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Why the Pope is wrong on markets

Maximilian Auffhammer, professor, international sustainable development | August 17, 2015

On a recent speaking engagement in Germany I ran into Prof. John Schellnhuber, who was on his way to the Vatican to present Pope Francis’ major coming out document on climate change. After I got over feeling oh so cool for being one degree of Kevin Bacon removed from one of the most powerful figures in the world, I did my homework and read the Laudato Si’, which carries the subtitle “On care for our common home.”

Pope FrancisThis is a well researched position paper which touches on a variety of topics and makes it very clear that the pope cares much more about distributional issues than the average economist. This is not difficult, as we are too often obsessed with efficiency (maximizing the size of the pie) rather than equity (who gets what size slice).

Point No. 190

Even though I am a Bavarian protestant married to a lovely South African Jewish lady, I have been a big fan of Pope Francis until I got to point 190 in the Laudato Si’:

“it should always be kept in mind that “environmental protection cannot be assured solely on the basis of financial calculations of costs and benefits. The environment is one of those goods that cannot be adequately safeguarded or promoted by market forces”. […] Once more, we need to reject a magical conception of the market, which would suggest that problems can be solved simply by an increase in the profits of companies or individuals. Is it realistic to hope that those who are obsessed with maximizing profits will stop to reflect on the environmental damage which they will leave behind for future generations?”

I went and sat in front of a wall and meditated on this statement for a little while (yes, my mom tried to make a Zen monk out of me). I agree with some of this sentiment. It is clear that profit/utility maximization has led to much of the environmental conundrum we find ourselves in. In a perfect world, firms pay for the full costs of their activities (which we call social cost of production). Consumers then only buy the product if these costs are at most as large as their willingness to pay for the good. If firms don’t have to pay for the full cost of their production (e.g. they get to use the atmosphere as a free dumping ground for greenhouse gases), the cost of production is artificially low and consumers buy more than they should at artificially low prices.

Does this happen? Well, yes! Most places in the world do not charge firms for their carbon emissions. California, Europe, parts of Canada are some noteworthy exceptions, though even in these places the price is well below the environmental cost of the emissions. Most Chinese firms, for example do not currently pay for their use of the atmosphere. Neither do India’s, Japan’s, Australia’s…. This leads to an overproduction of greenhouse gases.

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Is the optimal level of greenhouse gas emissions zero? The economist’s answer is a clear no. We derive great benefits from the combustion of fossil fuels. Light to read, heat to cook, gasoline combustion for transport. But is the price of fossil fuels too low? Nearly everywhere, the answer is yes.

Carbon pricing: a Nobel-worthy idea

The clear answer to fix this is to put a price on carbon, which makes producers (and in turn consumers) pay for the full cost of their use of the atmosphere. This ain’t rocket science. My undergrads get this. President Obama gets this.

In fact, Michael Greenstone – one of the most prominent environmental economists in the world and frequent Energy Institute visitor – led a federal working group to determine what the social cost of carbon is. The answer he and his coauthors came up with is approximately $40. What this means is that we should be adding approximately $40 to each ton of CO2 produced. This would raise the price of gas by roughly 40 cents per gallon.

The two ways economists argue one does this is by either charging a carbon tax or putting in place a cap and trade system. The word tax is political suicide, so we are most optimistic about the prospects of cap and trade. What you do is you issue a permit for each ton of CO2 and let firms trade these permits.

This has been shown to be quite effective at reaching a prescribed amount of pollution reduction. At least cost. The trick is to issue just enough permits, so the price in the market reflects the social cost of carbon. Most economists are on board with this. It’s a Nobel worthy idea.

Laudito Si’ on carbon credits

Well, the Pope does not agree.

“The strategy of buying and selling ‘carbon credits’ can lead to a new form of speculation which would not help reduce the emission of polluting gases worldwide. This system seems to provide a quick and easy solution under the guise of a certain commitment to the environment, but in no way does it allow for the radical change which present circumstances require. Rather, it may simply become a ploy which permits maintaining the excessive consumption of some countries and sectors.”

And I just don’t agree with Pope Francis. I think this hostility towards market-based instruments comes from three possible lines of thought:

  1. Imperfect markets are the source of the current dire state of the environment, hence why would we use markets as a fix?
  2. There was evidence of some fraud in the ETS, showing that these markets are subject to manipulation.
  3. There is no way a cap and trade market will get us to 80% emissions reductions by 2050. You just have to tell people what to do. Command and control is better at that.

My response to 1) is simple: The reason the environment is in such bad shape is that some markets fail. We teach this to undergraduates as they walk through the door. You can use cap and trade markets to fix market failures! This is what they are designed to do. Markets to fix markets! We sometimes use dynamite to extinguish bad fires!

The response to 2) is simple: Yes. Markets can be manipulated. But we learn and design better more foolproof instruments over time. No regulation is perfect.

My response to 3) is that standards are expensive, provide little incentive for technological innovation and are a pain to enforce. Don’t get me wrong. Emissions trading is not the only policy we should engage in. I am strongly in favor of significantly subsidizing R&D, for example.

What I wish the pope would have said is that market failures are the source of environmental degradation and we need to do everything we can to fix this. Our own governor Jerry Brown, who left a catholic seminary after three years to study classics at Berkeley is a staunch supporter of cap and trade.

So I would humbly ask Pope Francis to leave it up to science not faith to help us figure out how to fix the biggest environmental market failure mankind has faced in its history.

Cross-posted from the blog of the Energy Institute at Haas (tag line: Research that Informs Business and Social Policy).

Comments to “Why the Pope is wrong on markets

  1. Is the forty cent a gallon carbon tax (or whatever it needs to be called) going to be enough to relocate our coastal cities and infrastructure to higher ground? Of course not. The Pope is right, just too late. Please get up to speed about the real projections of global warming and likely sea level rise. Ten years ago the projections were fractions of an inch; now it’s meters.

  2. I fail to understand why so many people do not agree with the clearly evident proposition that the climate has always changed and that ascribing the relatively mild recent changes to human activity is a form of arrogance.

    Countless examples could be adduced; here is one from the book A Cultural History of Climate by German historian Wolfgang Behringer: “After a thousand years, the Younger Dryas ended as abruptly as it had begun. Within a few decades the onset of the Holocene raised average annual temperatures by as much as 7 degrees Celsius. Storms grew less intense and rainfall doubled. It is, as always, ultimately unclear what led to this radical climate change…” (pp. 41-42). We can, though, be fairly certain that human beings did not cause the rapid change.

    I wish the commenters on this blog would read a book written by a professor emeritus of energy and resources at UC-Berkeley: Jack Hollander’s The Real Environmental Crisis (published by the University of California Press). Here is a slight taste of what his book offers: “A great deal of global warming rhetoric gives the impression that science has established beyond doubt that the recent warming is mostly due to human activities. That has not been established” (p. 76).

    Read the entire 26-page chapter on global warming. Watch the YouTube videos of Freeman Dyson, Michael Crichton, Richard Lindzen and many others on the subject of climate change. And, please: do be skeptical of a Pope who professes to care about the environment but who doesn’t address the issue of population growth.

    • Yes, the climate has always changed, but that does not preclude the possibility that humans can do the same, or that humans can change it faster. I think the truly arrogant thing to do would be to assume that we can do whatever we want without there being consequences.

      The Holocene warming can be attributed to the Milankovitch Cycles.

      Yes, there are a few scientists who disagree with the idea of anthropogenic climate change. Yes, no one can say with “100%” certainty that humans are the primary cause. But the scientific evidence is overwhelming, and society would do well to act in accordance.

  3. Despite my dislike of all things religious, I dislike faith in market solutions even more.

    Cap and trade does indeed work well: within a nation that issues the permits. But this is a global phenomenon that will require a global solution through treaty. Cap and trade may play a part within the nations involved in the treaty, but there is no global authority that could issue the permits.

    And of course you are overlooking the pope’s bigger issue of social justice. Are the permits a giveaway to the wealthy? Either to wealthy nations or corporations?

  4. “Is the optimal level of greenhouse gas emissions zero? The economist’s answer is a clear no.”

    Unless you put an absurdly low price on the end of human civilization (which is the inevitable result of global warming), the answer is YES.

  5. First, it is good that economists are taking note of Laudato si’. Unfortunately, Auffhammer seems to have missed the core of the argument. For Pope Francis, like many natural scientists, understands that simply bringing the rest of the world up to First World levels of consumption is not a good idea:

    “Doomsday predictions can no longer be met with irony or disdain. We may well be leaving to coming generations debris, desolation and filth. The pace of consumption, waste and environmental change has so stretched the planet’s capacity that our contemporary lifestyle, unsustainable as it is, can only precipitate catastrophes, such as those which even now periodically occur in different areas of the world.”

    And, he is not shy about addressing what the current state of affairs means for poor people: “That is why the New Zealand bishops asked what the commandment “Thou shall not kill” means when “twenty percent of the world’s population consumes resources at a rate that robs the poor nations and future generations of what they need to survive”.

    For such reasons, he asserts that “Once more, we need to reject a magical conception of the market, which would suggest that problems can be solved simply by an increase in the profits of companies or individuals.”

    Moreover, for Francis, the proper function of an economy is to provide people with what they need to leave decent lives, and among the things they need are jobs and community, as well as goods and services. He does not think our economy, with its emphasis on profit, does very well at that.

  6. Here’s a suggestion about what the Pope was thinking.

    “Rather, it may simply become a ploy which permits maintaining the excessive consumption of some countries and sectors.”

    The environment/atmosphere is a global good, so a true carbon-pricing scheme would set a common price worldwide on carbon production. But some countries have way more money than others. The upshot would be that we in America get to pollute as much as we like, while in India and Africa they are stuck without feasible sources of energy. Departures from this scheme are no longer free markets in carbon.

    The “radical change” the Pope has in mind is that the West give up, or stop acting on, its economic dominance over the Rest and actually be on the same playing field.

  7. Auffhammer writes: “The two ways economists argue one does this is by either charging a carbon tax or putting in place a cap and trade system. The word tax is political suicide, so we are most optimistic about the prospects of cap and trade.” This allows him to later claim the options are cap-and-trade or command-and-control. Auffhammer does not consider fee-and-dividend or carbon auctions.

    There are several ways of using the market which differ on who pays and who gets the money from the carbon price. Details can make a difference, but the gist is this:

    Carbon tax: consumers pay, government gets the money
    Cap-and-trade: some corporations pay, some corporations get the money
    Fee-and-dividend: consumers pay, all people get the money
    Carbon auction: corporations pay, government gets the money.

    When we say corporations pay, we need to realize that corporations will distribute that onto their stockholders and other stakeholders depending on relevant markets and their position in those markets.

    The point is, cap-and-trade, which is complicated, is especially subject to corruption, and which tends to make the owners of corporations (mostly the rich) richer, is not the only way of carbon pricing even if we admit carbon taxes are politically impossible.

  8. Either Prof Auffhammer admits there are economic problems — e.g. fire prevention and mitigation, public health programmes, crime prevention and mitigation, universally available health care — for which no good market solution has been found despite determined effort, or he doesn’t.

    If he does, he needs to explain how anthropogenic global warming is not such a problem.

    If he doesn’t, he needs to publish those market solutions, known so far only to him, so we can study them and consider trying them out.

  9. It is also not rocket science to see that there are a couple trillion dollars’ worth of resources just waiting below ground that have to stay where they are for us to avoid catastrophic climate changes — what jiggering of market forces is going to, even eventually, be able to keep enterprising businessmen from exploiting those resources for all the good they can collaterally bestow (light, heat, transport) beside profit?

    Command and control are going to have to come into play sooner or later, and given expert apologists like Max, it’s looking like it will be later.

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