Introduction

At first blush, a chapter on economic and fiscal tools would seem to be out of place in a book about communicating climate change. And yet, markets and prices are essentially little more than structures which exchange information about what we value, and how much we value it. As Nobel prize-winning economist Kenneth Arrow put it, markets “can be viewed as information and decision structures in which communication takes the form of prices.…[P]rices … according to the pure theory, are normally the only communication that needs to be made” (cited in Babe, 1996).

For many economists, prices effectively communicate value automatically and most attempts to intercede in this self-organizing system are usually perceived as ill conceived and counterproductive because they interfere with the operation of Adam Smith's “invisible hand.” This theory holds that relatively unconstrained markets allocate wealth more efficiently than would any top–down attempt to manage markets. Economists have long recognized, however, that many market exchanges leave out a great deal of information. British political economist A. C. Pigou, writing in the 1920s, noted that smoke from a factory, for example, imposed costs on third parties that were not reflected in exchange prices (Pigou, 1932). These unaccounted costs could be conceived of as information failures; economists call them “externalities.”

For the most part, economists have used two devices to improve price signals so that they more accurately include information and value that are normally left out of market exchanges.