Practical Market-Based Solutions

William D. Nordhaus – Nobel Prize-winner and professor of economics and environment at Yale University – approaches environmental issues with an economist’s eye for rationality and practical efficiency. In this accessible overview, he details how to fold climate change mitigation into market processes. Nordhaus advocates policies, such as a carbon tax, that create maximum benefits at minimal costs, and he advises against arbitrary command-and-control regulation.

Global warming is a trillion-dollar problem requiring a trillion-dollar solution, and the battle for hearts, minds and votes will be fierce.William D. Nordhaus

Pragmatic environmentalists will recognize the necessary role of markets in protecting the planet. Nordhaus sensibly argues that measures that inflict the least harm to people’s lives and wallets will most easily gain widespread support.

Minimal Sacrifices

Nordhaus notes that those passionate about green issues may regard economics as legitimizing environmentally damaging growth, industrialization and consumerism.

Green thinking can help analyze and perhaps solve many of the thorniest problems of our age – global warming, pandemics, myopic decision making, overpopulation of people, and overharvesting of forests and fish. William D. Nordhaus

But economic tools and insights, he insists, offer environmental gains with minimal impacts on living standards, and they have the best chance of political support. However, Nordhaus concedes, green investment and research lack adequate incentives in free market economies.

When our economic accounts deal properly with the health benefits, environmental regulation has increased, not slowed, the growth of properly measured output.William D. Nordhaus

High-income countries have been generating less pollution per unit of energy and consumption due to efficiency savings, environmental regulations and economies shifting toward services. Thus, green policies can be positive in purely economic terms.

Social Value

Firms commonly tout their green or socially responsible credentials. Companies should focus on cost-effective activities that have social benefits and that take advantage of companies’ own processes or specialties.

A first guideline…is that the activities should pass a ‘social’ benefit-cost test even if they fail a ‘private’ profit-cost test…The second guideline is that firms should concentrate their resources on areas where they have comparative informational or economic advantages.William D. Nordhaus

Consumers will often opt for the cheap, energy-inefficient choice, even when they’re presented with information showing that more expensive green options can save them money in the medium and long term. This suggests a motive for governments to intervene to help further green objectives, Nordhaus believes, particularly in long-term projects such as insulation requirements in building codes.

Arbitrary and Inefficient

Clean air laws enacted in 1970 were part of the first big environmental legislation push in the United States, and they have endured. By 1990, government had chosen a market-inspired approach to sulfur dioxide pollution by giving tradable permits to polluters. The free-permits approach reduced initial political resistance, and the tradable aspect allowed the companies with the most cost-efficient pollution savings to undertake them first. This provided the impetus for international carbon pricing and taxing.

But today, the price of sulfur dioxide permits in the United States is far below the theoretical estimates of the marginal damage done. Questions arise over whether the offsets actually reduce overall emissions.

Command-and-control regulations cost significantly more than what is necessary to reach their environmental goals. William D. Nordhaus

The Green New Deal (GND) promoted by progressives in the US Congress seeks to recognize the seriousness of environmental issues and the central role government needs to play. But the GND also emphasizes command-and-control regulation, producing uneven and at-any-cost demands. Successful market approaches, Nordaus emphasizes, show that maximum pollution cuts are achievable when they have minimum economic cost.

The greater the distance between the decider and the decidee, the greater the chance for misaligned incentives and unrepresentative decisions.William D. Nordhaus

Local government is best placed to regulate externalities with local environmental implications. Yet the regulations created by nation-states are by far the most common and well-enforced. Liability laws and enhanced property rights can allow private parties to negotiate efficient outcomes. But climate change is an issue beyond the scope of any property-rights solution, and it brings with it issues of free-riding and incentives. While the harm is distant, both in geography and time, the sacrifice is near to home and immediate.

A Carbon Tax

From an economist’s point of view, a tax on carbon is an ideal method for dealing with climate change. It would directly and efficiently transmit information, through prices, throughout the economy, alerting consumers and businesses to the damage carbon dioxide causes. A simple tax would provide consumers and businesses with a basic price signal. A carbon tax, Nordhaus notes, does not require a large bureaucracy to collect information or enforce regulations. The higher price of carbon would stimulate investment in other energy sources.

Setting the universal global harmonized price [of carbon] at the right level is ‘all’ that is required for an efficient policy for climate change.William D. Nordhaus

A tax of $40 per ton of carbon emissions, which is the US government’s lower estimate of an appropriate rate, would generate a tax of 1% of GDP, or 8% of federal revenues, at 2019 activity. 

The harmonious application of a carbon tax across all major trading countries would ease negotiations and end the wrangling and coalition-shifting that arbitrary total emissions targets inspire.

Both theory and history suggest that some form of sanction on nonparticipants is required to induce countries to participate in agreements with local costs but diffuse benefits.William D. Nordhaus

The successful enactment of an international carbon tax club would be one of the most significant and positive steps of global cooperation ever taken. The stakes for planet Earth could not be higher.

Not By Accident

Professor Nordhaus did not win the Nobel Prize by accident. This sane, rational approach to accepting market-based solutions to climate change features his startling elegance of word and clarity of thought. He shows an exceptional understanding of how to present these complex ideas so that economists, policy makers and professors suffer no boredom, while laypeople, students and less-informed activists find accessible, perhaps eye-opening, ideas and strategies. Nordhaus avoids choosing political or philosophical sides. His solutions vest in the deceptively simple – yet still maddeningly complex – idea that a profitable business can also be an environmentally sound one. He endeavors to show how that can happen.

William D. Nordhaus’s books include The Climate Casino: Risk, Uncertainty, and Economics for a Warming World and Warming the World: Economic Models of Global Warming.