Examining Market-Based Solutions to Climate Change

A market failure is informally defined as an inefficient distribution of goods and services. In essence, a market fails when an individual entity makes a decision that is beneficial to itself but not beneficial to other market participants or society as a whole. The world’s latest instance of a market failure? Climate change.

The good news, as Assistant Professor of Finance Carolin Schellhorn, Ph.D., would tell you, is that there are a variety of ways to correct this market failure. And when exploring these options, it is important to bear in mind the need for a just transition, considering the impact on low-income or otherwise marginalized communities.

“These two things — climate change and social justice — intersect,” says Schellhorn. “People do want to address the climate crisis, but they also don’t want it done by increasing inequality.” To make a significant change, she stresses the need for a four-pronged approach in which consumers, investors, companies and the government work in conjunction to find a solution.

Schellhorn explains that Securities and Exchange Commission (SEC) enforcement may be a good place to start. The SEC is the body of government tasked with protecting investors and maintaining order in the securities markets. Schellhorn believes the SEC could pass and enforce regulations that would require companies to disclose relevant climate-related financial risk to their investors. By making this information accessible to the general public, current and potential investors could choose to invest their money with environmentally responsible companies.

Next on Schellhorn’s list is a carbon tax. This controversial option would essentially levy taxes against individuals and companies depending on the size of their carbon footprints. Of all the questions surrounding a carbon tax, one of the most pressing is how to approach implementing it on a practical basis.

“The biggest question really is how does the government implement a carbon tax so that it affects citizens and companies proportionately,” explained Schellhorn. “How high should the tax level be, should it increase over time, should it decrease over time — these are all options that have to be explored.”

Increasing the fuel tax in France last year caused widespread protests across the country by citizens unwilling to pay high prices for gas and other fossil fuels. A gallon of gas there already costs upwards of $6, 60 percent of which comes from taxes.

Schellhorn also suggests subsidizing research and development for decarbonization efforts, instead of for companies that produce fossil fuels. Conservative estimates say the fossil fuel industry receives over $20 million a year from direct government subsidies.

“The government has partnered before with companies for large scale innovation. They did it with the moon landing, and they even did it with natural gas fracking,” she says. “So there is certainly a beneficial role for the government to play in solving this crisis.”

Schellhorn’s final suggestion is the divestment movement, which includes university endowments, pension funds and other large investment portfolios. In this movement, investment managers are beginning to exclude from their portfolios stocks and bonds of fossil fuel companies and other corporations that are environmentally unfriendly.

Institutional investment managers can also pass regulations within their organizations that restrict investing to “green” or environmentally conscious companies, thus forcing other companies to consider cleaning up their environmental practices.

“People do understand that something needs to be done, but they don’t want to bear the brunt of the burden while people who are responsible for it pay as little as possible,” says Schellhorn. “We need a multi-pronged approach—consumers, investors, companies, government all trying to change. It can’t be changed on one end.”