The Economics of Climate Change
Filed Under: Environmental News on August 31, 2009
One of the reasons I oppose most of the climate change legislation or laws that are proposed in the world is because, like most laws, they are there to benefit the people who made them. In the case of America’s Cap and Trade system (the Waxman-Markey bill), the benefactors will be Al Gore and his buddies who run the carbon trade exchanges.
This article is about the economics of how these systems work and one way this is measured. Informative, whether you’re for or against the idea of global warming or using economic sanctions to stop or slow it. –Aaron
by Robert P. Murphy, Library of Economics and Liberty
During the last ten years, one of the biggest drivers of public opinion and policy has been concern over global warming or climate change. The economics of climate change uses economic theory and computer models to study the interactions among government policies, the climate system, and the economy. In this article, I survey the field and some of its major controversies.
The Intergovernmental Panel on Climate Change (IPCC) is the world authority on climate change science. In 2007, the IPCC shared the Nobel Peace Prize with Al Gore for its contributions to the fight against global warming.1 Its periodic reports do not contain new research but, instead, “make policy-relevant—as opposed to policy-prescriptive—assessments of the existing worldwide literature on the scientific, technical and socio-economic aspects of climate change.”2
The latest edition of the IPCC’s work is the 2007 Fourth Assessment Report (AR4), which consists of three volumes by different “working groups.”3 The gist of the IPCC AR4 is that human activities4 are leading to increasing atmospheric concentrations of CO2, methane, and other greenhouse gases, which allow sunlight to pass through them but trap some of the lower-frequency infrared radiation that bounces back off the earth. This “enhanced greenhouse effect” leads to global warming, which many scientists and economists warn will have dramatic effects on human well-being over the next several hundred years.
When proponents of government intervention refer to the “consensus” on climate change, they have in mind the results documented in the IPCC reports. There are qualified people who passionately dispute the alleged role of human activities in the observed global warming (of about 0.7 degrees Celsius) since preindustrial times.5 However, this article focuses specifically on economic issues. Even if policymakers took the AR4 results as gospel, some of the popular policy recommendations, such as those being proposed by key Congressmen, are difficult to justify.
If the physical science of manmade global warming is correct, then policymakers are confronted with a massive negative externality. When firms or individuals embark on activities that contribute to greater atmospheric concentrations of greenhouse gases, they do not take into account the potentially large harms that their actions impose on others. As Chief Economist of the World Bank Nicholas Stern stated in his famous report, climate change is “the greatest example of market failure we have ever seen.”6
To deal with climate change, many (perhaps most) economists favor an explicit Pigovian tax on emissions, ideally calibrated to reflect the “social cost of carbon.” This tax would cause firms to internalize the externality of (mostly future) climate-change damages.
Politically, an explicit Pigovian “tax on energy” would be very difficult to implement, especially in the middle of a global recession. Consequently, politicians have flocked to a “cap and trade” system, which has the supreme virtue of being utterly incomprehensible to most voters.
Under cap and trade, the government sets a total limit on annual emissions of greenhouse gases (the “cap”). Allowances to portions of this total limit are then either handed out to various groups or auctioned off to the highest bidder. Many people consider this approach a “market solution” because the permits can be traded. People who hold excess permits sell them to those who need more permits to cover their planned emissions.
Under ideal conditions, a carbon tax can mimic any cap and trade system. In the real world, transaction costs and various uncertainties cause the two approaches to have relative pros and cons. For example, because the damage from emissions is cumulative and long-term, while the compliance costs from emissions cuts are possibly acute and immediate, a predictable carbon tax might limit environmental damages at a much lower cost than a cap and trade system.7 On the other hand, it is much easier for outsiders to verify whether (say) China is adhering to its annual cap than to verify that it is appropriately taxing firms based on their individual emissions.8
Although most economists think that there is a case for government intervention to curb emissions of greenhouse gases, the actual calibration of such policies leads to controversies, some of which are discussed below.
To read the rest, click here.
Excellent piece. Extremely salient point.
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