With Many Ways to Look at Climate Change Economics, Initial Assumptions Are Key

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When Paul Krugman weighs in on anything, people listen. Princeton professor, New York Times columnist, and more recently, Nobel Prize in Economics laureate, Krugman’s C.V. shines unusually brightly even in the firmament he inhabits.

When he says, let’s do something about climate change, people—pundits, politicians, powerful people—listen. This is good, because we’re running out of time. And when he says, in the pages of the NYT Sunday Magazine, that we can limit climate change through "drastic cuts" in CO2 emissions “without destroying our economy,” people listen too.

Almost every serious commenter, in fact, agrees, in the broadest terms, with Krugman’s analysis. But people fight over semantics, and fights over semantics are always fights over politics.

While there is widespread agreement, according to Krugman, that a “market-based program to deal with the threat of climate change — one that limits carbon emissions by putting a price on them — can achieve large results at modest, though not trivial, cost,” people argue over “how fast we should move, whether major conservation efforts should start almost immediately or be gradually increased over the course of many decades.”

In the course of his argument, Krugman parries several objections. The main one is cap-and-trade vs. a carbon-tax based approach to carbon emissions. Both effectively create a tax, one indirectly, through the price of carbon permits, the other directly, through an economy-wide tax. But the former has more loopholes than the latter. The problem, which Krugman doesn’t lay out, is that Americans hate taxes, and riddle them with exemptions and exceptions.

As Krugman asks, “The question is whether the emissions tax that could actually be put in place is better than cap and trade.” The answer, plainly, is no.

Krugman goes on to the core of his argument: “What we need are market incentives for reducing greenhouse-gas emissions — along with some direct controls over coal use — and cap and trade is a reasonable way to create those incentives.” He places to the side the issue of altruism, and non-market-based incentives—massive command-and-control systems, for example, except in extenuating circumstances—for example, he advocates cutting off coal burning. Put aside most objections to his objections for the moment, with one caveat: the largest mega-corporations, Wal-Mart, for example, are structured internally on command-and-control systems. Wal-Mart’s 2009 revenue was over 400 billion dollars.

This is feasible. But it will impact growth. As Krugman writes, “One recent review of the available estimates put the costs of a very strong climate policy — substantially more aggressive than contemplated in current legislative proposals — at between 1 and 3 percent of gross world product.” Waxman-Markey, he notes, would have only very small impacts on US GDP, between “0.03 to 0.09 percentage points,” according to the Congressional Budget Office (Waxman-Markey was rejected by James Hansen on account of it doing nothing to arrest climate change and much to neuter the movement to arrest climate change).

Such estimates mean very little without serious delineation of what, for example, “very strong climate policy” means. But they do serve to grapple with conservative talking points to the effect that climate change abatement will be ruinous for the economy. It won’t.

Can’t assume growth

Krugman goes on to sharply dispel arguments about the costs of action versus the costs of inaction. He rightly finds this debate offensive. As he puts it, the “risk of catastrophe, rather than the details of cost-benefit calculations, makes the most powerful case for strong climate policy.” That said, that argument is over the route forward. Here is where Krugman starts maneuvering on treacherous, and arguably unstable, terrain.

The fundamental consideration here is this bit of phrasing: that economists are at a near-consensus “that the negative economic effects from this policy [of eventually placing an extremely high price on carbon] will be of manageable size.” Manageable is a nebulous term, but Krugman seems to place the parameters of his analysis at the William Nordhaus analysis and the Nicholas Stern analysis, writing of the latter that “On the other side are some more recent entrants to the field,” amidst this “debate.” Nordhaus, an economist at Yale, advocates a slow ramp-up of carbon prices because he believes that the economy will grow so quickly in the future that a future world will be able to pay for fixing or mitigating climate change and the damage from climate change. Stern and Simon Dietz, economists at the London School of Economics, take that claim head-on in the Review of Environmental Economics and Policy, writing,

"While the additional contribution of other greenhouse gases will depend on assumptions about business-as-usual emissions and control rates of these gases, the radiative forcing they cause, as well as atmospheric chemistry and carbon cycling, there is a strong likelihood that 480 ppm of CO2 will correspond to over 550 ppm of CO2e, 586 ppm of CO2 will correspond to over 700 ppm of CO2e, and 700 ppm of CO2 will correspond to over 900 ppm of CO2e."

According to Stern, Nordhaus expects 480 ppm of CO2 in the atmosphere by 2050, and still rising, with a seven percent chance of a ride in global temperatures of 5 degrees Celsius. Stern agrees with Krugman that this is not an acceptable scenario. And Krugman seems to agree with Stern that growth and avoiding climate change is possible, writing, “All of this is consistent with a growing economy.” In theory, this is obviously accurate, because we never know what is in fact possible. But practice will be different. For one thing, consider that Krugman is (implicitly) claiming that the Stern program is the one to follow, a reasonable claim given that he calls Waxman-Markey a “fairly strong” bill. James Hansen, the don of climate-change analysis, calls Waxman-Markey “ineffectual legislation larded with giveaways to special interests.”

Stern, on the other hand, endorses 350 ppm as a “very sensible long-term target.” In the short term, he argued, in the Stern Report, for a “stabilisation goal” that would lie “within the range 450-550 ppm CO2e,” since “stabilisation at 450 ppm CO2e or below is likely to be very difficult and costly.”

Stern, and following him, Krugman, is very clear that goals for CO2 concentrations are being determined on the basis of economic growth prospects, and to ensure continued economic growth. Krugman in turn argues circularly that reducing climate change is “consistent with a growing economy.” 100 percent true, because the degree of climate reduction has already been stipulated as a dependent variable, one based on how much change, and how fast a change, the economy can afford.

Livable first, growth second

Other models are available. Hansen takes a different route, suggesting that the first consideration is, what do we need to do to ensure a livable biosphere, and derives policy from that consideration. The New Economics Foundation, arguing against Krugman’s, and Stern’s assumptions, argues that Growth Isn’t Possible, the title of a recent report that argues that “indefinite global economic growth is unsustainable.”

Lyuba Zarsky, a researcher based at the Nautilus Institute in Monterrey, suggests a change of emphasis from talking about the economy to talking about development. The horizon of development should be “the generation of sustainable livelihoods.” To that end, industrial policy needs to be radically re-thought. It must be “pro-active,” “promote industrial diversification,” orient investment towards sustainable industrial plants and infrastructure, respond to local “geo-physical conditions,” and be governed by “accountable partnerships” involving all relevant stakeholders. That means there must be a “multiplicity of economic development paths.” But that doesn’t mean anything flies.

The new developmentalist approach, with its “overarching objective, to build endogenous productive capacity and its embrace of a strong role for government in industrial development,” is the best way to proceed, making sure to place a concern for climate risk and its disruptive potential into all future development plans. That also means re-structuring the World Trade Organization so hot capital flows don’t burn countries investing in climate-friendly—and potentially lower-growth—policies, and making sure that trade wars don’t result from tariffs associated with green protectionism.

Researchers contributing to the Other Worlds are Possible report, put out by the NEF and the International Institute for Environment and Development, add that “we are already surrounded by a sleeping architecture of better ways to organise our economies, communities and livelihoods.” Some focus on localized, renewable energy sources and strengthening local ecologies. Most relevantly, Manfred Max-Neef writes of that the “Transition must be towards societies that can adjust to reduced levels of (overall global) production and consumption, favouring localised systems of economic organisation.” The contrast between that proposal and Krugman and Stern’s could not be starker.

The point is not to demonize Krugman and Stern, who clearly mean to stop global warming. The point is to point to their unexamined assumptions. In this case, Stern explicitly and Krugman tacitly posit that the economy must grow. But it can’t, and so it won’t. The question is if it will be a managed de-growth or disaster. And that question will in part depend on whether tribunes like Stern and Krugman can revisit their untenable assumptions. Let us hope for the best.

(Photo via NASA)