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Thursday, May 31, 2007

Glenn Hubbard: Capitalism Against Climate Change

Glenn Hubbard comes out in favor of using tradable permits to control carbon emissions:

Capitalism Against Climate Change by R. Glenn Hubbard, Commentary, WSJ: The case for action to combat global climate change has grown increasingly compelling in recent years. Sadly the same cannot be said for specific proposals to address the problem. ... One recent ... proposal to balance a need for policy action with a mechanism for prudent economic risk management ...[is the] new recommendations by the National Commission on Energy Policy for an emissions trading program...

Good environmental policy relies on sound science. Some of the science surrounding climate change is clear. ... Other aspects of the science are more ambiguous... This means that estimates of the likely temperature and climate changes over the next century span a fairly wide range. The potential effects on people and ecosystems are even more uncertain.

Despite this uncertainty, most serious students of climate change believe that the likelihood of adverse climate change is sufficiently great to warrant action. But what action? ...

[N]ear-term actions should not impose greater risks than the problem they seek to address. ... If you smell smoke at home, it would be silly to do nothing until you actually see flames, but you also should not hose down the house after one whiff of what might be smoke.

For the global warming debate, uncertainty justifies neither inaction nor over-reaction. As the smoke analogy suggests, the United States should pursue a moderate policy that can be justified as we learn more about the threat of climate change and the costs of alternative responses.

The NCEP proposal meets this test of taking serious action while not imposing economic risks greater than the threat of climate change itself. ... It does this using ... tradable permits. In such a system, the use of coal, oil and natural gas will require permits in proportion to their CO2 emissions, typically sold along with the fuel -- so individuals need not deal with the permit market.  ... And revenue from the auction of a portion of these permits could be used to reduce the corporate income tax, blunting adverse economic consequences. ...

Over time, we know that new investment and technology will reduce costs; we do not want to force overly expensive reductions now when cheaper opportunities are just around the corner. Furthermore, pushing too hard too quickly will simply encourage emissions and jobs to move to other countries who have not yet adopted similar policies.

This ... highlights that it is vital to develop global institutions for promoting and measuring emission reductions, institutions that prevent emissions from shifting overseas and encourage the lowest-cost abatement... Developing these international institutions is a tall order but it need not happen right away.

Under the NCEP approach, the conversation among nations would become broader and deeper over time, much like the 50-year effort for the General Agreement on Tariffs and Trade and the World Trade Organization. What is important in the short run is that domestic policies have a forward-looking design that encourages both efficiency and global cooperation. ... A serious response to climate change must begin by turning our emissions downward without betting the bank. ...

Looks like it's time for two former chairmen of the Council of Economic Advisers for the Bush administration, Glenn Hubbard and Greg Mankiw, to settle this tradable permit versus carbon taxes issue once and for all. I propose an Econoduel. Mankiw versus Hubbard, whiteboards only, any theory goes, and you cannot be saved by the end of period bell. We'll need a referee, so I'll suggest John Whitehead at Environmental Economics as he seems relatively unbiased - he doesn't think there's much difference between the tradable permits and carbon taxes and doesn't really care which one we put into place, as long as we do something. [Update: Please see John's follow-up on this.].

There are different ways to approach the "should we respond aggressively" question, but let me stay within the example given above. Should we soak the house at the first whiff of smoke? The answer given above is no, but it depends on how you set up the scenario. Suppose that once you smell smoke, if you don't respond with full force and soak the house immediately and there is a fire, it will spread rapidly and burn down all 25 houses in the neighborhood (picture houses in a heavily wooded, dry and windy canyon). Thus, at the first whiff of smoke you have two choices, soak one house and suffer the associated losses with certainty, or, do nothing and risk losing all 25 houses if there really is a fire. Now, add that your experts are telling you there's a darn good chance there is in fact a fire, what should you do? Be prudent and wait until you know for sure?

Now, Hubbard argues technology gives us a reason to wait. We can weave that into the story by adding in some chance that, even if we don't respond immediately, we still might find a way to save the other 24 houses. You smell smoke, the analysts say they're pretty sure it's fire, but if you don't act there's still some chance you'll discover a way to save the other houses. Now should you wait?

But I'm reinventing the wheel. This has been covered:

Risk, Uncertainty and Irreversibility, Decision Theory, and Global Warming, by Brad DeLong: Alex Tabarrok protests that you should not do expensive and irreversible things before you know what is going on. I think that there is an important distinction to be drawn in decision theory between (a) risk on the one hand, and (b) the interaction of uncertainty and irreversibility on the other.

In general, briefly: As a baseline, you should start out thinking that you should do what it would be best to do if your central-case forecast were to come true. And then:

  1. Relative to that baseline, you should do more of things that reduce risks: a prudent portfolio should have some gold or silver in it (not much!) to guard against the potential inflationary collapse of fiat money systems and other political risks.
  2. Relative to that baseline, you should do less of things that increase risk: invest less in risky enterprises, and dump less carbon dioxide and methane into the atmosphere.
  3. You should delay doing expensive and irreversible things until you are confident that they are needed.
  4. You should prevent processes that could cause irreversible or incredibly-expensive-to-repair damage until you are confident that their effects will be harmless.

The first two principles are the appropriate ones for dealing with risk. The last two principles are appropriate for dealing with the interaction of uncertainty and irreversibility.

Thus if congress were on the verge of banning open-carbon-cycle power generation and vehicle operation in 2010, I would think that that was a bad idea because of principle 3. But congress isn't. The uttermost limit of political feasibility over the next decade is a fifty-cents-a-gallon-equivalent tax on carbon emissions. And that seems well-covered by principle 2. ...

The discussion continues from there (Victor's example is similar to the one given above).

Finally, I can't let this statement from Hubbard pass without comment:

And revenue from the auction of a portion of these permits could be used to reduce the corporate income tax...

Other ways to use these revenues come to mind.

Update: Greg responds to the WSJ editorial. Also, with regard to the Economatch, I should have made clear that politics counts in the scoring. Tyler Cowen [ID check]and Felix Salmon also comment.

    Posted by on Thursday, May 31, 2007 at 12:33 AM in Economics, Environment, Policy, Politics, Regulation | Permalink  TrackBack (1)  Comments (67)


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