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The Costs of Carbon Legislation

Tags The EnvironmentHistory of the Austrian School of EconomicsOther Schools of ThoughtPolitical TheoryPrivate Property

06/01/2009Robert P. Murphy
[An MP3 audio version of this article, read by Dr. Floy Lilley, is available as a free download.]

In two of his recent op-eds (here and here) for the New York Times, Nobel laureate Paul Krugman has challenged critics of the government's intentions to regulate carbon dioxide emissions, and he has even specifically endorsed the pending Waxman-Markey bill which includes a "cap-and-trade" program.Download PDF According to Krugman, the costs of such legislation are no big deal, and in exchange we avert catastrophe. So why all the criticism?

In the present article, I want to show the fragility of Krugman's position. For one thing, the true economic harms of "global-warming" legislation could be much higher than his own cited figures. For another, the benefits of such measures — in terms of averted climate-change damage — are quite negligible, unless other countries follow suit.

Finally, Krugman's strategic position on carbon legislation — "this bill is better than nothing" — is inconsistent with his own views of Obama's "inadequate" stimulus bill and Geithner's plans for revamping the banking sector. In short, if the world really is on the verge of catastrophe — which many alarmists tell us it is, and that's why we need to take immediate action — then why are so many of these same activists supporting legislation that their own models show will do virtually nothing?

The Economic Damages of Reducing Carbon Emissions

When politicians propose to penalize carbon dioxide (or more broadly, greenhouse-gas) emissions, the natural question most people ask is, "How much will it cost?" Because we live in a world of scarcity, if the government takes away options from producers (namely, the ability to emit as much CO2 as they want) then the output of goods and services will necessarily be lower than it otherwise would be.

So, if we are going to enjoy a smaller volume of output, in exchange for a lower probability of damages from climate change (according to certain models), then we need to have some idea of the quantitative tradeoffs involved. This is a purely utilitarian approach, to be sure: some people think carbon emissions need to be limited out of moral responsibility (either to the planet or to other humans living on the coasts of poorer countries), while others might think that factory owners have a moral right to emit as much CO2 as they want.

These are important questions, and most Austrian economists would want to answer the issue of ultimate property rights before even considering "costs and benefits." Yet I want to keep this article brief, and I have important points to make even taking Krugman's arguments on his own terms. So let's accept the basic framework of the debate as it will unfold in the media and much of the blogosphere over the coming months.

Here is Krugman talking about the economic damages of carbon legislation, or what is loosely classified as "the costs" of such measures:

A cap-and-trade system would raise the price of anything that, directly or indirectly, leads to the burning of fossil fuels. Electricity, in particular, would become more expensive, since so much generation takes place in coal-fired plants. … Consumers would end up poorer than they would have been without a climate-change policy.

But how much poorer? Not much, say careful researchers, like those at the Environmental Protection Agency or the Emissions Prediction and Policy Analysis Group at the Massachusetts Institute of Technology. Even with stringent limits, says the M.I.T. group, Americans would consume only 2 percent less in 2050 than they would have in the absence of emission limits.

Now hang on a second. What Krugman is doing here is exactly analogous to a "skeptic" or "denier" of manmade global warming pointing to a paper by Richard Lindzen or Roy Spencer, both of whom are very "careful researchers" and don't think greenhouse gas (GHG) emissions are nearly the problem that many other people in their field believe. Now when the "denier" on a blog cites the estimate of temperature sensitivity to GHG emissions from a Lindzen or Spencer, what does the average opponent do? Why, he claims that these guys are outliers, and that "the consensus" as represented by the Intergovernmental Panel on Climate Change (IPCC) shows what the real estimates are.

So in the same spirit, I can challenge Krugman's experts. The latest IPCC report (AR4Download PDF) says that aggressive action against GHG emissions — and the schedule of cutbacks contained in Waxman-Markey is very aggressive in the range of models studied by the IPCC — could cost up to 5.5 percent of global GDP by the year 2050, relative to the baseline trajectory of GDP if no carbon caps are imposed. Don't take my word — or the Heritage Foundation's — for it, either; big-time activist Joe Romm quotes their figure here.

Now the IPCC's (high-end) estimate is 175 percent above Krugman's reported figure. I have not parsed the particular studies Krugman relies on, and it's possible that their much lower cost estimates are the result of studying much less aggressive legislation than what the IPCC's representative models examined. But my point is, if the alarmists want to beat people over the head with "IPCC consensus," then let's at least be consistent. According to the IPCC, if the whole world followed the aggressive emissions schedule contained in Waxman-Markey, then the economic opportunity costs could be 5.5 percent of GDP by the year 2050.

Before moving on, let's make sure we understand what the economic jargon is saying: If your household would normally take in $100,000, then aggressive carbon legislation could raise the prices of goods and services such that you lose up to $5,500 in purchasing power, by the year 2050. (Because the total cap on emissions shrinks over time, the annual impact on consumption gets worse and worse as time rolls on. In the early years, the hit to income would be lower than $5,500 annually.)

Estimate Relies on Textbook Enforcement and Efficient Use of Revenues

It gets worse. These MIT and IPCC estimates assume an optimal enforcement of the climate policies, for all major governments and for a century straight. If you move beyond the "Summary for Policymakers" and turn to the actual meat of the IPCC report, you will find the following major caveat:

It is important to note that for the following reported cost estimates, the vast majority of the models assume transparent markets, no transaction costs, and thus perfect implementation of policy measures throughout the 21st century, leading to the universal adoption of cost-effective mitigations measures, such as carbon taxes or universal cap and trade programmes…. Relaxation of these modelling assumptions, alone or in combination (e.g. mitigation-only in Annex I countries, no emissions trading, or CO2-only mitigation), will lead to an appreciable increase in all cost categories. (Working Group III, p. 204, emphasis added)

It gets even worse. Most, and perhaps all, of these studies assume that the government uses the proceeds of the cap and trade (or carbon tax) in an efficient manner. In other words, the calculated "cost" of such measures refers to the economic concept of a "deadweight loss." For example, if the government collects $350 billion from auctioning off carbon permits, that revenue is not part of the "cost" of the program. Rather, what these typical studies call the "cost" — which can rise up to 5.5 percent of GDP by 2050, remember — refers to the forfeited goods and services due to the constraints on production possibilities, since the economy must emit a smaller amount of carbon dioxide.

Yet the government in practice will certainly spend more money than it otherwise would, if it has hundreds of billions in auction revenues at its disposal every year. The implementation of cap and trade will not simply reduce the deficit, or be used to reduce taxes dollar-for-dollar on labor (as many economists propose). Thus the costs in practice will be far higher; the government will end up squandering far more than 5.5 percent of total output in the year 2050, even if we took all of the other modeling assumptions at face value.

Benefits of Waxman-Markey Negligible

We have seen that the economic harms of legislation such as Waxman-Markey could be quite high. So what will it do to avert climate damage? According to this estimate by climate scientist Chip Knappenberger, Waxman-Markey would lead to a planet that warmed 9/100ths of a degree Fahrenheit less than would otherwise be the case, by the year 2050. In case you think Knappenberger's figure is bogus, look at the reaction by NASA scientists and others at a leading pro-intervention blog. They don't dispute the figure; they instead say that the United States must show leadership by capping its own emissions.

Ah, but this leads to an obvious follow-up question: has any researcher who is for Waxman-Markey done a simulation to show this process, by which other countries like China and India follow suit (after how much delay?) because of US leadership? Tyler Cowen — who is quite worried about climate change — has now twice asked on his own popular blog for advocates to give him such a model. He is aware of the arguments for the United States to take unilateral action (even though Knappenberger shows how little such action will do in and of itself), and Cowen simply wants these arguments to be formalized.

As of this writing, Cowen heard crickets chirping on this question. So far as I know, not a single person has even done a blog post giving a decent model showing the strategic interactions of various world powers, and what the likely net benefits are — including savings to the environment — from the Waxman-Markey bill.

Coming back to Krugman, this is all very interesting. For when the issue was the stimulus bill or bank "reform," Krugman argued that an inadequate measure could be worse than nothing, because it would squander President Obama's political capital. (See the last paragraph in this blog post for a good example.) So if the United States ends up having a huge legislation showdown, with pundits on both sides going nuts and accusing the other of all sorts of devilry, and the result is legislation that does very little to change global temperatures, might that be worse than nothing — especially if we have a very short time frame to act, as some leading alarmists tell us?


The global-warming debate has now been completely politicized, and partisans on both sides have often injected hidden values masquerading as scientific facts. I understand that even some libertarians believe the underlying science proves that "business as usual" will mean a huge form of aggression on the property rights of some of the world's most vulnerable people.

Even so, I think that the real threat to humanity comes from governments growing ever more powerful in the name of fighting climate change. Paul Krugman's recent attempts to justify these bold new measures ignore the IPCC itself, and even its "consensus" figures are based on wishful assumptions about the behavior of governments in the real world.

Whether you are a "denier" or whether you think carbon dioxide emissions need to be sharply reduced very quickly, you should be extremely skeptical of the process now unfolding in Washington. This isn't about saving the planet; it's about money and power.


Contact Robert P. Murphy

Robert P. Murphy is a Senior Fellow with the Mises Institute. He is the author of numerous books: Contra Krugman: Smashing the Errors of America's Most Famous Keynesian; Chaos Theory; Lessons for the Young Economist; Choice: Cooperation, Enterprise, and Human Action; The Politically Incorrect Guide to Capitalism; Understanding Bitcoin (with Silas Barta), among others. He is also host of The Bob Murphy Show.