Man-made global warming occurs as a result of burning fossil fuels, which releases carbon dioxide into the atmosphere. It's a negative externality—a spillover from an economic transaction that harms parties not directly involved in the transaction. In this case, the carbon dioxide released into the atmosphere is thought to be boosting temperatures, raising sea levels, and having other effects on the climate that people must adapt to (by using more air conditioning, switching crops, and so forth). Because of these spillover effects, the argument goes, the price of fossil fuels does not reflect the full cost of consuming them.
Ideally, once the full costs of man-made global warming are calculated, consumers, businesses, governments, and international agencies can adopt policies that take those burdens into account. The two policy options most widely discussed for setting a price on carbon dioxide are carbon taxes and cap-and-trade markets. Carbon taxes impose a charge on fossil fuels that is supposed to represent the negative externality associated with the emissions they produce, thereby nudging markets toward cleaner energy sources. Under a cap-and-trade scheme, the government sets a limit on emissions and divides the total among businesses by issuing permits. Enterprises that can cheaply abate their emissions will have some permits left over, which they can sell to other emitters that find cutting back too expensive. In this way, a market in pollution permits is supposed to find the cheapest way to cut emissions.
The goal of both approaches is to make polluters pay for the costs they impose on others. But they work only if those costs can be accurately assessed. In the real world things are never so simple. Estimates of the potential damage caused by global warming range widely, depending on predictions about how the climate will react to extra carbon dioxide, future economic growth, and, most crucially, the discount rate.
The discount rate reflects the time value of money, the fact that most people prefer a dollar today to a dollar a year from now. If someone is willing to forgo a dollar today in exchange for $1.10 in a year, his annual discount rate is 10 percent. To calculate how much we should spend to avoid damage caused by climate change, we need to know how much the dollars saved in 2100 are worth in terms of dollars forgone today. Experts have a wide range of opinions on that question.
Projections also must weigh the damage from man-made global warming against the cost of avoiding it. According to the Yale economist William Nordhaus, the optimum path toward cooling the climate using a carbon tax would cost $2.2 trillion and reduce global damage from climate change by $5.2 trillion during the next century. His calculation is based on a globally harmonized carbon tax that rises in constant dollars from about $35 per ton in 2010 to $90 per ton in 2050, eventually reaching $200 per ton in 2100.
In his recent comprehensive review of the literature on the economic impact of future climate change for the Copenhagen Consensus Center, the Dutch economist Richard Tol calculated that the optimal policy would be the equivalent of a 50-cent-per-ton tax on carbon dioxide rising at 5 percent a year for the next 90 years. This policy would yield $3 in benefits for every $2 spent. "Available estimates suggest that the welfare loss induced by climate change in the year 2100 is in the same order as losing a few percent of income," notes Tol. "That is, a century worth of climate change is about as bad as losing one or two years of economic growth."
There are a few studies that suggest that benefits of early, steep reductions in carbon emissions will outweigh the costs. Recent reports from the Pew Charitable Trusts and the Natural Resources Defense Council project that, as a result of global warming, U.S. gross domestic product in 2100 will be between 0.6 percent and 3.6 percent lower than it would otherwise have been, thanks to stronger hurricanes, rising sea levels, droughts, and the like. Assuming the $14 trillion U.S. economy grows at 2.5 percent per year, GDP in 2100 would be $130 trillion. If climate change pushes GDP 3.6 percent below what it would otherwise have been, that means GDP in 2100 would be about $125 trillion, or $5 trillion lower. That's not nothing, but the loss would be more than double that ($12 trillion) if U.S. annual economic growth were depressed from 2.5 percent to 2.4 percent a year between now and 2100 as a result of excessively aggressive climate change mitigation policies.
Econometric models tell us that implementing smart policies could avoid some damage from climate change. But according to these calculations, the benefits outweigh the costs only if the optimal policies are adopted. Will governments and international agencies be able to implement and sustain smart policies during the next century?
The tribulations of the European Union's cap-and-trade scheme, where the carbon market collapsed because most countries initially issued more emissions permits than there were overall emissions, is not a promising precedent; neither is the jockeying over the 1,468-page Waxman-Markey climate change bill in the U.S. On the international level, rapidly developing countries such as China, India, and Brazil are refusing to accept limits on their greenhouse gas emissions.
Many econometric models project climate change will have relatively minor effects on developed countries while significantly harming poor countries. One proposed policy solution is to have rich countries, which emit a disproportionate share of greenhouse gases, compensate poor countries. While this idea might seem appealing, one must consider the sorry 50-year record of wealth transfers in the form of foreign development aid. As the economist William Easterly has shown, most of the $2.3 trillion in aid that rich countries have poured into developing countries during the last half-century has been wasted. Is there any reason to think that trillions in climate change aid would be more effectively managed?
The transaction costs associated with addressing man-made global warming may turn out to be prohibitively high. In other words, the benefits achieved from trying to mitigate global warming will be swamped by the costs of distributing the corporate welfare used to buy the political acquiescence of various industries. You might hope to implement good public policy to deal with a problem, but if good public policy is impossible, policy nihilism is the more rational response.