Economics 12: global warming

by George Hatjoullis

The debate on global warming may heat up following this winter. Climate change is evident though the causes and nature of this change may still be the subject of debate. This is beyond the scope of the Economics series but we can consider the consequences of attempting to impose a CO2 emissions constraint on global economic activity. Let us assume that the UN agrees a maximum CO2 emission target in any one year and the problem of measuring emissions and the source of emissions is not insurmountable (a typical heroic assumption of economics). The first problem the UN would face is how to distribute the rights to emit CO2 across the globe. What would be a ‘fair’ distribution? Given that the global economy is a market economy , it might simply auction off the rights and use the proceeds to promote various CO2 emission reduction policies. It might also organise a secondary market in CO2 emission rights (CER) enabling countries and organisations (or even individuals) to continuously trade such rights.

The second problem the UN would face is policing the constraint. This enables us to introduce another important concept of economics; the free rider. The absence of CO2 emissions benefits all humanity. However, one entity (country, corporation) can gain if it ignores the constraint so long as everyone else abides by the rules. Obviously, if others become aware of the free rider, they may break ranks, and the constraint on CO2 emissions becomes merely a target and not an actuality. The UN would need to effectively police the constraint such as to persuade most that free riding was trivial. The funds from the auction might be used to finance such a policing operation but the effectiveness may still be limited and unconvincing. Let us assume that this problem can be solved and that the constraint is effective.

The CO2 constraint has introduced a cost to the production process; the right of CO2 emission. Previously this right was a free input but now each enterprise and activity must pay for the privilege. The result will be to change the nature, location and level of GDP. If the constraint is binding the ramifications could be very significant. Much existing plant and equipment would be rendered redundant and investment in new plant and equipment would incorporate new technologies. There would be another industrial revolution. Companies and nation states that use or produce carbon based products would be disadvantaged and suffer a negative GDP shock, whilst those able to function with ‘clean’ energy would prosper. In some respects it would reverse the consequences of the oil price increases of the last several decades. This could have widespread Geo-political consequences which would feed back into the economic sphere. However, it goes further than simply an increase in input costs. The constraint is binding so, unless there is sufficient clean energy and new technology in place, overall global GDP would probably fall. Many activities would simply have to cease. They would be banned or made prohibitively expensive.

The dislocation arising from an abrupt binding constraint on global CO2 emissions explains why such a constraint has yet to be attempted. Not only are there measurement and policing problems but the economic, social and political disruption could lead to wars (which would defeat the object of saving humanity and create quite a lot of CO2). So are we doomed? Not necessarily. The much derided market mechanism may help out. There is no question that industry tries to influence ‘demand’ via marketing and advertising. However, consumers can be quite sophisticated and insistent. They may not be able to judge the evidence on the importance of CO2 emissions but they can grasp the consequences if the scientific community is correct, especially if they have just experienced a polar vortex or live near a river or the coast (or in Perth, Australia). The governments of the world need not involve the UN (or any other supranational) in measurement or policing a binding constraint. Nor do they have to risk global conflict or inflict abrupt dislocation on the distribution of GDP across nation states. They ‘simply’ need to mark products with a carbon footprint (not an easy exercise but possible to approximate) much like some food packages now exhibit important nutritional information. The market will do the rest and quite quickly.

Information alone does not guarantee different outcomes. However, information coupled with motivation does produce different outcomes. It is a nudge approach to policy but one that can work. Simply making individuals aware of the marginal CO2 emissions of their activity can influence behaviour. It can also correct well-meaning errors. Intensive home-grown produce may have a higher carbon footprint than imports depending on the type of energy used in production and the comparative advantage of the overseas producer (naturally sunny). It may be that the conclusion is to consume less of the product from all sources. Indeed, given the state of technology, consuming less is probably the most effective means of reducing CO2 emissions. The implications for GDP are ultimately much the same as imposing a CO2 constraint, but achieving it through a better informed market place may be the most effective, and least dangerous, method. Economic theory invariably assumes that consumers have perfect information. It is time someone made the information on the carbon content of output available.

To recap:

1. CO2 emissions may be a problem for humanity. Imposing a binding CO2 emissions constraint on the global economy is a non-trivial exercise.

2. A binding constraint on CO2 emissions would have widespread economic, social and geopolitical consequences.

3. The market system offers an effective mechanism for reducing CO2 emissions in producing GDP, if the consumer is motivated. It merely requires complete information.

4. There is already evidence that the consumer is motivated. Extreme weather experiences will add to this motivation. What is necessary is better information.

5. In the short-term, the most effective way to reduce individual carbon footprints is to reduce consumption and GDP.