Stipulating a price for things – goods and services – is a way in which the market society has found to give them value. Services provided by nature deserve the same rationale: giving these services a price is a manner to recognize the value that they have.

One can argue that nature doesn’t have a price, that its value is inestimable. But to not assign a price at all to the services provided results in sending the wrong signals: by being “free”, many understand that nature can be exploited freely, at any cost.

The result is that the environmental damage resulting from this indiscriminate use ends up being paid by the entire society, particularly the most vulnerable members who have less material conditions and technology to adapt to a more hostile environment.

Economic mechanisms directed at correcting this distortion already exist: they are the so-called polluter pays and provider gets principles. Those who pollute pay those who conserve, which encourages protection practices and discourages destruction.

Contrary Signals

But, in current practice, this is not what happens. A company’s products are priced without incorporating the cost of the pollution generated in the making of the products. This results in passing on a contrary signal: it gives the understanding that the product is worth more than nature and generates what is called a market failure. And worse than this: subsidies still exist that encourage polluting activities, giving off even more contrary signals. The International Monetary Fund estimates that no less than US$ 5.3 trillion in direct and indirect subsidies are spent on fossil fuels around the world per year.

As observed by Tasso Azevedo, Coordinator of the Greenhouse Gas Emission Estimate System (SEEG), in an article published in O Globo newspaper, this is equivalent to more than 6% of global GDP and more than what is spent on healthcare globally. According to data from the International Energy Agency, direct subsidies only (value of the fuel below the value practiced in the international market) are greater than the record investment in renewable energy in 2015, which was US$ 315 billion.


In general, the manufacturer pockets the profits that come from their activities (privatization of earnings) and leaves the task of paying for the costs of pollution to society (socialization of losses). This is what is called a negative externality. Stipulating a price for this externality, therefore, is a powerful way to encourage a company to reduce the environmental damages that it causes (more about Externalities in edition 88 of PÁGINA22 magazine).

This negative externality can be exemplified by the contamination of water, soil and air, which causes diseases and reduces the quality of life. Another example are greenhouse gases (GHG) released into the atmosphere by a specific economic activity, which changes the climate globally. This change provokes more intense and more frequent occurrences of extreme events such as severe drought, torrential rains, tornados, and hot and cold fronts that result in landslides and flooding, death, mass migration and increased conflict, among other consequences.

All of this makes conditions more difficult for everyone, especially the poorest, and increases social inequality within and between countries. With each passing day, and we can experience this first hand, food production and energy production are becoming more expensive due to historic droughts, which in turn impact inflation, the cost of living, industrial activity, jobs and the increase in the incidence of tropical diseases.

Looking at the big picture, climate change could represent the collapse of the Earth’s vital systems with unpredictable impacts in the event that the increase in global temperature is more than 2 degrees Celsius compared with pre-industrial levels. Until now, the average increase has been 0.8 degrees.

Eliminating Emissions

The quantity of carbon that we have already emitted on Earth, which is cumulative, means that the increase in temperature can no longer be less than 2 degrees. That being so, we need policies that will allow humanity to adapt to the new climate defined by this increase in temperature. In order to stay within the limit of the 2 degrees – as agreed by world leaders at the Conference of the Parties to the United Nations Framework Convention on Climate Change in Cancun in 2010 -, we have a difficult, but not impossible task to reduce emissions to zero by the end of this century.

The task is so large that we cannot afford to ignore any existing mechanisms; be they command and control, defined by legislation and regulations; be they through awareness campaigns, education or investment in research and technology; be they through a system of emissions trading or carbon taxes.

Policies for climate change have been adopted by an increasing number of countries, states, and cities, using various types of instruments to implement abatement actions. The experience of developing policies for the climate demonstrates that, where the objective of reducing greenhouse gas emissions is concerned, no single isolated instrument is sufficient to deal with the wide array of sources and emitting sectors, while, at the same time, reaching ambitious reduction objectives at a reasonable cost.

The policies of command and control in Brazil, for example, while necessary, are not proving to be sufficient and therefor are making new approaches even more urgent. While global emissions grew by approximately 240% in the period from 1960 to 2008, in Brazil they increased by more than 680%. One of the reasons is that monitoring and enforcement are normally underfunded and therefore compromise policy objectives.

For this reason, regulations based on command and control are commonly criticized for being options that are centralized, inflexible, and more costly than necessary. Another disadvantage is that they tend to discourage innovation as they are generally limited to establishing minimum parameters and do not recognize additional efforts.

Incentive Instruments

In the last decades, regulations based on incentives have emerged as viable alternatives for dealing with environmental issues, including emission reductions.

There are various forms of using incentives to price carbon and thereby “internalize the externality”. This can be achieved through a tax on emitted carbon; the adoption of an emissions trading system; or even hybrid systems that combine the characteristics of trading and taxation (learn more about the various forms of pricing here).

The incentives can still be defined in a manner that compensates those who adopt less intensive carbon practices rather than penalizing those who still produce carbon in an intensive manner.

Apart from internalizing the cost of emissions, pricing instruments tend to be cost-effective or, in other words, they are capable of achieving a specific objective at the lowest possible cost. Additionally, they signal, through the bottom line, the importance of reducing emissions.

Under specific conditions, the two principal alternatives (taxation or trading of emissions) can achieve equivalent results in terms of quantity of reduction and total cost for society. In practice, there are advantages and disadvantages for each of them.

Taxation or a “carbon tax” allows (for those regulated) a certainty regarding costs and reduces risks for investors but may not guarantee the desired environmental result. In contrast, an allowance trading system means less uncertainty about the environmental result but may produce price volatility and risks for economic actors.

Among the great advantages of emissions trading is the encouragement of technological innovation of producers, the adoption of more efficient processes by the suppliers, the search for products with less intensive emissions by consumers and the opting for projects with less emissions by investors.

This is because, in establishing a price for the emissions, the trading system provides incentives so that producers substitute inputs and energy sources for low emission options and look for new technological solutions that would not be economically viable in the absence of this system.

Furthermore, when the cost of emissions is incorporated into the final price of goods and services, it is easier for consumers to perceive which goods and services are from a proactive chain that is emission intensive, making them capable of responding to alterations in price; or, in other words, avoiding a specific product when its price rises and substituting it for an equivalent product with a lower carbon intensity (learn more about the pros and cons of taxation versus emission trading here).

Participants in the value chain and governments are paying more and more attention to the increasing tendency of carbon pricing and are aware that this movement will affect business and public policies.

Besides, various countries are establishing reduction targets, triggered by the COP 21 conference in Paris at the end of this year (learn more here), and the tendency is that there will be more and more abatement commitments (see the chart below for possible types of commitments). A possible proposal for global action to deal with climate change that might be defined at COP 21 will probably contain market mechanisms as at least one of the ways to globally reduce the level of emissions.

Due to this, informing themselves about carbon pricing has become key in defining strategies and in the decision-making processes of businesses and governments.

Chart – Five types of abatement commitments:

  • Reduction in relation to a base year: Reduce or control the increase of total emissions in comparison to a year or base period (record).
  • Fixed number of emissions: Reduce or control the increase of total emissions to a fixed number for a year or future period (with no relation to a base year record).
  • Reduction of intensity: Reduce or control the increase of carbon intensity (GHG emissions per unit of another variable, for example, GDP), in relation to the carbon intensity of a base year (record).
  • Commitments in comparison with base line scenarios: Reduce or control the increase of total emissions in comparison to projected emissions in base line scenarios. Also known as “business as usual” – BAU – scenarios.
  • Other types of commitments: Consider increases in the percentage of renewable sources in the energy matrix, greater energy efficiency, reduction in deforestation, etc.

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