Economics of Climate Change

Economics has something to say on the topic of climate change. It asks, what are the costs of taking action, and what are the costs of not doing so?   If we can reduce costs by more than we have to spend, then surely we should take more actions now.  On the other hand, no sense in spending more than we’ll eventually save, properly discounted back to the present.

Simple to say, but complicated to apply.  How much do we really know about future costs of climate change?  At what rate should we discount the future into the present?  And how much can we lower the costs of action if we invest in technological improvement today?   Economic analysis can frame an optimal path forward once answers to these questions are forthcoming, but facts on the ground are constantly changing so the answer today might be different from that tomorrow. 

Still, economists agree on one fundamental principle.  If carbon dioxide and other greenhouse gases are a cause of adverse climate change, then these gases should be priced at their estimated costs to society.  Such pricing presumably will cause people to economize their use and encourage entrepreneurs to offer substitutes.  That’s why many economists (including me) advocate a carbon tax.  Cap and trade is another mechanism for pricing carbon, though for a number of reasons it’s a less desirable approach.  Still, if it’s the only way to price carbon, it’s probably better than nothing at all.

For the sake of argument, let’s agree that pricing carbon is the way to go.  But what price should be set, and how should it change over time?  A Dutch economist, S. J. Tol, has performed meta-analyses of estimated damages from climate change.  He finds that a price of about $20 per metric ton of carbon represents economists’ modal estimate.  But that translates to only about 20 cents per gallon of gasoline, a number many people find too low.  How much would 20 cents added to a gallon motivate people to change their driving and vehicle purchase habits? 

Some advocates of carbon pricing are willing to start with a low number but want it to rise steadily over time.  This would give people time to adjust but assure that carbon will become ever more expensive and hence achieve significant behavioral change.  There’s something to be said for this approach, but it ignores an important principle, namely that information changes over time, and we may later regret the pricing path we chose.  Suppose for example, that we eventually discover that climate change is less threatening than we once thought.  If so, we’d want a lower price for carbon, not a higher one.  Better to adjust carbon prices to the best available information as it is received than to move them according to a pre-set path. 

Of course, all this ignores political behavior, which generally doesn’t welcome new taxes and often seems to reflect a wish that the problem would evaporate.  Economists are off the hook for that; maybe political scientists should shoulder the blame.  But economists are on the hook for providing their best advice as the situation evolves, and right now that advice is to start pricing carbon as soon as possible and take it from there.