Home > The Economics Profession > What’s Missing in Paul Krugman’s Climate Economics Primer

What’s Missing in Paul Krugman’s Climate Economics Primer

from Peter Dorman

But let’s start by accenting the positive.  Krugman’s explanation of mainstream environmental economics is clear and powerful.  He recognizes that there really are a lot of free energy lunches lying around uneaten, in the form of potential efficiency improvements.  He knows that predictions of economic disaster due to carbon policy are without foundation and fail to take into account the potential for innovation.  Above all, he understands that investments in minimizing climate change offer valuable insurance against potentially catastrophic outcomes—the ice-sheet meltoffs and methane megabelches that we have little ability to predict and from which we would have little chance to recover.

Why ask for more?  Because three enormous concepts are completely missing. 

1. Equity.  How the burdens of climate policy, bearable as they may be, are distributed is a very big deal.  First, vast sums of money—hundreds of billions of dollars—are at stake.  Note that these do not reflect costs as economists understand the term.  We are not talking about overall loss of income and output, but transfers, money that will find its way from some folks’ pockets to others.  If carbon is priced, for example, then we will be paying this price, and someone else will be on the receiving end of those payments.  Who that is matters, big time.  Economists are not experts in climate science, but they have useful tools for analyzing and anticipating who will win or lose from a policy.  They have a large contribution to make in helping us design fair and equitable systems for controlling carbon, and this deserved some real estate in Krugman’s article.

But that may not even be the most important reason to support equity.  The bigger problem is that actual climate policy is lagging ever farther behind what is needed.  We still don’t have a policy framework at all in the US.  The European Union’s trading system has Europe on track to fail to meet its targets (unless the economic situation continues to deteriorate).  There are paltry carbon taxes here and there, too modest in size and coverage to make a difference.  There are many reasons for weak policy, but perhaps the most important is the fear of politicians everywhere that really cranking up the price of carbon will make voters furious once they get hit by rising energy costs.  An essential part of the solution, then, is a commitment, built into any legislation that has a whisper of a chance to be enacted, to return all or nearly all the proceeds from higher energy prices back to the public.  Just rebate it to them, and make the process completely transparent.  For every painful moment of facing a higher energy bill there needs to be a pleasant moment of getting a fat rebate check.  Can we break the political logjam otherwise?

Equity and political feasibility go hand in hand.

2. The pollution model.  It doesn’t work here.  The greenhouse gas problem is not a pollution problem, and if you apply pollution thinking you will come up with bad policies.

This is a problem for economists, since they have all been trained to see environmental problems in terms of pollution.  You will see in Krugman’s article, for instance, a comparison between the climate crisis and the problem of acid rain.  Acid rain was due to, among other causes, sulfur emissions from industrial smokestacks.  A cap and trade system was set up to limit the amount of these emissions, and the acid rain problem has been ameliorated.  Drawing on this experience, Krugman advocates cap and trade for carbon.  If carbon were a pollution problem he would be right, but it’s not.

Without going into detail, recall that there is a massive, planetwide carbon cycle, with huge quantities of carbon continually flowing between the atmosphere, the oceans and terrestrial ecosystems.  The flow of carbon from land and sea back up to the atmosphere is not the problem; it is part of the cycle.  The problem is that humans are burrowing into the earth to dig up carbon sources like coal, oil and gas that have been sequestered for hundreds of millions of years.  We are adding them to the carbon cycle, so that there will be more carbon everywhere, up in the sky and down on the earth’s surface.

What this means is that it is an error to try to mitigate climate change by controlling the “emissions” of carbon from human actions.  If the carbon has been dug up and added to the carbon cycle, it will find its way into the atmosphere no matter what we do.  And the carbon we emit that came to us from the atmosphere and will simply return there is not the problem.  This is a highly simplified version of the science behind climate change, and a longer account would explore the eddies and unevenness of carbon cycling, but it’s the right starting point.

Once you see that the pollution paradigm is wrong, two conclusions follow immediately.  First, what needs to be priced is not the carbon we emit, but the carbon that enters the cycle by being extracted from the earth.  That doesn’t invalidate Krugman’s broad generalizations, but it does suggest important dos and don’ts about carbon policy.  Don’t try to regulate the burning or other use of carbon on an industry-by-industry basis.  Don’t try to micromanage personal behavior or industrial processes.  Do keep carbon fuels in the ground, either by slapping high prices on their extraction, or directly restricting the amount that can be taken out.

The second point is that the offset business, by which permits to extract fossil fuels can be set aside in return for promises to plant trees or improve industrial processes in other countries, is a ruse.  It promises to make a lot of money for those in the right places, but it is antithetical to sound policy.  Period.

3. Economic interactions.  The market is a two-by-two mechanism.  It essentially sums up agreements between two parties, a buyer and a seller, altering prices according to the total buying and selling pressure at any point in time.  A fundamental limitation to markets emerges in situations characterized by interactions between many individuals and institutions, so that two-by-two adding up is ineffective.  An example is the role of cars versus trains in local transportation systems.  Markets can do a reasonable job of adjusting the number and quality of cars to the preferences of buyers and the costs of producers, but they cannot coordinate a system-shift from mostly-cars to mostly-trains, since there are so many interactions that are at stake, like urban density, the locations of jobs and residential areas, etc.  Markets tell us what people want, two at a time, based on what everyone else is doing, but they don’t coordinate shifts that make sense only if many do them at once.

This is important, since the shift to a low-carbon economy will be one of the largest system-level shifts in human history.  Much of it can be efficiently managed through markets, but only if the broad parameters are determined in a coordinated—that is, political—manner.  So far we are still in Krugman-land, in that he is advocating a mix of political (carbon pricing) and market mechanisms.  But there is a further wrinkle.  If we rely on the price of carbon to guide us from one economic configuration to another, we will almost certainly overshoot radically.  We will have to raise the price of carbon to a very high level so that, in this economy, with all its inherited biases toward energy profligacy, people will begin to cut back to the extent necessary.  Then, as the rest of the economy adjusts, this price will be seen to be much too high.  Of course, since the process will take place over many years, a too-high price translates into a too-drastic energy squeeze during the transitional phase.  By contrast, relying on quantities—limiting the amount of fossil fuels that can be extracted and letting the price rise as it will—does not overshoot in the same way.  There will still be a big price spike that can be alleviated over time as we build a low-carbon infrastructure, but the amount of energy made available will not be over-squeezed, since it will be directly controlled.  In simple language: economic theory tells us that, to achieve a system-shift in a densely interconnected economy, it is more efficient to control quantities than prices.  A carbon tax is inferior to a permit system in which the number of permits is fixed.

So this is my appendix to the Krugman primer.  He did a fine job with what he set out to do, but he left out important pieces that the public should be aware of, and that economics has the ability to provide.

  1. April 15, 2010 at 10:32 pm

    Great comments on the Krugman article. I’m still waiting for the first government to say no to the oil and gas industry. In BC, we are seeking to create new hydropower in order to extract coal, and hopefully shale gas for the extraction of tar sands to produce oil for the US market. And we are apparently considered “green” because we have a teensy carbon tax. It is painful to watch.

  2. April 16, 2010 at 5:16 pm

    Re: Equity. Two problems, first you are nation-centric, a classic economics fault. Second you presuppose that there is not already a transfer occuring. Most of the externalites of the auto-sprawl-waste-fosssil-fuel system are not picked up by the U.S. taxpayer, but rather by the poor of the world–e.g. the children with cancer in oil-drilling areas.

  3. Ed
    April 16, 2010 at 5:37 pm

    Nice critique. Krugman laid out a very nice mainstream environmental economics 101, that will help many people frame our growing climate problem as an economic problem.

    While I agree with you that keeping carbon out of the cycle is hugely important, you don’t lay out a system that gives incentives for doing so. Government is never going to cap oil and coal extraction, in fact Obama just increased it!
    Krugman’s conjecture that imposing a cap and trade system on carbon emitters doesn’t explicitly deal with keeping carbon out of the carbon cycle, but it does so implicitly. Increased costs on producing carbon will increase efficiency in carbon producers, as well as lower the relative cost of alternatives such as wind/solar/geothermal. The revenues from this tax could be used to further stimulate/subsidize renewable resources, further eliminating inputs into the carbon cycle. Ultimately, the goal should be to put a high enough price on carbon that it is not economically efficient to use such high amounts of it. This is how to get an across the board jump to another source of energy in a market economy.

    But the another problem with limiting inputs into the carbon cycle rather than taxing outputs is simply a regulatory one. If the US simply says thou shalt not extract coal, US firms will just buy it from China. Getting an across the board agreement on fossil fuel extraction is fantasy.

  4. Peter Dorman
    April 18, 2010 at 9:07 am

    Transit: I agree that global equity is crucial, but I didn’t want to take on everything at once. To summarize a much longer argument, I think that national equity is essential for getting political action at the national level, which is indispensable. A step toward global equity would be to institute a much smaller tax on international shipments of fossil fuels, with the proceeds distributed to all countries on a per capita basis, earmarked for adaptation. I hope to write more about this in the future.

    Ed: Krugman’s view of taxing or restricting carbon emissions rather than the entry of new carbon has great potential for ineffective or counterproductive action. Offsets are the most obvious example, but similar arguments could be made about other loopholes. As for the international dimension of capping extraction, it is true that a global agreement is not in the cards. National or regional (e.g. EU) policy is where it’s at. So any individual country should cap introductions of carbon to its own economy, whether by domestic extraction or imports. There can be tariffs on goods imported from countries that do not price carbon based on embedded carbon per unit. I avoided these details in my post, but of course they would have to be hammered out in any feasible plan of action.

  5. rachelincolombia
    April 26, 2010 at 11:49 am

    What about paying certain countries to leave oil below the ground? I agree, it´s going to rankle, but surely there is potential for this at least in cases where oil is located in areas where extraction will have other significant negative effects. The precedent is Ecuador´s Yasuni-ITT Initiative, which has attracted a reasonable amoutn of support from Germany and some other countries, and was almost secured during the Copenhagen conference. If we limit the policy relevance to other areas with oil which is proven to be profitably extractable, but is located in areas of high environmental value (i.e. the Amazon basin), this would then at least assure critics that it wouldn´t start to be used by the Saudis to claim money. In the short term, emissions may not fall as oil would be extracted from other areas, but in the long run, the use of this type of mechanism would surely send a positive message to governments and private actors alike. For anyone interested in these issues, please check out IIED´s new Due South Blog on recession and its implications for sustainable development, available at http://www.iied.org/sustainable-markets/blog/due-south

  6. May 1, 2010 at 6:39 am

    This is quite an interesting angle in some fashion. The problem I have with credits is who would own them. It appears to be setting up a tollboth for the investment bankers to run a corner on to derive income off the masses. Tax would work to some extent, but if it was the same around the world, where would the income flow and once it became standard, it would merely be another expense and have no effect.

    The best policy would be a crash course on development of large sources of non carbon energy. This might start with developing a means of reprocessing the spent fuel out of atomic reactors. Wind energy is an idea, but I don’t believe the windmill farms are going to do much more than make a dent and I am not even sure they end up being much of an energy net. I have read studies where tobacco makes a superior biofuel, but I haven’t seen any discussion of tobacco, maybe because it isn’t profitable to the chemical companies.

    One thing I have thought about is hydrogen technology. In my region of the US, the wind power is several hundred miles from the population centers. I have thought the way to transfer this energy is to convert it to hydrogen, pipe it and convert it back. I have also thought wind energy could be better harnassed by building well placed wind walls that would channel wind through turbines within the walls, designed in a way that would capture wind like a huge sail. Maybe this is too expensive and maybe it wouldn’t work, but something tells me a mile of wall would produce a massive amount of electricity.

  7. Norman L. Roth
    January 16, 2011 at 8:53 pm

    Does anybody really believe that neither the neoclassical economists nor the marxist-“progressives” ever wallowed in the murky waters of “the tragedy of the commons” or environmental-impact issues?..prior to the still septic “global-warming”-“climate-gate” scam? Actually both culprits have much in common on this core-issue. Both believed in the benefits of technological progress as a “cargo-cult”: With no potential opportunity costs or ‘tragedy of the commons’ scenarios.
    Marx & his “progressive” accolytes earnestly preached, for more than a century, that the capitalist “mode of production”(??)had a gift for technology applied to progress in industry,that resolved all problems related to abundance.It was those same wicked old capitalists, who [via a conspiracy which defies all reasonable notions of inevitable “co-ordination problems] maldistributed this produced wealth upwards unto themselves, via the nefarious strategem of “surplus-value”.
    The neoclassical mentors of the now very preachy & forgetful M. Krugman had their own less-straightforward version:
    [1]”The world can, in effect, get along without natural resources” Robert Solow, 1974. He,in 1957 [and later M. Swan] had already reduced the foundational relationship between technology and economics, to a residual operator contributing to “growth” [???] Now, the venerable M. Solow & his “Bourbakiist” colleagues in Europe,are squirming like preyed-upon eels to distance themselves from the most ruinous of their junk-science methodology…Their bizarre, misapplication of mathematics to economic “modelling”. AND:
    [2] Noted ‘paradigm-shifter’, born-again market hater, Hugo Chavez fan and ‘New-Economic thinker’ Joseph Stiglitz, 1979:”Natural resources are basically no different from any other factors of production”. Environmental indifference [pun intended] ad extremum, n’est ce pas ? Not to mention Stiglitz’s [forgotten?] “petite-grotesque” of Sept.1968, Economic Journal: “A note on Technical Choice under Full Employment in a socialist [??]economy”.Their late MENTOR-EMERITUS, Paul Samuelson was still triumphantly crowing away in 1989,the year they’d all like to forget:”The Soviet Union is an example of how a command economy can flourish” .

    But the ‘designers’ of the Global-warming/climategate book-cooking, are rank amateurs compared to the lords of academic economics:Your very own ‘paradigmers’ brought over sixty years of practice to the table on ‘climategate’s’ behalf.For the mentoring that dare not speak its name, M. Krugman, consider the techniques they finessed:Control-freaking the peer-review & publishing process [2]Blackballing & career wrecking of dissenters [3] Polemical assaults on the character & integrity of even the feeblest challengers.
    But for “straight-men” I still prefer the practitioners of the monetarist ‘conceit’.Does anyone recall Irving Fisher’s flirtation with pseudo-scientific ‘metaphor’? His ‘modeling’ of the “Quantity Theory” of Money on Robert Boyle’s Gas law? He is reputed to have built a real ‘model’ thereof; Complete with a full tank of unidentified hydraulic fluid, valves,pumps,tubes & pulleys.Perhaps it’s still buried away in the storage rooms of the Smithsonian? The venerable Milton Friedman never forgot it. His own version of monetarism embodied it.”Titrate” growth in M (money-supply) with “predicted” growth. How do we “predict”? Consult ‘Positive Economics’ 1953 for a definition that would get a freshman in Logic 101 chewed-out.i.e.No need to worry about the realism of the assumptions built-into the ‘model’.It’s the ‘quality’ of the ‘predictions’ that count. Norman L. Roth. Consult, TELOS & TECHNOS: The Teleology of Economic Activity & the Origins of Markets

  8. raymond lasek
    May 30, 2014 at 4:40 am

    Interesting that the idea of waste is dismissed in the analysis of Krugman. The idea of restricting the primary source of the transformation of the atmosphere upon which all life depends except for that at the bottom of the oceans would benefit from the analogy of buried carbon as a “poison”. Using this metaphor of the life cycle, carbon in the atmosphere is a poison for many forms of life as it raises the temperature beyond the temperature sensitivity of certain life processes. The carbon that comes out of the earth is the original source of this poison, which was originally removed from the atmosphere and the oceans by the industrious activities of organims over a period of millions of years. As we repoison the atmosphere and the oceans, it will be quite an adjustment for the forms of life that benefitted from its original removal, and will take quite a long period of human life on earth to return to the state that existed when we came into being and were able to increase not only our own numbers to the present levels but also produce all of what we have done including the domestication of animal and plant life that our huge numbers depend upon. It is quixotic to believe that we will be able to recover quickly from this accidental poisoning. No one can predict what the world will look like for us 1000, 10000, or 100000 years from now, when our descendants will be living in the world that we have and will be giving them for some time to come.

  1. December 18, 2016 at 4:36 pm

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