Friday, April 9, 2010

Affordably Green

I referred to this article by Paul Krugman in a post yesterday. It's worth highlighting, rather than leaving it as an update to my earlier post.

Prof Krugman starts with some basic economic theory, using those poor overused widgets as an example to illustrate the concept of the 'efficiency of free markets'. He then moves on to after-market interventions as a means of ensuring fairness, before discussing 'negative externalities':
When there are “negative externalities” — costs that economic actors impose on others without paying a price for their actions — any presumption that the market economy, left to its own devices, will do the right thing goes out the window. So what should we do? Environmental economics is all about answering that question.

One way to deal with negative externalities is to make rules that prohibit or at least limit behavior that imposes especially high costs on others. That’s what we did in the first major wave of environmental legislation in the early 1970s: cars were required to meet emission standards for the chemicals that cause smog, factories were required to limit the volume of effluent they dumped into waterways and so on. And this approach yielded results; America’s air and water became a lot cleaner in the decades that followed.
Krugman goes on to explore some of the downsides of dealing with negative externalities solely by prohibiting them through regulation and introduces the ideas of Arthur Cecil Pigou, from the early 20th century:
...economic activities that impose unrequited costs on other people should not always be banned, but they should be discouraged. And the right way to curb an activity, in most cases, is to put a price on it. So Pigou proposed that people who generate negative externalities should have to pay a fee reflecting the costs they impose on others — what has come to be known as a Pigovian tax. The simplest version of a Pigovian tax is an effluent fee: anyone who dumps pollutants into a river, or emits them into the air, must pay a sum proportional to the amount dumped.

...In practice there are a couple of important differences between cap and trade and a pollution tax. One is that the two systems produce different types of uncertainty. If the government imposes a pollution tax, polluters know what price they will have to pay, but the government does not know how much pollution they will generate. If the government imposes a cap, it knows the amount of pollution, but polluters do not know what the price of emissions will be. Another important difference has to do with government revenue. A pollution tax is, well, a tax, which imposes costs on the private sector while generating revenue for the government. Cap and trade is a bit more complicated. If the government simply auctions off licenses and collects the revenue, then it is just like a tax. Cap and trade, however, often involves handing out licenses to existing players, so the potential revenue goes to industry instead of the government.
In Krugman's article he looks further into options for policies aimed at reducing carbon emissions, comparing the relative merits and downsides different approaches. He follows up with estimates of the cost of doing something and doing nothing - which are at this time somewhat speculative. What is clear is that doing something sooner will be less costly than delaying action.

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.

I highly recommend reading the full article in the New York Times Magazine.

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