The Green Paradox is a phrase coined by German economist Hans-Werner Sinn to describe the fact that an environmental policy that becomes greener with the passage of time acts like an announced expropriation for the owners of fossil fuel resources, inducing them to anticipate resource extraction and hence to accelerate global warming.

The Green Paradox’s line of reasoning starts by recognizing a fundamental, unavoidable fact: every carbon atom in the gas, coal or oil extracted from the ground to be used as fuel ends up in the atmosphere, in particular if high efficiency combustion processes ensure that no part of it ends up as soot. About a quarter of the emitted carbon will stay in the atmosphere practically forever, contributing to the greenhouse effect that causes global warming.^[1]

Apart from afforestation, only two things can mitigate the accumulation of carbon in the atmosphere: either less carbon is extracted from the ground, or it is injected back underground after harvesting its energy.

Environmental policy efforts, however, in particular European ones, go in neither of these two directions, aiming instead at the promotion of alternative, CO₂-free energy sources and a more efficient use of energy. In other words, they only address the demand side of the carbon market, neglecting the supply side. Despite considerable investment, the efforts to curtail demand have not reduced the aggregate amount of CO₂ emitted globally, which continues to increase unabated.^[2] The reason behind this, according to Sinn, is that green policies, by heralding a gradual tightening of policy over the coming decades, exert a stronger downward pressure on future prices than on current ones, decreasing thus the rate of capital appreciation of the fossil fuel deposits. The owners of these resources regard this development with concern and react by increasing extraction volumes, converting the proceeds into investments in the capital markets, which offer higher yields. That is the green paradox: environmental policy slated to become greener over time acts as an announced expropriation that provokes owners to react by accelerating the rate of extraction of their fossil fuel stocks,^[3] thus accelerating climate change.

Countries that do not partake of the efforts to curb demand have a double advantage. They burn the carbon set free by the “green” countries ([Carbon leakage | leakage effect]) and they also burn the additional carbon extracted as a reaction to the announced and expected price cuts resulting from the gradual greening of environmental policies (green paradox).^[4]

Sinn emphasizes that a condition for the green paradox is that the resource be scarce in the sense that its price will always be higher than the unit extraction and exploration costs combined. He points out that this condition is likely to be satisfied as backstop technologies will at best offer a perfect substitute for electricity, but not for fossil fuels. The prices of coal and crude oil are currently many times higher than the corresponding exploration and extraction costs combined.

An effective climate policy must perforce focus on the hitherto neglected supply side of the carbon market in addition to the demand side. The ways proposed as practicable by Sinn to do this include levying a withholding tax on the capital gains on the financial investments of fossil fuel resource owners, or the establishment of a seamless global emissions trading system that would effectively put a cap on worldwide fossil fuel consumption, thereby achieving the desired reduction in carbon extraction rates.

Hans-Werner Sinn’s ideas on the green paradox have been presented in detail in a number of scientific article,^[5][6] his 2007 Thünen Lecture^[7] at the annual meeting of the German Economic Association (Verein für Socialpolitik), his 2007 presidential address to the International Institute of Public Finance in Warwick, two working papers,^[8][9] and a German-language book, “Das Grüne Paradoxon”.^[10] They build on his earlier studies on supply reactions of the owners of natural resources to announced price changes.^[11]