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Aligning incentives with climate action

Environmental action is more likely to succeed if policies can create the right motivation

Business people standing in a desert talking about economic and shareholder value

We are all of course well aware that Earth is halfway to Fucked Town because of climate change and anything short of a cataclysmic shift in how we act is going to be insufficient from making it the whole way. It seems unlikely that we are going to make that shift quickly given the natural algorithm of how the economy works. What I would invite you to think about in this post is the extent to which tweaks to how the economy operates could shift the dial on climate change.

There are several aspects of the modern economy that have contributed to catastrophic climate change - these are well understood and include:

1) Short term thinking - So what if we emit? We've got to turn a profit this quarter.

2) Tragedy of the commons - That guy is catching lots of fish, I want more fish too.

There is no quick fix. What is worth thinking about is how we can tweak this behaviour to maintain economic incentives and align with climate goals (particularly for private companies) so we can turn the ship away from the melting iceberg. Of course, governments and private companies will both have a hand on the steering wheel.

Businesses focus on short-term reward over long-term environmental health

First, let's look at short-term thinking. It is human nature to prioritise what's happening today over what's happening tomorrow. So how can we make tomorrow important? One option is to have an reward scale that creates the right incentives between the short and long term. The scale would deprioritise the short term with limited rewards in favour of long-term performance alleviating the business from having to worry about the next quarter. To align with societal goals the extent to which the scale prioritises the future over the present could be adjusted based on the industry we are talking about to create the right incentives. For example, for the energy renewables sector, the curve may be steeper than for oil (see below for illustrative purposes). Rewards for renewable energy would be made more immediate than for oil - incentivising change and using our desire for short-term reward to do it.

Tragedy of the commons means people are not incentivised to look after shared resources

Now let's consider the tragedy of the commons which essentially states that self-interested individuals are tempted to exploit a common resource to the detriment of society as a whole. The approach to addressing this issue typically involves regulation, special zones, private ownership, or some method of encouraging cooperation. Usually some combination of all these things. Let's use fishing as an example. An idea worth exploring here is using a carryover quota system which increases the allowable catch in conjunction with available fish stocks. Let me walk this through.

Imagine there are 2,000 fish and stocks grow at 10% per year. Jim is allowed to catch 80 fish. Jim decides to only catch 40 meaning fish he has under-caught by 40. The next year fish stocks increase to 2,156 fish (1,960*1.1). Jim as a reward for not meeting quota is allowed to catch an extra 5% on top of the amount he under-caught meaning he can catch 122 fish (80+40*1.05). At the end of year two there are 2,034 fish and Jim has caught a total of 162 fish.

Compared to Jim fishing his quota Jim has caught an extra 2 fish and total fish stocks have increased by 2. Jim now has an incentive to under-catch today so he can catch more in the future. It's a win-win.

Climate change is an outrageously difficult problem. Without a doubt we need to take bolder steps to move towards a more circular economy but there is substantial disagreement about how we do that. Purposeful policy action that aligns closely with how people are incentivised is more likely to be successful and will allow us to make meaningful progress.


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