Prof Nordhaus forgets some basic Economics

Wattsupwiththat today carries a summary of William D. Nordhaus’s latest paper on climate change policy. The paper “The architecture of climate economics: Designing a global agreement on global warming” is published at the Bulletin for the Atomic Scientists here.

The basic economic fundamental for any policy is to have a net welfare improvement. Therefore in designing this policy, there should be a reasonable expectation that benefits will outweigh the costs. Prof. Nordhaus simply looks at the improvements to be made from switching from cap and trade (per Kyoto Agreement) to a carbon tax. Not just any carbon tax, but one that is uniform throughout the world.

Nordhaus claims that people should face the social costs of their activities. A carbon tax provides four strong incentives:-

First, it provides signals to consumers about what goods and services produce high carbon emissions and should therefore be used more sparingly. Second, it provides signals to producers about which inputs (such as electricity from coal) use more carbon, and which inputs (such as electricity from wind) use less or none. It thereby induces producers to move to low-carbon technologies. Third, high carbon prices provide market signals and financial incentives to inventors and innovators to develop and introduce low-carbon products and processes that can eventually replace the current generation of carbon-intensive technologies. Finally, and most subtle of all, the use of carbon pricing provides simple, straightforward information that market participants need to undertake each of these three tasks. Of course, placing a market price on carbon use will not work magic.

As a means of making consumers use fossil fuels more sparingly, taxes on fuel are highly inefficient. With no close substitute (at least in cost) for fossil fuels (whether for transport, domestic fuel and light, or industry) rises in price are highly inelastic with respect to demand. That is why in the UK, it is a great way of raising tax revenue – you can raise with impunity without major fall-off in demand. Prof Nordhaus can check this out from the effect on demand to the rising price of oil.

As for making producers move to non-carbon sources of power, it is mostly being driven by government policy. The costs of wind and solar power are still far beyond those of fossil fuels and prone to supply problems. For instance, the recent extreme cold in the UK was accompanied by weak sunlight (it is winter with less than 8 hour days) and virtually no wind.

The incentives to producers to switch to alternative energy sources are already there from the high oil price. It has more than tripled in price in less than a decade. The marginal impact of increases energy prices through taxes will be small, if not insignificant.

The fourth is just a combination of the three. It is only a reason if the word “subtle” is replaced by “insignificant”.

The disadvantages of a carbon tax

What Nordhaus does not look at are the disadvantages.

  1. Carbon Tax is regressive within countries. Those who will have to give up cars and foreign holidays and suffer lower heating and lighting in their homes are the poorest. In Britain, where death rates already surge in cold weather, this will be exacerbated.
  2. A carbon tax works by providing a stark choice – you either reduce energy consumption (and reduce your standard of living) or see your living standards fall in other areas. Without
  3. For many in the poorer, but developing countries, aspirations will be dashed. Economic growth is closely related to increase in energy usage per capita. In India and China with rapid economic growth, hundreds of millions of families will be aspiring to cars, foreign travel, washing machines, refrigerators and warmer (or air conditioned) homes. To control CO2 emissions means denying them these opportunities for many years. This is not just making them less affordable. It is also through slowing those high rates of economic growth. For these people – 40% of the world population – this welfare loss will be far greater than anything that runaway global warming can engender.
  4. A uniform tax is ludicrous. In the UK of the £1.23 per litre I last paid for petrol ($7.30 per US gallon of gasoline) over 50% was in taxation. Yesterday the VAT went up 2.5%, adding another 3p per litre. In the USA it is much lower. In Brazil, diesel is restricted to goods vehicles only and carries no tax. In Iran fuel is subsidized. In the UK (and much of Western Europe) a uniform tax would lead to a reduction in tax in an area where you want to reduce emissions most, whilst achieving large emission reductions in some of the poorest, but developing countries.
  5. Society bears the costs of individual consumption externalities. You should compensate the losers whilst punishing the polluters. But to do this efficiently you need to first identify the losers and the gainers from CO2 emissions. Who will lose from the consequences of climate change is purely speculative.

 

Prof Nordhaus’s mistake is only to look at the advantages of a Carbon Tax over Cap and Trade. He does not look at improving the situation on having no policy at all. He ignores the poor, proposing a policy that will deny the aspirations of billions. Further, he does not take into account the political dimension. The democratic and rich countries will not vote for a policy that can only be effective by significantly reducing their living standards. In Western Europe, this is further exacerbated by most studies showing climate change will do little harm, or be of slight benefit. In China, constraint on CO2 emission growth will also strongly constrain economic growth, which will probably cause political turmoil. Yet without China and other emerging economies buying into CO2 constraint, then Western CO2 reductions are in vain. See a talk by Roger Pielke Jr.

However, Prof Nordhaus recognizes that non-participation costs are very high for achieving emissions targets