Economists lining up on climate change
Today’s Fin includes a full-page ad from five prominent financial market economists, calling for the introduction of a carbon trading scheme to reduce greenhouse gas emissions (paywalled, but it gets a brief mention here in the Oz). Meanwhile, Crikey yesterday ran a piece by another financial market economist, Michael Knox. Knox multiplies the estimated social cost of CO2 emissions from the Stern review ($85/ton of carbon) by total carbon consumption to get an estimated 5.3 per cent of GDP, and concludes (contra Stern) “This means that the cost is not 1 per cent of GDP but 5.3 per cent of GDP.
But Knox has the problem back to front here. He has calculated the cost to the world of Australia’s carbon emissions. Equivalently, this is the revenue that would be raised by a carbon tax of $85/ton, assuming a zero price elasticity of demand.
But the 1 per cent estimate of Stern, with which he is comparing his numbers is the cost of reducing emissions by 50 per cent relative to business as usual. Assuming the policy adopted was a carbon tax, with zero exemptions, the appropriate measure is the welfare triangle of deadweight loss. Knox has instead calculated the rectangle of revenue, a standard mistake for beginners in welfare economics, but a bit surprising to see from a senior financial economist.
While I’m on the topic, I should mention Labor’s plan for interest-free loans to households undertaking water-saving and energy-saving investments, to which I had some very modest input. Not surprisingly, I think the plan can be defended on efficiency grounds. As regards water, the case is simple. The current price paid by households is below the short-run marginal cost of water, and there are good reasons why we are unlikely to move to short-run marginal cost pricing any time soon. So, the incentives for households to invest in water-saving technology are inadequate, and an interest rate subsidy makes good sense.
On energy, the part of the scheme I like is the possibility of generating carbon offsets. Until we have a comprehensive emissions trading scheme, ensuring that all prices incorporate the social cost of carbon, it makes sense to reward people who reduce CO2 emissions with offsets credits. Politically, this all helps to make the point that the price of carbon is not a loss to the economy (as Michael Knox supposes) but a transfer from those who consume more carbon than average to those who consume less.