Better Economics for a Better Tomorrow: A market solution to global warming

This and all future articles from Gary Latanich will appear under the title:

Better Economics for a Better Tomorrow

For politicians wanting to address global warming, mandating pollution reduction levels (their favorite approach) requires that the government know what is technically possible. The problem is that the firms will not voluntarily divulge what they are or are not capable of doing. This process typically ends up in court with industry claiming that the required reductions are impossible to meet.

For your typical economist, taxation is their favorite tool. In this case it would be the carbon tax, which besides being incredibly unpopular with the public, not to mention the Republicans who have taken the Taxpayer Protection Pledge which guarantee’s opposition to any and all tax increases in Congress, requires the government to know the desired amount of pollution reduction at any point in time in order to set the appropriate tax. Tax too lightly and the problem persists. Tax too heavily and you risk destabilizing the economy.

But there is a third possibility, one that doesn’t get the press it deserves. The policy in question involves pollution permits, or as some call it “cap and trade.” This solution minimizes government interference in the economy and maximizes the results while avoiding the perennial problem of adequate technical information. All that is needed is the knowledge about how much carbon emission should be allowed. The steps in the permit process are exceedingly simple, identify the amount of carbon that will be allowed, issue permits equal to the allowable amount of carbon pollution, and auction permits to the highest bidder.

The results satisfy both politicians and economists. For starters, pollution is reduced to allowable levels. Those with low clean up cost’s drop out of the bidding and convert to alternative energy sources. Those with the highest clean up costs will bid the highest price, and have an incentive to find alternatives to fossil fuels. Environmental groups can bid on the permits thus reducing the level of carbon emissions below what the government is specifying. Changing carbon pollution standards can lead to changes in the number of permits. For firms whose higher prices are not acceptable to the public because of the high cost of the permits, or the high cost of alternative energies, these firms are legitimately out of business (the market has spoken).

This approach was used successfully by the EPA after it was written into the 1990 Clean Air Act. In the case of “acid rain” it required cutting overall sulfur emissions in half, but let each company decide how to make the cuts. Power plants that lowered their pollution more than required could sell those extra allowances to other plants. In the end, sulfur emissions decreased faster than predicted and at one-fourth of the projected cost. So successful was this approach that it was incorporated into the Kyoto Accords.

But, for all the success we had with the “cap and trade” approach, it still faces an up hill battle for acceptance as the solution to the much bigger problem of global warming. As Alan Blinder, the former Vice-chairman of the Federal Reserve put it, we much confront and defeat the three I’s, ignorance, ideology, and interest groups.

Ignorance comes into play because the public mistakenly thinks that the permits are allowing the biggest and largest polluters to buy out of the climate change solution which is the reduction in carbon emissions. Fortunately their fears are misplaced, as the number of permits is lowered, increasing numbers of firms must comply. And, as far as global warming is concerned, the reduction in carbon must be sizable, but a reduction to zero is not necessary.

Ideology will present itself as a problem because, by and large, Republicans have taken position that global warming is not a man-made phenomenon, but an issue promoted by liberals the solution to which (a carbon tax) will wreck the economy.

The final problem that will have to be overcome is opposition from special interest groups, specifically the petroleum and coal industry and utilities who are major producers users of fossil fuels. A complete migration from fossil fuels to renewable energies would render their physical plant obsolete, and their corporate stock worthless. Ignoring their concerns would be unethical. When society decides to make structural changes to the economy, it has an obligation to compensate those who will be on the losing end of the proposition.

Education and compensation can overcome ignorance and the opposition of special interest groups, but ideology will only be sidelined by an electorate, in the 2020 elections, committed to ending global warming. The good news is that “cap and trade” works, we eliminated the “acid rain” problem, and we can do it again and eliminate a problem that threatens our very existence.