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Halfway through reading Paul Krugman’s New York Times piece on green economics, I had my snarky retort all ready to go. Then in the second half he went and got all reasonable on me. I still don’t buy his conclusions, but (sadly for readers who like fireworks), he’s not (at least in this instance) nuts.
There have been exactly two great ideas in environmental economics, one from Arthur Cecil Pigou and the other from Ronald Coase. Krugman starts off with a good account of the first. Sometimes market transactions impose spillover costs (economists call them externalities) on innocent bystanders; carbon emissions are a good example. Pigou proposed to tax externalities at a rate commensurate with the costs they impose. If your smokestack causes $50 worth of damage, you pay a $50 tax. We call such taxes Pigovian. Krugman does a good job of explaining how they work, and why they’re usually preferable to direct mandates.
Here, though, is where I briefly thought Krugman had gone completely off the rails. He touts the merits of Pigovian taxes—the first great idea in environmental economics—while appearing completely to ignore the second great idea, namely Coase’s insight into how Pigovian taxes can backfire. Here’s the problem: Pigovian taxes will lead to fewer carbon emissions, and with fewer carbon emissions, less effort will go into seeking alternative solutions, like new technologies to cool the planet or new technologies to make life tolerable in a much warmer world. Nothing in pure theory can tell you whether such technologies are likely to be feasible or efficient, so nothing in pure theory can tell you whether a Pigovian tax is a good idea.
When it comes to macroeconomics, Krugman loves nothing more than to skewer writers who depart from the Keynesian gospel—writing, he says, as if Keynes had never lived. How delicious, then, to find Krugman writing as if Ronald Coase had never lived. Bloggers love this kind of irony.
So if Krugman had stopped there, my own retort would have been shorter, snappier and more quotable than the post you’re reading now. Alas for readers who enjoy that kind of thing, Krugman’s piece took a turn for the better. True, after all his paeans to Pigou, Krugman never mentions Coase’s name, and true, he never gives Coase’s ideas the same careful airing he gives Pigou’s. But his economics training wins out and eventually leads him into essentially Coasian reasoning:
It seems almost certain that … [a temperature rise of 9 degrees Fahrenheit] … would make the United States, and the world as a whole, poorer than it would be otherwise…But we have an advanced economy, the kind hat has historically shown great ability to adapt to changed circumstances….[This] should help us cope with a somewhat higher average temperature.
He then proceeds, just as Professor Coase would have us do, to think about just how well we might cope, to acknowledge that both action and inaction can be costly, and to inquire into the particulars of the situation. I think he gets several of those particulars wrong, but at least from this point on he asks most of the right questions. (I’ll elaborate on this later in the week.)
To recap: Krugman starts out with the right answer (“impose a Pigovian tax”) to the wrong question (“How can we best reduce carbon emissions?”). The right question is not how best to reduce emissions, but how best to cope with the fact that carbon-based technology can have a substantial downside. We might want to deal with that by reducing emissions; we might want to deal with it by finding other ways to cool the earth; we might want to deal with it by moving all our cities northward and inland; we might want to deal with it through some combination of those strategies; we might want to deal with it in some way that nobody has yet imagined. A Pigovian tax does a good job of reducing emissions, but at the same time it causes people to work less hard at the alternatives. Therefore, depending on particulars, a Pigovian tax could be an excellent idea or a disastrous one. Again, Krugman gets that right. Where he goes a bit wrong, I think, is in his assessments of the particulars.
This post is getting long, so I’ll save my quibbles for later in the week.
Yay, I hope Krugman responds to this.
I was curious what your opinion was of that article, so thanks for posting your thoughts!
Very tangentially related — the BBC also has an economics blog: http://www.bbc.co.uk/blogs/thereporters/stephanieflanders/
The writer isn’t as big a name as Krugman, and of course it’s about the UK, so perhaps not as cogent for you, but I thought it might provide more fodder for rants. ;-)
Neat! thanks for spelling that all out, and linking to Krugman’s piece which I had missed. Good stuff.
Typo alert: In quoting Krugman, either there should have been a “[sic]” or else “the kind hat has…” should have been “the kind that has…”
… or we might want to do nothing. I think the problem will be self-correcting. If we do nothing, in a few years the areas around the equator will be arid deserts, while many coastal areas will be under water, or subject to huge hurricanes. This should reduce the global population by more than 50%, and lessen humanity’s carbon footprint significantly.
Some questions, from an educational standpoint (i.e. not trying to score ideological points):
“Here’s the problem: Pigovian taxes will lead to fewer carbon emissions, and with fewer carbon emissions, less effort will go into seeking alternative solutions”
Does this imply that we would not want a Pigovian tax at all? Or just that we need other methods as well? It seems like a comparison could be made to simple vandalism — if I come to your house and cause 50$ worth of damages, we should definitely make me pay 50$. We do not worry that this will cause “less vandalism” or that society will not seek to finding alternatives to vandalism. Perhaps I misunderstood your argument, so certainly please feel free to correct my error! :)
“A Pigovian tax does a good job of reducing emissions, but at the same time it causes people to work less hard at the alternatives.”
Doesn’t it help spur innovation into at least alternatives to emissions? It seems like if the cost of “emissions” goes up then the relative value of “alternatives to emissions” (as a substitute) goes up as well, to the person making those emissions. I understand that those alternatives might not themselves be good for the wider question of “how do we deal with rising temperatures,” but this is just dependent on how well we’ve determined the causes of those rising temperatures.
Thanks in advance!
@Brian Moore, I think the question is who is being incented by the tax. If I’m a power company that uses coal to produce electricity, then the Pigovian tax may create an incentive for me to seek alternative sources. However, the reduction in emissions reduces your incentive to identify alternatives.
Remember during 2007-8, gasoline prices rose abruptly, and companies started seeking alternatives to gasoline, and spurred the rise in sales of hybrid cars. Then the economic crisis reduced demand, gasoline prices dropped, and we (at least Americans) were suddenly less focused on alternatives to gasoline. I think Steve is forecasting a similar effect from Pigovian taxes on energy.
Steve,
Doesn’t the whole argument about the harmful effects of Pigovian taxes, become a moot point if the Pigovian tax can be changed?
Would it be fair to summarize the argument as follows: “Suppose we’re all identical and cause $10 worth of spillover harm per mile driven. A Pigovian tax is set at $10 per mile. Now someone could find a way to mitigate the harm of the spillover effects of driving so their harm is now only $7 per mile. It would be efficient if we all then paid $1 per mile to use that new technology, plus a new $7 Pigovian tax. However, if the Pigovian tax is fixed at $10, then this won’t happen.”
Well, true, but — can’t we then just lower the Pigovian tax to $7? Anybody smart enough to set the Pigovian tax exactly equal to the spillover costs in the first place, is smart enough to lower it when those spillover costs go down.
I was hoping you’d have a response to this. I read the column and found once again that having listened to Krugman (at Montreal Worldcon) made the column much more readable for me. I could, internally, “hear” it in the voice he had when he gave talks at the con and knowing something more about him as a person somehow made the whole thing seem less dry and thus easier to read.
Bennett,
The problem with your hypo is that the technology will only be created if it reduces the production of carbon emissions. I think Steve’s point is that we don’t necessarily want to decrease carbon emissions- we really just want to reduce external costs. There may be ways to reduce the external costs from carbon emissions without reducing the carbon emissions, but with a tax on carbon, there is no incentive to buy or create such a technology.
It could be efficient to pollute as much as we want, have lots of cheap energy, and just move our cities.
I can think of one hypothetical way around the problem. What if the tax is fixed and not changed? Then doesn’t the government have an incentive to reduce the costs of pollution? If it would be cheaper for the city to move, couldn’t the municipality bargain with the pollution producers? If it costs a million dollars to move the city, but the factory pays $2 million in pollution taxes, the city could negotiate to remove the tax in exchange for $1,999,999, and move all of its people north. Now the factories are polluting, the water has risen, and the city is in the arctic, but is $999,999 richer.
That would be pretty difficult to implement.
Along these lines, I keep reading that “we” do something or “we” do nothing. What people typically mean when they say “we” is the government. Many people seem to assume that if the government doesn’t act no one will, hence nothing will be done. But putting even a little thought into questions like this shows this line of reasoning absurd. People react to things all the time without government intervention.
It’s important to understand the impact of government intervention, like Pigovian taxes, but it’s equally important if not more so yo understand how people react to other people’s actions. Not just how peope react to government actions.
I have more to say, but don’t have time to solidify and articulate my thoughts.
The flip side of Pigovian taxes are Pigovian subsidies. If the money from a carbon tax were available to reward activity that mitigated global warming, wouldn’t this encourage the search for alternative solutions?
And if the carbon tax worked well, either alone or as part of a broader solution, the money collected could be used to reduce other, more harmful taxes.