Economics of carbon credits

Pakistan can participate in the carbon credit market by taking steps to reduce its carbon footprint

Economics of carbon credits


market-based economy is the core of modern capitalist economics. All economic transactions take place in a market and have a price that reflects the cost of production and benefits/ damage to the consumers. If some resources do not have a price or if the market is non-existent, the resources are liable to misuse and waste. The environmental degradation is an example.

Ideally, in an economic transaction, the consumer pays the price reflecting the costs in terms of the production of that commodity to the producer. However, sometimes there are indirect or spillover costs of some production processes in terms of damage/ benefits that do not reflect in the commodity’s price. This makes the product external to the market, and the market-based economy cannot regulate it.

A cement producer might set the price of its product based on the cost of production but ignore the pollution, such as carbon emissions, in the production process. This pollution is external to the market and is called an externality in economic literature. Thus, anything outside the market is considered an externality. An externality can therefore be defined as a spill-over effect of an economic transaction that is external to the existing markets.

The economics of climate change and carbon emissions revolve around the concept of externality and mechanisms to internalise or put a price tag on it. There are carrot and stick solutions to the aforementioned externality problem of carbon emissions. The stick is to put a price on emissions; this is known as carbon pricing. The carrot is to provide incentives for the reduction in the level of externality (carbon emissions); this is known as a carbon credit.

The two solutions are the basis of the carbon market, where carbon credits are traded, and a price set on carbon. Therefore, the externality is thus internalised through the establishment of the carbon market.

Let’s understand the concept of carbon pricing and credits and explore the prospects for Pakistan. In terms of pricing, carbon emissions already come with a hefty price tag, but no one pays for it, certainly not the emitters. The environment and life forms pay the price.

Carbon taxes, a form of carbon pricing, seek to resolve this issue and make emitters pay for their carbon emissions. In the case of Pakistan, we pay the price in terms of anthropogenic disasters induced by industrialised countries. Therefore, not only is carbon taxation needed but at a global level, climate financing is required so that climate justice can be ensured.

This stick approach, although effective in theory, can slow down fast runners and, in the case of developing economies, halt economic growth. In countries like Pakistan business entities are overburdened and their share of carbon emissions is little compared to multinational companies.

China is one of the largest carbon emitters. It is also developing the world’s largest carbon trading market. Pakistan can take advantage of China’s carbon market and trade carbon credits for economic incentives. 

Against the backdrop of carbon pricing, the government of Pakistan has offered a commitment to the Asian Development Bank to initiate an implementation plan for the National Carbon Pricing Strategy. On the other hand, not much has been done by developed countries and financial institutions in terms of loss/ damage funds and climate financing to translate pledges into actionable fund transferring mechanisms. Progress on implementing Green Climate Financing and Just Energy Transition Partnerships (JETP) is slow.

The other option in carbon financing is carbon credits. It is an incentive-based instrument in which production companies emitting pollution have tradable certificates or permits that allow companies, industries, or countries to emit a tonne (1,000 kg) of CO2 or an equivalent amount of a different greenhouse gas. If a company, industry, or country wants to produce a tonne of carbon emissions, it will need a carbon credit, generating a demand for carbon credits in the carbon market.

Similarly, if a company prevents a tonne of carbon dioxide production, for example, through installation of an energy-efficient production process or by planting trees, the it can sell the carbon credits in the carbon market, generating supply. Carbon credits are a way to incentivise reductions in greenhouse gas emissions by allowing countries or companies to sell or trade their unused emissions allowances to those who have exceeded their limits.

Pakistan can participate in the carbon credit market by taking steps to reduce its carbon footprint and earn carbon credits in return. There are several ways Pakistan can earn carbon credits.

First, renewable energy, Pakistan can earn carbon credits by investing in renewable energy projects, such as wind, solar and hydropower. By reducing reliance on fossil fuels, these projects can help reduce Pakistan’s carbon footprint. Second, forest conservation, Pakistan can also earn carbon credits by implementing forest conservation programmes. Trees absorb carbon dioxide from the atmosphere, so by conserving forests and planting new trees, Pakistan can help the world reduce greenhouse gas emissions. Third, energy efficiency, which is another way Pakistan can earn carbon credits is by implementing energy efficiency measures. This could include improving building insulation, upgrading to more energy-efficient appliances, or implementing more efficient industrial processes. Lastly, waste management, Pakistan can also earn carbon credits by implementing waste management programmes that reduce the amount of waste sent to landfills. By reducing the amount of waste that decomposes and releases methane, a potent greenhouse gas, Pakistan can help to reduce its carbon footprint.

China is one of the largest carbon emitters. It is also developing the world’s largest carbon trading market. Pakistan can take advantage of China’s carbon market and trade carbon credits for economic incentives, as well as promote the greening of China-Pakistan trade and investments in the energy sector.

In the China Pakistan Economic Corridor, investments in coal-fired power plants can be converted into renewable projects that will not only foster Pakistan’s energy transition but also create carbon credits. By participating in the carbon credits market, Pakistan can earn revenue from selling its carbon credits and incentivise further reductions in greenhouse gas emissions.

The writer is an energy consultant. He can be reached at and tweets @Khalidwaleed_.

Economics of carbon credits