On a recent speaking engagement in Germany I ran into Prof. John Schellnhuber, who was on his way to the Vatican to present Pope Francis’ major coming out document on climate change. After I got over feeling oh so cool for being one degree of Kevin Bacon removed from one of the most powerful figures in the world, I did my homework and read the Laudato Si, which carries the subtitle “On care for our common home”. This is a well researched position paper which touches on a variety of topics and makes it very clear that the pope cares much more about distributional issues than the average economist. This is not difficult as we are too often obsessed with efficiency (maximizing the size of the pie) rather than equity (who gets what size slice). Even though I am a Bavarian protestant married to a lovely South African Jewish lady, I have been a big fan of Pope Francis until I got to point 190 in the Laudato Si:
“it should always be kept in mind that “environmental protection cannot be assured solely on the basis of financial calculations of costs and benefits. The environment is one of those goods that cannot be adequately safeguarded or promoted by market forces”. […] Once more, we need to reject a magical conception of the market, which would suggest that problems can be solved simply by an increase in the profits of companies or individuals. Is it realistic to hope that those who are obsessed with maximizing profits will stop to reflect on the environmental damage which they will leave behind for future generations?”
I went and sat in front of a wall and meditated on this statement for a little while (yes, my mom tried to make a Zen monk out of me). I agree with some of this sentiment. It is clear that profit/utility maximization has led to much of the environmental conundrum we find ourselves in. In a perfect world, firms pay for the full costs of their activities (which we call social cost of production). Consumers then only buy the product if these costs are at most as large as their willingness to pay for the good. If firms don’t have to pay for the full cost of their production (e.g. they get to use the atmosphere as a free dumping ground for greenhouse gases) the cost of production is artificially low and consumers buy more than they should at artificially low prices. Does this happen? Well yes! Most places in the world do not charge firms for their carbon emissions. California, Europe, parts of Canada are some noteworthy exceptions, though even in these places the price is well below the environmental cost of the emissions. Most Chinese firms, for example do not currently pay for their use of the atmosphere. Neither do India’s, Japan’s, Australia’s…. This leads to an overproduction of greenhouse gases.
Is the optimal level of greenhouse gas emissions zero? The economist’s answer is a clear no. We derive great benefits from the combustion of fossil fuels. Light to read, heat to cook, gasoline combustion for transport. But is the price of fossil fuels too low? Nearly everywhere, the answer is yes.
The clear answer to fix this is to put a price on carbon, which makes producers (and in turn consumers) pay for the full cost of their use of the atmosphere. This ain’t rocket science. My undergrads get this. President Obama gets this. In fact, Michael Greenstone – one of the most prominent environmental economists in the world and frequent EI visitor – led a federal working group to determine what the social cost of carbon is. The answer he and his coauthors came up with is approximately $40. What this means is that we should be adding approximately $40 to each ton of CO2 produced. This would raise the price of gas by roughly 40 cents per gallon.
The two ways economists argue one does this is by either charging a carbon tax or putting in place a cap and trade system. The word tax is political suicide, so we are most optimistic about the prospects of cap and trade. What you do is you issue a permit for each ton of CO2 and let firms trade these permits. This has been shown to be quite effective at reaching a prescribed amount of pollution reduction. At least cost. The trick is to issue just enough permits, so the price in the market reflects the social cost of carbon. Most economists are on board with this. It’s a Nobel worthy idea.
Well, the Pope does not agree.
“The strategy of buying and selling “carbon credits” can lead to a new form of speculation which would not help reduce the emission of polluting gases worldwide. This system seems to provide a quick and easy solution under the guise of a certain commitment to the environment, but in no way does it allow for the radical change which present circumstances require. Rather, it may simply become a ploy which permits maintaining the excessive consumption of some countries and sectors.”
And I just don’t agree with Pope Francis. I think this hostility towards market-based instruments comes from three possible lines of thought:
- Imperfect markets are the source of the current dire state of the environment, hence why would we use markets as a fix?
- There was evidence of some fraud in the ETS, showing that these markets are subject to manipulation.
- There is no way a cap and trade market will get us to 80% emissions reductions by 2050. You just have to tell people what to do. Command and control is better at that.
My response to 1) is simple. The reason the environment is in such bad shape is that some markets fail. We teach this to undergraduates as they walk through the door. You can use cap and trade markets to fix market failures! This is what they are designed to do. Markets to fix markets! We sometimes use dynamite to extinguish bad fires! The response to 2) is simple. Yes. Markets can be manipulated. But we learn and design better more foolproof instruments over time. No regulation is perfect. My response to 3) is that standards are expensive, provide little incentive for technological innovation and are a pain to enforce. Don’t get me wrong. Emissions trading is not the only policy we should engage in. I am strongly in favor of significantly subsidizing R&D for example.
What I wish the pope would have said is that market failures are the source of environmental degradation and we need to do everything we can to fix this. Our own governor Jerry Brown, who left a catholic seminary after three years to study classics at Berkeley is a staunch supporter of cap and trade.
So I would humbly ask Pope Francis to leave it up to science not faith to help us figure out how to fix the biggest environmental market failure mankind has faced in its history.