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Why the Pope is Wrong on Markets

On a recent speaking engagement in Germany I ran into Prof. John Schellnhuber, who was pope francison 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.

decadal-with-forcing-small

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:

  1. Imperfect markets are the source of the current dire state of the environment, hence why would we use markets as a fix?
  2. There was evidence of some fraud in the ETS, showing that these markets are subject to manipulation.
  3. 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.

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Maximilian Auffhammer View All

Maximilian Auffhammer is the George Pardee Professor of International Sustainable Development at the University of California Berkeley. His fields of expertise are environmental and energy economics, with a specific focus on the impacts and regulation of climate change and air pollution.

31 thoughts on “Why the Pope is Wrong on Markets Leave a comment

  1. How about taxing what we want people to use less of, gradually, steadily, and put all that revenue into the economy to drive a substantial transition to alternatives? I don’t see how it matters how much people consume of socially beneficial (as opposed to socially costly) products. We wouldn’t stop at the fairly arbitrary $40 per ton. We would add around $10 per ton per year for 10 years, a rate that has been forecast to bring emissions down to where scientists have said it needs to be. We would include a border adjustment to level the playing field and drive the price globally. Let’s ask Pope Francis.

  2. Only a market economist would suggest that we know the future cost of something like polluting the atmosphere. There are no perfect markets. Period. Look at what this thinking has done to us over the years. Robber Barons, governments bought by big corporations, the most recent recession. $40 per ton is a joke, and a bad one. Who is getting the $40 per ton — what are they doing with it? Is it going into a trust fund invested in “What oil?” to pay for the future costs. We need to sequester the carbon right where it is. In the ground. Don’t take it out!!

  3. Professor Auffhammer: First I thank you for reading the entire Papal encyclical, Laudato Si. I doubt that many economists have.

    You take issue with the Pope’s comments on the market and on trading carbon credits. I’m conversant with the familiar arguments and won’t get into that here.

    What I hope you will consider as you go forward with your work as an economist is the rest of what the Pope gets into. To put it into the current vernacular, Francis is recommending System Change, Not Climate Change. His comment on Cap and Trade is almost an aside.

    Francis recommends System Change rather than relying on technological change. The latter, in the end, is what Cap and Trade is hoped to bring about.

    Francis wants a massive redistribution of income, World GDP, from the wealthy to the poor. And that is not only from the North to the South but within the North and the South. That redistribution of income will, he expects, reduce consumption. Francis puts the blame for environmental degradation, the mistreatment of the world, on consumption and consumerism. More, Francis asserts that the present path of income distribution leads to “… social breakdown, increased violence and a rise in new forms of social aggression, drug trafficking, growing drug use by young people, and the loss of identity.” [page 32]

    On page 22 the Pope asserts that “We all know that it is not possible to sustain the present level of consumption in developed countries and wealthier sectors of society, where the habit of wasting and discarding has reached unprecedented levels.” I am guessing you know he is correct about that. If you disagree, why not take the assertion to task, as you have with your dispute on Cap and Trade?

    Francis recommends specifics as well. For example he mentions better mass transit (and offers an example from a successful change in a city in Brazil) rather than a market solution of more expensive gasoline.

    There is much, much more in Laudato Si, as you know. Don’t limit your writing about it to the bit about Cap and Trade.

    Gene Coyle

    • If the Pope wants to reduce consumption by redistributing income, he’s got the economics wrong, because the marginal propensity to consume (rather than save) is inversely related to income: higher income households tend to save more as a percentage of their income than low income households. This is just Econ 101. Redistributing income may well lead to a reduction in the social problems cited in the encyclical, but it won’t clearly reduce consumption. In any event, consumption, per se, isn’t clearly the problem. Rather, we are consuming too much of some things (coal) and too little of others (education and health care).

      • I think the Pope, rather than getting Econ 101 wrong, is teaching Econ 401. Let’s accept for the sake of argument that it is correct that higher income households save more out of marginal income than do lower income households. So far you are on safe ground. But now we have to think about what they do with the rest of their income — with what they are “saving.” Most will accept that they will be seeking good places to earn a return on the savings, hence they will be plowing it into what they hope will be profitable and growing businesses. It is spent on adding to the means of production, followed, they hope, by more consumption by people buying the output. In other words, the wealthy are causing things to be bought with 100% of their income, partly as consumption, partly as investment. So if their income is reduced, that total buying will be reduced.

        At the next level, maybe over in Finance 201, you could learn, as I’m guessing Pope Francis already knows, that redistributing income as he recommends is going to lower expectations of future earnings for business. (See the work of Myron Gordon — Google the Gordon Growth Model). Thus the businesses will be worth less, i.e. a drop in wealth for the higher income brackets, and the wealthy in general. So both the wealth and income effects are going to bang consumption by the affluent.

        Your final sentence asserts, furthermore, that the market isn’t working with respect to the choices consumers make. WHY are we consuming the wrong things and not the others? I’m not sure what level course, in what discipline, to recommend on that one.

    • The point of markets is not that they predict with accuracy the future cost; it’s that markets are the most effective means of aggregating the collective knowledge of everyone participating in the market. Relying on a few bureaucrats to make a single centralize decision is more likely to lead us down blind alleys and increases the risk from any single decision. We need to be thinking about risk management from all sides, not solely from the climate (even if that is the paramount risk.)

    • Gene, I expect that income redistribution will lead to increased consumption, not less. A single wealthy individual has only so much consumptive capacity. This is why Keynes promoted the idea of economic stimulus. As for transit systems, we can build the most effective ones is the system, but it cars are still cheaper (in both monetary, and time and convenience terms), consumers will continue to use them. The income elasticity of demand for auto travel is remarkable and can easily overwhelm price responsiveness.

  4. I think that the responses to Max’s post are confusing two matters: 1) whether markets are moral means of achieving environmental goals (which may be the Pope’s prime objection) and 2) whether markets are the most effective means of achieving emission reductions. I won’t comment on the first, but on the second, we have rarely tried to explicitly achieve such large societal transformations. Restricting GHG, unlike any other environmental regulation, will touch virtually every aspect of our economic activity. So we can’t look to standard environmental regulatory success as a metric for what might be achieved. The only previous efforts on a similar scale are the wholesale changes made in the Communist countries after World Wars I and II. And we can see that relying on central planning schemes were an abject failure. (https://mcubedecon.wordpress.com/2014/07/06/how-do-we-best-induce-technological-innovation-weve-already-run-that-experiment/) The problem is that anyone who believes that we can rely on coming up with such a comprehensive regulatory scheme is simply underestimating the complexity of trying to coordinate and monitor so many decisions. So markets may not achieve the results that we want, but they are still much more likely to achieve better results than any scheme that tries to dictate the choices of 7 billion individuals.

    Paco D’Exponere is right that California truly has not implemented a market-based approach (a point we made in comments we submitted in 2008 on the Scoping Plan.) But we also don’t know if this approach will be successful. In answer to Karen, there is significant controversy about whether the CPUC’s EE evaluation is unbiased. Would you as a regulatory agency like to publish a study that says that for the last three decades that you’ve wasted ratepayer money? We don’t yet have an unbiased assessment.

  5. The encyclical is an ecumenical document signalling a reconciliation between Vatican and the Latin American brand of liberation theology. The latter is hostile to markets because they are thought to inevitably exploit the poor. God knows, even if the Pope doesn’t, that exploitation, when it occurs, is a joint product of markets and rent-seeking. It is not inevitable.

  6. There are two statements in Max’s comment that I’d like to highlight:

    “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”.

    It may not be surprising that economists think climate change is a market failure, but I believe the Pope’s point is precisely that climate change is much more than that and therefore markets won’t solve the problem. The encyclical is much closer to the concepts of deep ecology enumerated by Arne Naess and others in the seventies. Following Polanyi, markets are embedded in a larger social context and is this social context of consumerism, materialism, lack of justice and collaboration that seems to be at the crux of the issue, according to the encyclical. Markets will be created reflecting these underlying causes and it seems this supports the Pope’s rejection to them as a solution. From point 202 in the encyclical: “Many things have to change course, but it is we human beings above all who need to change.”

    A more technical comment is related to “Is the optimal level of greenhouse gas emissions zero?”

    I feel Max’s straightforward answer, “a clear no” reflects that the question is incomplete. I believe the right statement would be “Is the optimal level of greenhouse gas emissions zero given the current stocks?”. There are many analyses that suggest that we indeed need to achieve zero or even negative emissions in the second half of this century to prevent temperature increases higher than 2 or 3 C. Even if we allow for some emissions, allocating them, again according to the encyclical, is a matter of justice, not efficiency. It seems the Pope doesn’t believe markets can produce just solutions, simply because they cannot be set up in a “neutral” way but will be influenced by the existing power balance.

  7. “The trick is to issue just enough permits, so the price in the market reflects the social cost of carbon.”

    If we knew the true social cost of carbon–and much less than a habitable climate were at stake–then a market approach might be adequate. By what method do we assign a cost to climate catastrophe given the enormous uncertainties involved? The models used to estimate SCC are subjective, cartoon representations of only a portion of the problem. Treating these estimates as representative of the true social cost requires a huge leap of faith. And as you note, we would still have global distributional and intergenerational inequities related to fossil fuel cost and benefits. Do we just explain to the millions displaced (not to mention dead) that the outcome is Kaldor-Hicks efficient? How about the market failure of imperfect information? Consumers can’t be expected to make the “right” choices after being subject to decades of disinformation from fossil fuel companies, Fox News, and others. What is the right price for carbon in this context?

    Perhaps as Stephen DeCanio suggests, economics is not the right language for addressing climate change, which is primarily a moral issue. We don’t use cost-benefit analysis to decide how to raise our children or whether to go to war, end slavery, or allow all couples to marry. If we agree that there are some issues for which economics should not be the final arbiter, shouldn’t society’s response to an existential crisis be among those?

  8. The pope and his advisors may view buying and selling “rights to pollute” as similar to the church’s history of papal dispensations. In critiquing “market forces,” they may not be rejecting all ways to price emissions. I think it’s wrong for you to dismiss all creative solutions as political suicide. Approaches like “Fee & Dividend” from Citizens Climate Lobby, with small but significant conservative support, are gaining traction.

    • As a Citizens’ Climate Lobbyist, I learned in June in DC that the vast majority of Republicans in the US Congress listen to proposals to put a price on carbon when the proposal is revenue neutral. Our proposal, the “George Schulz Carbon Fee and Dividend”, returns all of the fees to American households. These aren’t new taxes or new government. These are essentially permit fees to pollute the atmosphere paid by the companies that extract or import oil, gas and coal administered by existing agencies. The majority of Republican voters increasingly want Congress to act on climate. The political challenge is not really the electorate, it’s really the candidates with unlimited fossil fuel funding who threaten to run principled Republicans out of office by twisting truth and other deceitful campaign tactics. With a bipartisan solution like ours, along with our grassroots advocacy more than doubling every year, there will soon be enough principled Republicans with enough cover to sponsor a bill that is clearly the most fair and effective way to put a price on carbon and in alignment with the Pope’s concerns. A third of Congress is Catholic. I invite you and the commenters to join me in a vision of Pope Francis being greeted by Congress on Sept 24 with the introduction of a bill to price carbon that everyone CAN like and will do the job (and supported by enough Democrats willing to stop eyeing the revenue for their favorite programs.)

  9. (1) Doggone it, Max, stop calling it a tax! No-one thinks it’s a tax to pay the supermarket for the right to take food home and eat it; it’s not only politically incompetent, it’s just wrong. What you’re talking about is charging people to use the atmosphere’s limited GHG processing capacity. People who take that scarce resource without paying for it are takers/no-good goniff thieves, no different from shoplifters, and it’s the duty of government to protect us from being bad people.
    (2) You let the command and control advocates off too easily on the effectiveness criterion. On what planet does “telling people what to do” magically cause them all to do it? Personally, I know a lot more people who run stop signs and speed than don’t pay their taxes.

    • Hard to disagree with this point. It is difficult to read some of the posts addressing cultural biases, pricing responses, etc.

      Establish a cap and trade system and stick to it. The cap is established pursuant to the number of allowances (permission slips) that are distributed. Now it does not matter how people or institutions respond to pricing incentives, they are mandated to turn in the allowances at the end of an established time period, much like a tax bill. Enforce the obligation. There you have it.

      And since the basis of the system is an actual emissions cap and not a tax per ton, the influence of carbon pricing on behavior is irrelevant.

      To draconian, some may say! As the author points out, this is simply the process of requiring producers and consumers to pay the cost of their behavior. To do anything less would be tantamount to theft.

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