Carbon taxes delay CO2 emissions, but they don’t reduce them

The intellectual history of the carbon tax is a bit of a tragedy.

I always like to say that economists knew the solution to climate change before climate change existed. Arthur C. Pigou laid out the theory of externalities in 1920, long before global warming became a concern. And Pigou also provided the solution: if there is a negative externality, tax the thing that causes the externality. A carbon tax is the straightforward application of this idea.

It took quite a long time for climate change to become a number one concern in global politics and it took even longer for the carbon tax to become a viable idea in policy circles. There still is a lot of misunderstanding about how such a tax would work and it continues to face a lot of resistance. There is, of course, also disagreement about the appropriate tax rate and what to do with the revenue.

And yet, as many people still fail to realize, most countries already have an implicit carbon tax. Almost all developed countries already tax gasoline. The average gasoline tax in the OECD translates to an implicit carbon tax of 85 euros per ton of CO2 – which is in the ballpark of reasonable estimates of the social cost of carbon. That implies, at least to a first approximation, that the average user of a combustion engine car in the OECD already pays the full social cost of burning gas.

Of course, the problem with the existing implicit carbon taxes is that they are not uniform. The taxes on gas and diesel are much higher than those on coal, natural gas, and kerosine. There is a lot of variation in tax rates between countries. So the existing carbon taxe regime leaves a lot of room for improvement. But enacting an optimal carbon tax wouldn’t require us to change our tax system fundamentally – we would just need to tweak the existing fossil fuel taxes.

And let’s not forget the EU cap-and-trade system which imposes another implicit carbon tax on a broad set of emitters, from electricity generation to steel factories, refineries, and other energy-intensive industries to commercial aviation. The current price of carbon in the certificates market is 51 euros per ton – again, not far from mainstream estimates of the true externality.

Now here comes the tragedy – at the exact time that a carbon tax has become a mainstream idea, economists have started to realize a major flaw with it: A carbon tax may not actually reduce carbon emissions over the long run, but merely change the time-path of emissions.

Readers of this blog have long understood this. Hans-Werner Sinn has understood this even longer. Recently, I have seen indications that more and more economists are becoming aware of it.

Here is a graph from a recent paper by Jose Luis Cruz Alvares and Esteban Rossi-Hansberg:

Source: Cruz Alvares and Rossi-Hansberg (2021)

Under business as usual (represented by the light-green curves above), this model predicts that CO2 emissions would peak around the year 2100 and then start to decline, while temperatures would rise by about 7 degrees relative to pre-industrial levels. With a carbon tax of 50% (brownish curve), the peak of emissions would be shifted in time by a couple of decades and temperatures would rise somewhat less rapidly, but they would end up with the same cumulative emissions and the same long-run temperature increase. A higher tax rate (blue and dark green curves) would simply shift the time path of emissions and temperatures further into the future.

So these model projections show that a carbon tax merely stretch out the cumulative CO2 emissions over time without any long-run impact on the climate. No matter what tax rate is applied, in the long-run we’re going to end up with a rise of about 7 degrees.

This is a devastating result for carbon taxes. (Too devastating for the authors to put in the abstract, where they try to down-play this result as follows: “Carbon taxes delay consumption of fossil fuels and help flatten the temperature curve but are much more effective when an abatement technology is forthcoming.” I think “help flatten the temperature curve” is a little misleading , since it is really just a postponing of the temperature increase.)

The Cruz Alvarez and Rossi-Hansberg paper is notable for a number of other results. For instance, it has bad news on clean energy subsidies:

Clean energy subsidies have only a modest effect on carbon emissions and the corresponding evolution of global temperature since, although they generate substitution towards clean energy, they also lead to a reduction in the price of energy which results in more production and ultimately more energy use. These effects tend to cancel each other out.

Cruz Alvares and Rossi-Hansberg (2021), p 4

And it is the first paper I have seen (though I do not claim to have read every relevant paper) that tries to estimate the welfare cost of climate change taking into account that people will change their behavior when temperatures rise (including, if necessary, leaving their current home and migrate to better climates).

This is their summary of the key findings regarding welfare:

With the quantified model in hand, we can simulate the economy forward over several centuries and evaluate the economic consequences of global warming. This phenomenon is expected to have heteroge- neous effects over space, where the hottest regions in South America, Africa, India and Australia experience welfare losses of 15% and the coldest regions in Alaska, Northern Canada, and Siberia undergo welfare gains as high as 14%. On average, the world is expected to lose 6% in terms of welfare, although the exact number depends on the yearly discount factor.

Cruz Alvares and Rossi-Hansberg (2021), p 4

I have some trouble converting this finding into something tangible. Is a 6% drop in welfare a big deal or not? Imagine a politician saying “Vote for me, and I will make you 6% happier?” Would you vote for the guy? I don’t know. Maybe. I guess the question is: compared to what? Footnote 36 of the paper provides a clue:

Global average welfare losses are calculated as the population weighted average of the relative present discounted value of utility in the baseline case relative to the counterfactual without global warming.

Cruz Alvares and Rossi-Hansberg (2021), p 28

So this is one way to think about it. Taking the authors’ chosen discount factor of 0.964, a 6% reduction in the present value of utility is equivalent to an annual reduction of 0.21% for every year into eternity. For small changes, the change of utility is closely approximated by changes in income. Therefore, a 6% loss in welfare translates into a 0.21% loss in annual income, now and forever. Given that the average income of a world citizen in 2019 (pre-covid) was about 18,000 US dollars (purchasing power adjusted), the annual cost of climate change for the average world citizen is about 40 dollars.

40 bucks isn’t a lot. But there is, of course, a lot of uncertainty and a lot of variation across countries. Helpfully, the authors include this graph showing the regional variation of welfare losses (less helpfully, in the graph, red means welfare gains, blue welfare losses):

Cruz Alvares and Rossi-Hansberg (2021), p 29

In conclusion, I see signs that the academic consensus is slowly shifting away from the carbon tax precisely at a time, when that idea is getting a lot of traction from policy makers. I continue to believe, and I am emboldened by the research discussed above, that the solution to the problem of climate change is to curb the extraction of fossil fuels directly.

Supply-side policies against global warming

Alas, it turns out that I was not the first to point out the perverse dynamic supply-side effects of a carbon tax! (Well, I never really believed I was the first anyway.)

Hans-Werner Sinn wrote a whole book about it. It is called the “Green Paradox“. And there is some academic literature on it, although surprisingly little. (For instance, this recent paper on the role of oil reserves and marginal extraction costs).

Sinn also wrote this paper in 2007 which confirms my hypothesis that a rising carbon tax makes resource owners extract more fossil fuels in the short run. But he does so in a much more sophisticated dynamic general equilibrium model. The paper helps to answer one important objections I received in private conversations.

My good friend (and Graz Economics alumnus) Michael Schwarz points out that oil extraction can’t just be turned on and off like a water tap. There are extraction costs! Yes, indeed, and Sinns paper addresses this point: 

„If extraction costs are assumed, the problem of moving the economy in the wrong direction is mitigated, and with sufficiently strong extraction costs, current extraction may even move in the right direction.“

Sinn, HW. “Public policies against global warming: a supply side approach”, Int Tax Public Finance (2008), p. 21

But Sinn also points out:

„As marginal extraction costs are likely to be only a small fraction of the price of the extracted resource, the effect on the extraction path may be tiny. For instance, the average production costs of crude oil amounted to only about 15% of the average spot price in 2006.“

Sinn, HW. “Public policies against global warming: a supply side approach”, Int Tax Public Finance (2008), p. 20

Since oil extraction is a high fixed cost, small marginal cost industry, the average production costs overstate the marginal costs which are relevant for the extraction path.

Recent empirical research throws more doubt on the importance of extraction costs. Here is a quote from the paper by Heal and Schlenker linked to above:

Using data from a large proprietary database of field-level oil data, we show that carbon prices even as high as 200 dollars per ton of CO2 will only reduce cumulative emissions from oil by 4% as the supply curve is very steep for high oil prices and few reserves drop out.

Heal, GM and Schlenker,W, “Coase, Hotelling and Pigou: The Incidence of a Carbon Tax and Co2 Emissions” (July 2019). NBER Working Paper No. w26086

Sinn’s paper is interesting not just for its thorough analysis of the Green Paradox, but for suggesting a couple of alternative policies against global warming. The key to these policies is that they address the important point of the issue: the quantity of fossil fuels extracted.

Here are three of them:

  1. Capping fossil fuel production: Basically, we need to tell the oil sheikhs very gently and politely that they need to stop extracting oil. For example, we could agree a fixed quota for annual oil and gas extraction. Since the oil sheikhs are intelligent people, they might be pursuaded to do that if we offer some development aid in exchange.
  2. Emissions trading: We could set a global cap on carbon emissions and auction off carbon certificates to industries and households. The EU has already tried such a scheme, although the cap was probably too large and not enough industries were not included (e.g. airlines). The big advantage of emissions trading compared to a tax is that it directly addresses the quantity, not the price. The downside is that negotiating a global trading system opens up a huge can of worms: especially, which country gets how many certificates? How should the revenue be used, etc.
  3. Sequestration and afforestation: Another way to solve the problem would be to de-link carbon emissions from fossil fuel consumption. Sequestration, i.e pumping the emitted CO2 back into the earth is one way (how feasible this is techniqually, I have no idea). Growing more trees which absorb CO2 naturally is another. Again, there could be international agreements to subsidize both these things.

I think all these policy proposals should get at least as much attention as the carbon tax. Why is nobody talking about them?

I should also point out that the issue is broader than the carbon tax. Any policy that merely tries to shift the demand curve for fossil fuels down will fail achieve the objective of decreasing greenhouse gas emissions unless it avoids the perverse effect on the fossil-fuel supply curve. Subsidizing e-mobility, putting tarrifs on international shipping, shaming people into avoiding airplanes, incentivizing the installation of solar panels and wind energy – all those things merely change the demand side.

I think the demand side is the wrong side. Let’s talk more about the supply side!

Some unpleasant carbon tax economics

Every economist knows that a carbon tax is the correct solution to climate change. By correct I mean the solution that a perfectly informed, well-meaning dictator would choose.

But when I was recently brooding over some dynamic optimization problems, I made a discoverey that I haven’t seen anyone discuss. And I find it disturbing.

I’m going to develop the argument formally below, but I will give away the punchline. Brace for impact!

Theorem: A carbon tax that remains constant over time doesn’t change the extraction path of fossil fuel. A carbon tax that increases over time tilts the extraction path in such a way that more fossil fuel is extracted now, less later.

If this is obvious to you, you can stop reading and start freaking out. If you think that this must be wrong, I would like you to point out any error I made in the argument below.

Let’s start from the Hotelling rule which dictates how profit maximizing oil sheikhs exploit their resource over time:

P(1+r) = P’,

where P is today’s price for oil (or gas, or whatever), r is the real interest rate and a prime denotes future variables. The rule says that you want prices to rise over time at the rate of the real interest rate.

When I say P is the price for oil, I mean the price the oil sheikh gets. The price consumers pay is P(1+t) where t is the (ad-valorem) carbon tax.

Next we need to postulate a demand curve to translate the Hotelling rule, which is about the evolution of prices, into a rule about quantities. Let’s write the (inverse) demand curve as follows

P(1+t) = D(Q)

and let’s postulate that D is decreasing in Q. This should shock nobody: demand curves slope down.

I hope you agree with me that absolutely nothing about this is in any way controversial. But then you must agree with me that we can combine the Hotelling rule with the present and future demand curves to get the following equation:

D(Q)(1+r)/(1+t) = D(Q’)/(1+t’).

This, ladies and gentlemen, is the dynamic law of motion for fossil fuel consumption. It describes how the quantity of fossil fuel extracted from the ground evolves over time. Since everything that is extracted will be consumed in the end, it implies a time path of carbon emissions.

Now what can we deduce about that time path from this equation?

  1. Hold the carbon tax constant over time by setting t=t’, and you will see that the equation reduces to
    D(Q)(1+r) = D(Q’),
    which is exactly the same equation that would hold if no carbon tax existed at all. It follows that with a time-invariant carbon tax, the sheiks will go on extracting oil and carbon emissions will continue at the exact same rate as if there were no carbon tax.
  2. It gets worse.  Suppose the carbon tax increases over time, i.e. t<t’. The effect of this will be the same as if the real interest rate would increase: it will make fossil fuel prices rise at a faster rate. But how do sheikhs make the sure the price path is steeper? By extracting more today, thus lowering the price today, and less in the future, thus increasing the future price.

Quod erat demonstrandum!

Now, of course you can refine the argument. What if, for example, the carbon tax eventually becomes so high that even the most fanatical SUV lover will refuse to pump gas? I don’t think this changes the argument. All this means is that oil producers will tilt the extraction path even more towards the present.

After all, there is a fixed and finite reserve of fossil fuels in the ground. All a carbon tax can change is when it will be extracted and the price consumers will pay for it.

If my argument is correct, why exactly are we sure that a carbon tax is the correct solution to climate change?

Addendum: If you want to me more concrete, assume fossil fuel demand is iso-elastic with elasticity e. In this case it is almost trivial to derive the equilibrium quantity: If R is the current stock of oil reserves, the quantity extracted now is

Q = (1-1/s)R with s = [(1+r)(1+t’)/(1+t)]^e

Notice that the extraction share Q/R is increasing in s which is increasing in the ratio of future to present carbon taxes (1+t’)/(1+t).

Sind Österreichs CO2-Steuern zu hoch?

In einem interessanten Artikel über CO2-Steuern macht Andreas Sator vom Standard eine wichtige Entdeckung: 

Für die Höhe [der optimalen CO2-Steuer, Anm.] gibt es verschiedene Berechnungen, die von mindestens 35 Euro (Stiglitz-Bericht) über 60 Euro (IWF), mindestens 50 bis 100 Euro (Gernot Wagner) bis 180 Euro pro Tonne CO2 reichen (Umweltbundesamt). Schauen wir uns das an einem Beispiel an: einem Liter Benzin. Ein CO2-Preis von 100 Euro würde ihn um etwa 25 Cent teurer machen. Das ist nicht nichts, Schwankungen in dieser Höhe haben aber schon in der Vergangenheit nicht dazu geführt, dass Menschen ihre Autos massenweise in den Garagen gelassen hätten. Dazu kommt: Auf einen Liter Benzin sind jetzt schon 48,2 Cent Mineralölsteuer fällig – im Prinzip eine CO2-Steuer von fast 200 Euro.

Genau richtig! Österreich hat schon längst eine CO2-Steuer. Sie heißt Mineralölsteuer und beträgt 9,8 Cent pro Liter Heizöl, 39,7 Cent pro Liter Diesel und 48,2 Cent pro Liter Benzin. Wenn man diese Steuersätze durch den jeweiligen CO2-Ausstoß pro Liter dividiert und mit 1000 multipliziert erhält man die implizierte CO-Steuer in Euro pro Tonne. In nachstehender Tabelle habe ich das mal durchgerechnet: Im Durchschnitt wird jede Tonne CO2 durch die Mineralölsteuer mit 115 Euro besteuert.

Steuersatz (Euro pro Liter)CO2-Ausstoß (Kilogramm pro Liter)implizite CO2-Steuer (Euro pro Tonne)optimaler Steuersatz (Euro pro Liter)

In der letzten Spalte berechne ich den optimalen Steuersatz, wenn man die vom IWF empfohlenen 60 Euro pro Tonne als Basis für die sozialen Kosten von CO2 (Social Cost of Carbon) hernimmt. Diese Zahl stellt die geschätzten zusätzlichen Kosten des Klimawandels dar, die jede zusätzlich emittierte Tonne CO2 verursacht. Im Schnitt sollte man also Mineralöl mit 18 Cent pro Liter besteuern. Die derzeitigen CO2-Steuern sind mit 32,6 Cent pro Liter im Schnitt also fast ums Doppelte zu hoch!

Auch abgesehen von der durchschnittlichen Höhe, machen die Steuersätze aus klimapolitischer Sicht wenig Sinn: Benzin stößt weniger CO2 aus als Diesel und Heizöl, wird aber wesentlich höher besteuert. Das klimaschädlichste Heizöl trägt die geringste Steuerlast. Das ist nicht verwunderlich, weil die Mineralölsteuer ja nicht als CO2-Steuer konzipiert wurde.

Jetzt kann man natürlich trefflich darüber streiten, ob 60 Euro pro Tonne wirklich die gesamten sozialen Grenzkosten des CO2 abbildet. Ich bin hier kein Experte, möchte aber darauf hinweisen, dass Bill Nordhaus eine weit geringere Zahl angibt, und zwar 31 US-Dollar, und der hat schließlich den Nobelpreis dafür bekommen.

Bin gespannt, wie sich diese Entdeckung auf die Debatte um die “Ökologisierung” des Steuersystems auswirken wird. Meine Vorhersage: gar nicht.

Österreichs Klimastrategie ist viel zu konkret

Ökonomen kannten die Lösung für das Problem des Klimawandels als es ihn noch gar nicht gab. Im Jahr 1920 veröffentlichte Arthur Pigou sein Buch “The Economics of Welfare“, worin er erklärt wie man mit negativen Externalitäten umgeht: Man besteuert diejenigen, die die negative Externalität verursacht – und zwar möglichst so, dass durch die Steuer die privaten Kosten möglichst den sozialen Kosten angeglichen werden.

Der Klimawandel ist die Mutter aller Externalitätenprobleme. Unsere CO2-Emissionen hier und heute haben einen Effekt auf das globale Klima in der fernen Zukunft – und die Veränderungen im globalen Klima haben wiederum eine Reihe von komplexen, schwer vorhersehbaren und höchst unterschiedlichen Effekten auf Ökosysteme und unsere Gesellschaft.

Österreich hat sich mit den anderen Staaten dieser Welt im Pariser Abkommen dazu verpflichtet CO2-Emissionen zu reduzieren in der Hoffnung damit die globale Erwärmung auf 2 Grad gegenüber dem vorindustriellen Zeitalter zu begrenzen. So weit, so gut, obwohl man an der Effektivität und auch an der Sinnhaftigkeit des Abkommens zweifeln darf. Aber lassen wir diese Debatte beiseite und schauen wir uns lieber die neue „Klimastrategie” der österreichischen Bundesregierung an.

Was steht da drin? Im wesentlichen will die Regierung dass es in Zukunft keine Ölheizungen mehr gibt, dass möglichst viele Gebäude thermisch saniert werden, dass mehr mit Bahn und Rad und weniger mit Autos gefahren wird und wenn, dann mit Elektroautos.

An der Strategie wurde in den letzten Tagen viel kritisiert. Zu wenig konkret sei sie, die Finanzierung der vorgeschlagenen Maßnahmen sei unklar, die Zuständigkeiten seien nicht geregelt, usw.

In meinen Augen ist diese Kritik völlig verfehlt. Das wahre Problem ist: Die „Klimastrategie” ist viel zu konkret!

Es ist komplett unnötig, dass sich unsere Regierung Gedanken macht wie viele Ölheizungen es in Zukunft geben darf oder wie viele Solarpanels installiert werden müssen oder wie viele Elektroautos herumfahren sollen. Alles, was sie tun muss, ist eine Steuer für CO2-Emissionen einführen und dann dem Markt die Aufgabe überlassen herauszufinden, welche Heizungssysteme, welche Verkehrsmittel und welche Stromerzeugungsmethoden sinnvoll sind.

Natürlich gibt es wie bei jeder neuen Steuer administrative Herausforderungen: Wer genau soll die Steuer abführen? Wie genau wird die Steuer ermittelt? Wie geht man mit Importen und Exporten um? Aber ich bin mir sicher die braven Beamten des Finanzministeriums sind kreativ genug diese Probleme zu lösen, zumal sie auf die Hilfe von Umweltökonomen und Finanzwissenschaftlern zählen können. Schlaue Leute haben sich über all das schon Gedanken gemacht und Konzepte entwickelt. (Z.B. hier)

Es könnte so einfach sein.

Zum Pariser Klimaabkommen

Am Sonntag letzter Woche war Karl Steininger „Im Zentrum“ um über das Pariser Klimaabkommen zu diskutieren. Ich fand die Diskussion, gemessen an dem, was man sonst von diesem Format gewohnt ist, sehr wohltuend: sachlich, unaufgeregt, informativ.

Für alle, die das Abkommen verschlafen haben: Die 195 Staaten haben vereinbart, dass die Erderwärmung auf unter 2° (relativ zu 1880) begrenzt werden soll. Wie wollen sie das schaffen? Indem jedes Land sich selbst Emissionsziele setzt, über deren Einhaltung sie dann regelmäßig Bericht erstatten müssen. Was hat die Entwicklungsländer, die ja beim Kyoto-Protokoll nicht dabei waren, diesmal dazu gebracht zuzustimmen? Sie bekommen für ein paar Jahre (von 2020 bis mindestens 2025) 100 Milliarden Dollar jährlich um die Anpassungskosten abzumildern. Wie viel Geld ist das? Eine ganze Menge: Im Jahr 2013 betrugen die Ausgaben für offizielle Entwicklungshilfe ca. 160 Milliarden Dollar. Was passiert, wenn die nationalen Emissionsziele nicht eingehalten werden? Nichts. Die Berichte über die Einhaltung der Klimaziele sind rechtlich verpflichtend, nicht aber die Einhaltung der Klimaziele selbst.

Nun gut, die große Revolution, von der Francois Hollande gesprochen hat, ist das nicht. Aber sicherlich ist die Tatsache, dass Russen und Türken, Iraner und Israelis, Nord- und Südkoreaner hier miteinander an einem Verhandlungstisch saßen und ein gemeinsames Abkommen unterzeichneten, ein Riesendurchbruch.

Wem wird das Abkommen nützen? Dazu gehören sicher die Erzeuger von erneuerbarer Energie, die in Zukunft wohl noch stärker subventioniert werden. Die heimische Landwirtschaft wird es sicher verstehen, das klimapolitische “Momentum” (© Andrä Rupprechter) in mehr staatlichen Schutz vor bösen (weil klimaschädlichen!!!) Agrarimporten umzumünzen. Die Klimaforscher dürfen sich höchstwahrscheinlich über eine gesteigerte staatliche Nachfrage nach ihrer Expertise freuen.

Im besten Fall wird die Klimapolitik dazu führen, dass perverse Anreizsysteme abgebaut werden. Dazu gehören all die Dinge, die Karl Steininger genannt hat: das Pendlerpauschale, die steuerliche Begünstigung von Dienstautos, die Subventionierung ineffizienter Energieerzeugung. Und vielleicht wird Österreich ja wirklich zu einem “Silicon Valley” der grünen Energie, einem Hotspot Zentrum energietechnologischer Innovation.

Leider halte ich das für einen frommen Wunsch. Ich fürchte Klimapolitik wird das bleiben, was sie ist: ein sehr effektives Schlagwort, das gut organisierte Interessengruppen in der politischen Debatte benutzen, um sich auf Kosten der Allgemeinheut zu bereichern.

Hans-Werner Sinn’s theses on climate policy: a puzzle

I recently came across Hans-Werner Sinn’s 13 theses on climate policy. Prof. Sinn’s main target is Germany’s policy of radical transition from fossil fuels to renewable energy sources – the famous “Energiewende”. I think some of his arguments are very well taken, others are rather dubious. In particular, I would quarrel with theses #2, #3, and #4. But at the moment it is #10 which gives me headaches.

Here is his Thesis #10:

“The [German] Renewable Energy Act, which makes green power economically viable, is completely ineffective, since it conflicts with the European emissions trading system, which already caps CO2 emissions. The green power produced in Germany not only replaces power from fossil fuels, but also sets free the corresponding emission certificates. These certificates migrate via the markets to coal-fired power stations in other EU countries, where they facilitate an increase in CO2 emissions – or a reduction in savings – which exactly matches the German savings.”

This seems to be a perfectly valid argument. Now take a look at the graph below. It shows greenhouse gas emissions relative to the base year 2005, which is the year when the EU’s emission trading system began, for Germany (blue line) and the rest of the European Union (red line). Data source: Eurostat.

If Prof. Sinn’s thesis is correct, Germany’s emissions should have decreased faster than in the rest of the EU. Yet the exact opposite is the case: German emissions fell by 5 percent between 2005 and 2012 compared to 15 percent in the rest of the EU!

What’s going on here? I can’t see any mistake in Prof. Sinn’s analysis, but his analysis seems to be completely at odds with the data. The logical conclusion is that I must be missing something. What am I missing? Help!

GHG emissions

Degrowth vs. Decarbon

In reply to my last post, Katharina linked to a think tank arguing for “degrowth” as a strategy of preventing further global warming. My mini model seems to support exactly that strategy: reduce consumption and production to reduce greenhouse gas emissions. But there is another way to deal with the problem, which is usually referred to as “decarbonization”. This strategy calls for reducing the use of greenhouse gas emitting modes of production, like switching from coal to nuclear power. In my experience both strategies tend to be supported by the same set of people. But think about them in terms of my model and you realize that they cut in opposite directions – the more we “decarbonize”, the less we need to “degrow”, and vice versa.

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Climate Policy, GDP and Welfare

The 5th assessment report of the IPCC is drawing a lot of attention for its claim that reducing greenhouse gas emissions would only have small costs in terms of gross social product, that “saving the planet” is cheaper than we might think. I have not read the report in detail and I am in no position to say whether the IPCC got it right or wrong.

However, it occurred to me that the IPCC is asking the wrong question. They ask how much mitigation policies would cost in terms of (world) GDP. But climate policy is a classic case where GDP is a very bad indicator of economic welfare. Greenhouse gas emissions are a byproduct of producing goods and services and they cause global warming, which is arguably a bad thing, i.e. a negative externality. Individual consumers and producers do not take account of the negative effects of their consumption/production decisions on society and therefore consume and produce too much.

Here is how that works in a simple model. (For the visual types, here is how it works graphically: climate policy graph.)

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