It seems that the global climate change movement is faced by the problem of collective action: private businesses, by themselves, don’t have enough incentive to do their bit towards making our planet’s ecosystem a more sustainable one. However, if everyone were to collectively strive towards it, climate change and the consequent crises can be avoided.
One of the foundation stones on which economic theory is constructed, is that man is a rational being. Private businesses, or producers, operate in an economy by converting natural resources into various goods and complementary services. Each business will adjust their economic planning in such a manner so as to maximise their profits, given other players’ similarly planned moves, and given the set of laws within which they operate. From Game Theory, it can be seen that the Nash equilibrium will essentially be a point of the tragedy of commons, when the natural resource gets over exploited due to everyone’s rationally selfish motives. This might be an oversimplified example, but it can sufficiently explain the state of our planet.
An effective solution will be one in which we manage to change the supply and demand dynamics of various goods and services in the global economy in such a way that the new Nash equilibrium will be one where the use of fossil fuels is reduced to a level at which the ecosphere again becomes sustainable.
The standard paradigm in the substantial literature[i] available on the nexus of law and economics dictates that policy interventions be based on altering the expected outcome of businesses through the legislative process in such a manner that the current equilibrium becomes unfeasible. Producers would then automatically (by the invisible hand of the market forces) shift to a new equilibrium which, if the intervention is designed appropriately, will be a more sustainable one.
Perhaps then, the answer is in the law, in the international climate change negotiations taking place in the world. At the risk of dismissing this idea too soon, however, the ongoing negotiations taking place between governments of various countries should be looked at with a fair amount of cynicism. The United Nations Framework Convention on Climate Change (UNFCC) was formed in 1992 in Rio de Janeiro. From then till now, almost a quarter century later, it seems as if the governments are still at square one. Bringing 196 countries on the same page is, of course, a difficult task to accomplish, and there is no denying that we are making progress. But history is proof that such efforts can be flimsy at best and revocable at worst.[ii]
Nonetheless, there is hope that the upcoming COP21 in Paris this year will finally set the stage for action against climate change. All the nations will be submitting a set of Intended Nationally Determined Contributions (INDCs), whereby they agree to publicly outline what post-2020 climate actions they intend to take under a new international agreement. While this might bring consensus on action, what about finance? The developing countries want the developed ones to finance clean technology and adaption of infrastructure to the likely damage from climate change. It is easy to see how the problem of collective action still pervades.
With every COP summit, the questions keep changing. The danger, however, keeps becoming graver. It is here that this essay intends to move away from the significance of these negotiations and shed light on an equally important small movement gaining traction on the side. But only after a small theoretical digression.
A Study of the Focal Point Through Game Theory
Most cities of the world today have laws to check rash driving on the roads. Why is it then, in some countries, even after having these laws, over speeding and rash driving is the norm rather than the exception? The case in point is India, where the laws exist, yet, it is common to break signals, not maintain lane traffic, and overtake from the left (India is a right-hand drive country).
In his book, ‘Beyond the Invisible Hand’[iii], the noted Indian economist, Kaushik Basu, writes about the nexus of culture, law and economy, and how the former governs the latter. He puts forth his point by drawing from concepts in behavioural economics and Game Theory.
Basu says that the effectiveness of a law depends on the inherent culture in an economy. The ‘focal point’ for changing the equilibrium is therefore the perception of the law, and not the law itself. The law, after all, is nothing but some ink on paper. It is not surprising that it does not change the ‘game’ that people play. People’s calculation of the rational choices available to them will incorporate, not the law and its requirements, but the perception of that law in the society.
In the over-speeding example, the law will work only when people expect to get caught when they over-speed and hence will not over-speed, and by extension, when the police officer expects to get pulled up by his senior for dereliction of duty if he does not stop over-speeding motorists.
A Change in the Focal Point: Divestment From Fossil Fuels
This seemingly simple idea of a focal point of change can be applied to the climate change debate. The inherent culture of the society giving rise to expectations, which form the anterior law governing everyone’s behaviour in the aforementioned example, can be a potential driving force. As such, the movement of global divestment from fossil fuels holds possibility to alter the Nash equilibrium.
Launched in 2012 by students around the world to persuade their universities to divest from fossil fuel companies, this movement has gained substantial momentum in a few years. As per a Guardian article[iv], 220 institutions, including universities, faith organizations, local authorities, pension funds, and foundations, have now committed to divesting from fossil fuels. According to a study done by University of Oxford[v], it is the fastest growing divestment campaign in history and could cause significant damage to coal, oil and gas companies. The movement became substantial when the Rockefeller group – the oil giant which introduced America to petroleum – joined in and pledged to divest $60 million from its fossil fuel portfolio.[vi]
It should be noted, that even after this momentum, the amount of divestment required to actually create any substantial financial impact and not just a symbolic dent is very high. One of the leading environmentalists, Bill McKibben, calculates on his website that the fossil fuel industry needs at least $20 trillion of write-offs to keep 80% of the remaining fossil fuel resources in the ground and maintain the planet’s temperature rise to under 2 degrees.[vii] As per a report by Arabella advisors[viii], the inaugural cohort of individuals in the divestment campaign pledged over $2.5 billion in assets, a measly 0.01% of the total write offs required.
However, the case in point for this essay’s Game Theory analysis, perhaps, is that the aim of the divestment campaign is not to create a financial impact on the fossil fuel industry. If successful, it can galvanise the economic machinery of the world to shift to a more sustainable Nash equilibrium. As the Oxford study rightly points out, divestment campaigns are successful in lobbying for restrictive legislation. The producers, currently committed to their business models, dominate global politics to fulfil their self-serving interests. The divestment campaign is a chance at making these businesses politically, and not financially, bankrupt, thereby decreasing their leverage on global climate change politics.
Naysayers argue that divestment is not the right way, and that the world should look at policies like carbon pricing. However, as with most markets, the carbon market is not free from inefficiencies and asymmetries. Not only will the market take its time to reach equilibrium, but also who’s to say it will be the more sustainable one? If the immediacy of a solution was not the primary constraint, perhaps carbon pricing could have worked.
Moreover, the global divestment campaign should be viewed a complement to the international climate change talks. By themselves, the COP meetings are necessary but not sufficient solutions. If shaped correctly, the global fossil fuel divestment movement, together with the international talks, can become the sufficient solution. The complementarity exists in the opposite direction as well. If the governments agree to impose legally binding restrictions in the upcoming COP21 summit, fossil fuel investments will become a risky asset to hold, thereby decreasing its attractiveness in institutional investment portfolios.
The two pillars of action against climate change are the international negotiations and the grassroots push for divestment. These two together can keep the fossil fuels in the ground and change the way we produce and consume. Businesses in the market will always operate under the constraints of the law and its perception. By altering the two, the law through global emissions reduction commitments and the perception through the divestment movement, we can strive to change the focal point of the global climate change ‘game’.
[i] For example, see the following works:
Becker, G. (1968). Crime and punishment: an economic approach. Journal of Political Economy, 76.
Raz, J. (1980). The concept of a legal system. Oxford: Clarendon Press.
[ii] Harvey, F. (2015 June, 2). Everything you need to know about the Paris climate summit and UN talks. The Guardian. Retrieved from http://www.theguardian.com/environment/2015/jun/02/everything-you-need-to-know-about-the-paris-climate-summit-and-un-talks?CMP=EMCENVEML1631
[iii] Basu, K. (2010). Beyond the Invisible Hand: Groundwork for a New Economics. Princeton: Princeton University Press.
[iv] Howard, E. (2015 May, 19). The rise and rise of the fossil fuel divestment movement. The Guardian. Retrieved from http://www.theguardian.com/environment/2015/may/19/the-rise-and-rise-of-the-fossil-fuel-divestment-movement
[v] Ansar, A., Caldecott, B., Tilbury, J. (2013). Stranded assets and the fossil fuel divestment campaign: what does divestment mean for the valuation of fossil fuel assets? Smith School of Enterprise and the Environment, University of Oxford. Retrieved from http://www.smithschool.ox.ac.uk/research-programmes/stranded-assets/SAP-divestment-report-final.pdf
[vi] Goldenberg, S. (2014 September, 22). Heirs to Rockefeller oil fortune divest from fossil fuels over climate change. The Guardian. Retrieved from http://www.theguardian.com/environment/2014/sep/22/rockefeller-heirs-divest-fossil-fuels-climate-change
[viii] Arabella Investors. (2014). Measuring the global fossil fuel divestment movement. Retrieved from http://www.arabellaadvisors.com/wp-content/uploads/2014/09/Measuring-the-Global-Divestment-Movement.pdf