The Green Paradox: A Supply-Side Approach to Global Warming

When one thinks about what to do to combat climate change, the answer seems obvious: take steps to reduce the use of fossil carbon. Improve engine efficiency, switch to alternative sources of electricity and dilute motor fuels with bioethanol. And this is what the European Union appears to be doing; Japan is taking the same path to a large degree and North America rather less. But Hans-Werner Sinn is convinced that there is a paradoxical flaw in this approach to demand management.

From the point of view of energy producers, the knowledge that the international policy commitment is to use ever less fossil fuel generates a contrary incentive. Producers will want to sell as much as they can now while demand is strong and prices are high, rather than wait until demand and prices drop. Thus, when many countries signed up to the Kyoto Protocol to limit demand, and apparently anticipated demand shrinking even further in the future, fossil-fuel exporters responded by accepting slightly lower prices and selling strongly to those outside the protocol. This might even mean that more carbon enters the atmosphere right now than would have been introduced without the agreement. This is Sinn's green paradox: measures aimed at reducing atmospheric carbon may generate an incentive to burn more fossil fuel in the short term.

Sinn presents his argument with apparently implacable logic. He is alert to the societal dangers of climate change, but his reasoning has appealed to so-called climate sceptics because he offers good grounds for being sceptical about the steps currently being taken. He points out that the Kyoto Protocol has not led to a fall in the overall worldwide use of fossil fuel. Moreover, the measures taken by EU governments to encourage alternative fuels have cost Europeans money that has in effect subsidised the cost of fossil fuels in China, the US and the developing world.

The aim of Sinn's book is to shift our attention to the supply side. Sinn emphasises that the supply side is already highly "rationalised" because big oil and gas producers hire sophisticated consultants to work out the best way of extracting value from their finite resources. In economic theory, Hotelling's rule - nothing to do with hotels - governs how the rational actor will choose between maintaining wealth underground and extracting resources to turn them into money. Sinn notes that in practice there is already a bias towards short-term extraction compared with the ideal situation. This is both because the environmental harms associated with fossil fuels are not reflected in the price they command and because many oil-rich governments fear that someone else may expropriate their resources in the future (through invasion or putsch) so they have an incentive to cash in now. Policies to reduce progressively the use of fossil fuels reinforce this bias further.

These arguments are well made, even if the book appears to have been oriented a little too firmly to a US audience that must be reminded frequently that climate change is real. As a result, more than half the book is devoted to what is wrong with demand-side approaches, and only the final two chapters deal with the laws of supply. Still, the supply side is a fascinating place to look, even if it ultimately offers few comforts. For example, it turns out that fossil-fuel extraction is so enormously profitable that oil and gas prices would have to fall by more than 80 per cent to make extraction uneconomic. Accordingly, alternative energy will have to be extraordinarily cheap before fossil fuels are priced out of the market. Sinn offers no simple solutions but alerts us effectively to the supply side of the equation.