Incentives, risk and decision-making in mitigating climate change

Briefing Paper
William Blyth, June 2007

Responding to climate change will require clear and decisive action to be taken at many different levels, involving international and national institutions, corporations and individuals. The process of decision-making is made more complex by several sources of uncertainty and risk.
Carbon pricing is one way in which governments create incentives for companies to adjust their behaviour and invest in lower-emitting technologies. But policy uncertainty introduces investment risk, weakening these incentives.
Companies often call for greater regulatory certainty in order to reduce investment risk, but greater certainty may come at the expense of reduced policy flexibility. Policy-makers need an understanding of how risks are allocated in the decision-making process in order to design more effective policies and avoid simply transferring private-sector investment risk into more general economic risks.