How to decarbonize: On decarbonization

Synopsis: Central planning in decarbonization will impose excessive costs upon society.

Introduction

Fossil fuels are so deeply intermixed into the fabric of the modern economy that decarbonization has far-reaching impacts all across society.

In this context, a large-scale change in the mechanisms of production and consumption of energy is required.

This makes Governments an essential entity to the process of decarbonization. State coercion is required in order to reshape the incentives of the polluter.

However, the change will be achieved at the lowest cost to society if it is not centrally planned.

Why the state’s role is essential?

Each person that emits CO₂ is imposing a negative externality upon every other person in the world. This is a market failure. If people are left to themselves, there will be excessive CO₂ in the air.

Hence, the state’s role is essential in addressing this market failure.

What are the drawbacks of a centrally planned decarbonization process?

India has envisaged many initiatives towards decarbonization such as National Solar Mission, the National Hydrogen Mission, the National Electric Mobility Mission Plan, and others.

All the centrally planned programs are accompanied with physical targets established by the Union government, and then command-and-control systems which try to force implementation of the target. The central control increases the cost of decarbonization.

It has to be understood that, owners of energy-intensive factories will put their facilities in locations where energy is cheap. Hence, increasing cost due to centralised planning will drive out companies out of India.

In addition, the central planners are not maximising the objectives of the people, and are held back by low state capacity.

Why locally suitable mechanisms for decarbonization are best suited for India?

At every location in India, there are different efficient mechanisms for decarbonization. As an example, near Mumbai, the step function into the Western Ghats creates natural opportunities for energy storage by pumping water into natural and artificial reservoirs.

In Rajasthan, there is a lot of sunlight. All along the border with Nepal and Bhutan, there are natural opportunities to buy hydel power.

Hydrogen can be made, using solar electricity in the Middle East, and shipped to locations all along the Indian coast.

Why carbon tax is considered the right mechanism to induce local innovative thinking towards decarbonisation?

Carbon tax would drive up the price of fossil fuels. Once this is done, at every location, self-interested private people would look for the most efficient solutions.

This process of discovery will deliver the required decarbonization at the lowest cost to society.

What are the strengths in achieving decarbonization through the price system, backed by a carbon tax?

Firstly, it induces responses on supply as the economics of renewables producers would improve when compared with users of fossil fuels.

Secondly, it induces responses on demand e.g., data centres would move out of India into countries with a low cost of capital and high renewable energy opportunities.

Thirdly, it is a decentralised process i.e., the thinking and problem-solving at each location of the country would be done reflecting local conditions.

Fourthly, it involves constant adaptation based on technical change since both supply and demand will respond to the changing global technological frontier.

Finally, it avoids the difficulties of the state i.e., most of the work is done by private people, who are self-interested, as opposed to the state which has its own objectives and has low capabilities.

What is the way forward?

First, the job of the state is to establish present and future values of the carbon tax, and should decentralise decarbonisation process.

Second, state should review tax rates every five years, to ensure that the overall CO₂ emissions are on the desired path.

Source: This post is based on the article “How to decarbonize” published in Business Standard on 1^st November 2021.