Krugman on global warming policy

Paul Krugman has written a great article on the policy options available to reduce greenhouse gas emissions. It is well worth a read as it provides a great overview of the emerging economic consensus, and demonstrates why cutting greenhouse gasses wont destroy the economy as some have claimed.

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.

On the question of a carbon tax, vs cap and trade Krugman arrives at a similar conclusion as I have (something that I take to mean that I am at least partially on the right track), though it took me a while longer to arrive at this conclusion. Both a cap-and-trade system and carbon tax can be feasible, and while a carbon tax can be simpler, a cap-and-trade scheme is more politically viable. I still like the notion of a carbon tax because of its simplicity, but have come to accept that some form of cap-and-trade is a more likely outcome.

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 [a cap-and-trade] legislation like Waxman-Markey, which is full of exceptions and special situations. But that’s not really a useful comparison: of course an idealized emissions tax looks better than a cap-and-trade system that has already passed the House with all its attendant compromises. 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 it would be — indeed, there is no reason to believe that a broad-based emissions tax would make it through Congress.

As long as a proper price on carbon is achieved I am happy (particularly if there are no offsets). Market based solutions to such problems have been shown to work. But even a price on carbon might not be enough, because any legislation that becomes law will inevitably contain loop-holes, and those loopholes may have dire consequences for the climate system.

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.

These additional regulations will no doubt be tricky, but absent effective legislation with no loopholes, they will be a requirement.

So how much is all of this going to cost?

That is the good news. While the costs wont be negligible, they will be much lower than most people assume, and if past examples of similar regulations hold up, it will be less than the most optimistic estimates:

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.” That is, it would trim average annual growth to 2.31 percent, at worst, from 2.4 percent. 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 as for the world economy as a whole, it does even better, thanks to the easy efficiency gains to be made in developing countries (such gains have already been made in developed countries, so we have to work a little harder to achieve our reductions in GHG emissions).

And more importantly the costs are likely overstated by economic models:

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. 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.

The market-economy will adapt to the increased cost of greenhouse gasses just like it adapts to everything else. It has been shown time and time again that the costs of environmental regulations have been overestimated as economists as this article in American Prospect makes clear:

“In every case we have found where researchers have calculated actual regulatory costs and then compared them to ex ante estimates, the estimate exceeded the actual cost. We have uncovered a dozen such efforts, ranging from A (asbestos) to V (vinyl chloride). In all cases but one, the initial estimates were at least double the actual costs… When environmental economists figure their cost estimates, one particular lapse is quite startling. Economists have tended to grossly underestimate a virtue of markets they readily preach elsewhere: flexibility. When pollution regulation makes a certain type of production more expensive, markets adjust—in fairly rapid order, uncovering substitute methods of production, and developing cheaper cleanup technologies. This fact, while not completely ignored by economists, is seldom factored into their cost estimates. Instead analysts tend to predict future costs statically, as if firms would continue to use existing practices and technologies.”

The market-economy is incredibly adaptive, and it will adapt to a price on carbon just like it adapts to everything else.

But this cost issue is lost on many the opposition to carbon pricing has been completely dishonest:

This reaction — 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 — Ronald Reagan liked to talk about the “magic of the marketplace.” 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 favor of conservation?

And when that isn’t enough, they lie:

The National Republican Congressional Committee, for example, issued multiple press releases specifically citing a study from M.I.T. as the basis for a claim that cap and trade would cost $3,100 per household, despite repeated attempts by the study’s authors to get out the word that the actual number was only about a quarter as much.

The bottom line is:

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 — and you shouldn’t — 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.

Krugman even deals with the tricky China issue, offering two options:

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 (or the Indians or the Brazilians, etc.) 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 noncooperating countries a strong incentive to reconsider their positions.

While estimating the amount of carbon produced in the manufacturing would be difficult, and subject to abuse, it can be done right, and even the WTO has published a study agreeing.

The bottom line is that an international agreement on this issue is possible, despite the fact that it wont be easy.

Krugman even touches on the concept of uncertainty, and argues that uncertainty strengthens the case for action.

Finally and 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 modelers’ 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.

The Economist  recently published an article that arrived at the same conclusion:

“Plenty of uncertainty remains; but that argues for, not against, action. If it were known that global warming would be limited to 2°C, the world might decide to live with that. But the range of possible outcomes is huge, with catastrophe one possibility, and the costs of averting climate change are comparatively small. Just as a householder pays a small premium to protect himself against disaster, the world should do the same.”

And it is a conclusions shared by 75% of economists in a recent survey.

There is more in Kurgman’s article, and the whole thing is well worth a read.

We know how to limit greenhouse-gas emissions. We have a good sense of the costs — and they’re manageable. All we need now is the political will

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