Amrut Mody School of Management

A theoretical analysis of Carbon Credits- a perspective of

Austrian School of Thought

‘Those who clamour for “conscious direction”– and who cannot believe that
anything that has evolved without design (and even without our understanding it)
should solve problems which we should not be able to solve consciously- should
remember this: the problem is precisely how to extend the span of our utilization
of resources beyond the span of the control of any one mind; and, therefore, how
to dispense with the need of conscious control and how to provide inducements
which will make the individuals do the desirable things without anyone having to
tell them what to do.’1

To maintain a sustainable climate, the Intergovernmental Panel on Climate Change (IPCC)

has stated that Green House Gases (GHG) emissions will need to be reduced to 20-40 percent
of 2015 levels, by 2050. Even though the society has initiated a carbon trading regime as a
market based strategy to lessen the global condition and incentivise firms to invest in more
efficient technologies, emissions are still rising. This makes us question: Is this the right
policy? Can a capitalist society triumph over this self-perpetuating crisis? This argumentative
debate has seen carbon trading praised as a viable market solution, but also criticised as
inequitable and futile. This paper attempts to answer these questions and tries to scrutinize
the theoretical concept of carbon trading as an incentive to maintain a sustainable climate
through Austrian School of Thought.

Position of Austrian School

The origins of environmental economics in mainstream neoclassical theories lie in efficiency
and Pigouvian welfare economics. According to Roy Cordato, these theories have been
precluded by Austrian School economists as theoretically unsound and as yielding analysis
that does not mirror the real world2. This in turn, led to policy recommendations that, while
theoretically and formally well-designed, are unenforceable in nature. In general,
environmental economics is an extension of the theory of externalities and is predominantly
focused on maximizing the social value of utilization of resources.
Devotees to the Austrian school such as Menger, Von Mises, and Hayek, Machlup contend
that private property and the market facilitate impulsive and dynamic order as prices
coordinate individuals and firms. While there are traits of this in the neoclassical scrutinizes,
there are also unambiguous differences. Not least of which is a fanatical repugnance to
designed markets such as carbon trading. Hayek hypothesised that spontaneous human action

1
Friedrich A. Hayek, ‘The Use of Knowledge in Society’, The American Economic Review,
35 [4] 1945: 527.
2
Roy Cordato, ‘Towards and Austrian Theory of Environmental Economics’, The Quarterly
Journal of Austrian Economics, 7 (1) 2004: 3.
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in society can realize vast outcomes not possible under planned (rational) design. According
to Hayek, an example of this is, the impulsive unplanned development of language, a
distributed interaction of innumerable individuals, and perhaps man’s supreme
accomplishment.
There is an implicit or explicit acceptance that Austrian School’s ideas of true individualism 3,
subjectivism, marginalism and spontaneous order have been influential in the economic
theories. From an Austrian School perspective the carbon trading regime is based on a
combination of incompatible fundamentals. A false rationalistic individualism that is
characterised by its confidence in planned social order instead of banking on unplanned,
spontaneous results of the actions of free individuals. 4 Promoted through supra-national
design and execution (UNFCCC, EU, Etc.), conforming to Austrian School’s ideals only in a
sense that the structure encouraged is based on a social order where players are anxious only
with their individual welfare. The system is spontaneous in that it is grounded on the market
system, and designed in that it is developed and executed globally by international
organisations. According to Hayek false individualism would lead to authoritarianism 5. The
design, execution, and regulation of carbon markets in some way, seems to justify this theory.

Cost is Subjective
The theoretical diversion that underpins the fundamental difference to the mainstream
economics is the denial of market equilibrium by the adherents to the Austrian School. It is
impossible to know the ‘Pareto Optimality’ in a world where disequilibrium and uncertainty
are the norm and costs being subjective.
The theory of externalities is fundamentally based upon the idea that costs and benefits can
be quantitatively (in terms of money) measured by a third party outside the transaction. In the
case of carbon credits it is government and other supra-national organisations that intervenes
and facilitates by measuring and allocating allowances or imposing taxes. This principle is
opposed by the Austrian school as costs are subjective, i.e. costs cannot be quantitatively
measured by a third party observer.6 A summary of the repercussions of this for carbon
credits is:
1. Cost must be borne only by the polluter; it is not possible for cost to be transferred to
or levied on others.
2. Cost is subjective; it is in the mind of the polluter and no one else.
3. Cost is based on expectations; it is essentially future oriented.

3
‘True individualism believes on the contrary that, if left free, men will often achieve more
than individual reason could design or foresee’. Friedrich Hayek, Individualism and
Economic Order, Chicago 1980
4
Friedrich Hayek, Individualism and Economic Order, Chicago 1980
5
Friedrich Hayek, Individualism and Economic Order, Chicago 1980
6
Barry P. Brownstein, ‘Pareto Optimality, External Benefits and Public Goods: A
Subjectivist Approach’ The Journal of Libertarian Studies, 4 (1) (1980): 95-96.
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4. Cost can never be understood as because of the fact of decision itself: that which is
given up cannot be relished.
5. Cost cannot be measured by a party other than the polluter because there is no way
that subjective experience can be directly witnessed.’

Who bares the cost of change in climate? Surely not the decision maker i.e. polluters,
typically it is the world’s poor, who have contributed least to the malaise. Thus, the
neoclassical philosophies of efficient allocation and market failure are wholly rejected.
According to Austrians, ‘objective valuations of ecological phenomena are regarded as
manifestations of technocrats and bureaucrats own subjective preferences.’7 In which case,
carbon markets are a failure of government and other supra-national organisations, based on
calculations that could not perhaps be known, and not an efficient instrument to correct
climate change.
 Efficiency is a praxeological, i.e., individual goal pursuing problem, but value
maximisation not a problem. Then from a policy perspective, social efficiency is
evaluated in terms of the extent to which legal establishments facilitate uniformity
between the ends that players are pursuing and the means that they are choosing to
achieve those ends. I.e. though the supra-national organisations are facilitating carbon
trading the big players involved in the market are pursuing individual goal.

 Rejection of Pareto optimality.

CARL MENGER
Objective cost of production
7
John F. Broderick, ‘Business as Usual? Instituting Markets for Carbon Credits’: 65.

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MACHLUP’s TENETS
Idea of opportunity cost
Methodological individualism
Methodological subjectivism
Marginalism

LUDWIG VON MISES

Purposeful vs reflexive behaviour (praxeology)
Private ownership
Allocation of resources

HAYEK
Market is a process- a dynamic process

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Bibliography
Cordato, R. (2004). Toward an Austrian theory of environmental economics. Quarterly
Journal of Austrian Economics, 7(1), 3-16.
Hayek, F. A. (1945). The use of knowledge in society. The American economic review,
35(4), 519-530.

Word Count= 2000 (Excluding footnotes and bibliography)