To tackle climate change and to successfully implement the Paris Agreement, we need to recognise and own up to the reason behind the slow pace of action to date: the long-term and global nature of climate change conflicts with the priorities of decision makers, which are dominated by the short-term and by self-interest. Inaction is not for lack of the necessary technology and resources. Nor for lack of a compelling economic and moral case. The issue is that, with the exception of an altruistic and far-sighted tiny minority, taking action is in no one’s interest. The observation of Juncker, President of the European Commission regarding economic reform is entirely fitting also for climate change “We all know what to do, we just don’t know how to get re-elected after we’ve done it.” But can climate action be aligned with the priorities of today’s political and economic reality? Yes, it can.
The Paris Agreement offers much needed hope. For the first time, all countries agreed on a common climate goal and a process to reach it through voluntary and periodically revised individual contributions. Still, building on its achievements and strengthening cooperation will be critical for the agreement to live up to its potential. Its successful implementation is fragile due to competing and changing political priorities at the national level. Also, the considerable gap between the sum of national pledges and the global requirement to keep global warming within the 2 °C target remains to be closed.
How do we maintain the commitment to long-term climate goals and the intergenerational justice they offer against competing objectives with a more immediate benefit? Decarbonisation involves a burden now for rewards arising in 20, 50 and 200 years, a timeframe that is far beyond not only the horizon of politicians, but also most of us. Also, can a perspective of global advantages prevail, when the costs of climate action are born by those who act?
The answer lies in turning self-interest and short-term focused priorities from obstacles into drivers of mitigation. Innovative finance can help through changing incentives. To see how this could work, consider the following approach built on the achievements of the Paris Agreement. Pledges submitted by countries are developed into annual national emission benchmarks. A price for each ton of carbon saving is established. Emission benchmarks remain non-binding, but countries emitting less carbon than their benchmark in any year would receive a cash payment for every ton saved. A fund is created to make these payments by borrowing from private investors, for instance by issuing long-term bonds similar to multilateral development banks. The fund is backed by participating countries and repays its liabilities including interests through their contributions in the future. Finally, contributions of individual countries to the fund are based on a pre-agreed formula.
What are the benefits of such a design?
First of all, political commitment. Governments are much more likely to be supportive if they receive a short-term financial incentive than if they only face the costs of mitigation. This makes strengthening political commitment to mitigation and global cooperation more viable and less risky. It also makes closing the gap between the sum of intended national contributions and global needs more realistic. Even if national emission benchmarks exceed the overall global goal, countries will be motivated to reduce emissions below their benchmark, and the global target can thus be achieved.
Second, alignment with decision makers’ interest. Decoupling the allocation of costs, in the form of future payments to the fund, from taking climate action, transforms incentives from free riding to maximising gains. If the carbon price is set at $50 per ton for example, every reduction a country can achieve at a cost below $50 gives it an immediate profit. The individual cost and shared benefit of action that characterizes current mitigation efforts is turned upside-down and becomes the combination of individual benefit and shared cost. As any parent knows, rewards are very powerful.
Third, alignment with decision makers’ time horizon. Borrowing by the fund pushes the financial burden into the future. This increases the prospects for action now and aligns the benefits and costs of global mitigation more closely in time. Leaving a financial debt to future generations is preferable to leaving them a more costly and potentially insurmountable environmental burden. The sooner we act, the smaller the costs and risks of climate change.
Fourth, additional financing. Additional capital raised from private investors would help with the necessary adjustments and investments to decarbonise the global economy. The cost of this financing could also be more attractive than what individual countries, especially emerging and developing countries, have access to on their own.
Fifth, bespoke implementation. Being focused on emission results, this approach provides full political and policy flexibility for participating countries in how they curb emission, increasing its political attractiveness. Beyond accommodating their different circumstances and preferences, this also creates room for policy innovation.
Finally, no need for enforcement. The framework creates effective cooperation without the need for any enforcement mechanism in line with the approach of the Paris Agreement. This is an important advantage when dealing at the level of sovereign states. Those reducing emissions will receive payments, others will not.
The breakthrough of the Paris Agreement creates an opportunity we cannot afford to waste. To secure its successful implementation we need to align climate action with the interest of decision makers. This will not deal with all obstacles and the transition to a decarbonised economy will still have its many challenges. However, financial incentives do work and can go a long way to overcome these. They can ensure progress and can mitigate the risks of political changes, complacency and backsliding. Incentives are very powerful.