Personal Carbon Trading: The Economic Fundamentals

Climate targets, such as those set out under the Paris Agreement, require simultaneous action at local levels, supported by national and global initiatives and regulations. A dominant issue with addressing global warming is the lack of individual accountability for the damage GHG emissions cause – there is a ‘free rider’ problem. Meeting ambitious targets can be helped by mechanisms that address this accountability issue, such as personal carbon trading.

There are, of course, many hurdles to get local people and governments on board and the economics is simplified here to illustrate the points. However, the theoretical argument for a carbon accounts framework that allows trading between those with ‘high’ footprints and ‘low’ footprints, whilst incentivising all to lower their emissions, is convincing.

Externality

Climate change is already having an impact, much of which is increasingly irreversible. The IPCC stated in their 2023 report^[1]The United Nations Intergovernmental Panel on Climate Change (IPCC)’s sixth assessment review of the current state of the climate 2023 report covers the work of hundreds of scientists that climate change has already ‘led to widespread adverse impacts and related losses and damages to nature and people. Vulnerable communities who have historically contributed the least to current climate change are disproportionately affected’.

Externalities occur when production or consumption impacts third parties not directly related to the transaction. Externalities can either be positive or negative. For example, just driving into a city centre will cause external costs of more pollution and congestion to those living in the city.

However, most of the impacts of today’s carbon emissions will fall in the future, perhaps even most significantly, the impact and loss will be felt most by those not even born yet (or those who are too young today to influence emissions). The potential scale of these impacts, if actions are not taken today, is worrying. The solution: resolving the negative externality now, requires individuals to consider the impact their actions will have not only across countries, communities and cultures, but also temporally, on future populations.  

Most of the impacts of today’s carbon emissions will fall in the future. Today’s young people and especially those not even born yet will feel the loss most, even if CO₂ emissions were completely halted immediately. The potential scale of these impacts, if little action is taken today, is vast. The simple but challenging economic solution is to resolve the negative externality, requiring individuals today to consider the impact their actions will have not only across countries, communities and cultures, but also temporally, on people in future.

Personal carbon trading will internalise this – creating accountability today for the damage caused in the future. It brings the Marginal Private Benefit (MPB) of emissions in line with the Marginal Social Benefit (MSB). As the MPB is greater than the MSB, by fixing the quantity of emissions, the level of emissions is lowered to a given level that achieves this desired ‘internalisation’.

By having a fixed ceiling of aggregate emissions, and an initial carbon quota for each person, those with lower carbon footprints can sell their excess emissions to those willing to pay to emit more. Whilst this incentivises everyone to reduce their emissions, it allows those who place more value on activities with higher footprints to maintain their lifestyle, but at a price. Rather than banning damaging activities through strict legislation, this will reduce emissions while maintaining individual flexibility and choice.

Carbon Price

Establishing a carbon price is a challenge that policymakers, businesses and consumers face – how much should we pay to emit GHGs? In real life contexts this might be asked in a number of ways.

• What tax should we pay on fuel?
• How much should international travel cost us?

There are countless examples where moral hazard and information barriers make it difficult to reach the correct answer, i.e. an acceptable price that achieves the required level of emission reduction. This concept has been discussed in detail by economists trying to establish the ‘social cost of carbon’ and has introduced complex discussions about the appropriate discount rate to use in long-term social contexts.

Personal Carbon Trading simplifies the problem. The question we must ask instead is ‘What quantity of emissions is acceptable?’, or in other words, ‘What level of aggregate emissions achieves the Paris Agreement targets?’. From there, we work backwards, determining the initial carbon budget to give each person and then, they can trade.

A carbon price is determined over time, by markets. As people trade, they show their willingness to pay for additional emissions. If, over time, people value emissions higher, demand for emissions will rise, and so the price will increase accordingly. Importantly, all this can happen whilst still controlling total emissions.

Redistributive

Higher income individuals generally emit more than lower income individuals, and it is developed countries, with high average incomes per capita, that have contributed to the bulk of climate change. Simply, they can afford to ‘do’ more. They travel and purchase goods from further afield.

With personal carbon trading, individuals are each initially allocated the same carbon budget. The purchase of emissions from low emitting, lower income individuals by high income individuals might be considered controversial – the idea that the rich can ‘buy’ their way out of being green. However, with an aggregate limit on overall emissions, it will reach a point for most where the price they must pay exceeds the benefit.

An income redistribution will occur where the rich pay the poor for their extra emissions, an added benefit for policymakers looking to reduce income inequality and somewhat correct the inequality between those emitting and those impacted.

Innovation

Innovation that reduces carbon emissions produced by business and industry is encouraged because consumers choose goods and services that have lower emissions in order to lower their own carbon footprints.

For example, imagine two companies – A and B – selling identical goods, let’s say milk. If firm A develops a technology that enables milk to be refrigerated using less energy, the carbon footprint of the milk that firm produces will be lower. So long as any price increase from the cost of developing the technology is less than the applicable carbon emissions price in the market, individuals will choose to purchase from firm A over firm B as the net customer cost is lower for firm A milk than firm B milk.

Behavioural Change

One of the hardest aspects of a green transition is driving behavioural change to create ‘green’ behaviours. A recent quote by the Centre for Climate Change and Social Transformation (CAST)^[2]See the article at Centre for Climate Change and Social Transformation highlighted that ‘government intervention was essential to behaviour change’. Personal Carbon Trading ‘nudges’ individuals into more sustainable lifestyles not only through creating a cost of emissions but also by improving awareness. If individuals become aware of which of their activities have high footprints, they can choose which activities to change to suite their lifestyle, and will also better understand the impact of their actions.

With reduced information barriers, more will become educated on the climate impacts of their own consumption decisions, these ‘nudges’ could lead to a shift in social norms as individuals feel pressurised to reduce their carbon footprint – even if they can buy emissions, they might choose not to, and save their tokens instead – removing them from the market further reducing emissions.

This multiplier effect, where there is more demand for pro-environmental policies and actions in general as a result, is an added benefit compared with legislative or business level interventions that do not address individual consumer behaviours.

This article focuses on the economics rather than the practicality. Personal carbon trading will start at a local level within climate conscious groups, but there is potential for such a scheme to have wider reach. Companies might ask employees to track and trade their carbon emissions for ‘Green Weeks’, for example. The hope is that personal carbon trading reaches local, national and international governmental levels as the economic concept is evidenced and the need for action becomes increasingly clear.

Interested? Read more here.