The textbook economics of cap-and-trade
I realized, after the last post, that it might be useful to write down just what the Econ 101 version of cap and trade looks like; as it happens, this also helps explain the intellectual sins of Glenn Beck and Martin Feldstein.
So here we go. Bear in mind that something like what follows can be found in just about every intro textbook.
Think of the benefits to the private sector from pollution. Yes, benefits — in the sense that it’s cheaper to pollute than not to, or that it’s easier to produce goods if you don’t worry about whatever emissions result as a byproduct. So we can think of drawing a curve representing the private marginal benefit of emissions, as in this figure:
In the absence of government action, the private sector will increase emissions up to the point where there is no further marginal benefit. That is, emissions will rise to whatever level is implied by profit-maximization, paying no attention to the effects on the environment.
A cap-and-trade system puts a limit on overall emissions, so that emitters have to pay a price for emitting. This price will, as shown in the figure above, equal the marginal benefit of the last unit of emissions allowed.
Now, the cost to the economy of this limit is the benefit the private sector would have gotten by emitting more than is allowed under the cap. It’s shown in the figure as the red triangle labeled “deadweight loss”. CBO puts these losses under Waxman-Markey at 0.2-0.7 percent of GDP in 2020, 1.1 to 3.4 percent in 2050. These costs have to be set against the environmental benefits.
Finally, here’s a number we can do something with. If we grant Krugman his figure, that Waxman-Markey will only cost 0.2%-0.7% of the GDP in 2020 — and 1.1%-3.4% in the year 2050…. …then he needs to concede it’s a bad deal. Let’s compare apples to apples, using the IPCC’s own models. Assuming (with no change) a 4.5-degree Celsius increase by the year 2100 (which I personally think is ludicrous, but whatever), then if the U.S. “goes it alone” with Waxman-Markey targets that 4.5-degree rise is tempered by only 0.2-degrees. http://masterresource.org/?p=2355 Now, let’s assume the entire rest of the planet plays along. (And this means now, because according to that best-case scenario, carbon emissions in Asia would start going down as soon as next year!) That would account for a 2.37-degree “slowing” of the warming. http://masterresource.org/?p=2367 Recap – Is 3-percent of the GDP in 2050 worth a path that leads to almost no benefit if we go it alone? Is it worth it if the entire planet goes along (in a very unrealistic manner?) And do we trust those models even? I don’t trust the models. But Krugman does, and for him to sell us this lesson on cost-benefit analysis without showing the results of the calculations from those very same models is disingenuous. It’s not a good deal – even under the most forgiving scenario with the most benefit-of-the-doubt to his side.