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Krugman's Environmentalist Economics

Yesterday, Paul Krugman blogged about the economics of environmentalism and alternative energy, trying to twist the argument in his favor by claiming that there simply are not the incentives in place to attract investors into alternative energy industries. Writes Krugman, “If you seriously believe in markets, you should believe that given the right incentives — namely, putting a price on emissions, through either a tax or a tradable permit scheme — the economy will find lots of ways to emit less.” Believe it or not, Krugman is trying to address free market economists, or — as he puts it — economists who believe in the “magic of the market”. He suggests that those who are really pro-market should support the legislation of taxes and permits to regulate emissions.

Krugman’s case, though, is either misleading or incomplete, and fails to actually address the reasons why free market economists oppose tax and permit schemes. Namely, by putting a limit on emissions you also limit production, because the level of emissions is related to the degree of productivity. Of course, the ratio between emissions and production can be changed in favor of production with the introduction of new technologies, but new technologies themselves can only be invented and invested into after a sufficient degree of capital accumulation has taken place. By limiting productivity you are, in effect, limiting the ability to invest. In this sense, emission caps — in whatever form they are legislated in — are counterproductive.

Krugman rightly points to historical advancements that have made machinery more efficient, such as steam engines. Krugman suggests that emissions regulations will incentivize greater advancement. But, not only does limiting a firm’s productivity make it more difficult to introduce new technologies to increase efficiency, but the incentive was already there. Emissions represent waste, and there is always an incentive to reduce waste. Waste is a cost; the cost is foregone production (waste is capital goods that did not go into the produced product, similar to how heat is the “waste” product of energy conversion). That is why more efficient engines have been produced, and why factory waste has decreased over the past two hundred years.

Finally, even if you could “incentivize” (read ‘force’) companies to invest in alternative energies, the fact is that you are “incentivizing” the company to invest along a line that they originally deemed less worthy. In other words, they are forced to invest in lines deemed second best (or worse) to the investment they would have completed otherwise. This represents economic waste, or a cost, in the form of opportunity cost (the difference between the value of the original investment and the value of the whatever-best investment [X1-Xn]).

I do not intend on commenting on the legitimacy of any of the anthropogenic global warming theses. I am not a scientist, nor have I read enough to even remotely qualify me as someone with an educated opinion. But, even conceding the argument that anthropogenic global warming is real, Krugman’s argument is not persuasive. I think the incentive to reduce waste already exists, and I think that historically we have seen this incentive put to use. We should not forget about the incentives which could be put into place if there was a private legal system that evolved around the protection of property; that is, if the market process tended towards a greater internalization of the costs of pollution.

George Reisman, in Capitalism, discusses this a bit, pointing to how much cleaner our air, streets, and water systems are compared to two hundred or one hundred years ago, largely thanks to technological advances. I think people like Paul Krugman simply refuse to see the market process as it really is. They start with assumptions that clearly favor their positions, even if they are not grounded in reality, and go from there.

This is not my biggest problem with Krugman’s argument, though. I think there is a serious lapse in economic and theoretical honesty in his writing. Even if Krugman is unwilling to budge regarding incentives, he should admit that his “solution” would come with a production cost. He should come out and say that his case basically amounts to utilitarianism, where he thinks a loss in production is worth the environmental effects his policy is expected to have (for society as a whole). Instead, he tries to catch free market economists in an “aha!” moment by leaving out the majority of the details — details that do not favor his reasoning.

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