Photograph by Yoshikazu Nema; Artwork by Yuken Teruya
By PAUL KRUGMAN
Published: April 5, 2010
If you listen to climate scientists — and despite the relentless campaign to discredit their work, you should — it is long past time to do something about emissions of carbon dioxide and other greenhouse gases. If we continue with business as usual, they say, we are facing a rise in global temperatures that will be little short of apocalyptic. And to avoid that apocalypse, we have to wean our economy from the use of fossil fuels, coal above all.
But is it possible to make drastic cuts in greenhouse-gas emissions without destroying our economy?
Like the debate over climate change itself, the debate over climate economics looks very different from the inside than it often does in popular media. …[There] is widespread agreement among environmental economists that a market-based program to deal with the threat of climate change — one that limits carbon emissions by putting a price on them — can achieve large results at modest, though not trivial, cost. There is, however, much less agreement on how fast we should move, whether major conservation efforts should start almost immediately or be gradually increased over the course of many decades. …
Environmental Econ 101 If there’s a single central insight in economics, it’s this: There are mutual gains from transactions between consenting adults. … More than that, some careful analysis shows that if there is effective competition in the … market, so that the price ends up matching the number of widgets people want to buy to the number of widgets other people want to sell, the outcome is to maximize the total gains to producers and consumers. Free markets are “efficient” — which, … means that nobody can be made better off without making someone else worse off.
Now, efficiency isn’t everything. …[There] is no reason to assume that free markets will deliver an outcome that we consider fair or just. … But the logic of basic economics says that we should try to achieve social goals through “aftermarket” interventions. That is, we should let markets … [make] efficient use of the nation’s resources, then utilize taxes and transfers to help those whom the market passes by.
But what if a deal between consenting adults imposes costs on people who are not part of the exchange? … When there are “negative externalities” — costs that economic actors impose on others without paying a price for their actions — any presumption that the market economy, … will do the right thing goes out the window. So what should we do? Environmental economics is all about answering that question.
One way to deal with negative externalities is to make rules that prohibit or at least limit behavior that imposes especially high costs on others. That’s what we did in the first major wave of environmental legislation in the early 1970s: cars were required to meet emission standards for the chemicals that cause smog, factories were required to limit the volume of effluent they dumped into waterways and so on. And this approach yielded results; America’s air and water became a lot cleaner in the decades that followed.
But while the direct regulation of activities that cause pollution makes sense in some cases, it is seriously defective in others, because it does not offer any scope for flexibility and creativity. …
Enter Arthur Cecil Pigou, an early-20th-century British don, whose 1920 book, “The Economics of Welfare,” is generally regarded as the ur-text of environmental economics.
… What Pigou enunciated was a principle: economic activities that impose unrequited costs on other people should not always be banned, but they should be discouraged. And the right way to curb an activity, in most cases, is to put a price on it. So Pigou proposed that people who generate negative externalities should have to pay a fee reflecting the costs they impose on others — what has come to be known as a Pigovian tax. The simplest version of a Pigovian tax is an effluent fee: anyone who dumps pollutants into a river, or emits them into the air, must pay a sum proportional to the amount dumped.
…[With] the rise of environmental regulation, economists dusted off Pigou and began pressing for a “market-based” approach that gives the private sector an incentive, via prices, to limit pollution, as opposed to a “command and control” fix that issues specific instructions in the form of regulations.
The initial reaction by many environmental activists to this idea was hostile, largely on moral grounds. Pollution, they felt, should be treated like a crime rather than something you have the right to do as long as you pay enough money. …[There] was also considerable skepticism about whether market incentives would actually be successful in reducing pollution. Even today, Pigovian taxes as originally envisaged are relatively rare. The most successful example I’ve been able to find is a Dutch tax on discharges of water containing organic materials.
What has caught on instead is a variant that most economists consider more or less equivalent: a system of tradable emissions permits, a k a cap and trade. In this model, a limited number of licenses to emit a specified pollutant, like sulfur dioxide, are issued. A business that wants to create more pollution than it is licensed for can go out and buy additional licenses from other parties; a firm that has more licenses than it intends to use can sell its surplus. This gives everyone an incentive to reduce pollution, because buyers would not have to acquire as many licenses if they can cut back on their emissions, and sellers can unload more licenses if they do the same. …[Economically], a cap-and-trade system produces the same incentives to reduce pollution as a Pigovian tax, with the price of licenses effectively serving as a tax on pollution.
In practice there are a couple of important differences between cap and trade and a pollution tax. One is that the two systems produce different types of uncertainty. If the government imposes a pollution tax, polluters know what price they will have to pay, but the government does not know how much pollution they will generate. If the government imposes a cap, it knows the amount of pollution, but polluters do not know what the price of emissions will be. Another important difference has to do with government revenue. A pollution tax … imposes costs on the private sector while generating revenue for the government. Cap and trade is a bit more complicated. If the government simply auctions off licenses and collects the revenue, then it is just like a tax. Cap and trade, however, often involves handing out licenses to existing players, so the potential revenue goes to industry instead of the government.
Politically speaking, doling out licenses to industry … offers a way to partly compensate some of the groups whose interests would suffer if a serious climate-change policy were adopted. This can make passing legislation more feasible.
…[The] Waxman-Markey bill, a cap-and-trade setup for greenhouse gases that starts by giving out many licenses to industry but puts up a growing number for auction in later years, was actually passed by the House of Representatives last year; it’s hard to imagine a broad-based emissions tax doing the same for many years. …
In any case, experience suggests that market-based emission controls work. Our recent history with acid rain shows as much. The Clean Air Act of 1990 introduced a cap-and-trade system in which power plants could buy and sell the right to emit sulfur dioxide, leaving it up to individual companies to manage their own business within the new limits. …[Over] time sulfur-dioxide emissions from power plants were cut almost in half, at a much lower cost than even optimists expected; electricity prices fell instead of rising. Acid rain did not disappear as a problem, but it was significantly mitigated. …
…The emission of carbon dioxide and other greenhouse gases is a classic negative externality — … . Textbook economics and real-world experience tell us that we should have policies to discourage activities that generate negative externalities and that it is generally best to rely on a market-based approach.
Climate of Doubt? …[It’s] worth establishing three things about the state of the scientific debate.
The first is that the planet is indeed warming. … [If] you look at the evidence …— taking averages over periods long enough to smooth out the fluctuations — the upward trend is unmistakable: each successive decade since the 1970s has been warmer than the one before.
Second, climate models predicted this well in advance, even getting the magnitude of the temperature rise roughly right. …So the fact that climate modelers more than 20 years ago successfully predicted the subsequent global warming gives them enormous credibility. …
…[My] third point: models based on this research indicate that if we continue adding greenhouse gases to the atmosphere as we have, we will eventually face drastic changes in the climate. …[We’re] talking about massively disruptive events, like the transformation of the Southwestern United States into a permanent dust bowl over the next few decades.
… Is a cap-and-trade program along the lines of the model used to reduce sulfur dioxide the right way to go?
Serious opposition to cap and trade generally comes in two forms: an argument that more direct action — in particular, a ban on coal-fired power plants — would be more effective and an argument that an emissions tax would be better than emissions trading. … There’s something to each of these positions, just not as much as their proponents think.
When it comes to direct action, you can make the case that economists … are too ready to assume that changing people’s financial incentives fixes every problem. In particular, you can’t put a price on something unless you can measure it accurately, and that can be both difficult and expensive. So sometimes it’s better simply to lay down some basic rules about what people can and cannot do. …
Is there a comparable argument to be made for greenhouse-gas emissions? My initial reaction, which I suspect most economists would share, is that the very scale and complexity of the situation requires a market-based solution, whether cap and trade or an emissions tax. … Reducing emissions of those gases will require getting people to change their behavior in many different ways, some of them impossible to identify until we have a much better grasp of green technology. … Econ 101 tells us … that the only way to get people to change their behavior appropriately is to put a price on emissions so this cost in turn gets incorporated into everything else in a way that reflects ultimate environmental impacts.
… A market-based system would create decentralized incentives to do the right thing, and that’s the only way it can be done.
That said, some specific rules may be required. James Hansen, … has argued forcefully that most of the climate-change problem comes down to …burning coal, and that whatever else we do, we have to shut down coal burning over the next couple decades. …[A] market-based system might turn out to have loopholes — and their consequences could be dire. So I would advocate supplementing market-based disincentives with direct controls on coal burning.
What about the case for an emissions tax rather than cap and trade? There’s no question that a straightforward tax would have many advantages over legislation like Waxman-Markey, which is full of exceptions and special situations. … The question is whether the emissions tax that could actually be put in place is better than cap and trade. There is no reason to believe that … a broad-based emissions tax would make it through Congress.
To be fair, Hansen has made an interesting moral argument against cap and trade, one that’s much more sophisticated than the old view that it’s wrong to let polluters buy the right to pollute. What Hansen draws attention to is the fact that in a cap-and-trade world, acts of individual virtue do not contribute to social goals. If you choose to drive a hybrid car or buy a house with a small carbon footprint, all you are doing is freeing up emissions permits for someone else, which means that you have done nothing to reduce the threat of climate change. … But altruism cannot effectively deal with climate change. Any serious solution must rely mainly on creating a system that gives everyone a self-interested reason to produce fewer emissions. …
The bottom line, then, is that while climate change may be a vastly bigger problem than acid rain, the logic of how to respond to it is much the same. What we need are market incentives for reducing greenhouse-gas emissions — along with some direct controls over coal use — and cap and trade is a reasonable way to create those incentives. …
The Cost of Action Just as there is a rough consensus among climate modelers about the likely trajectory of temperatures if we do not act to cut the emissions of greenhouse gases, there is a rough consensus among economic modelers about the costs of action. That general opinion may be summed up as follows: Restricting emissions would slow economic growth — but not by much. The Congressional Budget Office, relying on a survey of models, has concluded that Waxman-Markey “would reduce the projected average annual rate of growth of gross domestic product between 2010 and 2050 by 0.03 to 0.09 percentage points.” … Over all, the Budget Office concludes, strong climate-change policy would leave the American economy between 1.1 percent and 3.4 percent smaller in 2050 than it would be otherwise.
And what about the world economy? In general, modelers tend to find that climate-change policies would lower global output by a somewhat smaller percentage than the comparable figures for the United States. …
Such figures typically come from a model that combines all sorts of engineering and marketplace estimates. …
There are, … a number of ways this kind of modeling could be wrong. Many of the underlying estimates are necessarily somewhat speculative; … There is also reason to doubt the assumption that people actually make the right choices: many studies have found that consumers fail to take measures to conserve energy, like improving insulation, even when they could save money by doing so.
But while it’s unlikely that these models get everything right, it’s a good bet that they overstate rather than understate the economic costs of climate-change action. That is what the experience from the cap-and-trade program for acid rain suggests: costs came in well below initial predictions. …
… Even if you do not fully trust the models — … history and logic both suggest that the models are overestimating, not underestimating, the costs of climate action. …
The China Syndrome … China, which burns much more coal per dollar of gross domestic product than the United States does, overtook us by that measure around three years ago. Over all, the advanced countries — the rich man’s club comprising Europe, North America and Japan — account for only about half of greenhouse emissions, and that’s a fraction that will fall over time. In short, there can’t be a solution to climate change unless the rest of the world, emerging economies in particular, participates in a major way.
Inevitably those who resist tackling climate change point to the global nature of emissions as a reason not to act. Emissions limits in America won’t accomplish much, they argue, if China and others don’t match our effort. … Indeed, emerging economies feel that they have a right to emit freely without worrying about the consequences — that’s what today’s rich countries got to do for two centuries. It’s just not possible to get global cooperation on climate change, goes the argument, and that means there is no point in taking any action at all.
…Carrots, or positive inducements, are one answer. Imagine setting up cap-and-trade systems in China and the United States — but allow international trading in permits, so Chinese and American companies can trade emission rights. By setting overall caps at levels designed to ensure that China sells us a substantial number of permits, we would in effect be paying China to cut its emissions. Since the evidence suggests that the cost of cutting emissions would be lower in China than in the United States, this could be a good deal for everyone.
But what if the Chinese (or the Indians or the Brazilians, etc.) do not want to participate in such a system? Then you need …carbon tariffs.
A carbon tariff would be a tax levied on imported goods proportional to the carbon emitted in the manufacture of those goods. Suppose that China refuses to reduce emissions, while the United States adopts policies that set a price of $100 per ton of carbon emissions. If the United States were to impose such a carbon tariff, any shipment to America of Chinese goods whose production involved emitting a ton of carbon would result in a $100 tax over and above any other duties. Such tariffs, if levied by major players — …— would give noncooperating countries a strong incentive to reconsider their positions.
…Keeping world markets open is important, but avoiding planetary catastrophe is a lot more important. …[You] can argue that carbon tariffs are well within the rules of normal trade relations. As long as the tariff imposed on the carbon content of imports is comparable to the cost of domestic carbon licenses, the effect is to charge your own consumers a price that reflects the carbon emitted in what they buy, no matter where it is produced. …[The] World Trade Organization, which is charged with policing trade policies, has published a study suggesting that carbon tariffs would pass muster. …
The Costs of Inaction …[Climate] modelers themselves have grown increasingly pessimistic. What were previously worst-case scenarios have become base-line projections, … . Underlying this new pessimism is increased concern about feedback effects — for example, the release of methane, … from seabeds and tundra as the planet warms.
At this point, the projections of climate change, assuming we continue business as usual, cluster around an estimate that average temperatures will be about 9 degrees Fahrenheit higher in 2100 than they were in 2000. That’s a lot — equivalent to the difference in average temperatures between New York and central Mississippi. … And the troubles would not stop there: temperatures would continue to rise.
Furthermore, changes in average temperature will by no means be the whole story. Precipitation patterns will change, with some regions getting much wetter and others much drier. Many modelers also predict more intense storms. Sea levels would rise, with the impact intensified by those storms: coastal flooding, already a major source of natural disasters, would become much more frequent and severe. And there might be drastic changes in the climate of some regions as ocean currents shift. …
While there may be some benefits from a warmer climate, it seems almost certain that upheaval on this scale would make the United States, and the world as a whole, poorer than it would be otherwise. How much poorer? If ours were … [an]agricultural society, extreme climate change would be obviously catastrophic. But we have an advanced economy, the kind that has historically shown great ability to adapt to changed circumstances. …[The] same flexibility that should enable us to deal with a much higher carbon prices should also help us cope with a somewhat higher average temperature.
…[It’s] not just a matter of having warmer weather — many of the costs of climate change are likely to result from droughts, flooding and severe storms. The other is that while modern economies may be highly adaptable, the same may not be true of ecosystems. The last time the earth experienced warming at anything like the pace we now expect was during the Paleocene-Eocene Thermal Maximum, … when temperatures rose by about 11 degrees Fahrenheit over the course of around 20,000 years (which is a much slower rate than the current pace of warming). That increase was associated with mass extinctions, which, to put it mildly, probably would not be good for living standards.
So how can we put a price tag on the effects of global warming? The most widely quoted estimates, like those in the Dynamic Integrated Model of Climate and the Economy, known as DICE, used by Yale’s William Nordhaus and colleagues, depend upon educated guesswork to place a value on the negative effects of global warming in a number of crucial areas, especially agriculture and coastal protection, then try to make some allowance for other possible repercussions. Nordhaus has argued that a global temperature rise of 4.5 degrees Fahrenheit … would reduce gross world product by a bit less than 2 percent. But what would happen if, as a growing number of models suggest, the actual temperature rise is twice as great? Nobody really knows how to make that extrapolation. For what it’s worth, Nordhaus’s model puts losses from a rise of 9 degrees at about 5 percent of gross world product. Many critics have argued, however, that the cost might be much higher.
Despite the uncertainty, it’s tempting to make a direct comparison between the estimated losses and the estimates of what the mitigation policies will cost: climate change will lower gross world product by 5 percent, stopping it will cost 2 percent, so let’s go ahead. Unfortunately the reckoning is not that simple for at least four reasons.
First, substantial global warming is already “baked in,” as a result of past emissions and because even with a strong climate-change policy the amount of carbon dioxide in the atmosphere is most likely to continue rising for many years. So even if the nations of the world do manage to take on climate change, we will still have to pay for earlier inaction. As a result, Nordhaus’s loss estimates may overstate the gains from action.
Second, the economic costs from emissions limits would start as soon as the policy went into effect and under most proposals would become substantial within around 20 years. If we don’t act, meanwhile, the big costs would probably come late this century … So how you compare those costs depends on how much you value costs in the distant future relative to costs that materialize much sooner.
Third, and cutting in the opposite direction, if we don’t take action, global warming won’t stop in 2100: temperatures, and losses, will continue to rise. So if you place a significant weight on the really, really distant future, the case for action is stronger than even the 2100 estimates suggest.
Finally and most important is the matter of uncertainty. …The recent doubling of many modelers’ predictions for 2100 is itself an illustration of the scope of that uncertainty; … Beyond that, nobody really knows how much damage would result from temperature rises of the kind now considered likely.
… As Harvard’s Martin Weitzman has argued in several influential papers, if there is a significant chance of utter catastrophe, that chance — rather than what is most likely to happen — should dominate cost-benefit calculations. …
Still that leaves a big debate about the pace of action.
The Ramp Versus the Big Bang …On one side are economists who have been working for many years on so-called integrated-assessment models, which combine models of climate change with models of both the damage from global warming and the costs of cutting emissions. … Thus Nordhaus’s DICE model says that the price of carbon emissions should eventually rise to more than $200 a ton, effectively more than quadrupling the cost of coal, but that most of that increase should come late this century, with a much more modest initial fee of around $30 a ton. Nordhaus calls this recommendation for a policy that builds gradually over a long period the “climate-policy ramp.”
On the other side are …[those] who work with similar models but come to different conclusions. …Nicholas Stern, an economist at the London School of Economics, argued in 2006 for quick, aggressive action to limit emissions, which would most likely imply much higher carbon prices. This alternative position doesn’t appear to have a standard name, so let me call it the “climate-policy big bang.” …
The policy-ramp advocates argue that the damage done by an additional ton of carbon in the atmosphere is fairly low at current concentrations; the cost will not get really large until there is a lot more carbon dioxide in the air, and that won’t happen until late this century. And they argue that costs that far in the future should not have a large influence on policy today. …
The big-bang advocates argue that government should take a much longer view than private investors. Stern, … argues that policy makers should give the same weight to future generations’ welfare as we give to those now living. Moreover, the proponents of fast action hold that the damage from emissions may be much larger than the policy-ramp analyses suggest, either because global temperatures are more sensitive to greenhouse-gas emissions than previously thought or because the economic damage from a large rise in temperatures is much greater than the guesstimates in the climate-ramp models. …
The Political Atmosphere …[The] House has already passed Waxman-Markey, a fairly strong bill aimed at reducing greenhouse-gas emissions. It’s not as strong as what the big-bang advocates propose, but it appears to move faster than the policy-ramp proposals. But the vote on Waxman-Markey, … revealed a starkly divided Congress. … And the odds are that it would not pass if it were brought up for a vote today.
Prospects in the Senate, where it takes 60 votes to get most legislation through, are even worse. …
So the immediate prospects for climate action do not look promising, despite an ongoing effort by three senators — John Kerry, Joseph Lieberman and Lindsey Graham — to come up with a compromise proposal. (They plan to introduce legislation later this month.) Yet the issue isn’t going away. …
Paul Krugman is a Times columnist and winner of the 2008 Nobel Memorial Prize in Economic Science. His latest book is “The Return of Depression Economics and the Crisis of 2008.”
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