Energy economist Severin Borenstein in a new post at his Energy Institute Blog argues that the favorite of most economists, pricing greenhouse gases, won’t be enough to harness global warming. Borenstein, faculty director at the Energy Institute at the Haas School of Business, writes, “I’m as big an advocate of pricing GHGs as other economists working on climate change. Adding the cost of negative externalities to the price users pay is a very powerful was to bend consumption in a more responsible direction.”
But carbon pricing can’t get the job done alone. “The idea that we can ratchet up the tax until we hit the desired emissions doesn’t recognize that most of the global emissions are now coming from relatively poor countries. Politically, they are even less likely than the developed world to accept a large carbon tax. And economically, a big tax, given current technologies, would significantly slow their climb out of poverty.”
That a carbon tax will encourage innovation, says Borenstein, is “just straightforward economics. But straightforward economics also tells us that even if emissions are priced, there is a second market failure that the price won’t address: inefficient markets for innovation. Successful innovators typically can only capture a small share of the value they create for society.”
Intellectual property laws, giving inventors a monopoly for a period of years, are “not a good approach when we need rapid diffusion of GHG-reducing technologies in poor countries. Furthermore, IP protection is complex and costly to use, and IP laws are weakly enforced or non-existent in most of the developing world.”
Another approach, used by most developed nations, is to “subsidize knowledge creation – for instance, through grants to researchers and innovative entrepreneurs, freely accessible libraries and data, and R&D tax breaks. “Knowledge creation,” Borenstein writes, “generates huge positive externalities that are not reflected when we simply ‘get the prices right’ for good and services in the economy.”
“Economists widely agree that this imperfection in the knowledge market leads to sub-optimal levels of innovation, but at this point in a climate change conversation, someone will ask wouldn’t markets at least have as much incentive to climate change as other challenges, such as curing diseases or creating more realistic video games?”
That won’t work “if other nations – particularly the low-income, developing countries where GHG emissions are growing fastest – don’t get the prices right.”
What to do? Here’s where some economists will start to feel their skin crawl: subsidies. “Subsidizing innovation effectively is not easy,” says Borenstein. “It means some degree of administratively picking winners among the many creative, or just crazy, ideas that are out there for eliminating GHG emissions. The process will be imperfect, mistakes will be made, and corruption can easily work its way in. Those are good reasons to do it carefully and monitor the programs closely. But they’re not good reasons to conclude that pricing emissions alone has the Good Economics Seal of Approval.”
— Kennedy Maize