Emissions Reduction Strategies: How to Choose the Right Policy Mix

Policy makers must ensure that the policy mix does not promote conflicting incentives

The types of policies used to reduce carbon emissions will differ over time as some issues emerge as more powerful problems to be addressed, requiring new solutions.  Policies can be national or regional, or require international cooperation: bilateral, multinational or at the global scale.  Climate change mitigation is clearly a global problem, but one which includes national consideration such as energy, transport, land use and manufacturing policy, and as such, domestic and international policies will be needed to provide incentives for mitigation. 

There are many methods and procedures that form a part of policy but are not legally enforced.  Awareness campaigns, education and information dissemination, social movements, awards, and climate action naming and shaming might each enrol people or organisations to take action to reduce emissions.  Other potentially effective ways of reducing carbon emissions without recourse to legally binding policy include voluntary commitments, schemes or agreements, contracts, and, sanctions for failure to comply with agreed targets. 

While these strategies might play a role in the policy mix, I’ll consider just three types of high impact policy, those aimed in particular at reducing emissions from energy use: Imposed standards, market instruments and financial instruments.

Agreements, standards, technical requirements and regulations enforced within a jurisdiction are the most direct types of policy instrument that a government has at its disposal.  These types of instruments are often referred to as “command and control” instruments, but are not always inflexible, universal or dictatorial.  For example, framework based instruments enable different types of requirements to be set that will rely upon a degree of interpretation, depending on, for example, local conditions, or local environmental considerations, rather than a single measure. 

Market instruments are economic instruments that tackle climate change by ensuring that large carbon emitters monitor their activity effectively and are able to use incentives provided by specifically designed market mechanisms to reduce emissions for individual companies and for the sector as a whole.  Individual instruments include charge schemes, such as a levy on fossil fuels (or a levy exemption for other energy generation) and various trading mechanism, for example the European Union Emissions Trading Scheme (EU ETS), which offer incentives to reduce emissions by setting emissions targets to a fixed number of tradable credits or permits, and enabling companies that reduce their emissions to sell any remaining credits they no longer need, at the market price, as though it were a commodity.

Financial instruments are used to address carbon emissions by making financial resources available for investment in emission reduction strategies.  These include subsidies or tax exemptions for decarbonisation schemes, grants or loans for renewable energy projects or the availability of funds to tackle emissions directly, for example in enabling the purchase of energy saving equipment.  Such financial instruments are often applied at the domestic level, but this need not be the case, for example a trading block such as the EU might provide the funds from a central pool and oversee the implementation of such instruments. 

So far, this is relatively straightforward, but now for the complicated part: the challenge for policy makers is to develop a policy mix in which an existing range of policies, including some standards, some taxation and some financial incentives apply to energy production or consumption, are supplemented or superseded by other policies, and such policies must provide signals and incentives that are collectively coherent and self reinforcing.  This is not an easy challenge as specific policy instruments contradict other policy instruments either directly, or through their impact on a feature related to another policy.  In addition, there will often be multiple objectives for policy makers to consider in addition to reducing emissions, such as combating energy poverty or providing funds to enrol developing countries into a global decarbonisation programme. There will also be policy trade-offs, tensions and unintended consequences, and some existing policies are so embedded in ways that could create resistance to new incentives.

Avoiding inappropriate policy portfolios is crucial and will require a policy maker to consider the interaction between different policies in great detail.  One strategy for maintaining a coherent policy portfolio, though, will be to select an appropriate index, such as maintaining a stable carbon price.  In this way, policymakers will be able to develop hybrid market/financial instruments, such as an auction reserve price trading scheme, or complementary cap-and-trade schemes with a carbon tax or feed-in tariff, in ways that limit fluctuations in the carbon price.  In this way the effects of adding a carbon tax to an existing cap-and-trade system can be assessed in terms of its impact on market carbon prices.

Avoiding policy combinations that destabilise carbon prices will be crucial if trading schemes are to be successful, and features such as a carbon price floor or price safety valves can be shown to have an impact on the effectiveness of a policy using an economical rationale, but must be designed into a coherent policy framework to avoid potential incompatibilities emerging from elsewhere in the application of related policy. 

The difficulty of developing an effective policy mix should not be a reason for inaction because not having effective incentives is the problem we face.  Instead policy makers have an opportunity for improving the existing policy mix, but must do so by understanding which types of incentive work and why, and tailoring the policy mix in a coherent way to give clear signals to business and consumers.

(a more detailed analysis of the mix of policy instruments will be published in: Haynes, P and Huang, Y. (forthcoming 2011) Designing and Implementing Policy Instruments for Decarbonisation, in Barker, T. and Crawford-Brown, D. (eds.) Decarbonising the Global Economy Cambridge: Cambridge University Press)