HM Green Investment Bank?

Watching the Queen's Speech this morning on the news was uneventful. It's written by "her government" (i.e. the conservative coalition), and she's not allowed to say anything that they don't approve beforehand.

HM Queen Elizabeth II of the Very Serious People (source)

The beginning of the speech was annoyingly predictable.  She affirmed that her government is committed to austerity-driven deficit reduction, which has worked swimmingly already. One member of the House of Commons who refused to go to the speech rightly pointed out that the UK has just entered into a double dip recession.

But I'll leave that discussion to the blogosphere's dark wizards macroeconomists. What really piqued my interest was the Queen's announcement that her government will be forming a Green Investment Bank.

It's likely that an emissions trading scheme, maybe even an international market, would be at the core of a Green Investment Bank (I'll refer to this as GIB for the rest of this post). An ETS would generate capital gains that, in an ideal world, the GIB would funnel toward "low-carbon growth" in developing countries, which might include infrastructure modernization and R&D spending. An explanation of how this might work is presented here. I've sort of been expecting this. A few economists have been going on about it for a while, and Nicholas Stern mentioned in last semester in one (or more) of his speeches at LSE.

In theory, I guess, that's all well and good, but it's important to take a step back and ask ourselves if we really want to put an investment bank in charge of something as important as greenhouse gas (GHG) emissions reductions. Investment banks are pros at figuring out how to bend the rules, or when it's more profitable to break the rules and pay a fine. In a well-established market (blah blah with some other assumptions blah blah), that would be fine. The penalty imposed on a polluter who doesn't sufficiently abate will offset the social costs of the pollution. BAM. Everyone's happy (and no worse off than they were before). Efficiency achieved!

According to Bloomberg, polar bear futures are at an all time low.
(picture cred)

But, carbon markets are a lot trickier than most markets; a classic and appropriate discussion of this is Hardin's "Tragedy of the Commons," although if you read it, you should only pay attention to parts of it as he's kind of wacky about population control and stuff.

The underlying premise of carbon markets, and the rationale for a GIB, is that climate change will be real, real bad if we don't do something about it soon, and fast. Indeed, that's one of the main points of the Stern Review (written by Prof. Lord Stern, who I suspect will lead this bank, but maybe that's a premature assumption). However, it's generally accepted that market based instruments (which, intuitively, would form the bulk of a GIB's operations) are more suited to meet economic efficiency criteria, and not necessarily any environmental standards. If there is some emissions threshold that society can't afford to cross, a top-down (alternatively, a command-and-control) approach is superior to market based instruments. Think about a carbon tax. If, somehow, you have all the necessary information and set a tax to achieve a socially optimal level of abatement, then the abatement target will be achieved at least cost, but only in a perfectly functioning market.  Even minor distortions like other taxes or subsidies (which are exacerbated by institutional problems like corruption and monitoring and compliance issues) can make it cheaper for polluters to pay a tax than abate. Efficiency achieved?

We can look at this from a different angle.  The commoditization of nature is shameful, but when it comes to analyzing the costs and benefits of carbon markets or emissions standards or whatever, that commoditization extends to humans.  A friend of mine suggested a headline we might see in the FT in a few years:

Goldman Sachs posts record profits as Bangladesh sinks into the ocean

Obviously, that's a stretch (I hope), but it's a useful hyperbole for the way banks work. Since they operate in monetary units, they have to "think" in monetary units.  People become dots on a graph, aggregated into a gross (in both senses of that word) VSL term in some wonky cost-benefit equation. You can't blame a bank, though, for doing its job, so if people expect a specific environmental outcome, as opposed to a financial one, it's probably best not to rely on a gaggle of money-hungry financiers, even if some of the people working there are "nice".

To summarize, it's unwise to rely on financial institutions to achieve environmental goals, and since the rationale for swift action within international markets rests on the assumption of impending catastrophic climate change, it seems a bit hypocritical, especially for so many esteemed economists, to ignore the inefficiencies and other weaknesses of carbon markets, despite their theoretical simplicity. And if that's not reason enough to be skeptical of a GIB, the recent (and ongoing) financial crisis should have made us exceedingly wary of the role of investment banks in society, especially when we're trying to make it better.