Heiner Flassbeck – The CO2 Cap, Certificates, and the “Distortions”

The Liberals are desperately looking for a purely market-based solution to the climate problem. But there is no such thing. Monetary policy could teach us why a CO2 cap and certificates can never work.

Heiner Flassbeck is an economist, as well as publisher and editor of “Makroskop” and “flassbeck economics international

Originally posted in German at Makroskop

Translated and edited by BRAVE NEW EUROPE

The neo-liberal economists, the liberal politicians, and the conservative market economists have a recurring dream. In it they solve a problem without state intervention, as it were, while still demanding subsidy from the state. The squaring of this circle works, however, because the state, on the basis of scientific (or generally technocratic) findings, merely prescribes a quantity restriction (offer) for market participants. The state-limited supply leads to the market finding the right price – together with the market forces on the demand side. In the eyes of good market economists, this price is clearly to be seen as THE market price, even though it was not achieved entirely without the intervention of the state.

This “ingenious solution” was invented to control the money supply in a market economy. The supply to the economy of state-issued money is not completely possible without the state, however much one tries to “objectify” the money supply (as Germany’s Council of Economic Experts once called it). In this view, the “supply of money” is determined purely technocratically by a politically independent institution (such as the godlike Deutsche Bundesbank) and made available solely on the basis of the (politically overriding) objective of combating inflation. The price – in this case the interest rate – is then to be determined by the market on the basis of the supply provided by the central bank and the demand coming from the money market.

The market will solve the problem

Exactly this solution is what many liberals and conservatives have in mind for solving the climate crisis. They want to continuously reduce CO2 emissions (in line with scientifically defined targets) and only issue as many certificates as are scientifically justifiable. Ideally, the governments of the world would decide to cap the number of certificates once and for all today. In this way, the reduction would be set year after year on a fixed path at exactly the rate that is necessary – in accordance with scientific guidelines – to reach zero in 2050, or a value that is considered to be climate-neutral.

The idea is that the market will then find an appropriate price to which everyone must adapt. Because the markets are efficient and innovative, the liberals and conservatives believe that this is the way to reduce CO2 emissions at the lowest cost. The German Council of Economic Experts, for example, states in its special report on the climate crisis:

“Separate emissions trading can directly ensure the achievement of the quantity target. In the case of a CO2 tax, this would require a regular adjustment of the tax. The credibility of this programme would be compromised if its reliability was questioned because of political interference. The price in emissions trading, on the other hand, is determined by fixing the quantity of allowances”.

Christian Lindner of the German Liberal Party (FDP) becomes downright euphoric when he describes how well the market can regulate the problem if a lid is placed on the system today and the market is then allowed to have its say. Heike Göbel from the German daily Frankfurter Allgemeine Zeitung is rather precious on this point. As a good market economist, she cannot help but push the certificate model into the foreground. Somehow, however, doubts start to creep in and suddenly there is talk of “distortions” that can occur if the certificate model is applied consistently.

That is exactly the right keyword: there will be “distortions” if the liberals and conservatives allow the certificate system to come into play, i.e. in what they consider to be the market economy. Adaptation, even if it is efficient and accompanied by technological innovations, is in any case a constraint. An economy and society completely geared to the consumption of fossil energy cannot be thrown into reverse in just a few decades without the price increases inevitably associated with it forcing companies and private households to radically change or restrict their business models and lifestyles.

If the liberals were only a little wiser, they would ask themselves, before they frivolously commit themselves to a certificate model for climate protection, why the beautiful technocratic supply model never came into play on the money market despite the godlike Bundesbank. Neither the Bundesbank nor any other major central bank has ever made an offer of money and left it to the market to find the right interest rate. Monetarism, as the doctrine is called, which assumes a direct connection between the money supply and the inflation rate, has been invoked time and again as an ideological basis, but never really applied.

Instead of imposing a rigid quantity requirement, the central banks always fixed the interest rate directly and varied the amount of money made available in the same way, resulting in a high stability of the price on the money market, i.e. the interest rate. The supply of money has therefore been adapted incredibly flexibly to the demand for money in order to guarantee stability in interest rates. After all, interest rate stability is exactly what is needed by market participants who are expected to invest in fixed assets over the long term.

If one had set a rigid target for the money supply (i.e. an increase of about 5 percent per year and no more), enormous fluctuations in interest rates would have ensued in the form of strongly volatile demand for money – which would presumably have made stable and rising investment activity impossible. In the final analysis, the central bank reacted directly to investment activity and – depending on the economic situation – behaved in such a way that a stable inflation rate, but also sufficient investment activity, were possible.

Volumes and prices

The hope of the monetarists – and the “full-money” theorists – that a rigid corset could be put onto an unstable and extremely fragile system, was naive from the start. It is just as naive to believe that the market economy can be given a CO2 volume corset without enormous distortions in the form of dramatic price fluctuations and above all – with a steadily declining number of certificates – price increases. And it is also infinitely naive to believe that these price increases, which are ultimately the responsibility of the democratic states, would simply be accepted by society and market participants. Any price fluctuations would be interpreted as political interference and the pressure on governments to limit price fluctuations with additional certificates would increase tremendously.

One only has to imagine what would happen if one wanted to achieve a commitment by the governments of the world to organise Peak Oil, Peak Coal, and Peak Gas at the same time. That would be nothing more than to decide that, from now on, the quantities of fossil fuels produced around the world will be capped by a political decision and then reduced to such an extent that the quantities produced in 2050 are exactly in line with the objective of reducing CO2 emissions to levels compatible with climate neutrality.

That is precisely what any effective climate policy must aim to achieve. From 2050, fossil fuels must remain largely in the ground, no matter what control mechanisms are used to achieve that goal. But no one dares even to express such a thought. And that is because everyone knows the outcry from the public that would follow, among the producers of these raw materials, and among many politicians, who would then demand the immediate revocation of the decision.

The mere fact that liberal and conservative circles like to philosophise about certificates, without considering quantity restrictions for the economy and their price effects, shows that they have not understood the problem or prefer to ignore it. The liberals and the conservatives would be the first to use the burdens on the economy as an unassailable argument in the event of price increases, to negotiate exceptions for their own clientele.

Price control is the solution

The only “realistic” solution that exists is consistent price control by the global community of states over very long periods of time. Contrary to what is claimed again and again, no attempt of this sort has ever been made in the history of mankind. One need hardly say that this is a Herculean task on an international level which hardly stands a chance of being put into practice today.

But, it is still important to remove that miracle drug, “certificates”, from the hands of the supposed market economists because it is used as an alibi and a diversionary tactic. The search for a solution can only be pursued successfully if there is fundamental clarity about the role of the state, and the sort of adjustment tools that are available in a market economy.

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