Economic Efficiency of Climate Finance
Governments have employed a number of market-based/economic instruments to support climate change policy goals, such as encouraging emission reductions, with the intention of minimising costs. Besides taxes, one of the most prominent market-based instruments is the CO2 Emissions Trading Scheme (ETS) introduced by the European Union (EU) and the state-level emissions trading foreseen in the Kyoto Protocol to the United Nations Framework Convention on Climate Change in 2005. The overarching aim of economic instruments is to adjust prices and with them the incentives for market players to reflect the true impact of their decisions on society – including environmental costs that would otherwise be externalised.
This policy brief explains the concept of internalising externalities and provides an overview of climate finance instruments to address market failures related to clean energy