Economics of Climate Change

I recently read a fantastic article in the NYTimes discussing the economics of climate change. The author, Paul Krugman, compares and contrasts in remarkable simplicity, the concepts of Cap and Trade and an Emissions tax, two options currently being floated as methods to force corporations into being responsible for their environmental impact. Before reading this article, I had a difficult time wrapping my arms around either of these alternatives.

One of the biggest issues facing the future of our environment is that the environmental impact of corporations is simply not accounted for (read the excerpt below).The author admits that measuring environmental usage is more of an art than a science, but through either a Cap and Trade and an Emissions tax, we will incent (force) corporations into improving their environmental record or paying for it. Naysayers believe this will devastate the US Economy but Krugman believes that even overestimating the costs will have a very small impact (leaving our economy between 1.1% and 3.4% smaller in 2050). Hopefully in the near future we will have political leaders willing to make these difficult choices in the face of animate opposition from corporations and conservatives alike (the same conservatives who championed market-based solutions under Reagan).

The full article can be read here.  An excerpt is below:

Environmental Econ 101

If there’s a single central insight in economics, it’s this: There are mutual gains from transactions between consenting adults. If the going price of widgets is $10 and I buy a widget, it must be because that widget is worth more than $10 to me. If you sell a widget at that price, it must be because it costs you less than $10 to make it. So buying and selling in the widget market works to the benefit of both buyers and sellers. More than that, some careful analysis shows that if there is effective competition in the widget market, so that the price ends up matching the number of widgets people want to buy to the number of widgets other people want to sell, the outcome is to maximize the total gains to producers and consumers. Free markets are “efficient” — which, in economics-speak as opposed to plain English, means that nobody can be made better off without making someone else worse off.

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But what if a deal between consenting adults imposes costs on people who are not part of the exchange? What if you manufacture a widget and I buy it, to our mutual benefit, but the process of producing that widget involves dumping toxic sludge into other people’s drinking water? 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.