Why scientific understanding is key to tackling climate-related market inefficiencies

Market failure means the market fails to maximize societal welfare due to the inefficient allocation of goods and services. This can result from insufficient or a complete lack of information. Many argue that climate change is one of the most significant representations of market failure, driven by the misalignment of market incentives with societal and environmental costs. But why did this happen, and how can it be addressed?

Greenhouse gas emissions are a clear example of negative externalities. The costs associated with rising global temperatures, extreme weather events, sea level rise, and more are not factored into the prices of goods and services produced by polluting industries. Essentially, every product comes at a discount, and the climate pays the difference. Clean air and a stable climate are considered public goods, which markets typically underprovide due to insufficient investment incentives—a classic example of the free-rider problem. The prioritization of short-term gains through overproduction while ignoring long-term environmental damage only exacerbates the issue.

The solution to this problem might seem straightforward at first glance: eliminate the lack of information and account for climate change in the pricing of goods, a process known as "internalizing the externality." Carbon pricing is one financial instrument that achieves this. For example, with the EU Emissions Trading System (ETS), companies are assigned an emissions ceiling; if they exceed it, they must purchase carbon credits. They can buy these from companies that stayed below their limits through climate innovation or projects with positive climate impacts, like reforestation. Green subsidies and other financial incentives further support investments in these public goods. Private investments can also come from mechanisms such as use-of-proceeds financing, sustainability-linked finance, and debt-for-nature swaps.

However, many questions remain unanswered for these systems to function effectively. For example, what is the cost of one ton of CO₂? (See our other navigator, titled Global Carbon Pricing: Moving from Fragmented Policies to a Unified Framework, for more insights.) How do we value climate-positive investments that aren’t directly tied to CO₂? And what if we lack information on certain CO₂ dynamics?

Marine carbon sequestration provides a good example of these challenges. Oceans are one of the largest carbon sinks on the planet, absorbing nearly 30% of CO₂ emissions from human activities. Yet, we know very little about how the blue economy (e.g., offshore wind turbines) impacts this carbon cycle. This lack of understanding makes it impossible to incorporate climate externalities into pricing while also discouraging investors from supporting blue nature restoration projects due to the uncertainty of their impact.

Market failures typically arise when there is a lack of understanding of the underlying dynamics of a system. For climate change, these dynamics are highly scientific. Research will be critical to developing the right financial instruments that accurately account for climate change and enable the financing of what may be humanity’s biggest challenge to date. Although climate financing might seem like a practical, hands-on issue, its theoretical foundations cannot be overstated.

At Ortelius, we address this issue by participating in the BERNARDO project, where we investigate innovative financial instruments backed by scientific research on Belgium’s marine carbon cycle. This work is being undertaken in collaboration with our partners Mantis Consulting, ORG Urbanism & Design, Ghent University, and VLIZ.