Markets are the path to climate optimism
The media climate narrative has become quite pessimistic of late: congressional action underwhelmed climate movement leaders; executive pathways look bleaker than ever; and another meeting of the international Conference of the Parties failed to instill confidence in meeting aggressive global temperature targets. But if we pause to reevaluate domestic emissions trends and market drivers, there’s a compelling case for climate optimism.
Market forces and state policies have resulted in the United States exceeding the emissions targets of the most ambitious federal climate regulations to gain traction. This unexpected progress says two things: 1) central fiat like regulation and huge public spending has been a poor indicator of climate progress; and 2) decentralized climate leadership has been more productive than centralized leadership—and the gap between the two is poised to accelerate. A decentralized strategy provides tremendous opportunities for bipartisanship as such policies can align conservative principles with the emissions targets sought by progressives. This suggests that the most productive theory of change on climate would prioritize improving state policy and unleashing market forces, rather than restricting them.
Voluntary Action Outperforms Compulsory Interventions
Evidence shows that decentralized actions have driven emissions reductions beyond the expectations of federal fiat. In 2020, U.S. carbon dioxide emissions were 24 percent below 2005 levels. This exceeded the target in the 2009 Waxman-Markey bill, often considered the biggest climate package to pass either Congressional chamber. The power sector led the way with a 33 percent cut in emissions relative to 2005 levels, a target reached a decade earlier than the most ambitious federal regulation—President Barack Obama’s Clean Power Plan—anticipated. The trend in emissions decline cannot be explained solely by central policy; private actors and sub-national policy catalyze these declines.
The decentralized drivers of emissions reductions are clear: state policy and market forces, with the latter exploding in recent years. The most prominent state policy has been renewable portfolio standards (RPS). RPS drove roughly half of renewables growth since 2000, but fell precipitously in recent years. RPS accounts for just one-third of renewable growth projections over the next decade. In other words, even the most impactful compulsory intervention has been surpassed by the appetite of market forces to decarbonize. This profound development materialized during the most politically inauspicious time.
Counterintuitively, domestic climate progress blossomed during the only presidential administration in decades to believe that climate change is not a problem. Although President Donald J. Trump was wrong on climate science, he may have provided the most important natural experiment on the future of decarbonization. In the absence of federal government coercion or central planning, the private sector and civil society seized the climate leadership mantle. The result was greater emissions reductions than aspired to by the regulatory agenda of Trump’s predecessor.
By the end of Trump’s tenure, the private sector’s environmental appetite ballooned to $17 trillion— one-third of domestic assets under management. Even Trump’s preferred fuel—coal—was in sharp decline as market forces displaced its role in the energy industry while capital markets began shutting off access to conventional capital over environmental concerns. This underscored the rise of markets expressing the environmental intrinsic values of investors, consumers and employees, while business leadership began responding to internal and external moral pressures that materially affected bottom lines. For example, credit rating agencies began building environmental reputation parameters into estimates of default risk. As Trump pulled the United States out of the Paris Agreement, businesses and civil society responded by pledging their own commitments through efforts like We Are Still In to “fill the vacuum of leadership.”
Voluntary, decentralized forces are fueling the bulk of emissions reductions today—and there is far greater potential tomorrow. A tidal wave of corporate clean energy investment is underway and a new UBS survey found climate change is more important to investors than ever. Most expect sustainable investing to match or exceed traditional investment vehicles. Importantly, this is happening at the speed of business, not government. Corporate leadership is especially advantageous since it transcends political boundaries, with the potential to drive global emissions reductions that have thus far eluded the negotiated agreements of central governments.
Policy Implications
If the private sector is sufficiently motivated, it may seem there is little cause for policy reform. That might be true if emission profiles were perfectly transparent; transactions among market participants were frictionless; and existing policies did not impede the clean transition. But none of this holds true. Further, we do not yet know the extent to which markets are “internalizing” environmental externalities like greenhouse gases.
At this stage, we know that the private appetite for decarbonization—though it faces significant obstacles—is robust. Emissions information deficiencies impede the accuracy of measurements and reporting, which is particularly challenging for indirect emissions in complex supply chains and dynamic markets like electricity. Greenwashing remains commonplace and the metrics for corporate sustainability are a mess. None of this is insurmountable, especially with the potential of digital platforms to bolster climate transparency. Markets are self-correcting some of this, but such issues may justify a limited role for government to reduce information deficiencies, fraud and transactions costs for environmental attributes.
Existing policies create massive roadblocks to clean capital investment. These range from barriers to entry for clean resources like tax code inefficiencies to barriers to exit like subsidies for incumbent assets. But the single greatest impediment to domestic climate progress this decade is regulatory barriers. There are dozens of discrete regulatory barriers, but even a small sample highlights this point:
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Zero carbon resources comprise 90 percent of new projects in grid interconnection processes, totaling about three-quarters of the capacity of all existing power plants. Regulatory delays may slow a project by years, and only about one quarter of projects reach completion.
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Transmission development is vital to the clean transition but regulatory processes stifle development, delay “surviving” projects by years and disadvantage low-cost advanced technologies. All problems stem from regulatory defects including planning, cost allocation, permitting and siting, as there is “no lack of private capital, private sector interest, or private sector ability to build transmission.”
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Inefficient environmental permitting now afflicts clean projects the most, paradoxically increasing emissions as most new projects are cleaner than legacy assets they displace. For example, the National Environmental Policy Act affects more clean and conservation projects (42 percent) than fossil projects (15 percent) at the Department of Energy.
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The “soft costs” of many clean technologies exceed their “hard costs” in large part due to artificial costs imposed by regulation and taxes. Consider that solar costs half of what it does in the United States in countries with simple and automated building permits.
In this sense, many forms of “climate policy” are not climate policy at all, but a variety of good economic policy with climate co-benefits. Such “dual justification” presents a basis for a reform strategy that simultaneously bolsters economic growth and improves the health of our climate. This aligns with conservative economic philosophy and could establish criteria for federal bipartisanship and a red state reform guide. Blue states could also benefit by revising green industrial policies to focus on fungible paths to emissions reductions.
Reforms that enable private decarbonization trailblazers can expedite emissions reduction pathways for actors who are less motivated or under-financed. Corporate sustainability leaders are pushing for emissions transparency; the proliferation of competitive energy mechanisms; removal of regulatory impediments; and emissions-based reforms to generic clean energy promotion policies. For example, overhauling grid interconnection; opening energy markets to competition from new entrants; expediting clean project permitting and siting; and reforming RPS to make renewable energy credits emissions weighted all would boost innovation, lower costs and improve environmental outcomes.
Aside from clearing the path for market forces, there is another appropriate role for limited central government. This includes making economical investments that the private sector will not—namely upstream research and development (R&D). The federal government should lead a retool of international climate agreements, addressing compliance limitations; securing concessions from developing countries that comprise the bulk of emissions; enabling consistent emissions and carbon offset frameworks across jurisdictions; and establishing performance-based benchmarks that credit emissions progress by centralized and decentralized actors alike. Such an approach is more likely to secure bipartisan buy-in, which is imperative for the United States to be taken seriously in international climate negotiations.
Revisiting the Climate Theory of Change
Despite staggering market developments, the apparent theory of change behind domestic decarbonization has been slow to move past fiat strategies. Part of this can be chalked up to a central planning fallacy. That is, an overconfidence in knowing what the future holds and the best way to organize economic activity. For example, decades of failed energy policies have their roots in policymakers placing too much confidence in notoriously inaccurate forecasts. In recent years, many climate strategies have been premised on inaccurate expectations of the future.
The fallacy manifests in the bias of studies informing climate strategy, which routinely overestimate the performance of policy interventions and underestimate unconstrained markets. The inability of past studies to anticipate shifts in market forces caused the inflated emissions baselines in Waxman-Markey and the Clean Power Plan, which gave the impression that such policies held greater climate value than was true in hindsight. Today’s emissions projections retain a similar form of bias. The latest long-term emissions outlook by the Energy Information Administration (EIA) projects a 5 percent increase in U.S. energy-related carbon dioxide emissions by 2050 relative to 2020. This may seem bleak if not for factoring in EIA’s historic forecasting inaccuracies like under-projecting growth in clean resources. Their current fossil projections are also far above the outlook of investors with skin in the game.
Such bias was also evident in studies that influenced recent Congressional packages, which projected that federal interventions would have a large impact on emissions. This underscores at least three discrepancies between the models and reality: 1) simulations typically presumed that firms select least-cost technology, when instead markets exhibit a clear willingness to pay a clean premium; 2) models understated or ignored artificial barriers to new investment; and 3) estimates understated or ignored implementation flaws of policy interventions, such as the massive risk of gaming under the Clean Electricity Performance Program. Generally, the results overstated the emission effects of fossil fuel regulation and clean standards or subsidization, while ignoring policy reforms that would address the binding constraints of emissions reductions, especially barriers to capital stock turnover.
This may explain why practitioners—especially those who deploy and manage capital—are asking why Congressional climate spending packages would mostly pay for what the private sector already wants to finance but struggle to build in this regulatory environment. The gulf between practitioners’ reality and academic simulations is widening. The former reveals optimism for private-led decarbonization and the latter implies emissions are tied to fiat.
The time has come to recalibrate emissions models and climate strategy. Modelers need to represent the real-world preferences of market participants, limitations of new policy implementation and clean investment constraints imposed by existing policy in order to accurately inform policymaking. There should be no doubt among climate scholars that the private sector is equal to—if not greater than—policy interventions in defining emission trajectories. Climate strategists would be wise to prioritize reforms that accelerate drivers of voluntary emissions cuts and improve state policy, R&D programs and strategic international cooperation.
The last decade makes clear that we should have more confidence in healthy markets than overconfident central plans. The judgment of the many, not the few, is poised to unleash a new era of climate optimism.
Image credit: sbw19
