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Carbon pricing – the cost of the damage caused by climate change – can be an
important part of a broader climate policy that creates incentives to reduce emissions.

The recent economic downturn reduced global greenhouse gas emissions

by a scale larger than that seen during the financial crisis of 2009-10. This
decline was, unfortunately, only temporary, and emissions have already
reached pre-pandemic levels. The threat of climate change persists.

Countries in Asia and the Pacific need to plan their recovery over the
medium and long-term. In this context, it will be important to reduce
emissions cost-effectively while safeguarding government budgets.

Carbon pricing is a central element of the broader climate policy

architecture and, if designed well, is one solution. The cost of the damage
caused by climate change is not typically incorporated into the price of
goods and services, based on the greenhouse gas emissions that they
cause. This market failure results in a lack of incentives to reduce the
emissions that cause climate change. Carbon pricing helps address this
imbalance.

The two-primary carbon-pricing policy instruments are a carbon tax and an

emissions trading system. A carbon tax creates a financial liability for
emitters, giving them incentives to innovate and transit to clean energy and
energy-efficient operations. An emissions trading system typically involves
a government-set cap on permitted greenhouse gas emissions, with the
system leaving the price for emissions to be determined by the market.

The use of carbon pricing in Asia and the Pacific is increasing, with six
carbon pricing initiatives implemented on the national level, consisting of
four domestic emission trading systems and a carbon tax in two
jurisdictions.

Japan imposed a ‘Tax for Climate Change Mitigation’ on the consumption

of fossil fuels and uses the revenue to mitigate energy-related emissions.
Singapore uses a carbon tax for certain industrial facilities and plans to
spend the revenue on carbon-abatement projects. The Republic of Korea
established the region’s first nationwide emissions trading system in 2015,
whereas the People’s Republic of China has, most recently, launched its
national emissions trading system. For countries like Japan, Republic of
Korea, and the People’s Republic of China that have announced net-zero
targets, carbon pricing is expected to be a key element in the climate policy
toolbox to help them achieve their climate ambitions.

Baseline and crediting mechanisms are another form of carbon pricing

where the emission reduction is given a value, compared to the approaches
where there is a cost to emit. The region also has successful experience
participating in baseline and crediting mechanisms, through the Clean
Development Mechanism, associated with the Kyoto Protocol, and the Joint
Crediting Mechanism, initiated by Japan in 2010, which facilitates the
diffusion of advanced low-carbon technologies for mitigating greenhouse
gas emissions. Such mechanisms channel additional finance to low-carbon
investments and could do so also during a recovery phase.

For carbon pricing to be viable in the long-run towards net-

zero emission pathways, there is a need to transform not just
the industrial sectors but also emphasize on research and
development for low carbon technologies as well as incentivize
behavioral change.

In the present context, policymakers may be concerned that deploying

carbon pricing instruments during a recession may choke-off a recovery
and hamper growth. However, they can be designed to align with desired
characteristics of stimulus in developing countries and to not negatively
impact low-carbon businesses.

An effective approach would be to initially implement a policy with a low

price to incentivize the development of much needed policy infrastructure
for carbon pricing instruments. Further, they should be simple to
implement and administer, and they should not just be designed urgently,
but also smoothly and sensibly to foster not just a green recovery, but also
green growth aligned with net-zero emissions.

For example, carbon tax and allowance auctions from emissions trading
systems can help governments collect revenue. A carbon tax clearly
generates revenue for a jurisdiction, but an emissions trading system can
do so as well when the jurisdiction sells some or all emissions permits,
typically through auctions, rather than allocating them freely (which is also
an option and can have advantages early in the lifetime of the emissions
trading system). Further, such a system is countercyclical in that the
demand and price of allowances will go down in a recession, just when
regulated firms need relief.

Making carbon pricing politically viable may also require additional policies
to mitigate the adverse economic and social consequences of carbon
pricing policies. For example, distributing revenues in the form of a fixed
“dividend” to family and individuals generates political support for the
policy.

In cases where carbon pricing initiatives are implemented in parallel to

removing monetary or financial subsidies for carbon intensive products
(such as fossil fuels), there would be a fiscal benefit from reduced
budgetary expenditure. While it would probably be difficult to convert such
a saving stream to a financing instrument, the reduced budgetary burden
could still create fiscal space.

For carbon pricing to be viable in the long-run towards net-zero emission

pathways, there is a need to transform not just the industrial sectors but
also emphasize research and development for low carbon technologies as
well as incentivize behavioral change.

Irrespective of the choice of the carbon pricing instrument and other design
considerations, it is critical to ensure that the price of carbon and the policy
mix are sufficient to address the costs caused by climate change. Building
stakeholder consensus and effective communication are other key
elements.

By doing so, carbon pricing in combination with other policy instruments

can provide motivation to make investment decisions and innovation that
favor low carbon technologies, goods, and services, while helping countries
to not only meet their short-term climate mitigation targets but also long-
term net-zero targets.

Policymakers should not wait – they need to evaluate the options, consult
stakeholders, and do the preparatory work for carbon pricing such that
carbon pricing instruments can be launched once the conditions are right.