One important effect of politicians establishing fixed targets related to net zero gaols is that they provide a long-term framework for decision taking by all actors. In the case of business investments with a long term pay-off there is a benefit derived from certainty around one important element in the planning horizon. In manufacturing, GM’s decision to stop making petrol driven passenger cars and SUVs by 2035 no doubt reflects in large part this kind of horizon scanning. So far over 100 companies have committed themselves to a net zero target and the role and importance of these kinds of corporate decisions at the level of the individual firm is likely to grow. For investors in equity and bond markets the framework provides an incentive to invest in ‘green’ instruments and to move away from oil, gas and coal mining companies. A similar incentive to be selective applies to lenders.
Bringing forward market trends
A second effect of mandated targets is that market trends may be accelerated. This has been illustrated in the COVID crisis where compulsory lockdown and stay-at-home measures have spurred on-line shopping and entertainment and remote working. It is still unclear how far these developments may revert to trend or prove reversible. For example, corporate environments may require a return to physical presence in offices in order to maintain a corporate ethos, effective supervision and compliance with corporate or regulatory standards. Nevertheless, a trend to an on-line world was already established prior to COVID, and command and control measures may have accelerated the trend. In the case of global warming there is already a trend towards eco-friendly investments, an uptake of electric vehicles and a phasing out of fossil fuels. Mandated targets and compulsory switching will, in some cases, simply accelerate market changes, rather than work against the market.
A third effect is to incentivise innovation and to shorten the time interval between innovation and the market introduction of an innovation. For example, advances in battery technology, in carbon capture, in energy storage, in turbines for wind power, and shifts in methods of household heating and cooling are all actual, or likely, areas of innovation to benefit from government commitments to decarbonisation. The International Energy Agency 'roadmap' estimates that about half of the emissions reductions needed to achieve net zero by 2050 will come from technologies that are currently at the demonstration or prototype phase.
By changing the decision-taking horizons of individuals and corporations, by accelerating market trends, and by incentivising innovation, command and control measures help to constitute and to shape the market going forward. without necessarily working against markets. They allow for price signals to coordinate and to incentivise within the new parameters. Nevertheless, questions remain about the downside. There are three important potential downside effects: First, around the credibility of command and control; secondly, around the departure from the standard path of incremental change in public policy, and thirdly, around the calculation of net costs.
Credibility and market signals
Price signals in the market are inherently unstable and typically ‘overshoot’ as part of their ‘discovery’ function. However, there is an important difference between price formation in the market and public policy formation. Prices are a reflection of the combined decision making of many different actors, reflect many different behaviours and motivations and a multiplicity of views about both the present and future. By contrast, command and control actions emanate from one actor’s view of the public good (a government) reflect one main motivation (re-election) and incorporate a single view of the future (the government view, or Brussels view, in the case of the EU)..
In the case of policies to mitigate or to adapt to climate change, governments are acting collectively, their actions are triggered and supported by the views of a majority of climate scientists and there is electoral support too. Multilateral agreements such as the Paris Agreement help further to mobilise public support. Nevertheless, a reliance on a cartel of governments remains very different from relying on the composite of signals given by market pricing. Any uncertainty about the credibility of the commitments of governments dilutes the market benefits of clear signalling.
The issue of government credibility is illustrated by the history of the EU’s emissions trading market established in 2005. The market has been trading so far in 2021 at between Euro 30-60/t CO2e. At this price level the market is working broadly as intended to provide incentives for polluting industries to reduce their emissions towards meeting the EU objective of a 55% reduction in greenhouse gas emissions by 2030 compared with the base year of 1990. It sets an important example of how markets can work together with government mandated climate change mitigation targets. However, it has taken four design iterations to reach this point. In each of the first three schemes, between 2005 – 2020, prices fell precipitously from their opening levels and at an average of less than Euro 10/t CO2e between 2012-2018 were probably too low to provide significant market incentives to reduce emissions. The main impediment has been the overgenerous allowances made by governments reflecting the gap between their rhetoric and their actions. A further modification of market structure is now proposed by the EU Commission to increase the coverage of the scheme, to try to tighten the benchmarks against excessive allowances and to withhold excessive permits within the Market Stability Reserve.
In this context the IEA 'Roadmap' notes that while commitment to net zero by 2050 or 2060 have been made by governments accounting for 70% of global emissions, 'few' have underpinned their commitments with specific measures and policies. There remains therefore a large potential gap between rhetoric and reality. Government signalling thus remains unstable.
Large scale v incremental change
A second potential drawback to ‘command and control’ measures in relation to climate change is that it departs from the standard model of social change in democratic societies. Market oriented democracies typically rely on processes of gradual change. In the market, prices are always in a process of continual adjustment. Similarly, in relation to public policy, change is usually ‘incremental’, even taking political swings into account. ‘Command and control’ represent a switch to large-scale social engineering where everybody is affected in a major way across a wide swathe of decision taking. Karl Popper famously argued against such large-scale engineering in ‘The Open Society and its Enemies’. Herbert Simon also argued that rational decision taking was likely to favour incremental ‘partial adjustments’ rather than whole-world views.
The advantages of incrementalism in public policy are mainly around dealing with the sources of uncertainty in public policy. At the start of the policy process there may be uncertainty around the diagnosis; at the end of the policy process there may be uncertainty about the actual effects of policies adopted. Incrementalism provides a way to reduce the risks of error.
In the case of ‘command and control’ measures in the context of climate change policies, a majority of climate change scientists are confident in their diagnosis. In addition, the risks of getting it wrong are said to be outweighed by the catastrophic consequences of not taking sufficient precautionary measures in a climate ‘emergency’. Nevertheless, majorities can be wrong, and the risk of large-scale errors remain. Those who follow John Stuart Mill and Karl Popper in holding that all scientific theories should be regarded as open to disproof and falsification would warn against relying too heavily on projections based on theories of the human contribution to global warming that may need to be amended. In addition, precautionary measures are costly.
The adoption of ‘command and control’ measures is a way of mandating priorities in the allocation of resources, both in the public sector and also in respect of private resources.
In a resource constrained world, the prioritising of climate mitigation measures takes away public sector resources that could be devoted to other collective objectives, such as the education of younger generations or to care for aging societies. The implications of prioritising the uses of private resources can be illustrated in respect of the disposition of household incomes.
The largest item of private expenditure in developed countries is on housing in the form of rents and mortgage payments (around 20% of income on average across all income groups in all OECD countries). When households are required to change their heating and cooling systems, or to replace windows, or to better insulate roof spaces, some households will be financially squeezed to meet their housing payments. At the same time, transportation costs and household utility bills will also be climbing. As a result, homelessness will increase, more people will be pushed off the housing ladder, income and wealth inequalities will increase. It is possible for governments to try to offset these extra costs through subsidies and other forms of redistribution. Thus, the EU Commission is proposing that ETS revenues be used to support 'sustainable renovation' for low income groups. However, subsidies are difficult to target in ways that channel them effectively to those most in need and that prevent them going to middle income groups.
The IEA 'Roadmap' argues that cost increases for the consumer will be offset by efficiency savings so that energy costs will take a smaller share of disposable income. While this may be true over the long term, the short term, up-front costs of transition cannot be avoided. The mandating of priorities is not cost free and has to be weighed alongside other uses of resources both private and public and other views on relative priorities.
‘Command and control’ measures in the COVID crisis met with some public resistance in democracies on both sides of the Atlantic and elsewhere, even though the controls have been for strictly limited durations. The reasons for resistance seem to have ranged from individuals who felt their ‘rights’ were being infringed, to those who were simply inattentive to the risks they might have posed as potential transmitters of infection to others. The experience warns that some resistance can also be expected in the case of long-term ‘command and control’ measures in the context of climate change policies. There will be errors in policy, net costs will inevitably be misjudged in some cases, and governments facing re-elections may face mixed signals about priorities from electorates who face the costs of transition..
What this means is that the turn to ‘command and control’ measures represents a higher risk strategy for governments than appears at first sight. Other approaches are needed. The IEA Roadmap indicated two other channels for change. One involves greater reliance on market measures such as emissions trading schemes that put a price on carbon. The second involves placing greater emphasis on developing information that will impact behaviour in the market. With greater, and more reliable, market transparency around carbon usage and transparency around carbon footprints, all actors, supply chains, investors and consumers, can be better informed and more responsive to emissions.
The IMF is proposing a global carbon tax as a way to avoid unilateral measures such as the EU's proposed carbon border tax. However, in the long run, measures that incentivise behavioural change at the level of consumers, corporations and investors may offer a more reliable path to change without the resistances that can be expected with command and control.