Climate Change Economics

16 September 2009 at 9:14 am 17 comments

| Glenn MacDonald |

Some thoughts about how carbon emissions will evolve. Assume carbon emissions cause climate change. (Obviously this is controversial. But I have nothing new to add to this and so am willing to grant this assumption.) There are two fundamental economic forces at work. One is that emissions are a classical prisoners’ dilemma. That is, reducing emissions is costly, and the benefits to any one country are mainly enjoyed by others. Thus, in equilibrium, there will not be a lot of effort devoted to reducing emissions. Getting around this would require either some sort of external enforcement, e.g., the United Nations (pause for laughter!), or some approach based on repeated interaction; unfortunately the latter requires more patience and information than is realistic in this situation. Thus, consistent with the data, emissions will grow, and, per my assumption, climate change will ensue. Second, tastes for amenities such as clean air appear to be normal goods, maybe even luxuries. Individuals in China, eastern Europe, . . . appear to have little interest in these amenities, given what they might have to forego to have them, whereas many in the US, Canada, western Europe, . . . seem more inclined to pay a little more for green goods and services. Thus, efforts to reduce emissions will grow as more and more countries prosper sufficiently that their inhabitants are willing to forgo consumption for cleaner air, etc. So, from an economic perspective, the most realistic way to fewer carbon emissions and (per my assumption) less climate effects is through the aggressive promotion of activities that promote growth: free trade, democracy, economic freedom, reduced taxes, regulations and tariffs, protection of property rights. . . . Interestingly, freeing individuals to pursue their interests is likely the best practical/realitic approach to what, at first blush, seems like a classical case for collective action.

Entry filed under: Former Guest Bloggers, Myths and Realities, Public Policy / Political Economy.

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17 Comments Add your own

  • 1. David Deeds  |  16 September 2009 at 1:10 pm

    Oh Peter – still trapped in the rational man myth. This is a classic commons problem and markets are lousy at solving them. Solutions require collective action. In this case the action is most likely to be collective action in the developed world to create a tariff structure based on carbon emissions from the production process and corresponding carbon taxes on production within the developed economies. The EU will likely lead the way on this one – The Greens are a real political force. Without collective action the outcome will simply be ever increasing carbon production combined with lots of hand wringing, dire warnings etc.

  • 2. David Gerard  |  16 September 2009 at 1:24 pm

    The problem with the argument is that CO2 isn’t a conventional pollutant. When you emit SOx, NOx, CO, PM, Pb you get nasty local and regional air quality problems that us rich people don’t like, so we figure out a way to address the problem. With CO2 you don’t have the same problem or the same response. Hence, US emissions of CO2 have continued to grow even while conventional pollutants have been substantially curbed.

    So, assuming India, China, Indonesia, etc… develop in a fashion similar to the US, we would still see CO2 emissions growing there even if they take measures to address their own pollution issues.

    This shows the US trends:

  • 3. Peter Klein  |  16 September 2009 at 4:34 pm

    David D: Whatever myths I may still be trapped in — and there are surely many — please note that this guest blogger Glenn’s post, not mine! (I will say, though, that you haven’t convinced me that markets can’t solve this kind of commons problem. The historical record suggests that collective action doesn’t have a great record in solving them either. Rather, technical change and stronger definition and enforcement of property rights has tended to be the best remedy for commons problems.)

  • 4. David Deeds  |  16 September 2009 at 7:47 pm

    The historical record suggests that benevolent dictatorship is perhaps the most effective, but nobody’s appointing me anytime soon.

  • 5. Jason  |  16 September 2009 at 8:23 pm

    Indeed, here is a classic case of collective action needed, but because collective action is unlikely to happen, the practical approach is to just let people do what they do.

    But then there’s nothing interesting about this, unless you want to claim that the practical approach actually ends up being better than collective action. After all, you will admit that the practical approach will involve climate change actually happening….

  • 6. srp  |  17 September 2009 at 12:15 am

    Peter Huber’s argument is also persuasive and goes even farther. He points out that the economic value of accessible fossil fuels is trillions of dollars, most of it lying within the political control of relatively poor countries. Or, in non-monetary terms, that fuel could be burned by poor people to produce vast amounts of electric power, transportation, food, steel, etc. What are the chances that it will not be burned?

    Unless something cheaper were developed or some sort of imperialistic coercion from developed countries were applied, neither of which seems likely, then combustion is on the way. If you believe that this means severe climate effects then you need to be thinking about adaptation or geoengineering. The good thing about Glenn’s policy is that it helps the most with adaptation–richer countries can react to climate impacts more easily.

  • 7. clem  |  17 September 2009 at 5:53 pm

    Growth is the solution to curb carbon emission. Hum. Chinese are polluting so much because they are poor. Hum.
    Metric tons of CO2 emission per capita in the US (2006): 19
    Metric tons of CO2 emission per capita in China (2006): 4.6 and it was just 2.1 in 1990, so while Chinese per capita income has rocketed so have their CO2 emissions (to a lesser extent but the climate does not care about ratios but absolute levels).
    The richer you are the more you pollute, the stronger your economic growth rate the larger your emission growth. It is true though that Western Europe and the US have been stabilizing their per capita emission, but at a level that’s way higher than the world average, so I can’t see what generalized abundance would do to reduce CO2 emission. Ah of course, if everyone was as rich as Western Europe and North America CO2 emissions would grow at a much slower rate but would stand at an unsustainable level nonetheless. Freeing people to pursue their own interest may indeed help to get richer, but the correlation between income per capita and CO2 emission per capita is strong, so it won’t make their environment cleaner.

  • 8. Peter Meyer  |  21 September 2009 at 8:13 am

    Glen’s basic premise is faulty:
    “…emissions are a classical prisoners’ dilemma. That is, reducing emissions is costly, and the benefits to any one country are mainly enjoyed by others.”
    — NOT!! … and the falsehood is arguable on multiple grounds.

    1. There is extensive evidence about the energy efficiency measures that are net positives for those who engage in them. The best summaries of these findings were done by the McKinsey Global Institute in the past two years.

    2. If there is a greater than zero probability that alternative energy and efficiency technologies will be in very high demand in the future, then there is a potentially significant payoff to the economies of those countries that are in the lead in developing those technologies that would warrant current costs for a high future return on investment.

    3. There is the other side of the prisoners’ dilemma – the costs of doing nothing. His proposition assumes the do-nothing alternative does not impose costs in the relatively near tuture. Recent evidence on forest fires and mean temperatures, not to mention data on droughts and storm patterns, suggests this assumption is false.

    Ample evidence abounds at

  • 9. Peter Klein  |  21 September 2009 at 8:55 am

    Peter, regarding #1, nobody opposes individuals and firms taking these actions. But, of course, there is no need for “climate change policy” regarding them, because individuals and firms will simply do them. It’s the same with “socially conscious” business practices. If consumers desire “green” or “sustainable” or “fair-trade” products then firms have an incentive to supply them. This is simply not a public policy issue.

  • 10. Tim Worstall  |  22 September 2009 at 6:56 am

    “Thus, efforts to reduce emissions will grow as more and more countries prosper sufficiently that their inhabitants are willing to forgo consumption for cleaner air, etc. So, from an economic perspective, the most realistic way to fewer carbon emissions and (per my assumption) less climate effects is through the aggressive promotion of activities that promote growth: free trade, democracy, economic freedom, reduced taxes, regulations and tariffs, protection of property rights.”

    Interesting thought but sadly, as with so many interesting thoughts, not novel.

    Something very much like this is actually one of the economic models feeding into the IPCC reports on climate change.

    Yes, it does provide most of the best outcomes as well.

    Have a look around the SRES (just search google for it) and read chapter 4.

  • 11. gpeters  |  22 September 2009 at 11:07 am

    Peter K, would my economist friends offer there is room for a “disclosure” requirement in the public policy arena. That is, while we might not need a policy on emissions reductions, is there room for policy on disclosure of emisssions. Admittedly, if consumers made decisions based upon the information, there is incentive to provide it without policy. However, this does not address any perceived incentives for non-disclosure.

    I am looking for a good paper that describes the potential “markets” problem that a public policy on disclosure would create (in any setting)? I realize the choice of an acceptable disclosure measure has its own difficulties.

    Accounting research spends a great deal of time trying to understand the disclosure decisions of managers (including biased disclosures, voluntary disclosures, and proprietary costs of disclosures). Of course, we borrow heavily from the economics literature.

  • 12. Peter Klein  |  22 September 2009 at 12:06 pm

    Gary, good question, I’m not aware off-hand of any studies on mandatory disclosure in your context, though there must be some work on, e.g., FDA food-labeling requirements. What I had in mind was product characteristics that go beyond those mandated in the generic product-safety rules, like dolphin-safe tuna or fair-trade coffee. Indeed, just yesterday I saw an ad for a car (Lexus, I think) that was 80% made of recyclable materials. Obviously the seller is targeting a particular demographic that is willing to pay a price premium for that level of perceived environmental friendliness.

    Now that I think of it, I believe there were a bunch of Journal of Law and Economics papers in the 1970s on FDA labeling rules, concluding that product safety had actually declined, in many cases, as a response to these rules. The argument was that consumers were lulled into a false sense of security such that there was little incentive for sellers to exceed the minimum standards. I can’t recall the exact cites (Peltzmann?). Maybe somebody out there can help….

  • 13. gpeters  |  22 September 2009 at 2:37 pm

    The “minimum” response problem, is something that has been nagging at me. Generally, we think about disclosure being a good thing in terms of driving competition (everyone wants to look marginally better, so they are looking for ways to perform better). However, I am curious about conditions in which disclosure would actually drive an equilibrium where everyone goes to the minimum level of activity or performance, opposite of what was intended with the disclosure policy. Note that this would be in the absence of any minimum standard of performance. Maybe this will spark an idea for the analytic audience.

    I am currently working with a co-author on the cross-country determinants of carbon disclosures. Hoping to get the paper on SSRN very soon.

  • 14. Peter Klein  |  22 September 2009 at 4:00 pm

    OK, here are the ones I was thinking of:

    Peltzman, Sam. 1974. “The Benefits and Costs of New Drug Regulation.” in Regulating New Drugs, ed. Richard L. Landau (Chicago: University of Chicago Press, 1973), pp. 114–211.

    Linneman, Peter. 1980. “The Effects of Consumer Safety Standards: The 1973 Mattress Flammability Standard.” Journal of Law and Economics 23: 461-

    I’m sure there are many more recent studies in this tradition, however. You might find some sources at

  • 15. gpeters  |  22 September 2009 at 4:39 pm

    Here is an example of related environmental issues in the accounting literature:

    Clarkson et al. 2004, The Accounting Review

    “…The existing environmental literature suggests that investors condition their evaluation of the future economic benefits arising from environmental capital expenditure on an assessment of the firms’ environmental performance. This literature predicts the emergence of two environmental stereotypes: low-polluting firms that overcomply with existing environmental regulations, and high-polluting firms that just meet minimal environmental requirements. Our valuation evidence indicates that there are incremental economic benefits associated with environmental capital expenditure investment by low-polluting firms but not high-polluting firms. We also find that investors use environmental performance information to assess unbooked environmental liabilities, which we interpret to represent the future abatement spending obligations of high-polluting firms in the pulp and paper industry….”

  • 16. RSSted Development  |  22 September 2009 at 5:25 pm

    This won’t work. If China and India grow to have per capita C02 equal to the Western world, then worldwide C02 measures will more than triple.

    To get down to the levels greens are advocated everyone, including China and India, will have to lower our per capita emissions. We would have to lower them to sub-Saharan African levels. I.e. nearly nonexistent.

    Good luck on that.

  • 17. RSSted Development  |  22 September 2009 at 5:25 pm

    *are advocating

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