Economists and experts alike argue that climate change is the greatest market failure. This is majorly due to the businesses’ inability to account for the costs of their emissions, which impact society negatively. But how did climate change become a market failure and what are its consequences if left unchecked?
Climate change as a market failure
A market failure causes an inefficient distribution of products and services in a free market. It affects the intended outcomes expected by the market and environmental players.
Market failure is a situation in which transactions involving some products in a free market are inefficient. Here, the benefits and costs of the transaction are not limited to the supplier and consumer but spill over to third parties. This spillover leads to an inefficient distribution of resources.
An example is the gas pollution emitted from industrial processes. The individual consumer or producers don’t feel the cost of this pollution but society does. Thus, we say market failure occurs when free-market processes affect societal welfare.
Climate change is the significant changes in weather patterns over a period. A major cause of climate change is the emission of greenhouse gases from various market processes involving the burning of fossil fuels.
Economists believe that climate change is the greatest market failure because it’s the product of multiple market failures that organisations have been unable to account for. The biggest one is the social and environmental cost of releasing greenhouse gases, like carbon dioxide and chlorofluorocarbons that travels to the earth's atmosphere, absorb, and trap heat.
Check out our explanation about Market Failure to learn more about this topic.
A factory releases greenhouse gases into the atmosphere, Pixabay.
Is climate change caused by many market failures?
Climate change is a market failure. Economists like Nicholas Stern have shown that climate change is the result of many other market failures.
One of these market failures is the greenhouse - gas externality. Due to our economic activities, we release many greenhouse gases like CO2 (carbon dioxide), CH4 (methane), and N2O (nitrous oxide), into our atmosphere. The emission of these gases doesn’t affect the firms that produce them, but they have a negative effect on society. These societal effects of greenhouse gases are called negative externalities.
Externalities occur when organisations make decisions that only consider their costs and profit, but not the effects of producing their goods and services on society.
When a business doesn’t consider the effect of its activities on society, society has to bear the cost of the business emissions. You can see this in Figure 1.
Figure 1. Negative externalities, StudySmarter Originals
In Figure 1 above, we can see that the social costs are greater than the private costs. This is true because when a firm produces a good or service that emits greenhouse gases, the social costs to the environment and third parties is greater than the production costs.
Causes and consequences of climate change
Due to a constant drive towards innovation and beating their competition, organisations look for ways to make production processes easier and provide unique products to consumers. This innovative evolution has led them to burn fossil fuels during their production processes. In turn, it has also led consumers to contaminate the environment when consuming certain products. The gases released during the burning of these fossil fuels are mostly greenhouse gases which lead to climate change.
Climate change is caused by multiple market failures:
The consequences of climate change as market failure are hard to predict over the long term. We can predict, however, that climate change will be mostly experienced by underdeveloped nations and future generations.
These consequences include:
Possible solutions to climate change as a market failure
One solution that economists have suggested is government intervention by introducing policies that increase the cost of the processes that release greenhouse gases into the environment.
In a move to avoid biases, the cost of carbon release during industrial or household processes should be uniform. This can be achieved through the introduction of carbon emission taxes or emissions trading schemes.1
Also, governments should stimulate a drive towards low-carbon releasing innovations such as the production of electric vehicles. This can be achieved by providing subsidies and incentives to bodies that are investing in these innovations.
Policy and government support should aim towards the generation of new networks. An example of this is the creation of smart electric grids for electric cars and charging spots to promote the usage and development of these technologies.
Businesses should also adopt the green energy approach. This involves the use of renewable energy sources and green-certified materials for their production processes.
Green certification are used to indicate environmentally friendly products or processes.
In conclusion, though the consequences of climate change as market failure are hard to predict over the long term, the negative externalities it currently has on the immediate environment are hard to ignore. Governments need to put regulations in place to check businesses activities that have a direct impact on society and to safeguard the environment.
Market Failure Climate Change - Key takeaways
Sources
1. Clara Changxin Fang. Sustainability (Aug 2018) https://www.liebertpub.com/doi/full/10.1089/sus.2018.0011
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