Citizen Writes
Research hot topics
Tackling climate change and adaptive policy
2023-11-22
By Professor Ania Zalewska, Research Chair and Professor of Finance, University of Leicester School of Business
When in 2015 the Paris Agreement was signed by 195 signatories, there was a huge sigh of relief and sense of achievement. It seemed that significant cooperation across countries was possible and there was hope that a material reduction of greenhouse gas emissions and the restriction of the rise in temperatures were achievable.
The annual meetings that followed the Paris Agreement have revealed, however, that the agreement was far from being the great leap forward in achieving the agreed goals that everyone had hoped for. Seven years (and COPs) down the line and it is crystal clear that the economic rationale that was supposed to guide the common action to achieve the better good has given way to free riding and delays in making and implementing the necessary policies.
The lack of transparent, clear and universally accepted standards of what is green and what is not green, and the problems in reaching agreement on who, how much and to whom compensation for breaching these standards should be paid, have resulted in many projects that could help in reducing greenhouse gas emissions being diminished in scale and scope, or being delayed or never being initiated at all.
From the start it was clear that the bulk of the cost of the green transition would have to be borne by businesses and households. Given that government budgets were already overstretched, new taxes would have to be raised to find money for new green investments. Therefore, one can see the logic and potential efficiency behind policy approaches that aim for greater direct engagement of businesses and households rather than to tax them first, only to later redistribute the money to induce appropriate business strategies and investments. However, some degree of predictability and consistency of regulators and policy makers is necessary if businesses and individuals are to be willing to undertake the necessary green initiatives and commitments.
Obviously, regulators and policy makers are unable to create a perfectly stable regulatory environment in the sense that the rules and policies once in place do not change for a considerable period. This is particularly the case where technology and the economic features of an industry are changing quickly (e.g., due to technological progress, uncertain consumer attitudes, etc.), making it impossible for regulators and policy makers to fully and correctly predict what needs to happen and how it will need to be regulated.
This is the case for climate change issues, so fixing all the specific bits of regulation and policy for long periods is not really viable. Regulation and policy has to adjust over time. It may even be that regulatory changes will have to be more frequent in the future than they had been in the past simply because they will need to accommodate the speed with which technological innovation occurs. However, as I argue (with co-author Paul Grout) in the paper* written for the National Infrastructure Commission, this does not mean that regulators and policy makers can change direction as they wish. To be successful, the regulation and policy needs to be what we call “adaptive”.
We use the term “adaptive regulation” to describe regulation that adapts as time passes but also sticks to core, longer lived principles. If a regulator always sticks to longer lived principles, then it gives firms confidence in judging how a regulator is likely to respond to unforeseen events. Thus, investors have the confidence that will be able to invest with a degree of certainty, that there will be no unpredictable regulatory or policy shocks. Of course, there will always be shocks arising from changes in the world. It is just the response to the shocks by regulators and policy makers that shouldn’t be too hard to understand (even though the companies and their investors may have preferred the change had not happened). Note that a regulator cannot just say that these are the long run principles and expect that the benefits of adaptive regulation will arise instantaneously. It is only by showing over time that the big principles are indeed being stuck to, even when there are short term regulatory or political gains that could be achieved by taking a short-term view, that investors and companies will have confidence in the regime.
However, in the path to a greener economy, what we have been experiencing is the opposite of adaptive regulation or adaptive policy. Neither regulators nor governments appear to stick to long lived principles that could stimulate green investments and initiatives. Even worse, it is not only that they do not stick to such principles, but that they cannot even agree what such principles might be.
This is true for individual counties, and even more pronounced for international agreements. For instance, the agreement that established the principle of compensation for poor countries affected by climate change was adopted in 1992 at the Earth Summit in Rio de Janeiro. The concept of addressing “loss and damage” associated with effects of climate change was further elaborated by the Paris Agreement, subsequently adopted by COP21. Subsequent COP meetings have discussed potential solutions for addressing loss and damage associated with climate change in vulnerable countries. Yet, as of today no working arrangements have even been pencilled in, nor are there signs that such arrangements could be agreed and put in place in the near future. Against this background, it is easy to see why businesses are making sufficient green investments and consumers are slow to commit to major changes in their lifestyles.
Sadly, what is clear by now is that the target of limiting the global warming to 1.5C above the pre-industrial level by 2050 is likely to be missed and global greenhouse gas emissions have not dropped or even levelled since the Paris Agreement (indeed, they have increased from 50.13 billion of metric tones in 2015 to 53.59 billion metric tones in 2022).
*See Grout and Zalewska ‘Adaptive Regulation, Market Risk and the Cost of Capital‘ (National Infrastructure Commission), which itself is based on Grout and Zalewska ‘The Impact of Regulation on Market Risk’ (Journal of Financial Economics).