Will government solutions to global warming be worse than global warming itself? Remember that man-made global warming is a negative externality that occurs when burning fossil fuels release carbon dioxide into the atmosphere. Economists define negative externality as a spillover from an economic transaction that harms parties not directly involved in the transaction. In this case, the carbon dioxide released into the atmosphere is thought to be boosting temperatures, raising sea levels, and having other effects on the climate that people must involuntarily pay to adapt to (more air conditioning, switching crops, and so forth). Thus, goes the argument, the price of fossil fuels does not reflect the full cost of consuming them.
Ideally, once the full costs of man-made global warming are calculated, consumers, businesses, governments, and international agencies can adopt policies to take such costs into account. The two policy options generally discussed in this light are cap-and-trade carbon markets and carbon taxes. The idea behind carbon markets is that governments ration how much carbon dioxide and other greenhouse gases may be emitted by setting an overall limit on emissions. Emitters are then required to have a government-issued permit for each ton of carbon dioxide they release into the air. The total amount of permits cannot exceed the cap. Emitters that need to increase their emission allowance must buy permits from those who emit less, creating a market for carbon dioxide emissions permits. The goal of such a rationing scheme is to create a market that sets a price on the negative externalities imposed by burning fossil fuels.
Similarly, imposing a tax on emissions aims to correct the negative climate externalities produced by burning fossil fuels. A carbon tax is a Pigouvian tax (after the economist Arthur Pigou) levied on a market activity to take into account the negative externalities of that activity. In Pigou's formulation, negative externalities occur when the social cost of a market activity exceeds the private cost of the activity, which is another way of saying that the activities of some people are imposing uncompensated harms on other people. The result is that markets over-supply a good—in this case, the energy produced from fossil fuels. The goal is to set a tax equal to the cost of the negative externality, thus nudging markets to produce efficient amounts of a good.
The laudable goal of both carbon markets and carbon taxes is basically the same: make polluters pay for the costs they involuntarily impose on others. So all that remains is to calculate the costs and let policy makers impose either the appropriate markets or taxes. The problem is that in the real world things are never as simple as economic theory would have it. Estimates of the potential damage caused by global warming range widely, depending on estimates of how the climate is likely to react to extra carbon dioxide, future economic growth, and, most crucially, the discount rate.
That term refers to the fact that most people prefer to have a dollar today than a dollar a year from now. This means that current dollars are worth more than future dollars; that people discount the value of future dollars. In other words, a person might be willing to forego a dollar now, but only in exchange for more than a dollar next year. From this insight, economists have developed the concept of discount rates. Let's say someone is willing to forgo a dollar today in exchange for $1.10 next year. The discount rate would be 10 percent. So here's the question that bedevils those trying to calculate the future damages caused by climate change: How much is a dollar in 2100 worth in terms of dollars foregone today? Let's just say that experts have a wide range of opinions on what the proper discount rate should be.
What about the damage we can expect from man-made global warming versus the costs of taking action? According to one calculation performed by Yale economist William Nordhaus, the optimum path toward cooling the climate using a carbon tax would cost $2.2 trillion and reduce climate change damage globally by $5.2 trillion over the next century. His calculation implies a globally harmonized carbon tax that rises in constant dollars from about $35 per ton in 2010, to $90 per ton in 2050, eventually reaching $200 per ton in 2100. In his recent comprehensive review of the literature on economic impacts of future climate change for the Copenhagen Consensus Center, Dutch economist Richard Tol calculated that the optimal policy would be imposing the equivalent of a $0.50 per ton carbon dioxide tax rising at 5 percent per year for the next 90 years. This policy would yield $3 in benefits for every $2 spent. "Available estimates suggest that the welfare loss induced by climate change in the year 2100 is in the same order as losing a few percent of income," notes Tol. "That is, a century worth of climate change is about as bad as losing one or two years of economic growth."
On the other hand, there are a few studies that suggest the benefits of early steep reductions in carbon emissions will far outweigh the costs. A 2006 study by British economist Nicholas Stern found that spending 1 percent of GDP annually to achieve massive early reductions in carbon dioxide emissions is justified. Stern has now upped his estimate to 2 percent per year. Many economists, however, argue that Stern used an unrealistically low discount rate of 0.1 percent to achieve his results. A 0.1 percent discount rate implies that someone would forego $100 today in order to obtain $100.10 a year from now.
Looking at recent reports by the Pew Charitable Trusts and the activist group the Natural Resources Defense Council, U.S. GDP in 2100 is projected to be between 0.6 and 3.6 percent lower than it would otherwise have been. Assuming the $14 trillion U.S. economy grows at 2.5 percent per year, GDP in 2100 would be $130 trillion. If climate change damages push GDP 3.6 percent below what it would otherwise have been that means that GDP in 2100 would be about $125 trillion, or $5 trillion lower. That's not nothing, but the loss is more than double ($12 trillion) what would occur if U.S. economic growth were depressed from 2.5 to 2.4 percent per year between now and 2100.
Clearly, econometric models tell us that implementing smart policies could avoid some damage from climate change. But whether or not the benefits outweigh the costs depends entirely on the policies being optimally adopted. But will governments and international agencies be able to sustain smart policies over the next century? The tribulations of the European Union's cap-and-trade scheme and the current political jockeying over the 1,468-page Waxman-Markey climate change bill in the U.S. Congress are not promising. On the international level, rapidly developing countries like China, India, and Brazil are refusing to accept limits on their greenhouse gas emissions.
Along similar lines, numerous econometric models project that while climate change will have relatively minor effects on developed countries it will significantly harm poor countries. One proposed policy soluton is to have rich countries that emit a disproportionate share compensate poor countries. While this idea might seem appealing to some, one must also consider the sorry 50-year record of wealth transfers in the form of foreign development aid. As development economist William Easterly has argued, most of the $2.3 trillion in aid that rich countries have poured into developing countries over the past half century has been wasted. Is there any reason to think that trillions in climate change aid would be any more effectively managed?
Man-made global warming may simply be a negative externality for which the transaction costs are too high. In other words, any benefits achieved from trying to mitigate global warming will most likely be swamped by the costs of distributing the corporate welfare used to buy the political acquiescence of various industries. As much as one might hope to implement good public policy to deal with the problem, policy nihilism might be the only rational response to global warming.
Ronald Bailey is Reason magazine's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is now available from Prometheus Books. This column first appeared at Reason.com.