Krugman on Building a Green Economy

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Krugman on Building a Green Economy

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Last week’s NY Times Sunday Magazine featured Nobel prize-winning economist Paul Krugman’s take on climate economics.  Krugman notes that climate modelers have gained “enormous credibility” by successfully predicting the past 20 years of global warming.  He concludes that climate trends over decades (which wash out short-term weather fluctuations), show that “the planet is indeed warming” which will lead to “massively disruptive events, like the transformation of the Southwestern United States into a permanent dust bowl over the next few decades.”

Krugman calls for the use of economic tools to curb the climate threat.  He deftly articulates how (“Pigovian”) taxes discourage pollution by placing some of the “externalized” cost of pollution back on polluters, without the inefficiency and intrusiveness of regulations.  He notes that a “cap-and-trade system produces the same incentives to reduce pollution… with the price of licenses effectively serving as a tax on pollution.”  He explains:

A pollution tax… imposes costs on the private sector while generating revenue for the government. Cap and trade with auctioning… is just like a tax.  [But current legislative proposals] involve[s] handing out licenses to existing players, so the potential revenue goes to industry instead of the government… as a way to partly compensate some of the groups whose interests would suffer if a serious climate-change policy were adopted.  This can make passing legislation more feasible.

Krugman also acknowledges Dr. Hansen’s (and our) point that cap/trade punishes individual initiative to reduce GHG emissions.  But Krugman never mentions the possibility of a carbon tax with revenue returned directly to the public, which should do even more to make passing legislation feasible and would avoid the volatility, manipulation and the need for “offsets” that effectively eviscerate the “emissions certainty” of a cap. Moreover, returning revenue to consumers rather than supporting “incumbent technologies” would encourage consumers to make the choices needed to speed our transition to a green economy.

Krugman confronts the problem of discounting the cost of future climate damage. Normal discounting (typically applied to business investments) drastically reduces the present value of future gains or losses; such discounting thus supports only small investments and low carbon taxes to avoid future climate damage. Siding with Sir Nicolas Stern, Krugman concludes that such large discounting is unfair to future generations; it effectively assumes away the potential for global catastrophe.  Thus, despite his political judgment about cap-and-trade, Krugman’s reasoning supports the view that a substantial carbon price with a serious ramp-up is needed.

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  1. I couldn’t agree more. It’s long past time to put good public policy above political expediency and to heed the advice of virtually all the world’s leading scientists and economists by taking a serious look at a revenue-neutral carbon tax.

  2. Re “Krugman never mentions the possibility of a carbon tax with revenue returned directly to the public”: True, but he also fails to mention the possibility of cap-and-trade with revenue recycling (“cap-and-dividend”). This is not a cap-versus-tax issue. The policy rationale for revenue recycling applies equally well to cap-and-trade and taxes; it is not an argument for favoring taxes over cap-and-trade.

    The more fundamental point that Krugman misses is that any allocation scheme — whether it be revenue recycling, free allocation via grandfathering, whatever — can be applied equally well with a tax as with cap-and-trade. It does not matter whether someone gets their allocation in the form of a tradable allowance having a market value of X dollars, or as a cash handout of X dollars from tax revenue.

    Krugman’s entire cap-and-trade advocacy argument is based on the premise that cap-and-trade is politically viable, while a tax is not, because cap-and-trade admits free allocation while a tax does not. But that’s a false distinction. Whether free allocation is good or bad is irrelevant to the cap-versus-tax debate, because cap-and-trade and carbon taxes can both be implemented with free allocation — or with any other preferred allocation method.

    Cap versus tax; free allocation versus revenue recycling — two completely separate issues; do not cloud the former with the latter.

  4. So maybe we don’t need a “tax”; what we need is a “fixed-price sale of allowances”. The government could issue “credit vouchers,” which could be applied to allowance purchases. 🙂

  5. If I have 100 units that remove carbon dioxide and produce oxygen, can I receive tax credits or payments for these units?

  6. Postscript: From a March 1 New Yorker profile of Krugman:

    Why was it so politically difficult to reregulate the banks? he [Krugman] wondered. Why couldn’t the Administration harness the populist outrage? What good had Wall Street ever done for America? “There must be something useful in there, but it is really hard to see what,” he says. “That’s everybody’s challenge: come up with a clearly beneficial example of financial innovation without mentioning A.T.M.s, and no one can do it. If there are arbitrage opportunities and you’re able to spot them a few seconds before anybody else, you can make a lot of money, but there’s no actual social gain from doing that. We’ve tried talking to our friends in finance, and they say, ‘Liquidity, liquidity, liquidity.’ Well, there is some social loss if people are hanging on to a lot of idle cash, so the financial system, by providing liquid assets that provide a pretty good yield, is supposed to deal with that. But it turns out that, just when you need it most, that liquidity froze…

    So why is Krugman supporting a climate policy (cap/trade/offset) built around Wall St?

  7. In “Note to Krugman: Carbon Markets Are a Different Beast,” Michelle Chan, financial analyst at Friends of the Earth writes:

    “Krugman… predicts that we won’t see an Enron-type debacle in carbon because markets will be large and demand for emissions permits will be responsive to prices. He sides with those who do not believe speculators played much of a role in the 2008 commodity price spikes (a hotly debated topic, which even Krugman concedes “is not out of the question”), dismissing concerns about excessive speculation as well.

    But carbon is not going to be like any other commodity; the supply of allowances and credits is designed to contract, making market surveillance activities (e.g. monitoring whether prices are being artificially manipulated) more difficult. And unlike other consumable commodities, carbon allowances have one single producer with no marginal cost of production, and can be banked indefinitely with no costs. Since carbon will be dominated by financial speculators (it is already being marketed as a “new asset class” to investors), how does one determine whether the price of carbon is tethered to “market fundamentals”?

    Far from assuming that carbon markets are going to behave just like any other type of commodity, we instead should figure out those aspects of carbon which are unique and ensure that adequate market regulations and monitoring programs are in place. For example, the Waxman-Markey bill includes a mechanism which would flood the market with more carbon (from offsets and borrowed allowances) if it a particular trigger price is reached. Such price triggers generally do not exist in other commodities markets, creating the need for additional oversight of market manipulation. In addition, the strategic reserve could create other temptations: since carbon traders often own offset companies, they may rally to push carbon prices to the trigger price, to enrich their offset businesses.”

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