Tuesday, June 10, 2008

In a less than perfect world 

In a perfect world we would know how much damage pollution does, we'd know who did it, and we'd know how to costlessly assess those who create the harm and transfer the money to those who are harmed. We could total the costs and benefits and arrive at a measure of whether the ratio was greater than one, and if so we would be able to do it.

In a perfect world those costs and benefits would be compared to those for other projects and, given a limited budget, could be decided whether we should take care of these things first or wait to deal with more pressing needs. Bjorn Lomborg's Copenhagen Consensus provides the answer for that perfect-world question.
Scarcity is a core economic concept, though politicians and even many economists prefer to ignore it. There isn't an unlimited amount of money to be spent on every problem, so choices have to be made. The question addressed by the Copenhagen Consensus Center is what investments would do the most good for the most people. The center's blue-ribbon panel of economists, including five Nobel laureates, weighed more than 40 proposals to improve the world by spending a total of $75 billion over the next four years.
The top investments on their list, ranked by benefit-cost ratio, were heavily populated by issues of malnutrition and disease prevention. The top-ranked item for dealing with global warming was research and development of low-carbon emitting technologies ... but the consensus group had expended their $75b budget by then. Other items provided a better return on investment.

But the world is not frictionless. Knowledge is imperfect. Identifying who gains and who loses from environmental degradation (if you accept it happens -- not all do) is difficult. And each scheme we try creates incentives for "capture". This month's Wired has the provocative cover "Inconvenient Truths about Global Warming" and contains this admonition against cap-and-trade:
All the so-called clean development mechanisms authorized by the Kyoto Protocol, designed to keep 175 million tons of CO2 out of the atmosphere by 2012, will slow the rise of carbon emissions by ... 6.5 days. (That's according to Roger Pielke at the University of Colorado.) Depressed yet? Kyoto also forces companies in developed countries to pay China for destroying HFC-23 gas, even though Western manufacturers have been scrubbing this industrial byproduct for years without compensation. And where's the guarantee that the tree planted in Bolivia to offset $10 worth of air travel, for instance, won't be chopped down long before it absorbs the requisite carbon?

Nationally managed emissions-trading schemes could do a better job than Kyoto's we-are-the-world approach by adding legal enforcement and serious oversight. But many economists favor a simpler way: a tax on fossil fuels. A carbon tax would eliminate three classes of parasites that have evolved to fill niches created by the global climate protocol: cynical marketers intent on greenwashing, blinkered bureaucrats shoveling indulgences to powerful incumbents, and deal-happy Wall Streeters looking for a shiny new billion-dollar trading toy.
Carbon taxes aren't a panacea either, though, as the debate last week among economists (captured well by Brad DeLong) demonstrates. You might argue that the second- and third-order effects are a wash, and you might be right, but the truth is you don't know. Both cap-and-trade and carbon taxes create pools of money for government to shovel out to favored constituencies (the latter pointed out this morning in Rep. Bachmann's editorial) but, as one of my colleagues pointed out this morning, that's money that is supposed to compensate those who are harmed by carbon emissions. The excuse of high transactions costs in making the transfer to the harmed is no excuse for letting government charge the tax on the beneficiaries of carbon emission and pass it among its political benefactors.

The value of the Copenhagen Consensus in the global warming debate is to identify the benefits of using carbon taxes or cap and trade. In it, the benefit cost ratio of these actions alone are estimated to be 0.9, i.e., the benefits are less than the costs. The return is greater only when used in conjunction with research and development (or which, to put it bluntly, the expected benefits are speculative. That's the imperfect world in which we live.