Monthly Archives: January 2014

The Silver Bullet Of Climate Change Policy


By Bob Litterman and Gernot Wagner

Whenever the conversation turns to climate change, someone is sure to opine that there’s no silver bullet. The issue is simply too complex to have one solution. When you focus on all the changes that need to occur to reduce greenhouse gas emissions globally it seems like a multifaceted approach is the only way forward.

Most of the world’s vexing problems share that feature. Mideast peace, nuclear non-proliferation, Eurozone stability, and plenty of other national security problems have no single right plan of attack. Some past plans might have brought us tantalizingly close to a seeming solution, but then reality started interfering once again, reconfirming the complexity of it all.

Climate change must surely be in that category. No single country, no single technology, no single approach can seemingly solve this one for us once and for all. Picking a single technology will almost inevitably end in some form of disappointment. Bureaucrats, the saying goes, ought not to try to pick winners. Leave that to venture capitalists for whom failure is a way of life. For every Apple and Facebook, there are dozens who never make it out of the garage. And clean technology doesn’t yet even have a single Apple and Facebook as the standout approach revolutionizing the field.

It turns out, though, that how you frame the issue is crucial. If you think like an engineer there are dozens of challenges. If you think like an economist, there is one. It’s guiding the ‘invisible hand’. How can you create the appropriate incentive to decrease the pollution that’s causing climate change? For that, the government need not be in the business of picking winners at all. What it should—and can—do is identify the loser that’s been clear for decades: greenhouse gas pollution. And the solution is equally clear: create incentives to reduce emissions by pricing it. If we make this one change, most other actions that are needed will follow.

That’s what the European Union has done by capping carbon emissions from its energy sector, including large industrials, covering almost half of total carbon emissions. That’s what California is doing with over 80 percent of its total global warming emissions. It’s what China is experimenting with in seven city and regional trials, including in Beijing and Shanghai. All these systems put a price on greenhouse gas pollution.

On the other side of the ledger, there are still much larger incentives to consume fossil fuels in many other countries. The International Energy Agency estimates that global subsidies are well over $500 billion. These subsidies, which incentivize emissions, sadly dwarf the paltry incentives to reduce them. Free marketeers, small government advocates, and others who dislike distorting government subsidies should be appalled at the tax money poured into fossil fuels.

There’s one simple principle that’s been around in economics for so long that no economist worth his or her degree would question the conclusion: increase the price, watch the quantity demanded go down. It’s such a universal truism that economists call it the “Law of Demand.” Generations of graduate students have estimated the effects of price on demand for anything from the generic widget to demand for car miles driven. People may be irrational at times, but one thing that we know for sure is that they respond to incentives.

Everything we know from decades of the study of human behavior would lead us to believe that carbon pollution will go down as the price on emissions increases. The only interesting question is by how much.

The prescription then for anyone seriously concerned about climate change is simple: price carbon to the point where its now unpriced damages are incorporated into the price, and get out of the way. It’s simple. It works. It’s conservative to the core.

It’s also a silver bullet solution if there ever was one.

Bob Litterman is a Partner at Kepos Capital, LP. Gernot Wagner is a senior economist at the Environmental Defense Fund.

Posted in Cap and Trade, Politics, Technology | 3 Responses

Why the cost of carbon pollution is both too high and too low

From EDF Voices:

Tell someone you are a “climate economist,” and the first thing you hear after the slightly puzzled looks subside is, “How much?” Show me the money: “How much is climate change really costing us?”

Here it is: at least $40.

That, of course, isn’t the total cost, which is in the trillions of dollars. $40 is the cost per ton of carbon dioxide pollution emitted today, and represents the financial impacts of everything climate change wreaks: higher medical bills, lost productivity at work, rising seas, and more. Every American, all 300 million of us, emit around twenty of these $40-tons per year.

The number comes from none other than the U.S. government in an effort to uncover the true cost of carbon pollution. This exercise was first conducted in 2010. It involved a dozen government agencies and departments, several dozen experts, and a fifty-page, densely crafted “technical support document,” replete with some seventy, peer-reviewed references and an even more technical appendix.

Cass Sunstein, the Harvard legal scholar of Nudge fame, who was co-leading the process for the White House at the time, recently declared himself positively surprised how the usual interest-group politics were all-but absent from the discussions throughout that process. This is how science should be done to help guide public policy.

The cost of carbon pollution is too low

The number originally reached in 2010 wasn’t $40. It was a bit more than half as much. What happened? In short, the scientific understanding of the impacts of rising seas had advanced by so much, and the peer-reviewed, economic models had finally caught up to the scientific understanding circa 2007, that a routine update of the cost of carbon number resulted in the rather dramatic increase to near $40 per ton. (There are twenty pages of additional scientific prose, if you want to know the details.)

In other words, we had been seriously underestimating the cost of climate change all along. That’s the exact opposite of what you hear from those who want to ignore the problem, and the $40 itself is still woefully conservative. Some large companies, including the likes of Exxon, are voluntarily using a higher price internally for their capital investment decisions.

And everything we know about the science points to the fact that the $40 figure has nowhere to go but up. The more we know, the higher the costs. And even what we don’t knowpushes the costs higher still.

Howard Shelanski, Sunstein’s successor as the administrator of the Office of Information and Regulatory Affairs (OIRA, pronounced “oh-eye-ruh”), has since presided over a further update of the official number. In fact, this one didn’t incorporate any of the latest science. It was simply a minor technical correction of the prior update, resulting in a $1 revision downward. (The precise number is now $37, though I still say $40 at cocktail parties, to avoid a false sense of precision. Yes, that’s what a climate economist talks about at cocktail parties.)

And once again, it all demonstrated just how science ought to be done: Sometimes it advances because newer and better, peer-reviewed publications become available. Sometimes it advances because someone discovers and fixes a small mathematical error.

Your input is needed

While announcing the correction, Shelanski added another layer of transparency and an opportunity for further refinements of the numbers: a formal call for public comments on the way the cost of carbon figure is calculated, open through January 27 February 26.

We are taking this opportunity seriously. EDF, together with our partners at the Natural Resource Defense Council, New York University School of Law’s Institute for Policy Integrity, and the Union of Concerned Scientists, is submitting formal, technical comments in support of the administration’s use of the cost of carbon pollution number as well as recommending further revisions to reflect the latest science.

The bottom line, as economists like to put it, is that carbon pollution costs society a lot of money. So as the technical experts trade scientific papers, you can help by reminding our leaders in Washington that we need strong, science-based climate policies.

Update (on January 24): The official comment period just was extended for another month, through February 26. More time to show your support.

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