Kyoto is good for business

America's refusal to mend its ways in the face of climate change is foolish in every sense. In the l

When George W Bush rejected the Kyoto accord, he said American jobs were his overriding concern. Many saw this as the triumph of market economics over environmental responsibility. But Bush's economics are confused. Action to curtail CO2 emissions does not threaten jobs, and failure to act would be a rejection rather than embrace of market economics.

There is no absolute certainty that global warming is occurring - but there is a very high probability that the world is warming up and that the cause is the big increase in CO2 atmospheric concentrations which has occurred since the industrial revolution.

Rapid climate change will cause great economic and social harm. Sometimes the impact could be catastrophic - low-lying areas flooded by rising sea levels; sometimes simply regrettable - low-level skiing resorts made untenable. But the total cost is likely to be huge. Even on the narrow calculus of economics, the case for taking forceful action to limit climate change is overwhelming.

The required scale of action is also huge. Present emission levels are causing rising atmospheric concentrations. To stabilise concentrations will therefore require total global emissions to be brought below present levels. But the 4.5 billion people of the poor and developing world currently produce emissions that are, per capita, a quarter of those of the one billion rich. Since the only equitable and politically feasible long-term vision would give each country a roughly equal right to emissions per capita,the emissions of the developed world will ultimately have to fall not by the 5-10 per cent agreed in the Kyoto protocol, but by 70 per cent or more.

Cutting emissions by that amount will entail costs. Switching to non-fossil fuels would require us to commit more economic resources to energy-producing sectors. Cutting energy consumption would reduce productivity unless we invest more in capital equipment, higher skills and improved techniques. Both effects will tend marginally to reduce measured prosperity.

These prosperity costs will be manageable, however, because we enjoy two great advantages - time and the power of market economics. We don't need to cut immediately, but steadily and at an increasing pace over 50 to 100 years; and the price mechanism is a powerful tool for achieving that adjustment at minimal cost.

The market-friendly policy, indeed, is not to reject Kyoto, but for governments to ensure a high and rising price of fossil fuels through the imposition of high and rising taxes. This would bring forward and smooth the rise in energy cost that would otherwise occur later and in a more disruptive step-change fashion. It would ensure that prices reflect the true costs that fossil fuel use imposes on the economy; and it would unleash the myriad adjustments that would enable us to cut emissions at only a small cost to growth. A petrol price rise produces only a small immediate cut in journeys made, but over the long term it influences whether people buy fuel-efficient cars, whether car manufacturers make fuel efficiency a priority in product development, whether their suppliers research new lightweight materials, and how intensely distribution companies focus on fuel costs in decisions on warehouse location. Price-elasticity estimates suggest that a petrol price rise of 10 per cent produces in the short term only a 1 per cent fall in miles travelled, but over the long run a 10 per cent or greater fall in petrol consumed. The more and the earlier we use market instruments - tax in particular - to stimulate action, the lower will be the total cost of adjustment.

Costs can therefore be made manageable. Studies by Cambridge Econometrics show that the cost of a 17 per cent reduction in Britain's CO2 emissions by 2010 (compared to 1990) would amount to only 0.28 per cent of that year's GDP, reducing by 0.02 per cent the annual growth rate from 2000 to 2010, with Britain attaining in mid-February 2011 the prosperity it would otherwise reach six weeks earlier. Estimates over longer periods are inherently more uncertain, but orders of magnitude can be indicated to counter "end of growth" scare stories. If renewable fuels, for instance, cost three times as much as present fossil fuel prices, the impact of Britain switching to a primarily renewable basis by 2050 would be to reduce national income in that year by just 4 per cent. This would cut annual growth from now till then by only one-tenth of 1 per cent - implying that we would reach in 2052 the standard of living otherwise attained in 2050. This is a choice we can afford to make, and a trade-off we have no right to reject at the expense of vulnerable people elsewhere in the world.

That choice, moreover, has no consequences for jobs. The idea that it does is based on the confused notion that countries achieve higher employment by competing for a limited pot of world prosperity. But economies achieve high employment if they have labour markets flexible enough to create new jobs to replace old, above all in untraded sectors of the economy such as retailing, leisure and healthcare.

There is no reason why a slightly lower rate of productivity growth should mean fewer jobs. Higher fossil fuel prices and lower energy consumption therefore have no long-term consequences for employment levels and no short-term consequences - provided they are introduced steadily rather than suddenly. Indeed, if higher taxes on fossil fuels are used to reduce payroll taxes for lower-paid workers, they are likely marginally to increase employment.

The American rejection of Kyoto threatens to harm the world environment and increase America's reliance on oil imports from the world's most unstable region for fear of economic consequences that have been hugely exaggerated and misunderstood.

America's position on this issue, however, does not excuse European inaction, nor does the situation that developing countries are currently outside the Kyoto framework. Opponents of action argue that there is "no point" if all countries are not signed up. This is a poor argument. First, because 60 per cent of current emissions come from the developed world: cutting those is disproportionately important. Second, because the developed world, by committing to stretching emission-reduction targets and rising energy prices, can stimulate the development of energy-efficient products and renewable energy sources subsequently used elsewhere. America, Japan and Europe together can certainly go it alone: but even Europe's market of 370 million consumers is sufficiently large to stimulate important technological development.

To ensure such developments, Europe's policy must be co-ordinated. In terms of Kyoto targets, it already is - all European countries are committed, none is claiming the right to be a free-rider on others. But Europe's response would be more effective still if energy taxes were harmonised at European level. Right now, energy-intensive industries can relocate within Europe to lower-tax countries, undermining the desired incentive effect. Harmonising at European level would reduce the potential for such relocation effects.

Taxes on energy should therefore be raised and ideally harmonised at European level. Not exactly a message likely to appeal in Eurosceptic Britain after a winter of fuel protests. But that illustrates a crucial point. The economics of climate change are far easier than the politics. We are not constrained from action by a threat to jobs, a dramatic prosperity penalty, or the logic of market economics. We are constrained only if politicians lack the will to use the market instruments available to achieve necessary adjustment at acceptably small cost.

Adair Turner is a former director general of the Confederation of British Industry. His recent book Just Capital: the liberal

economy is published by Macmillan (£20)