How can we design a solution to climate change?

What do plunging global markets have to do with climate change? The need to step in first, by designing mechanisms that prevent such crises, says Nobel economist Eric Maskin.

24 Jul 2020

One example is the financial crisis of 2008, the effects of which the world is still feeling even as it endures the economic crash associated with the spread of the COVID-19 coronavirus.

“One thing that this crisis established quite clearly is that financial markets by themselves don’t always produce the outcomes that we would like,” says Maskin, an American economist and 2007 Nobel Laureate, recognised for having laid the foundations of mechanism design theory along with Leonid Hurwicz and Roger Myerson.

“Particularly when there is a financial meltdown that affects the global economy adversely, this goes to show that somehow we have to modify financial markets.”

Regulation of the financial system as one of the global warming solutions

Modifying free market systems - by designing financial regulation that limits leverage, for example – can produce better results. As Maskin explains, this mechanism design theory takes people as they are and tries to reconcile their individual goals with the goals we have as a society.

These principles are particularly relevant regarding global warming, where free markets alone will not provide a solution and there is a need to induce countries to commit to reducing emissions.

“Climate change is not likely to lead to disaster in the next few years, although we are already beginning to see the possible repercussions. But there is a significant risk that if we do nothing, it will lead to catastrophic outcomes down the road, in 50 years’ time, possibly less.

So doing something about climate change is a high priority for the world,” Maskin says.

Reducing carbon emissions working back from the result

The key when designing good mechanisms is to understand the goals, inclinations and behaviors of all these participants – that is, you start with the result you would like and work backwards to figure out how you get there.

Working back from a result of lower greenhouse gas emissions brings us to a mechanism, in the form of an international agreement under which countries commit to reduce their greenhouse gas emissions.

“It’s through such a mechanism that we’ll ultimately solve the global warming problem. So, the potential implications of mechanism design are really quite broad and important,” Maskin says. “In fact, we saw what the free market produces. It produces occasionally a meltdown. We have to modify free market systems, using our mechanism design tools, by for example designing financial regulation that makes sense.”

Canada Asset Management

Views and opinions expressed are presented for informational purposes only and are a reflection of UBS Asset Management’s best judgment at the time a report was compiled, and any obligation to update or alter forward-looking statement as a result of new information, future events, or otherwise is disclaimed. Commentary is provided at a macro level and is not with reference to any investment strategy, product or fund offered by UBS Asset Management and is provided in Canada generally pursuant to the registration exemption provided for in Section 8.25(2) of National Instrument 31-103 and in Ontario pursuant to Section 34 of the Securities Act (Ontario) and does not purport to be tailored to the needs of the person or company receiving the advice.. The information contained in the materials should not be considered a recommendation to purchase or sell any particular security. The materials and content provided will not constitute investment advice and should not be relied upon as the basis for investment decisions. As individual situations may differ, clients should seek independent professional tax, legal, accounting or other specialist advisors as to the legal and tax implication of investing. Plan fiduciaries should determine whether an investment program is prudent in light of a plan's own circumstances and overall portfolio. UBS Asset Management services offered to Canadian persons are provided by UBS Asset Management (Canada) Inc., a Nova Scotia corporation. UBS Asset Management (Canada) Inc. is an indirect wholly-owned subsidiary of UBS AG and is registered as a portfolio manager and exempt market dealer (in all provinces of Canada), commodity trading manager (Ontario), adviser – commodity futures (Manitoba) and investment fund manager (Ontario, Quebec and Newfoundland), all pursuant to Canadian securities law. Materials may include forward-looking statements. Actual future results, however, may prove to be different from expectations. Past performance is no guarantee of future results. Potential for profit is accompanied by possibility of loss.

Please confirm you are a Canada resident to proceed.

Confirmation
Please select at least 1 checkbox

SI Foresight

 

Asset Management services and solutions in your location

Please select your region

 

For further information on what we can offer you, please get in touch.