How the free market protects the planet better than regulations

Ignacio de la Torre. Professor. IE Business School

18 December 2013

Although the US still hasn’t signed up to the Kyoto Protocol it is performing better than Europe in terms of CO2 emissions, thanks to the free market model it applies to companies prospecting for natural resources.

In spite of the fact that the USA did not sign the Kyoto Protocol and the EU did, US CO2 emissions have performed far better than Europe’s. The reason for this is the shale gas revolution, which has permitted the US to replace the use of carbon with that of gas, which produces approximately half the amount of contamination that carbon does in order to produce energy. Excess carbon has been channeled to Europe, which is still having to cope with higher energy costs than those in the US.  The result is that in spite of voluntarily signing the Kyoto Protocol, we have performed worse than our friends in the US. Meanwhile, emerging economies are investing huge amounts of money in subsidizing petrol, a populist measure which ironically is making levels of C02 emissions considerably worse.

There are basically three possible solutions to a problem like this: regulate it, ban it, or use the market to mitigate it.   Occasionally state intervention is the only way. When Cambodia was abandoned by the Khmer Rouge, for example, a liberal described how some cars drove on the left and some on the right, and that despite his liberal tendencies, he felt that it made a lot of sense for the state to intervene to force all the population to drive on the same side of the road.

The key is to find the optimum point of intervention, and to ensure that whoever oversees the process is in favor of keeping regulatory intervention to a minimum.   When it comes to fighting climate change, although there are factors that permit us to say that negative externalities make it necessary to intervene, the US can teach us another lesson, given that European intervention has proven to be inefficient on every level.  In the US, the land owner can run the risk of financing prospecting to see if natural resources can be found there, because if they appear, they belong to the landowner.  In Europe, regulations are contrived to ensure that any natural resources discovered end up largely in the hands of the state.  The logical consequence is that Americans have been far swifter to mobilize technology and their own resources in the search for natural gas. The result of replacing carbon with gas is less contamination and cheaper energy.  Hence, in spite of full awareness and regulatory tussles, carbon was behind 30% of world energy production in 2012, the highest level since 1969.

Although the EU continues to be interventionist in other fields, such as its ban on exporting oil, and even making the export of gas difficult, the balance of its regulation is favorable where climate change is concerned.  In Europe, political intervention in the world of renewable energy has been nothing short of tragicomic. Spain approved the first regulation of renewable energies during the second mandate of Aznar, a day after the terrorist attack of March 11, with what was effectively an interim government.  The regulation worsened in relative terms with Zapatero’s first legislature, and the resulting monstrosity was the same old tariff deficit and the enormous associated debt. The unenlightened despotism of both parties produced a surrealist regulatory regime that we are all paying for now.

As Dr. Lomborg stated in Wall Street Journal, Spain currently spends 1% of its GDP (some 10 billion euros out of a total of 60 billion deployed on subsidies for renewable energies) on solar and wind power, which is more than it spends on higher education. By spending this amount on renewable energy, by the end of last century Spain had managed to delay the impact of global warming by just 61 hours in total, according to a study carried out by Yale University. Moreover, the governments of many emerging economies apply enormous subsidies to petrol. One particularly paradigmatic case is that of Venezuela, which spends 22 billion dollars a year on subsidizing petrol, which is double the amount it spends on healthcare. Iran spends 82 billion dollars on petrol subsidies, Saudi Arabia 61,000 billion, and Russia, India and China spend between 30 and 40 billion dollars each.  In other words, they buy political stability in exchange for subsidized CO2 emissions.

During the economic crisis that struck the Roman Empire in the third century, inflation was an enormous problem. Emperor Dioclecianus tried to tackle it using regulation: he prohibited inflation by law by fixing prices. In spite of the futility of said measure, similar laws have been stupidly enshrined down through history, the French Revolution being one such example, and more recently the unbelievable country of Venezuela.  The result is always the same: the market determines the level of inflation by balancing supply and demand, and interventionist measures limit supply, which brings about inflationary pressure and ends up, paradoxically, harming the poorest segment of the population.

Today the world is facing the problem of climate change (the fight against inflation will no doubt start in a year’s time). There are two possible postures   the powers that be can take, either ban it and regulate it, or mitigate its effects using the free market mechanism.

Time will soon put the effectiveness of such contradictory solutions in their place. 




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