LET us imagine that we are government officials thinking about managing the risks associated with climate change. We could be based in Washington, Westminster, Cape Town or St Helier.
Our task is to develop and implement environmental policies which will change behaviours and engender co-operation across the societies we have been given the mandate to govern. As we debate our policy options, a team of consultants has been appointed and they are specialists in human psychology. They bring to our attention three important considerations:
1. Experiments have shown that people systematically misjudge the expected impact of low-probability, high-severity events. If an outcome is potentially very bad, but the probability relatively low, or perceived to be low – for example, a climate-induced shift in the Gulf Stream – most of us have very little experience of such events and underestimate the consequences.
2. These misperceptions can lead to inefficient levels of insurance and risk prevention. In the case of environmental risks, this commonly leads to incorrect economic valuations being applied. In other words, the financial cost is not considered justified.
3. Lastly, when attempting to reduce the expected impacts of a risk, people tend to prefer private reductions of probabilities, rather than for the collective.
In aggregate, these behavioural factors make our job, in government, extremely challenging. We recognise, however, that many social dilemmas in environmental policy can be modelled, and a combination of stick-and-carrot incentives can be used by planners to foster co-operation or ‘buy-in’ across the general public.
Continuing with our role play, we have decided that our first policy centres on greening the housing stock. Around a fifth of the UK’s carbon emissions are thought to come from heating homes. Therefore, if we are to meet our climate-change obligations, this is an important policy to successfully implement, whatever the jurisdiction.
What incentives can we use?
The co-hosts of COP26 – Italy and the UK – provide examples of two different approaches. Boris Johnson’s government has recently announced that it is exploring plans to link mortgages to green home improvements by imposing targets for lenders. Highlighting the move as part of its net-zero strategy, the government advised it was working with mortgage lenders to support homeowners in improving the energy performance of their properties. Measures being considered include voluntary targets for banks to improve the average energy performance certificate of the homes in their lending portfolio, by 2030. These targets could become mandatory ‘if insufficient progress’ were made.
According to a study by Nationwide Building Society, the average cost of energy-efficiency improvements for a single home is about £8,100. Some lenders have already introduced green mortgage products, offering a discounted interest rate on homes with a high energy-efficiency rating. However, even with this lower cost of borrowing, homeowners are still faced with this significant capital outlay and the reduced energy bills do not offset this for a number of years.
Italy has adopted a very different approach. If you want to insulate walls and windows and install a heat pump, boiler or solar panels, the government will pay you 110% of the cost. Yes, you read that right – all of it and then 10% on top, to be offset against your taxes over the next five years, up to a maximum of €100,000 per home. It is an incredibly generous incentive and is being taken up by huge numbers, leading the government in Rome to claim that, in the first eight months of this year, they have reduced emissions of CO2 from home heating by as much as they did in the past 20 years.
The total cost of this incentive in 2021? A cool €9 billion.
Why so ambitious? The policymakers in Italy believe it is the only way to convince people to get work done on their homes. Paying a proportion of the cost simply will not succeed, as the majority of people either cannot afford to pay the rest, or have other more urgent priorities.
The big downside to this incentive has been overheating the building industry, with so many trying to take advantage of this offer before it expires in a year or two’s time. In other words, rising costs and inflation.
Again – back to our role play; which policy to implement?
Do we adopt the carrot of lower borrowing costs for homeowners and the stick to banks to ensure they lend? Do we pay for everything and more, further fuelling inflation and increasing public debt? Or do we do nothing, in the hope that high-impact, climate-linked events eventually prompt action by householders?
Who would be a politician?