How expensive is pollution?

The Economics of Climate Change explores the economics of public policies for curbing greenhouse gas emissions. Each national policy has some connotations for global applications. These policies aim to minimize losses to production capabilities of the world’s economies while decreasing global warming: the more effective the economic model for the reduction of greenhouse gases, the less expensive it will be. Improvement to the environment from decreased carbon dioxide emission, the principle greenhouse gas, must be weighed against the resulting decreased productivity in industry. Carbon dioxide emission should be tackled at the global scale because it diffuses throughout the atmosphere instead of only over the offending country and is a long-term problem because it is relatively inert naturally. This paper studies the connotations of present national policies for global application.

The negative effects of the rising global temperature caused by carbon dioxide emission fall under two categories: market and non-market damages. The market damages decrease productivity in terms of weakening market efficiency in the prices and quantities of goods. The common method to measuring these damages is to model changes to the production function in an industry such as agriculture. However, the authors believe that this is simplistic and models should be designed to incorporate the possibility of product substitution. Non-market damages, which include biodiversity and other environmental indicators, are more difficult to assess. The costs for curbing emission depend upon finding and utilizing fuels which produce less carbon dioxide, the decrease of fuel use in general, and using alternate goods which require less energy in their production. Historically, simpler models have treated technology as an exogenous variable which likely overestimates the cost and does not forecast the need and effectiveness of investment in technology. Instead, Goulder and Pizer believe the models which treat investment endogenously are an improvement.

Meta-analysis of 28 studies by Weyant and Hill (1999) highlight the benefit of reducing emissions to be between -$10 and +$350 with a cost of between $10 and $212 for a 10% reduction of emission with a 90% confidence in these calculations. This vast range illustrates the uncertainty in the sundry factors of climate change and raises the question whether we should “act today or wait for better information” (page 5). Although sunk costs and irreversible decisions on the expense side exist, the consensus among the studies cited is that measures today will have small marginal costs and major environmental benefits.

Emission taxes, abatement subsidies, emission quotas, tradable emission allowance, technology subsidies, and performance standards are methods that should be considered by policies makers. Early economic work studied a carbon tax and found a tax equal to the marginal climate-related damage to be most efficient. More sophisticated tools which factor in uncertainty, market failures, and distributional impacts have at least partially undermined this conclusion.

Pizer and Goulder cite research that concludes that in the face of an avoided damage benefit schedule that is relatively flat, using a tax, even though it means that emissions levels will be uncertain, is more effective that using a emissions quota because the uncertainty of the marginal price from a quota is more expensive than the uncertainty of total emissions. Carbon taxes and auctioned permits are also cheaper than technology subsidies because there will be inefficiency associated with distortionary taxes to finance the technology subsidies instead of revenues that can be used to pay for cuts in distortionary taxes on income, sales, or payroll which arise in taxes or permits. The United States, EU, and Canada rely on freely distributed trading programs for either pollutants. Firms bear less cost in this system and can even profit because free allowances allow firms to retain the rents from higher output prices and gives them money to meet other compliance costs. Although taxes and auctioned permits appear to be most cost-effective, free distribution may be more politically viable.

Technology advancement also can minimize the cost. Because the revenue from inventions often cannot be fully realized by the inventor, government incentives should be used to encourage development. Other alternatives for reducing gases is simply to store them either through injecting the gases into depleted oil reserves or planting trees which convert carbon dioxide into oxygen. Geological sequestration is currently too expensive but there is hope that this can be corrected. The conclusion among economists is that no single method will cover the problems of cost uncertainty, distribution, and technology development. The Kyoto Protocol, the first major international push to reduce carbon dioxide emissions, assigns sellable emission permits amongst the participating countries (which notably do not include the USA) between 2008 and 2012. The Protocol is criticized for not including developing countries and being overly stringent and myopic, but nonetheless represents the first step towards global policy. It is evident reducing greenhouse gases will be very expensive and, therefore, our goal should be to minimize these costs.