Government meddling and increased air pollution

When economists speak about climate change risk, they use a lens of externalities. Simply put, externalities emerge when exchanges between two parties has consequences that spill over onto third parties. These externalities are labelled “negative” when these spillovers hurt third parties.

Greenhouse gas emissions resulting from economic activity constitute a negative externality, as producers and consumers in any exchange do not pay the full social cost of their actions (present or future). This, economists argue, is a form of market failure. Economists then propose corrective policies for governments to enact. A good example of such a corrective policy is the carbon tax. Because it raises the price of pollution, it internalizes the externality.

The discussion generally ends with how further government interventions will internalize the externality. However, are there margins where greater reliance on markets and scaling back government intervention would constitute a superior course of action? In other words, is it possible that prior government actions made the problem larger so that it would be more accurate to speak of government failure? This possibility is rarely (if ever) discussed in the sphere of public affairs.

Yet, consider the example of highways in Quebec, which suggests that you can observe this possibility in your daily life. In the 1970s, the provincial government removed all tolls on highways. By eliminating road-pricing, the Government of Quebec reduced the cost of using an automobile and thus encouraged traffic jams, which are associated with greater levels of air pollution (in addition to the cost in time to commuters). The move away from road-pricing worsened the problem of air pollution, but that move was a move away from market mechanism. A hypothetical move back to road-pricing would reduce greenhouse gas (GHG) emissions and help mitigate climate change.

While the example of Quebec highway suggests that this “government failure” is ubiquitous, it does not speak to the contribution of “government failures” to the overall problem. One could argue that, while valid, this argument explains only a small portion of the problem of climate change. Thus, most of the efforts should come from policies such as new regulations and/or a carbon tax.

But that would be incorrect.

Consider the case of fossil fuel subsidies. In countries representing roughly one-third of the world’s population, gasoline prices are reduced to artificially low levels. Because consumption is greater at these lower levels than it would be at the market price, the governments of these countries (which include India, China, Iran, Algeria, Venezuela and Egypt) must spend public funds to pay for the greater consumption. In essence, consumption of oil is subsidized. The environmental downside is that the incentives to invest in energy-saving technologies and to use energy more parsimoniously are weakened. The result is greater levels of GHG emissions and conventional air pollutants.

In the early 1990s, some economists had begun to point to the importance of this effect. For example, a World Bank study suggested that eliminating those subsidies in the 1980s would have reduced GHG emissions by between five and nine per cent. Such a reduction some three decades ago would also have affected downwards the trend of GHG emissions. In a more recent report, the OECD found that the immediate abolition of these subsidies would reduce GHG emissions by 10 per cent. Finally, the International Monetary Fund found that, if the subsidies were eliminated, emissions of carbon dioxide would fall by 4.5 billion tons representing 13 per cent of total emissions.

To put these numbers into perspective, the potential reduction found in the OECD study is enough to do a seventh of the effort needed to accomplish the ambitious objective of stabilizing GHG concentrations at 450 parts per million (thus limiting climate change to below two degrees Celsius). Alone, this policy packs quite a punch and it makes it hard to not consider seriously the possibility that government meddling with market processes made the problem even bigger than it was.

Imagine all the other policies—including Quebec’s move away from road-pricing—and compare their effects to the impact of fossil fuel subsidies. Even if each policy is individually small, their sum may amount to much more. So maybe it is time to consider each of these small pebbles. This might open the road to a more modest, but more efficient, set of environmental policies that rely on the idea that, before doing anything, it’s best to stop doing what makes things worse.