Published in Green Alliance pamphlet Is there more to life than trading? Seven views on designing a low carbon future, in 2008.

Climate change is the defining issue of the twenty first century. If we find the solutions to the challenges it presents there is some prospect that the nine billion people with whom we will be sharing the planet can have secure and prosperous lives. If we do not find the solutions, then the prospect of prosperity and security for all of us will become increasingly remote.

Europe’s political leaders have defined a two degrees rise in temperature as the threshold of dangerous climate change. Jim Hansen, the doyen of climate scientists, has recently argued that even that might be too high for safety. As things stand, the odds are at best about even that we can stay below this threshold. Unless global greenhouse gas emissions peak within the next decade or so and then decline very rapidly, those odds will worsen considerably.

Climate change is a bad problem that is getting worse but as things stand it remains manageable. If we continue as we are, it will very soon become unmanageable. To succeed, we must make the global energy system carbon neutral by about the middle of the century. This will be a massive task. It will require co-ordinated action on a scale never yet attempted by mankind, making the Apollo or Manhattan Projects look trivial by comparison.

But we start with an advantage. The technologies to solve this problem are available or within reach today. And we know that we can afford to deploy them. Over the next 25 years shifting the world’s energy system from carbon intensive to carbon neutral will cost the whole world a lot less than the $600 billion annually that the Iraq war has cost the United States alone.

What we do not know is whether we can agree to spend the money to deploy the low carbon energy technologies that are necessary. That is down to the politics. For this generation of politicians to fail at a task that is within the envelope of our technical and economic competence to solve would be a betrayal of the future unparalleled in history.

One of the many factors making climate change a uniquely difficult problem is the ticking clock, the two parts per million increase in the concentration of greenhouse gases in the atmosphere each year. That clock is ticking faster. There is no rewind button on the climate. We cannot go back and correct mistakes. Once the extra carbon is in the atmosphere we must live with whatever climate it produces whether we like it or not.

This means that we cannot afford policy failure. With most issues, especially those as complex and politically difficult as climate change, we learn empirically, by trial and error. Policy options are implemented, policy failures identified and new policy options developed. Progress is incremental.

If we make the wrong policy decisions in the next few years, it will be impossible to keep the eventual rise in global temperatures below a devastatingly dangerous three degrees, let alone the two degrees Europe’s leaders think is already risky. Dealing successfully with climate change requires transformational change and policies that will produce it.

The principal policy tools available to politicians to tackle climate change are few in number although there is an infinite variety of ways in which they can be designed and combined. Essentially, they boil down to three: sermons, regulations and taxes. Sermons, technically voluntary measures, are the tool of first choice for almost any environmental problem. Climate change is no exception. But long experience in many fields has shown they don’t work.

There is a broad agreement among policymakers that establishing a price for carbon is essential for making the transition to a low carbon economy. This can be done directly, by taxing carbon, or indirectly, by establishing through regulation a limit to the total amount of carbon allowed to be emitted (a cap) and then allocating rights to emit carbon under the cap to carbon emitting businesses, either by giving away or selling those rights. Businesses with more emissions rights than they need are allowed to trade them with those who do not have enough, thus creating a cap and trade policy.

For many people, carbon prices are an alternative to regulation. This is a confusion. It is only an alternative if the price is set by a tax in which case it is a straightforward impost by government. To create a carbon market price by a cap and trade policy, a set of regulations must first be legislated both to establish the cap and then to allocate the emission rights and the terms under which they may be traded.

The theory is that a carbon price, however it is set, sends a signal to consumers and investors to alter their behaviour so as to emit less carbon. This is seen by many policy-makers as a more efficient means of driving carbon out of the economy than simply setting technical standards to specify the amount of carbon goods, such as vehicles, or processes such as electricity generation or metal smelting, can emit.

If there is some uncertainty as to whether carbon prices really will produce transformational change in consumer and investor behaviour as rapidly as required, there is no doubt at all that they will generate massive revenue flows. The fate of the revenues arising from governments setting carbon taxes or selling emission rights is an under-discussed issue of central importance in climate change policy.

These revenues can either flow into the general pool of government revenues or into financing the adoption of the carbon neutral energy technologies necessary to preserve climate security. In Britain, the Treasury has already set its face firmly against using them to accelerate the transition to a low carbon economy. It believes that the carbon price signal alone will be enough to drive the necessary technology deployment.

There are a number of very good reasons for supposing that its faith in the magic of markets is misplaced. At best, a carbon price will make a difference at the margins. Price signals are helpful if you are making incremental decisions. However, incremental decisions will not stabilize the climate in the time we have available. Furthermore, there are many price signals in a market place and not all of them are going in the same direction. The fuel duty escalator illustrates this difficulty perfectly. As you may remember, it raised the tax on petrol six percent in real terms each year. But while the tax was going up, the real cost of driving fell for other reasons and real disposable incomes rose over forty percent. Not surprisingly, driving behaviour did not change very much. The policy did however raise a very large amount of revenue for the government, all of which went into the general revenue pool.

If prices really did work as the magic theorists believe, you would expect that a rise in the price of oil from under $20 a barrel at the beginning of the century to over $100 today would have stimulated a huge rush to decarbonise the economy. What has actually happened is that it has stimulated massive investment in exploiting tar sands and oil shales, in converting coal to liquids and in developing environmentally destructive biofuels.

The truth is that markets work much better in economic models than they do in the real world. In the models, investors behave as you assume they will. In the real world, they are much more inventive. Generally, they try hard to find new ways to carry on doing exactly what they were doing before. Economic models are useful tools to help you think about the world. They are very dangerous alternatives to doing that thinking.

Nothing illustrates the incoherence in market distorted thinking about climate change better than a deep contradiction in this government’s policy. Such is its belief in the power of markets that in the same energy white paper we are told that we must liberalise energy markets as quickly as possible to drive energy prices down for competitiveness reasons and that we must drive the price of carbon up aggressively for climate reasons.

Nowhere are we told how the left hand pushing energy prices down at the same time as the right hand is pushing them up leads you to anywhere other than the land of the deeply confused.

There are many other unsolved problems with a market-led climate policy. Markets, even when mature, are by definition volatile and prices in them difficult to predict. This discourages precisely the kind of high risk, long-life investments in the step change technology transition we need to stabilise the climate. Carbon markets are far from mature and thus even more volatile.

Without a global price for carbon, there will be competitiveness risks for those economies that do put a price on carbon. But to get a global price for carbon we have to agree a global cap on emissions and a mechanism for allocating the permits under that cap.

You have only to have read the papers recently to know what an impossible dream that is. America will not agree until the Chinese agree and the Chinese will not agree unless the Americans act first. And in any case, if they were to agree, it would be to the least they thought they could get away with.

The widely held belief that building carbon markets is the best policy for tackling climate change is the triumph – and tragedy – of theory. Of course they have a role to play but it is currently much smaller than is believed and much too small to solve the problem.

In practise, three other policy tools are much more important and reliable if we are to mobilise the tremendous capacities of the business community in time to make a difference.

The first is to set the right technical standards to drive the technology deployments we need. A carbon neutral energy system will be much more electricity dependent as all of the gas will have to be driven out of domestic and much commercial heating and cooling. Coal will be the preferred fuel for most of this electricity generation. We need to put in place now the regulations necessary for all new fossil fuelled stations to be carbon neutral and for older stations to be progressively brought under this regime by 2030.

Britain is about to embark on a massive programme to build some three million houses in the coming years. It is committed to making these houses green. One way to ensure that this happens is to use a regulation to prevent the supply of gas to those houses. If we do not do so now we will only have to pay a lot more later to remove that gas if we are to achieve a carbon neutral energy system by mid-century.

The second is to structure the regulation of energy markets so as to allow utilities to pass through the additional capital and operational costs of making the low carbon transition to the whole of the customer base. This would spread the costs so thinly as to make them much more bearable than the current oil price rise we have absorbed with little difficulty. But to do this we must have reliable discovery of the costs of deploying the necessary technology.

Achieving this cost discovery makes the EU’s proposed programme of 12 demonstration plants by 2015 for coalfired generation with carbon capture and storage an urgent priority. This programme has been proposed by the Commission but it is not funded. Its total cost might run to some six billion euros. This sounds like a lot of money until you realise that the windfall profits to the European electricity utilities from the second phase of the carbon trading system might amount to some 54 billion euros.

The third is to spend public money to buy the public good of a stable climate by paying to accelerate the rate at which low carbon technologies are deployed thus driving down their costs more rapidly than markets alone could ever accomplish. This will be particularly necessary to deploy the massive infrastructure to transport, compress and manage the carbon we must store from coal-fi red power stations. We will similarly need to invest in the infrastructure necessary to fully incorporate renewable technologies such as wind and solar into the electricity system.

This infrastructure is the equivalent in the competitive low carbon economy of the twenty first century to the motorway network in the twentieth century. No one would ever have suggested that road pricing would have built the motorway network. It is even less likely that a carbon price alone will build the infrastructure for a carbon neutral energy system.

Faced with this challenge, many politicians will be tempted to put this issue in the ‘too difficult’ box. They should have more faith, both in themselves and the public they lead. To win the cold war we spent billions of pounds each year to build weapons systems we hoped never to use. When they became obsolete, we spent more billions to build new weapons systems we hoped never to use. We did this because we had clear-eyed and determined political leadership.

Climate change threatens to undermine the prosperity and security of 60 million Britons a lot more certainly than did the threat of the cold war turning hot. But what is in question is whether we have the clear-eyed and determined political leadership to deploy the resources we know we have to win this battle.