I am not a fan

You’d be forgiven for having missed the story that in late March, Russian retailers were complaining about a lack of sugar. Sugar producers had simply stopped delivering the goods to retailers and shelves were increasingly empty. If that reminds the older readers of the situation in the Soviet Union, you are not wrong, since the cause of this temporary shortage was similar. In December, President Vladimir Putin ordered a price cap on sugar and sunflower oil to limit inflation and enable poorer Russians to be able to afford basic food items. The government limited prices for a pound of sugar to 36 Rubles for producers and 46 Rubles for retailers. That was roughly one quarter below the existing retail price at the time and would have cost sugar producers an estimated $140 million in lost revenue. To make up for this shortfall, the government promised to pay the sugar producers about half of it through government subsidies, yet, when the subsidies didn’t arrive in time, the sugar producers simply stopped delivering their goods and threatened to stop producing sugar altogether until the government paid up.

I thought this kind of government intervention in market prices was a thing of the past (or limited to countries like Venezuela or Cuba) but it seems to make a comeback in many places.

Just think of the European Central Bank’s flirtations with lower interest rates or lower capital requirements for green loans or loans that foster a more sustainable economy. While well-intentioned, reducing the interest rate on some loans is the same as limiting the price for borrowers. Yes, it does make financing green projects cheaper, but it also leads to severe misallocation of funds. On the one hand, banks that cannot charge a higher interest rate on green loans might stop making these loans altogether. Or if banks have to hold fewer reserves against these loans, they will gladly make one loan after another, even if these loans make no economical sense – thus creating a bubble in green loans. In either scenario, capital gets severely misallocated and creates significant long-term costs.

A study of Central and Eastern European countries’ efforts to reduce their greenhouse gas emissions in the aftermath of the financial crisis showed that the two main obstacles to a greening of the economy were a lack of supply of loans from banks and an unwillingness and lack of urgency in company management. The result of these two effects was that the reduction in greenhouse gas emissions from the private sector in these countries was much lower than needed or planned. Does this mean that we need to make loans cheaper for companies who want to reduce their greenhouse gas emissions? In my view no.

Instead of centrally regulating prices, the better solution would be to internalise externalities and put a price on carbon for the entire economy. Furthermore, every company should be required to measure their greenhouse gas emissions and publish plans on how they want to reduce these emissions over time. Putting a price on carbon internalises the cost of greenhouse gas emissions into the market mechanism and ensures that loans are only made if profits from a project exceed the total costs (including damages to the environment) of a project. And by forcing companies to measure and defend their greenhouse gas emissions and reduction targets, management has to focus more on that topic and investors can decide on their own if they want to invest in a specific company or not. 

I know it is tempting in the face of a global development like climate change to demand increased government regulation, and I am all for increased government regulation if it is smart and doesn’t lead to bubbles or other unintended consequences. But I am afraid promoting sustainable investments by manipulating the price of financing loans is not one of these regulations.