The writer is a PhD student in the economics department at the University of Georgia and a winner of the Political Economy Club essay prize
At his Leaders Summit on Climate this year, US president Joe Biden unveiled a plan to more than halve US greenhouse gas emissions from 2005 levels by 2030. Unlike previous attempts to counter climate change through carbon taxes, this proposal included extensive government investment and regulatory changes.
But now the gritty reality of passing the associated legislation has hit. Is more state spending politically feasible? Are there alternatives, such as a mileage-based tax on drivers, as some lawmakers have suggested? Yet regulatory and small taxation changes are no substitute for comprehensive, transformative intervention. The president’s initial proposal was on the right track.
In economic theory, climate change is a conceptually simple, though inconvenient, problem: it is simply a negative externality. A negative externality occurs when one person’s behaviour adversely affects another in ways she cannot (legally) control. In an unregulated market, too many of these negative externalities are produced. In the case of climate change, we each produce too much greenhouse gas because we do not consider its effect in ruining the climate for others.
Economics has an off-the-shelf remedy: tax it. This creates disincentives to the activity, which offsets the externality effect. A cap-and-trade scheme such as the EU uses has a similar effect.
Biden’s climate change strategy eschews this straightforward gambit. Instead, we get a complex mix of supply-side investment and regulation targeted at specific sectors. It is the kind of government meddling traditionally regarded with suspicion by “mainstream” economists, and indeed I hear many economists make this complaint. When such an elegant correction to a market failure exists, why risk a more unconventional strategy? Is this a concession to political reality? Partly, yes. Biden did not believe a new tax on consumers could pass Congress. Is this therefore a second-best strategy? Not necessarily.
The problem with the simple story of climate change as an externality is just that: it is too simple. It neglects important dynamics in adapting the economy to climate change, which require a more extensive response than a carbon tax. These dynamics are addressed by the Biden plan.
The first of these is the supply side of the economy. The traditional story says that, left to our own devices, we consume carbon-intensive products, and therefore a tax is required to divert our consumption away from them. In turn, this incentivises businesses to produce more carbon-efficient products because demand for them has risen.
However, this ignores market failures which exist on the economy’s supply side. Many goods which we want consumers to switch to are public goods, goods which a private actor would have little incentive to provide. The bipartisan infrastructure bill includes the installation of electric vehicle charging stations across the US. This kind of provision would not automatically arise without direct government investment — and however much you tax my petrol car, I will not go electric unless you give me a place to charge it.
The second is the economics of innovation. Goods are not simply “supplied”; in many cases, they need to be invented. It has been known in economics for some time that in a free market, research and development is underprovided. Paul Romer won the 2018 Nobel Prize in economics for this discovery. Even if you create demand for more carbon-efficient energy, the private sector will be too slow to innovate to supply it.
This argues strongly for the inclusion of large government expenditures on R&D for carbon capture and energy storage, as in the bipartisan proposals.
Finally, the textbook story ignores dynamic effects. Many green energy sources benefit from “learning by doing”: the more we produce and consume them, the more efficient they become. This is something ignored by a carbon tax, which taxes the carbon produced today but does not take account of the carbon we might save tomorrow. It is therefore welcome that Biden plans to put in legislation a requirement for a portion of energy to come from zero-carbon sources. Subsidies for electric cars can also be justified in these terms, although again this measure did not survive bipartisan talks.
The plan is far from perfect. Greater investment in rail infrastructure, on a scale currently observed in China, would be a helpful addition in transitioning Americans away from cars. There is little in the proposals that addresses consumption of carbon-intensive imported goods; this is an area where a well-designed carbon tax might in fact be helpful.
And of course, there are real concerns that this may be too little, too late. This is especially the case when we consider the sort of measures which can gain the support of Republicans, if passed through bipartisan agreement, or “centrist” Democrats, if passed through reconciliation.
A plan for transitioning to a low-carbon economy was overdue. Although this might not look like a plan the textbooks would have prescribed, it may be better for it.