Building a Green Economy to Avoid Climate Catastrophe: We Can Do This

Climate Science & Climate Economics 
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. The casual reader might have the impression that there are real doubts about whether emissions can be reduced without inflicting severe damage on the economy. In fact, once you filter out the noise generated by special-interest groups, you discover that 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. Free markets are “efficient” — which, in economics-speak as opposed to plain English, means that nobody can be made better off without making someone else worse off. Now, efficiency isn’t everything. In particular, there is no reason to assume that free markets will deliver an outcome that we consider fair or just. So the case for market efficiency says nothing about whether we should have, say, some form of guaranteed health insurance, aid to the poor and so forth. But the logic of basic economics says that we should try to achieve social goals through “aftermarket” interventions. That is, we should let markets do their job, making 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? What if you manufacture a widget and I buy it, to our mutual benefit, but the process of producing that widget involves dumping toxic sludge into other people’s drinking water? 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, left to its own devices, 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 behaviour 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. Consider the biggest environmental issue of the 1980s — acid rain. Emissions of sulphur dioxide from power plants, it turned out, tend to combine with water downwind and produce flora- and wildlife-destroying sulphuric acid. In 1977, the government made its first stab at confronting the issue, recommending that all new coal-fired plants have scrubbers to remove sulphur dioxide from their emissions. Imposing a tough standard on all plants was problematic, because retrofitting some older plants would have been extremely expensive. By regulating only new plants, however, the government passed up the opportunity to achieve fairly cheap pollution control at plants that were, in fact, easy to retrofit. 





A. C. Pigou was an early-20th-century British don, whose 1920 book, “The Economics of Welfare,” is generally regarded as the ur-text of environmental economics. He enunciated 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. 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. What has caught on 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 sulphur 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. In fact, 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.

Politically speaking, doling out licenses to industry isn’t entirely bad, because it 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. These political considerations probably explain why the solution to the acid-rain predicament took the form of cap and trade and why licenses to pollute were distributed free to power companies. In the US, the Waxman-Markey bill, a cap-and-trade setup for greenhouse gases, starts by giving out many licenses to industry but puts up a growing number for auction in later years, and 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. Some senators have recently floated a proposal for a hybrid solution, with cap and trade for some parts of the economy and carbon taxes for others — mainly oil and gas. The political logic seems to be that the oil industry thinks consumers won’t blame it for higher gas prices if those prices reflect an explicit tax.

In any case, experience suggests that market-based emission controls work. Our recent history with acid rain shows as much. The US Clean Air Act of 1990 introduced a cap-and-trade system in which power plants could buy and sell the right to emit sulphur dioxide, leaving it up to individual companies to manage their own business within the new limits. Sure enough, over time sulphur-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 results, it would seem, demonstrated that we can deal with environmental problems when we have to.

The emission of carbon dioxide and other greenhouse gases is a classic negative externality — the “biggest market failure the world has ever seen,” in the words of Nicholas Stern, author of a report on the subject for the British government. 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?
This is an article on climate economics, not climate science. But before we get to economics, it’s worth establishing three things about the state of the scientific debate. The first is that the planet is indeed warming. Weather fluctuates, and as a consequence it’s easy enough to point to an unusually warm year in the recent past, note that it’s cooler now and claim, “See, the planet is getting cooler, not warmer!” But if you look at the evidence the right way — 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. While it’s relatively easy to cook up an analysis that matches known data, it is much harder to create a model that accurately forecasts the future. So the fact that climate modellers more than 20 years ago successfully predicted the subsequent global warming gives them enormous credibility. 

Supposed recent climate science scandals evaporate on closer examination, revealing only that climate researchers are human beings, too. Yes, scientists try to make their results stand out, but no data were suppressed. Yes, scientists dislike it when work that they think deliberately obfuscates the issues gets published. What else is new? Nothing suggests that there should not continue to be strong support for climate research.

And this brings me to 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. Let’s be clear. We’re not talking about a few more hot days in the summer and a bit less snow in the winter; 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. 

Now, despite the high credibility of climate modellers, there is still tremendous uncertainty in their long-term forecasts. But as we will see shortly, uncertainty makes the case for action stronger, not weaker. So climate change demands action…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. After all, greenhouse gases are a direct or indirect by-product of almost everything produced in a modern economy, from the houses we live in to the cars we drive. Reducing emissions of those gases will require getting people to change their behaviour in many different ways, some of them impossible to identify until we have a much better grasp of green technology. So can we really make meaningful progress by telling people specifically what will or will not be permitted? Econ 101 tells us that the only way to get people to change their behaviour 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. 

When shoppers go to the grocery store, for example, they will find that fruits and vegetables from farther away have higher prices than local produce, reflecting in part the cost of emission licenses or taxes paid to ship that produce. When businesses decide how much to spend on insulation, they will take into account the costs of heating and air-conditioning that include the price of emissions licenses or taxes for electricity generation. When electric utilities have to choose among energy sources, they will have to take into account the higher license fees or taxes associated with fossil-fuel consumption. And so on down the line. 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, the renowned climate scientist who deserves much of the credit for making global warming an issue in the first place, has argued forcefully that most of the climate-change problem comes down to just one thing, burning coal, and that whatever else we do, we have to shut down coal burning over the next couple of decades. My economist’s reaction is that a stiff license fee would strongly discourage coal use anyway. But 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.

The bottom line, 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 modellers 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 modellers 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 US Congressional Budget Office, relying on a survey of models, has concluded that the Waxman-Markey Bill “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.” That is, it would trim average annual growth to 2.31% at worst, from 2.4%. Over all, the Budget Office concludes, strong climate-change policy would leave the American economy between 1.1% and 3.4% smaller in 2050 than it would be otherwise. One recent review of the available estimates put the costs of a very strong climate policy — substantially more aggressive than contemplated in current legislative proposals — at between 1 and 3% of gross world product.

While it’s unlikely that the 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. And in general, what the models do not and cannot take into account is creativity; surely, faced with an economy in which there are big monetary payoffs for reducing greenhouse-gas emissions, the private sector will come up with ways to limit emissions that are not yet in any model.

What you hear from American conservative opponents of a climate-change policy, however, is that any attempt to limit emissions would be economically devastating…this extreme pessimism about the economy’s ability to live with cap and trade  is very much at odds with typical conservative rhetoric. After all, modern conservatives express a deep, almost mystical confidence in the effectiveness of market incentives. They believe that the capitalist system can deal with all kinds of limitations, that technology, say, can easily overcome any constraints on growth posed by limited reserves of oil or other natural resources. And yet now they submit that this same private sector is utterly incapable of coping with a limit on overall emissions, even though such a cap would, from the private sector’s point of view, operate very much like a limited supply of a resource, like land. Why don’t they believe that the dynamism of capitalism will spur it to find ways to make do in a world of reduced carbon emissions? Why do they think the marketplace loses its magic as soon as market incentives are invoked in favour of conservation?

Clearly, conservatives abandon all faith in the ability of markets to cope with climate-change policy because they don’t want government intervention. Their stated pessimism about the cost of climate policy is essentially a political ploy rather than a reasoned economic judgment. The giveaway is the strong tendency of conservative opponents of cap and trade to argue in bad faith. The truth is that there is no credible research suggesting that taking strong action on climate change is beyond the economy’s capacity. 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. We can afford to do something about climate change.

The massive extent of eastern China air pollution visible from space: 
Beijing has completely disappeared under the haze (courtesy NASA).  

The China Syndrome
The United States is still the world’s largest economy, which makes the country one of the world’s largest sources of greenhouse gases. But it’s not the largest. 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. And they highlight China’s obduracy in the Copenhagen negotiations as evidence that other countries will not cooperate. 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.

For those who think that taking action is essential, the right question is how to persuade China and other emerging nations to participate in emissions limits. 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, Indians or Brazilians do not want to participate in such a system? Then you need sticks as well as carrots. In particular, 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 — probably the United States and the European Union — would give non-cooperating countries a strong incentive to reconsider their positions. 

To the objection that such a policy would be protectionist, a violation of the principles of free trade, one reply is, So? Keeping world markets open is important, but avoiding planetary catastrophe is a lot more important. In any case, however, 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. That should be legal under international-trading rules. In fact, even the World Trade Organization, which is charged with policing trade policies, has published a study suggesting that carbon tariffs would pass muster.

Needless to say, the actual business of getting cooperative, worldwide action on climate change would be much more complicated and tendentious than this discussion suggests. Yet the problem is not as intractable as you often hear. If the United States and Europe decide to move on climate policy, they almost certainly would be able to cajole and chivvy the rest of the world into joining the effort. We can do this. 

The Costs of Inaction
Climate modellers themselves have grown increasingly pessimistic. What were previously worst-case scenarios have become base-line projections, with a number of organizations doubling their predictions for temperature rise over the course of the 21st century. Underlying this new pessimism is increased concern about feedback effects — for example, the release of methane, a significant greenhouse gas, 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. Such a huge change would have to be highly disruptive. 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 modellers 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. It’s always worth bearing in mind that London is at the same latitude as Labrador; without the Gulf Stream, Western Europe would be barely habitable.

There are at least two reasons to take sanguine assessments of the consequences of climate change with a grain of salt. One is that, as I have just pointed out, 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, about 55 million years ago, 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, would not be good for living standards.

Most important is the matter of uncertainty. We’re uncertain about the magnitude of climate change, which is inevitable, because we’re talking about reaching levels of carbon dioxide in the atmosphere not seen in millions of years. The recent doubling of many modellers’ predictions for 2100 is itself an illustration of the scope of that uncertainty; who knows what revisions may occur in the years ahead. Beyond that, nobody really knows how much damage would result from temperature rises of the kind now considered likely.

You might think that this uncertainty weakens the case for action, but it actually strengthens it. 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. And utter catastrophe does look like a realistic possibility, even if it is not the most likely outcome.
 
Weitzman argues — and I agree — that this risk of catastrophe, rather than the details of cost-benefit calculations, makes the most powerful case for strong climate policy. Current projections of global warming in the absence of action are just too close to the kinds of numbers associated with doomsday scenarios. It would be irresponsible — it’s tempting to say criminally irresponsible — not to step back from what could all too easily turn out to be the edge of a cliff… All we need now is the political will.

The  widely admired progressive economist Paul Krugman won the 2008 Nobel Memorial Prize in Economic Science. The above is an edited synopsis of his longer original in The New York Times magazine, (April 2010), which can be consulted for an more extensive discussion of certain economic & political factors in the US.