Economists have long argued that the best way to fight climate change is to levy a price on carbon emissions, either via a global specific carbon tax or a competitive worldwide market for emission permits. This price should equal to the present value of current and future global warming damages from emitting one ton of carbon today, and be the same throughout the world. Despite decades of climate negotiations, very little success has been achieved in implementing such first-best climate policies.
There are various roots of this disappointing cleavage between theory and practice. First, global warming is the only truly global externality. Policy makers face huge free-riding problems with countries choosing to protect jobs in fossil-based industries at hom,e in favour of protecting the planet. If only some countries price carbon, this will depress the world price of coal, oil and gas, and thus some of the cuts in emissions are offset by higher emissions elsewhere. This phenomenon is called carbon leakage and can be overcome by border tax adjustments or trade tariffs on non-participating countries. Second, politicians tend to procrastinate so their successors have to deal with the unpopular task of fighting climate change. Politicians also prefer the “carrot” to the “stick” and give huge renewable energy subsidies and green R&D subsidies, instead of pricing carbon. Although such policies lock up more fossil fuel reserves and carbon in the crust of the earth, they waste public money and induce rent seeking. Furthermore, postponing climate policy and subsidising renewable energy induces fossil fuel producers to exhaust reserves more quickly, and to accelerate emissions and global warming. These Green Paradox effects thus add to carbon leakage. As far as financial markets are concerned, there is a risk of stranded financial assets associated with irreversible investments, if policy makers suddenly take credible and effective action to fight global warming. Third, second-best and political economy issues facing climate policy have received almost no attention. Fourth, global warming is not just a gradual process but also manifests itself by irreversible tipping points.
In 2011, Rick van der Ploeg and Professor Cees Withagen of the Vrije Universiteit Amsterdam were awarded a five-year ERC Advanced Grant to develop a better understanding of these obstacles and the challenges facing climate policy in practice. Early work analysed the factors driving the Green Paradox, and also made a case for a moratorium on coal. The project has also identified an intimate connection between spatial leakage and the Green Paradox. Postponing carbon pricing and relying on renewable subsidies leads to an acceleration of emissions and global warming in the short run; in the long run less fossil fuel is taken out and thus cumulative emissions and peak global warming fall. Whether global welfare increases as a result depends on whether the price elasticity of fossil fuel demand is small, relative to that of fossil fuel discoveries and supply.
As shown in work with Armon Rezai, the inability to commit to future climate policies can pose severe time consistency issues. This has also led to the development of simple rules for the price of carbon, which are more credible and easier to understand and communicate. Research with Aart de Zeeuw shows how a well-designed climate policy that prices carbon can curb the risk of tipping points, such as reversal of the Gulf Stream or melting of the big Ice Sheets. Precautionary saving, in advance of the climate catastrophe, may be needed to be better prepared for the tip and the catastrophic drops in aggregate output and consumption when it strikes.
RELATED RESEARCH PUBLICATIONS
- Ploeg, F. van der and A.J. de Zeeuw (2017). Climate tipping and economic growth: precautionary saving and the social cost of carbon, Journal of the European Economic Association, forthcoming.
- Rezai, A. and F. van der Ploeg (2017). Second-best renewable subsidies to de-carbonize the economy: commitment and the Green Paradox, Environmental and Resource Economics, 66, 3, 409-434.
- Rezai, A. and F. van der Ploeg (2016). Intergenerational inequality aversion, growth and the role of damages: Occam’s rule for the global carbon tax, Journal of the Association of Environmental and Resource Economists, 3, 2, 499-522.
- Ploeg, F. van der (2016). Second-best carbon taxation in the global economy: the Green Paradox and carbon leakage revisited, Journal of Environmental Economics and Management, 78, 85-105
- Ploeg, F. van der and C. Withagen (2012). Too much coal, too little oil, Journal of Public Economics, 96, 62-77.
- Ploeg, F. van der and C. Withagen (2012). Is there really a Green Paradox?, Journal of Environmental Economics and Management, 64, 3, 342-363.