TOWARD A STRONGER ECONOMY

In any discussion about climate change, you will almost certainly hear the claim that reducing our greenhouse gas emissions will harm the economy. Even proponents of climate policy seem to take this as a given when they argue that environmental protection justifies the economic costs that could result.

The view seems to make intuitive sense: greenhouse gas emissions result from energy use, efforts to reduce emissions will make energy more expensive, higher energy prices will hinder economic activity and thereby harm the overall economy. For all its intuitive certainty, however, the view that increasing energy prices must necessarily harm the economy is patently false. Basic economic principles instead suggest that including a price on pollution would lead to an overall economic improvement. In this post, I’ll explain why.

Greenhouse gas emissions impose costs on the economy by causing climate damages. Some of the consequences of climate change (expected or already underway) include impacts on human health, property damage from floods, changes in the availability of fresh water, increased coastal inundation, and more intense storms (among a range of other impacts). These current and future climate impacts are part of the economic costs of our greenhouse gas emissions.

Critically, these economic costs do not get paid directly by those who pollute so they don’t factor in to their decisions about how much to emit. Rather, everyone in society pays (or subsidizes) these costs by suffering the impacts of climate change. This is a bad situation economically.

To understand why, imagine an economy consisting of only two people: you and me. If I can take an action that returns to me greater economic benefits than the costs I must pay, then it makes sense for me to do it. That remains true no matter what costs you may also incur from my action, since I don’t pay your costs. Now suppose that your costs and my costs together equal more than the total benefits of the action. The economy as a whole is actually worse off by my taking the action. If I had to pay all the costs (and received all the benefits), then I would take only those actions that resulted in more net benefit than cost for the economy as a whole.

This is the problem with pollution. Polluters will choose to emit greenhouse gases, even when doing so causes a net economic loss to society, because they don’t pay the costs associated with climate change. Therefore, policies that require emitters to pay for the economy wide costs of their pollution would actually tend to benefit the economy as a whole.

Unfortunately, we don’t know exactly (and likely can’t know) the economically optimal price to put on climate pollution. The fact that people, and the natural systems that we depend on, are heavily adapted to our current climate suggests that the costs of climate change will be considerable. Nevertheless, we could still get lucky (i.e., experience less dramatic climate changes and face more minor societal impacts), unlucky (i.e., face dramatic climate changes and catastrophic impacts), or end up with climate impacts somewhere in between those extremes. Setting the best pollution price (from an economic perspective) depends on knowing just how lucky or unlucky we’ll be. We won’t know that with certainty until after the fact (see this post about dealing with uncertainty).

Even with this uncertainty, economic improvements remain possible. For most countries, including the United States, polluters currently don’t pay any costs for their contribution to climate change, meaning they can treat the atmosphere like a free sewer for greenhouse gases. Adding a pollution fee could get us closer to the right pollution price, even if we can’t expect to get that price exactly right.

Not all policies are equally effective economically, however, so it’s certainly possible to make wasteful and ineffective choices. This doesn’t lend much support to fears about the economic consequences of reducing emissions though, because the major policy debates tend to focus on market-based mechanisms (either a cap and trade system or a pollution fee). These are approaches that would put a price on pollution and allow for the largest reduction in emissions at the lowest cost. As long as we put a price on pollution that brings the costs polluters pay closer to the total costs of their activities, then overall economic gains, not losses, can be expected. (In a future post I’ll write about choosing a pollution fee under uncertainty and whether it is better to err on the side of a fee that is too low or too high).

Of course, other factors could outweigh the economic considerations. For example, society may view fairness, ethics, or moral preferences as being more important than the economic implications. At a minimum, policies that seek to reduce or eliminate pollution subsidies will have winners and losers even as the economy as a whole improves. Do those who will lose deserve special consideration, even at the expense of the wider economy? They probably do in many cases but that important question isn’t how discussions about climate policy usually get framed. Instead we hear dubious assertions about impending economic damage. (Note also that with overall economic gains exceeding the losses, it is possible to compensate fully those who lose and still have some of the gains left over).

Policy makers clearly face difficult choices in dealing with climate change. The best hope for making those choices wisely, in my view, is to begin by retiring the old canard that reducing greenhouse gas emissions requires economic sacrifice. Instead, the current subsidies to pollute cause economic harm. If we can counterbalance those subsidies with some form of pollution fee, then the economy as a whole can be expected to improve.