Economics of Climate Change

I recently read a fantastic article in the NYTimes discussing the economics of climate change. The author, Paul Krugman, compares and contrasts in remarkable simplicity, the concepts of Cap and Trade and an Emissions tax, two options currently being floated as methods to force corporations into being responsible for their environmental impact. Before reading this article, I had a difficult time wrapping my arms around either of these alternatives.


One of the biggest issues facing the future of our environment is that the environmental impact of corporations is simply not accounted for (read the excerpt below).The author admits that measuring environmental usage is more of an art than a science, but through either a Cap and Trade and an Emissions tax, we will incent (force) corporations into improving their environmental record or paying for it. Naysayers believe this will devastate the US Economy but Krugman believes that even overestimating the costs will have a very small impact (leaving our economy between 1.1% and 3.4% smaller in 2050). Hopefully in the near future we will have political leaders willing to make these difficult choices in the face of animate opposition from corporations and conservatives alike (the same conservatives who championed market-based solutions under Reagan).

The full article can be read here.  An excerpt is below:

Environmental Econ 101

If there’s a single central insight in economics, it’s this: There are mutual gains from transactions between consenting adults. If the going price of widgets is $10 and I buy a widget, it must be because that widget is worth more than $10 to me. If you sell a widget at that price, it must be because it costs you less than $10 to make it. So buying and selling in the widget market works to the benefit of both buyers and sellers. More than that, some careful analysis shows that if there is effective competition in the widget market, so that the price ends up matching the number of widgets people want to buy to the number of widgets other people want to sell, the outcome is to maximize the total gains to producers and consumers. Free markets are “efficient” — which, in economics-speak as opposed to plain English, means that nobody can be made better off without making someone else worse off.

But what if a deal between consenting adults imposes costs on people who are not part of the exchange? What if you manufacture a widget and I buy it, to our mutual benefit, but the process of producing that widget involves dumping toxic sludge into other people’s drinking water? When there are “negative externalities” — costs that economic actors impose on others without paying a price for their actions — any presumption that the market economy, left to its own devices, will do the right thing goes out the window. So what should we do? Environmental economics is all about answering that question.

5 thoughts on “Economics of Climate Change

  1. I’m glad to see you writing about this! Raising awareness of the environmental crisis we are facing is imperative right now. And we have to at least try to see the influencing factors. Thanks for posting this.

  2. That was a fantastic article. The divide on the issue stems partly from the long-held and constantly perpetuated belief that corporate social responsibility necessarily derives from the amorphous ideal of altruism — not that altruism is “bad” or limited to a more “liberal” leaning stance, just that it can be hard pill to swallow when corporate models are involved. (Wasn’t it Milton who said, a long time ago, that the only social responsibility of businesses was to increase profits?) This article stated, in clear and simple terms, that self-interest and economic and global survival, require greener strides.

    I’ll be the first to admit that, even when studying environmental law, I couldn’t really wrap my head around the economics at play, which are a huge piece of the puzzle. Shameful.

  3. Krugman leaves out the regulatory framework that is in place to enforce a cost on “negative externalities”. How is it that you can pay your way out of “negative externalities” by planting trees in your own back yard? If I take note on an open exchange that a credit is currently at a 30% discount to the profit I can make by whilst exploiting a “negative externality”, how is this going to stop this from occurring? The credit cost is going to be pushed to my customer anyhow.

    In an earlier blog post, Keith made the decision to sell out of his China holdings after learning of the Tibetan’s plight.

    Did selling out of the funds help his Tibetan acquaintances? Do the new funds really have absolutely no connection to anything you find socially unacceptable?

    Instead of a passive response of selling, could he not have continued to profit from these pieces of paper and redirected the profits towards a group that could help change the plight of these Tibetans? Or used the income to go fight for their freedom?

    Human’s make decisions based on our own self interest. I just hope that before I die, I see self interested anchored in ethos and morality instead of self-importance.

    A Business just like a Union or government is a legal entity with a mission. The key is to have the leaders in all legal entities make decisions based in self interest anchored by ethos and morality.

    • Hi Tom,
      Thanks for the comment – I think this paragraph sums it up:

      “Human’s make decisions based on our own self interest. I just hope that before I die, I see self interested anchored in ethos and morality instead of self-importance. ”

      Have you seen the movie zeitgeist and its addendum? I highly recommend you do. It discusses how our entire monetary system, based on profits, creates an environment of scarcity, and hence the exploitation and divisions between people all trying to get their piece of the pie that is disappearing. They propose an alternative world based on abundance, or a resource economy, relying on the earths resources and technology – to the point where most of us could even stop working. Its hard to get your head around at first, because we’ve been programmed for so long to think in terms of profit and self-preservation.

      Anyway, good food for thought:

  4. I will have to watch the movie. I am always open to new ideas. I have always thought that we should have a monetary system where for each achievement you get a credit or certificate. We can call then certificates of achievement. You accumulate without distribution through your first 16-18 years, then get to share or distribute them for the rest of your life. These certificates could be exchanged for good or services for anyone. Each person would achieve something for someone else in exchange for a certificate. However the big hole in my system is that someone would have to dole them out initially and how would you distribute them for large projects for the common good.

    I’ve always thought communal living would be interesting but still the pigeons fight for the crumbs.

    I will check out the movies.

    I envy your search for your inner spirit. It is this discovery that leads people to a firm foundation of ethos and morality. This discovery of a higher purpose and holding oneself accountable in preparation for what will come one day. Too many of us have strayed from preparation constantly striving to feel good in the moment.

    Great stuff here!! Keep writing.

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