1.0 Introduction

One of the authors of this book recently had some surprise visitors to his environmental and natural resource economics class. It was alumni week at the college, and four members of the class of 1950, back for their 60th reunion, joined our discussion. We were talking about sustainability, and suddenly the day’s lecture became very real. How has life really changed since these visitors left college in 1950? Have six decades of intervening economic growth—with per capita gross domestic product (GDP) more than tripling—made life better? Or have the costs of growth made things worse? Is economic growth sustainable? And in the coming decades, will your generation’s quality of life rise or fall?

So imagine now: You are that older woman or man, heading to the classroom this week for your 60th class reunion. You are 80-something, and for you, it will be sometime in the 2070s. As you listen to the young professor at the head of the class talking about the latest theories, you sit back and reflect on the changes that you have witnessed in your lifetime. Maybe your story will go something like this:

Over the 21st century, you lived through both deep recessions and economic booms, through wars and political upheavals. You experienced staggering technological breakthroughs, unprecedented droughts, sea-level rise that forced millions from their homes, large-scale extinctions, and the outbreak of new diseases. Against this background, you and your classmates from around the world maintained a relentless focus: redesigning every city on the earth, reengineering production processes, reimagining the global food system, and reinventing transportation.

World population increased from 8 to, eventually, 10 billion people. And through a heroic effort, ramping up in the 2020s, your generation managed to completely phaseout fossil fuels, rewiring the entire planet with a new generation of renewable energy technologies and stabilizing the global climate.

At the end of the day, you shepherded both the human race and the remaining species on the planet through a critical bottleneck in human history, in which rising populations, aspiring to ever-higher levels of consumption, ran up against critical global resource shortages. Above all, you managed, by 2050, to roll back emissions of global warming pollutants by 80 percent and stabilize the climate. In doing all this, you created tens of millions of jobs, helped lift billions of people out of poverty, and built a global economy that is truly sustainable.

Will that be your story?

We hope it will. And if so, you have a lot of work to do! Yours will be the “greatest generation” because you must guide the earth through this extraordinary half century. Your decisions will have profound consequences not only for you and your children but indeed for a thousand human generations to follow.

This book introduces you to economic concepts and tools that you will need to make the journey. We begin by framing economics in terms of four basic questions as they apply to the defining environmental—indeed, civilizational—challenge of your lifetime: climate change.

1.1 Four Questions

Did you drive to school today? Or to work? Every mile you drove, you pumped around a pound of carbon dioxide (${\text{CO}}_2$) into the air. This is a part of your small daily share of the more than 25 billion pounds people around the world contribute annually from the burning of carbon fuels such as coal, oil, natural gas, and wood. Carbon dioxide is a greenhouse gas—a compound that traps reflected heat from the earth’s surface and contributes to global warming. Other greenhouse gases include nitrous oxide from natural and human-made fertilizers; methane gas emitted from oil and gas production and transport as well as from rice production and the digestive processes of cows and sheep; and chlorofluorocarbons (CFCs), once widely used for air conditioning, refrigeration, and other industrial applications.¹

As a result of industrialization and the ensuing rapid increase in greenhouse gases in our atmosphere, the vast majority of climate scientists agree that the earth’s surface temperature will rise over the next few decades. The extent of warming is uncertain: low-end estimates suggest an increase in the earth’s average surface temperature over preindustrial levels of 3 degrees F by the year 2100. The official high-end prediction from the UN’s International Panel on Climate Change is 11 degrees over this time period. To put that number in perspective, during the last ice age, the earth’s average surface temperature was only 9 degrees F colder than it is today.

The potential consequences of this warming range from manageable to catastrophic. The first major impact will be on patterns of temperature, flooding, and drought, affecting agricultural output. As the planet heats up, it “forces” the hydrologic cycle adding more moisture to the air, leading to both more extreme precipitation and flooding, along with increased temperatures, increased drought, and changed patterns of drought. More northerly regions may actually experience an increase in precipitation and yields, but the current grain belts of the United States, Australia, and central Europe will become drier and agricultural output in these regions will probably fall. The net global effect through the mid-century is expected to be, on balance, negative. It will be particularly harsh in many developing countries, which lack resources for irrigation and other adaptive measures. Tens of millions of people are likely to be at risk of hunger as a result of climate change.

Second, natural ecosystems will also suffer from climate change. The U.S. Environmental Protection Agency (EPA) has estimated that, by the year 2050, the southern boundary of forest ecosystems could move northward by 600 kilometers, yet forests can migrate naturally at a much slower pace. Several major vegetation models predict large-scale forest dieback in, among other places, the southern and eastern United States and the Amazon Basin. Human and animal diseases and agricultural pests will thrive in a warmer climate.

Major impacts in the oceans will occur not only because of warming waters that, for example, directly kill coral reefs but also because the oceans are absorbing large quantities of ${\text{CO}}_2$ released by fossil fuel combustion. This in turn is leading to ocean acidification: the pH of the ocean has dropped markedly in the last century. As the ocean continues to acidify, life at the base of the ocean food chain could begin to die off. On both land and sea, massive disruption of ecosystems and widespread extinctions, affecting perhaps 30 percent or more of the life on the planet, are thus likely.

The third concern is the possibility of a sea-level rise as ice caps in Greenland and Antarctica begin to melt, and the warming ocean expands. An increase in sea level of 3 feet—well within the realm of possibility within your lifetime—would flood many parts of Florida, Louisiana, Boston, and New York City as well as much of low-lying countries such as Bangladesh and the Netherlands (unless they were protected by dikes). As many as 1 billion people live in areas that might be directly affected.

The globe is very likely locked into a further warming of at least 3 degrees F over the next 100 years. This warming will have far-reaching human and ecosystem effects, but if contained would be a manageable event. Increased warming, however, not only would have a greater impact but also could result in truly catastrophic outcomes. One of these would be the collapse and melting of the Greenland and West Antarctic Ice Sheets events that would, over the course of several hundred years, raise sea levels by 40 feet or more and inundate many of the world’s major cities. Some scientists believe that a warming of 4 degrees F or more would significantly raise the probability of this event. Dr. James Hansen, NASA’s chief climate scientist, stated in early 2006:

How far can it go? The last time the world was three degrees [C] warmer than today—which is what we expect later this century—sea levels were 25m [75 feet!] higher. So that is what we can look forward to if we don’t act soon…. I think sea-level rise is going to be the big issue soon, more even than warming itself…. How long have we got? We have to stabilize emissions of carbon dioxide within a decade, or temperatures will warm by more than one degree [C]. That will be warmer than it has been for half a million years, and many things could become unstoppable…. We don’t have much time left.²

A catastrophic collapse of the ice sheets is far from certain, but as Dr. Hansen suggests, decisions to be made in the next decade about reducing greenhouse gas emissions could have dramatic consequences lasting for tens of thousands of years.

Climate change is an environmental reality that presents stark choices. On the one hand, substantial, short-term reductions in the human contribution to the greenhouse effect would require dramatic changes in energy use. In particular, our casual reliance on fossil fuels for transportation, heat, and power would have to be dramatically scaled back and new, clean-energy sources developed. On the other hand, the consequences of inaction are potentially disastrous. By continuing to pollute the atmosphere, we may be condemning the next generation to even greater hardship.

This book focuses on the economic issues at stake in cases such as global warming, where human actions substantially alter the natural environment. In the process, we examine the following four questions.

1. How much pollution is too much? Many people are tempted to answer simply as follows: any amount of pollution is too much. However, a little reflection reveals that zero pollution is an unachievable and, in fact, undesirable goal. Pollution is a by-product of living; for example, each time you drive in a car, you emit a small amount of CO₂ to the air, thus exacerbating the greenhouse effect. The question really is, “At what level are the benefits of pollution (cheap transportation in the case we started with) outweighed by its costs?”

   Different people will answer this question in different ways, depending on their value systems: “costs” of pollution may be defined narrowly, as strictly economic, or they may be broadened to include ethical considerations such as fairness and the protection of rights. Costs may also be difficult to measure. Nevertheless, it is clear that a rough weighing of benefits and costs is a critical first step for deciding “how much is too much.”

2. Is government up to the job? After resolving the first question, we must then rely on government to adopt laws and regulations to control pollution. But, is our government able and willing to tackle the tough job of managing the environment? The costs and mistakes associated with bureaucratic decision making, as well as the likelihood of political influence in the process, will clearly have an impact on government’s ability to respond effectively to this challenge.

   The first Earth Day was April 22, 1970. Also that year, the U.S. Congress passed the first major pollution control initiative, the National Environmental Policy Act, which, among other things, created the EPA. Looking back over our 40-plus years of experience in regulating the environment, we have a record of both successes and failures to evaluate. Such an exploration can help us design policies to increase the effectiveness of the governmental response.

3. How can we do better? Suppose that as a society we decide on a particular target: for example, reduce CO₂ emissions by 80 percent by 2050. Given the limitations that government might face, identified in the answer to the second question, how can we best achieve that goal? A long list of policies might be used: regulations, taxes, permit systems, technology subsidies (or their removal), research incentives, infrastructure investment, right-to-know laws, product labeling, legal liability, fines, and jail terms. Which policies will most successfully induce firms and consumers to meet the target?
4. Can we resolve global issues? Finally, regulating pollution within a single nation is a difficult task. Yet problems such as global warming transcend national boundaries. Brazilians say that they will stop cutting down and burning their rain forests to create crop and rangeland as soon as we stop driving gas-guzzling cars. (Although the United States has only 4 percent of the world’s population, we account for close to 17 percent of the greenhouse gases.) How can this kind of international coordination be achieved? Are economic development and environmental quality necessarily in conflict? And to what extent can the explosion in population growth and per capita resource use, which ultimately drive environmental problems, be managed?

Let us return to our discussion of climate change and see what type of answers we might develop to these four questions. Global warming is a consequence of what is known as the greenhouse effect. Solar energy enters the earth’s biosphere in the form of visible and ultraviolet light from the sun. The first law of thermodynamics—energy can be neither created nor destroyed—requires that this energy go somewhere, and much of it is radiated back into the biosphere as infrared radiation or heat. ${\text{CO}}_2$ and other greenhouse gases surrounding the earth let in the visible and ultraviolet light from the sun. Yet, like a blanket, these gases trap the reflected infrared radiation (heat) close to the earth’s surface.

Until the present time, the naturally occurring greenhouse effect has been primarily beneficial. Without the planet’s blanket of water vapor, CO₂, and other gases, the average temperature on the earth would be about 91 degrees F colder—well below the freezing point. The problem we face today is the steady increase in human-made greenhouse gases, which began with the Industrial Revolution but dramatically accelerated after World War II. In less than two centuries, the thickness of the CO₂ blanket in the atmosphere has increased by more than 25 percent, rising from 280 parts per million (ppm) in 1880 to over 400 ppm today. Every year the blanket gets thicker by about 2 ppm. The question facing humanity is, how thick should we let this heat-trapping blanket grow? Should we try to hold it to 450 ppm? 550 ppm? 650 ppm? Or even roll it back to 350 ppm?

Is human-induced warming here yet? The earth’s average temperature has risen more than 1.8 degree F over the last century, and the warming has accelerated in the last few decades. The year 2016 was the hottest on record, and the last decade has been the hottest in the last several thousand years. Back in 1995, the Intergovernmental Panel on Climate Change (IPCC), an organization of some 2,500 scientists operating under the auspices of the United Nations, made it official that greenhouse effect was here. According to the IPCC, “the balance of evidence suggests that there is a discernible human influence on global climate.” Since then, the evidence supporting human-induced warming has become much stronger.³

Today, scientists are virtually unanimous in their opinion that further warming will occur, but the magnitude of the warming is difficult to predict. Nevertheless, we do have a range: recall 3–11 degrees F.

Uncertainty in predicting the degree of global warming is primarily due to the presence of positive and negative feedback effects. If it were necessary only to predict the impact of greenhouse gases on global temperature, the problem would be difficult enough. But changing temperatures will in turn affect many different parts of the earth and its surface, leading to either an acceleration of warming (positive feedback) or a deceleration (negative feedback).

Two examples of negative feedbacks include the possibility that increasing cloud cover will reduce the amount of radiation entering the earth’s atmosphere or that increasing amounts of CO₂ will lead to higher rates of plant growth and thus more trapping of CO₂. Negative feedbacks would clearly be welcome, but unfortunately, positive feedbacks appear just as likely, if not more so, to occur. For example, higher temperatures may generate widespread forest fires and forest dieback in regions such as Amazon; lead to the emission of methane and ${\text{CO}}_2$ currently trapped in frozen bogs and peat fields at high latitudes; expose heat-absorbing darker earth under ice shields; or reduce the capacity of ocean organisms to fix CO₂ in their shells. These positive feedbacks have led some researchers to believe that at some point, global warming will trigger a runaway greenhouse effect, in which the initial warming will feed on itself. Under this scenario, policymakers no longer face a continuum of temperature possibilities: a warming of somewhere between 4 degrees and 11 degrees. Instead, there are only two options: either hold warming to the low end, 4–5 degrees, or risk triggering positive feedback loops that quickly drive the planet’s temperatures up by 9–11 degrees, the equivalent of a swing of ice-age magnitude, only in the opposite direction.

In the face of this uncertainty, what action should be taken to prevent or mitigate the consequences of global warming? Following the outline described, we can begin to tackle this daunting question piece by piece.

1.2 How Much Pollution Is Too Much?

To answer this first question, let us first see where we stand on targets to reduce global warming pollution. At a UN-sponsored meeting in France in 2015, 170 countries across the world agreed to the Paris Climate Agreement, a set of voluntary commitments to cut global warming pollution. The United States committed that it would reduce emissions 30 percent below 2006 levels by 2030. China committed to capping their emissions by 2030, and to subsequent reductions. Added together, if the countries all follow through on the actions they committed to in Paris, scientists estimate that this will hold planetary warming to a total of 6 degrees F above preindustrial levels.

At the same time, world leaders also agreed to convene in 2020 with proposals for deeper global warming pollution cuts that would reduce the total warming to the official UN target of 4 degrees F or lower. Finally, back in the United States, the major Republican candidates for President in 2016 were all opposed to any action on climate change. The reasons? First, most Republican candidates questioned the scientific consensus that humans are causing climate change. And second, they all argued that serious efforts to reduce fossil fuel emissions would be much too costly. Candidate Marco Rubio, reflecting the party’s viewpoint, said that reducing fossil fuel use would have “a devastating effect on the economy.”⁴ Taking no action to reduce emissions and sticking with business-as-usual would likely lock in at least an 8 degree F warming.

So what is the “right” level of global warming pollution? Emissions leading to a 4-degree increase in global temperatures (the Paris goal), a 6-degree increase (the Paris commitments), or an 8-degree increase (the no-action outcome)?

Economists typically answer this type of question using a benefit–cost framework. How big are the benefits of reducing warming? And what would it cost? Would phasing out fossil fuels really wreck the economy? However, quantifying the benefits and costs of reducing emissions is a difficult task, primarily because uncertainties loom very large in the case of climate change. On the benefits side, analysts are required to estimate the damages that will be avoided 100 years hence by stabilizing ${\text{CO}}_2$ as it affects not only global agriculture and human health but also species extinction and biodiversity. Moreover, across the planet, some regions will gain and others will lose; impacts will be proportionately larger in poor countries and smaller in rich countries. Developing countries will be hardest hit because they tend already to be in warmer and drier parts of the planet—but more importantly, because they have lesser financial resources for adapting their agriculture or building sea walls.

Putting a monetary value on such benefits presents difficult issues, among them: How do we deal with uncertainty and the possibility of cataclysmic change? How do we value damage to future generations? Can we measure the value of intangible or “priceless” benefits such as human suffering and death averted or forests saved? How do we weigh the fact that some countries will lose more compared to others in the warming process? These are issues we explore in detail later in the book.

Nevertheless, and bearing in mind these large uncertainties, two prominent economists—Sir Nicholas Stern, former head of the World Bank, and William Nordhaus from Yale University—have recently offered very different perspectives on the net benefits of aggressively reducing global warming pollution. The two researchers start with different estimates of “business-as-usual” warming by 2100, that is, the warming that would occur in the absence of any laws or government policies requiring or subsidizing emission reductions. Stern explores a range of between 5 and 11 degrees F of warming from current levels, while Nordhaus focuses on a single warming estimate, a “best guess” of under 5 degrees F.

Stern’s projections are that, unchecked, global warming would reduce global output of goods and services from 5 to 20 percent, and the higher end is more likely. (For a reference point, the Great Depression of the 1930s led to a reduction in U.S. GDP of 25 percent.) Nordhaus is much more sanguine, arguing that by 2100, the impacts would be closer to a significant but much smaller 3 percent of world output.⁵

With such large damages, Stern’s analysis calls for rapid cuts in emissions to hold global warming to the low end: 4 degrees F. This would require global reductions of 25 percent below 1990 levels by 2050. However, since emissions from India, China, and Brazil will keep increasing for some time, this means 80 percent reduction by 2050 for the developed countries. Stern estimates that this policy would cost—in the form of reduced consumption—about 1 percent of global GDP per year by 2050, equivalent to about $540 billion (about half a trillion) in today’s dollars.

Nordhaus, by contrast, calls for much smaller cuts of about 15 percent below business-as-usual, rising to 25 percent by 2050 and 45 percent by 2100. Because emissions will increase by a large amount under business-as-usual, relative to 1990 levels, Nordhaus is actually recommending an increase in global annual emissions of around 40 percent by 2050. Under Nordhaus’s analysis, this policy of holding emissions down relative to their unregulated state would trim warming from a projected 5 degrees F increase to 4 degrees F. Nordhaus figures that the total benefits of this reduced warming will be $7 trillion, while the costs will run $2 trillion, leaving society $5 trillion better off.

These are two very different policy prescriptions: “deep cuts” in emissions versus “start slow, ramp up.” But interestingly, both researchers arrive at similar answers to the “how much is too much” question: both recommend holding further global warming to the low end of 4 degrees F! Their big differences in recommended emission cuts instead reflect disagreement on three points: (1) how much warming will be generated by business-as-usual, (2) the costs of action to slow climate change, and (3) the costs of inaction.

First, on the climate-warming side, Nordhaus sticks with a single “best guess” to back up his start-slow policy recommendation. If business-as-usual “only” leads to a 5 degrees F warming by 2100, it won’t require as much in emission cuts to get us back to 4 degrees. Stern, by contrast, is both less certain about the simple correlation between ${\text{CO}}_2$ buildup and future temperatures and much more worried about the possibility of positive feedbacks and the unleashing of a runaway greenhouse effect of the kind discussed earlier. Stern takes seriously the possibility that business-as-usual will blow quickly past 5 degrees F, and push us beyond 10 degrees F, within your lifetime. A 2009 Massachusetts Institute of Technology (MIT) study clearly supports Stern on this—it pushes the median projection of warming by 2100 under business-as-usual to a high-end, catastrophic 10 degrees F, with a one in nine chance that temperatures could rise as high as 12.5 degrees F.⁶

Second, Stern sees deep cuts in emissions as achievable at relatively low cost to the global economy: 1 percent of GDP. The Stern perspective is that energy efficiency and renewable energy technologies such as wind and solar electricity offer great promise for de-linking economic growth from fossil fuel use relatively quickly, thus achieving emission reductions cheaply. In important cases, emission reductions can even be achieved at a profit when initial investments in energy efficiency and renewable energy are offset by reduced spending on fossil fuels. Nordhaus, by contrast, does not believe in the potential of these low-cost alternatives. He reckons instead that Stern-level cuts would require, for example, more than a doubling of the cost of coal-fired electricity, cutting deeply into the growth of the global economy. (See more on this energy cost debate in Chapter 18).

Finally, Stern sees much bigger damages from global warming than does Nordhaus, even for the low end of 4 degrees F. There are three reasons for this. First, Stern includes more “nonmarket” costs of global warming—species extinctions, lost services provided by ecosystems, and negative impacts on human health. Second, Stern explicitly incorporates the fact that people in poor countries will bear the greatest costs of climate change. And finally, Stern puts more weight on the climate change costs borne by future generations than does Nordhaus. Valuing nonmarket goods, human health, and ecosystem services; weighting for equity in benefit–cost analysis; and the appropriate discounting of future benefits and costs are the issues we take up later in the book. For now, recognize that Stern and Nordhaus are the leading economic voices in a deadly serious debate: is global warming a civilizational challenge demanding immediate and deep emission reductions or is it simply another in a list of big problems, amenable to a go-slow fix?

Underlying the recommendations for only modest emission cutbacks is a belief that climate stability is important but not critical to the well-being of humanity. The argument is that people adapt to changing resource conditions. As emissions of greenhouse gases are regulated, the price of ${\text{CO}}_2$-based services will rise and new low-${\text{CO}}_2$ technologies will come on board, ensuring that greenhouse gas concentrations eventually stabilize. Moreover, the development of new agricultural techniques will ensure that adequate food supplies are maintained even in the face of a changing climate and sea walls can be built to hold back rising sea levels. In addition, agriculture in some regions will gain from a warmer, wetter ${\text{CO}}_2$-enhanced climate, and cold-related deaths will decline. Some analysts even envision the winners from climate change assisting those (mostly in poor countries) who lose out from sea-level rise and flooding. Clearly, there will be significant losers from climate change, but on balance, it is believed that the quality of life for the average person in most countries can continue to rise even in the face of “moderate” climate change.

This mid-range benefit–cost perspective maintains that a near-term policy of ${\text{CO}}_2$ cuts below correct levels is too costly. Investing resources and person-power in reducing greenhouse gas emissions will divert investment from schools or health care, lowering living standards for future generations. Benefit–cost analysis is needed to obtain the right balance of investment between climate protection and other goods and services that people value.

It is critically important to recognize that virtually all economists conducting benefit–cost analyses of climate-change policy today agree that government action is needed immediately to cut emissions of global warming pollutants. A recent survey of climate economists puts the number calling for action at 94 percent.⁷ The debate is not over whether near-term emission reductions is required but by how much. As noted, in Paris, the United States committed to medium-term reductions of 30 percent below 2006 levels by 2030, and the UN calls for a 2050 goal of much deeper 80 percent cuts. Nordhaus (but not Stern) would be okay with the go-slow 2030 target, while Stern (but not Nordhaus) would be pleased with the ambitious 2050 goal. Perhaps over the coming decade, economists will be able to settle their debate on the appropriate goal for the next half century.⁸

Note that the use of benefit–cost analysis by economists is implicitly endorsing an unstated ethical goal: control pollution only if the measurable monetary benefits of doing so are greater than the measurable monetary costs. This is one answer to the question “how much is too much?” It is called an efficiency standard for pollution reduction.

However, there are ways of thinking about pollution standards other than through a narrow comparison of economic costs and benefits. First, there are issues of fairness: inaction on our part—though it may provide for somewhat higher incomes today, particularly for citizens in affluent countries—may condemn future generations, in particular those in already poor countries, to even greater hardship. Can we justify actions today that, for example, will destroy entire island nations and their cultures? A second answer to the question “How much is too much?” emphasizes fairness. This is called a safety standard. Safety requires reducing pollution to (socially defined) “safe” levels, unless the costs of doing so are prohibitive.

Finally, there is the question of fundamental uncertainty regarding our impact on the planetary ecosystem. As we saw with Nordhaus, benefit–cost analysts typically assume an intermediate case of predictable damages, but, of course, a worst-case scenario might emerge. In a related vein, can we even begin to put benefit numbers on things we know nothing about? For example, what would be the value to future generations of the unique genetic code that will be lost as species extinction accelerates? When uncertainties dominate benefit–cost analysis, it becomes a blunt, and sometimes misleading, tool. In the global warming case, a good number of economists argue that the future consequences of a destabilized climate are simply too uncertain—and potentially catastrophic—to justify making decisions based primarily on benefit–cost studies. In the face of this uncertainty, a third standard emerges—ecological sustainability. This standard requires protecting natural ecosystems from major changes—again, unless the costs of doing so are prohibitive.

The policies flowing from the safety and ecological sustainability standards are similar to Stern’s: initiate a substantial reduction in emissions. Such a recommendation is strengthened by a final argument we explore in Chapter 10 that lost consumption from controlling ${\text{CO}}_2$ emissions in an affluent country such as the United States really means very little over the long run. Because the happiness derived from consumption is in many ways a relative phenomenon, a general increase in income only accelerates the “rat race,” leaving few better off in absolute terms. Put very simply, if fighting global warming reduces the level of U.S. GDP by 2 percent in 2050, then who would really care? Fighting global warming would only mean that we would all be becoming slightly less rich together. Recall that real global GDP is expected by many economists to continue to grow at close to 2 percent per year, regardless of global warming. So the costs of stabilizing the climate would be that, as a world, we would need to wait until 2051 to be as rich as we otherwise would have been in 2050!

In response to these arguments put forward by safety and sustainability advocates, efficiency defenders would respond that aggressive global warming actions will impose excessively high costs on the current generation, and by depressing current investment in capital goods, research, and education, affect the welfare of future generations as well. The bottom line is that, regardless of whether formal benefit–cost analysis is involved, the public debate over global warming is framed in terms of costs and benefits. On one side, efficiency advocates will stress the measurable costs involved in reducing global warming and will advocate small reductions. On the other, proponents of safety and ecological sustainability will argue for major greenhouse gas cutbacks, focusing on uncertain but potentially devastating impacts on future generations.

The purpose of this book is not to sort out which answer is “correct,” but rather to better understand the different positions. However, the first essential step in addressing any environmental problem is to decide how much pollution is too much? Once this is resolved, it is then possible to move on to the second question.

1.3 Is Government Up to the Job?

For reasons explored further in this book, an unfettered free-market economy will produce too much pollution by almost anyone’s standards. This suggests that government needs to step in and regulate market behavior in order to protect the environment. But government itself has its own limitations. Is government up to the job?

There are two obstacles to effective government action. The first is imperfect information. Regulators often have a hard time obtaining accurate information about the benefits and costs of pollution reduction. Benefits such as reduced incidence of cancer, visibility improved, and ecosystems salvaged are hard to measure and even harder to quantify. Costs are also hard to gauge accurately because they depend on the details of how an industry actually operates. Under these circumstances, even well-meaning bureaucrats may have a difficult time imposing regulations that achieve cost–effective control of pollution.

The second obstacle lies in the opportunity for political influence. How much impact do ideology and raw political power have in determining what types of pollution are regulated, which natural resources are protected, and which polluters are punished? Evaluating the importance of this problem requires a theory of governmental action. Economics, like all social sciences, is not a “value-free” pursuit. This is most apparent in political economy, where scholars of different political persuasions are in the business of analyzing government activity.

Traditional conservatives view governmental intervention as a necessary evil and argue for as limited a government role as is possible in all affairs, including environmental affairs. Conservatives argue that government legislators and regulators are self-interested individuals who desire to maximize their own well-being rather than wholeheartedly pursue their stated public mission. Such officials, in theory, seldom act in the public interest but instead serve special interests such as, for example, coalitions of particular businesses, environmental groups, women’s or civil rights groups, or labor unions.

In contrast to this conservative view, progressives view government as capable of promoting an activist agenda to serve the general interest of the public. Like conservatives, progressives acknowledge the possibility of government failure. Yet in contrast to the conservative position, progressives argue that the problem with government involvement in the economy is not primarily the existence of pluralistic special interest groups but the dominance of big business and development interests in the legislative and regulatory process. For example, progressives point to well-financed lobbying by the fossil fuel industry as a major obstacle to the resolution of the global warming issue.

As the next section illustrates, these different perspectives on the potential for effective government action will determine views on the best policies for dealing with global warming.

1.4 How Can We Do Better?

As noted, in Paris, all the countries committed to cutting or capping global warming pollution. ${\text{CO}}_2$ is the most important of the greenhouse gases, contributing about 60 percent of the total greenhouse effect. It is produced by the burning and decay of carbon-based materials: coal, oil, and plant matter. Given what we have just learned about the political economy of regulation, how do we set about controlling ${\text{CO}}_2$ emissions?

Government could take many possible actions to control CO₂ emissions. We can divide such measures into roughly three categories. First is command-and-control regulation, the current, dominant approach to environmental protection. Under command and control, government would regulate ${\text{CO}}_2$ emissions by mandating the adoption of particular types of ${\text{CO}}_2$ abatement technology on, for example, coal-burning power plants. Other types of technology would be required for automobiles, still others for natural gas plants.

As we shall see, command-and-control regulation has been widely criticized as centralized and inflexible, and thus, much more costly than necessary. Many economists have advocated a switch to incentive-based regulation. Incentive-based approaches set emission targets and leave it up to industry to figure out the best way to comply. Incentive-based regulation is called so because firms are provided with incentives to reduce emissions: a tax on pollution is one example and cap-and-trade systems (discussed later) are another example.

Finally, government can intervene more directly to encourage the development and diffusion of new clean technologies. For example, government can force firms to meet energy-efficient design standards, such as building codes. Or government could promote clean technological change through its investment activities—for example, by favoring rail transport infrastructure over autos or providing research and development funding for solar energy. Which of these is the best method?

Of these three methods, economists of all stripes believe that incentive-based approaches, where feasible, are the best foundation to reduce pollution and resource degradation. There are two major policy tools: pollution taxes and cap-and-trade systems. To deal with U.S. ${\text{CO}}_2$ emissions, for example, a tax based on the carbon content of fuels (a carbon or ${\text{CO}}_2$ tax) would be one of the most effective policies we could use. By raising the price of “dirty” (carbon-intensive) fossil fuels, the marketplace would promote “clean” (lower carbon) fuels such as renewable electric power. The alternative approach, cap-and-trade, would place a cap on total U.S. ${\text{CO}}_2$ emissions. Then the government would auction off just enough permits to emit a ton of ${\text{CO}}_2$, so that the auctioned permits add up to the cap’s total. Just like a ${\text{CO}}_2$ tax, cap-and-trade would also place a price on pollution, in turn raising the price of dirty fuels. As we will discuss later, California is in the process of implementing a statewide cap-and-trade law for global warming pollution.

How high should the tax be? That depends on the underlying “how much is too much?” goal. Revisiting the Stern-Nordhaus debate from the previous section, to help achieve 80 percent reductions by 2050, Stern advocates prices with teeth—instituted now at $70 a ton and rising to $224 a ton by 2050. Nordhaus, by contrast, recommends a tax starting at $25 and rising to $93 over the same period.⁹

To put those numbers in perspective: a price of $25 per ton of carbon would raise gas prices by about 25 cents a gallon and coal-fired electricity by around 2.5 cents per kilowatt hour (kWh)—noticeable. But a $70 tax per ton of carbon would boost gas prices by $.70 per gallon, and coal-fired power by around 7 cents per kWh, a significant increase in both gasoline and electricity prices here in the United States. These kinds of energy price increases—if not cushioned—could pose serious hardship, especially for low-income Americans who spend a disproportionate share of their monthly paychecks on gasoline, heat, and electricity.

How to ease the blow to consumers and make this kind of policy politically possible? A ${\text{CO}}_2$ tax, or a government auction of ${\text{CO}}_2$ permits, would generate a lot of revenue. And to offset the problem of higher energy bills, much of this revenue could be rebated directly to taxpayers. One variant of a cap-and-trade system, dubbed “Sky Trust,” would involve issuing one share of the total U.S. ${\text{CO}}_2$ quota, established by the government, to every woman, man, and child in the country.¹⁰ A nongovernmental organization would then hold these shares in trust and, each year, auction them off to companies selling products that emit global warming pollutants (oil refineries, electric power producers, etc.). For each ton of CO₂ emitted annually, a company would have to buy a 1-ton permit at auction. At the end of the year, each citizen would receive a check equal to his or her share of permits in the annual auction. Estimates put the likely dividend at more than $600 per person each year. And it appears that under a Sky Trust system, most Americans would actually be better off economically—that is, their dividend check would be larger than their increased energy bills. This would be a terrific way to make controlling global warming pollution a politically popular idea!

At the end of the day, putting a price on pollution—either through a tax or cap-and-trade—is the number one general recommendation from economists for protecting the environment. And done right, this kind of policy can actually benefit low- and middle-income consumers. But in the global warming case, pricing pollution alone will not be sufficient to achieve Stern-level cuts of 80 percent by 2050. To get there, Stern and other economists recommend direct government promotion of clean technologies.

Government could strengthen efficiency standards for fuel, lighting, and power; revamp the transport infrastructure; promote high-speed rail as a substitute for short plane flights; restructure zoning laws to encourage denser urban development; and increase investment in mass transit.

Finally, government-funded research and development (R&D) of new energy technologies, in particular those that utilize renewable, non-carbon-based sources, such as energy efficiency and solar, wind, and fuel-cell power, might be promoted. Significant carbon taxes combined with substantial government-sponsored R&D of clean-energy technologies and an aggressive approach to promoting efficient energy use is the route to achieving deep reductions in global warming pollution by 2050.

Conservative economists would be suspicious of government regulations mandating energy efficiency or government-funded R&D of clean-energy technologies. The question they would ask about such an agenda would be, can the government do a better job developing appropriate technologies than the market already does? First, conservatives would charge that the R&D pool is likely to become just another government pork barrel. Second, even granting efficient operation, some would maintain that government bureaucrats would have a hard time picking winners and determining which potential technologies are feasible, cost–effective, and environmentally benign.

Progressive economists would respond that existing government decisions such as energy tax breaks for fossil fuels, highway construction funds and other subsidies for auto transport, tax, and zoning policies that encourage suburbanization, and high levels of poorly targeted R&D funding already constitute a de facto plan with major negative environmental and economic effects. The choice, therefore, is not between free markets and central planning but rather between myopic and farsighted government policies.

Progressives maintain that on energy policy, our market system (which is already affected by substantial government involvement) has failed miserably to deliver appropriate technology. Because private investors do not take into account the tremendous costs to society of carbon-based fuels, incentives do not exist to develop appropriate technologies. In addition, a network of vested interests, inappropriate government subsidies already in existence, and substantial economies of scale all justify government involvement. Due to the massive nature of the market failure, the argument is that picking winners would not be hard: among the obvious candidates are energy efficiency technologies, photovoltaic solar cells, and wind power, to name a few.

How can we do better? Most economists argue that a greater reliance on incentive-based approaches, such as pollution taxes or cap-and-trade systems, makes sense. Economists who hold a progressive viewpoint and/or who believe deep cuts in global warming pollution are needed argue that government should also take a more active hand in promoting the development and diffusion of clean technologies.

1.5 Can We Resolve Global Issues?

Whether a government relies primarily on traditional regulatory mechanisms to achieve greenhouse gas reduction targets or employs more incentive-based regulations and direct investment tools, its efforts will be in vain if other nations do not also reduce emissions. Global warming requires a global solution.

${\text{CO}}_2$ reduction is what is known as a public good, a good that is consumed in common. This means, for example, that if the United States cuts back ${\text{CO}}_2$ emissions by 20 percent, the whole world benefits. Thus, since emission reduction is costly, each country would prefer to see the other cut back and then get a “free ride” on the other’s action. Because every country is in this position, there is great incentive for signatories to a treaty to cheat on any agreement. One reason that nations are reluctant to commit to substantial CO₂ reductions is the fear that other countries will not comply, and, thus, their sacrifice will be meaningless in the long run.

However, economists would welcome being proven wrong in this logic. The fact that most developed countries are moving ahead with reductions in greenhouse gas emissions suggests that under a sufficient environmental threat, nations can work together to at least mitigate the impact of the free-rider problem. With global warming, however, a major, long-run challenge will be bringing low-income countries into the process. Rapid economic growth (led by China), increasing energy use, and, in places, accelerated deforestation are quickly increasing the share of global warming pollution arising in the developing world. (More on these issues in Chapters 18–20.) Some would argue that it is unrealistic and unfair to expect these countries to sacrifice economic growth by reducing ${\text{CO}}_2$ emissions in exchange for uncertain environmental gains.

Yet economic growth in many poor countries has its own environmental costs and may prove unsustainable. The economic growth process is often rooted in exploitative colonial relationships that have encouraged the establishment of lopsided, resource-dependent economies. In the modern context, debt has replaced colonial status as the mechanism by which wealth flows from the poor to the rich. Deforestation, overgrazing, and massive pollution from mineral and oil development persist, reinforced by a network of government policies favoring local elite and multinational corporate interests, all occurring in an environment where common property resources are available for exploitation. When economic growth fails to compensate for natural resources depleted in the process, the economic development process is unsustainable; that is, growth today comes at the expense of future generations. (For a more careful definition of sustainable development, see Chapter 19.)

It is clear that the economic needs of the world’s poor nations must be placed at the forefront of an effort to reduce global warming. In this fashion, global agreements to control greenhouse gas pollution are most likely to succeed. But it is also true that developing countries have more to lose from global warming because they have lesser resources to finance adaptive measures, from resettlement to irrigation to dike building. It is possible that by adopting a combination of energy efficiency and conversion to renewable energy sources (biomass, wind, and solar), poor countries can substantially slow the rate of increase of ${\text{CO}}_2$ emissions at the same time promoting sustainable development, which in turn will lower population growth rates.

Is there a way to facilitate the development and transfer of this kind of technology by wealthy nations to developing countries? Fortunately, yes. A version of cap-and-trade has been suggested for resolving equity issues between the wealthy and low-income countries. Such a system would work in the following way: A successor to the Paris treaty would determine a worldwide greenhouse gas emission target and then assign each country a quota based, for example, on its total population.

Thus, each person in the world might initially be permitted to make an equal contribution to global warming. But because the average Indian, for example, uses only 4 percent as much energy as the average American, low-income countries would have an excess supply of permits, while we in the wealthy countries would have an excess demand.

Because the permits are marketable, we would buy some from the poorer countries of the world to maintain our energy-intensive lifestyles. The funds generated could then be used to support the kind of investments in low-carbon energy—wind, solar, biofuels—that poor countries will require to develop. Moreover, because we would now be paying directly for our global warming, we would have the incentive both to conserve energy and to seek out new clean-energy technologies.

Tradeable permit systems of this kind put a price on pollution. Within a country, companies that can now emit CO₂ for free would find pollution becoming expensive. This would give companies an incentive to reduce emissions and, more importantly, would encourage the development of clean-energy technologies, such as wind and solar power, and vehicles powered by fuel cells. At the international level, selling CO₂ permits provides the financial means for poor countries to leapfrog the period of fossil-fuel-intensive development and move straight to clean-energy options.

Of course, nothing comes without a price. Although under the system outlined both poor countries and average Americans would reap financial benefits from the sale of permits, rich-country customers (those same average Americans) would pay much of the price of pollution reduction in the form of higher prices for energy, cars, and manufactured goods, at least in the short run. As usual, the essence of the economic debate boils down to a comparison of benefits (reducing global warming) versus costs (higher prices for goods and services). Do the benefits of aggressive action to reduce greenhouse gas emissions outweigh the costs? At this point, the case remains open. Some economists say reduce a little; others say reduce a lot. This book gives you the tools you need to better understand the debate and make up your own mind.

1.6 Summary

This chapter has provided an introduction to the scientific issues surrounding the buildup of greenhouse gases in our atmosphere and the resultant global warming. But global warming is only one of the myriad environmental challenges posed by human activity. From the siting of landfills at the local level to regulations on chemical emissions from manufacturing plants that are issued by national governments to international agreements designed to preserve species diversity, the need for a public that is informed of the underlying scientific issues is great.

Environmental economists must also rely on scientific assessment of the dangers posed by environmental degradation to ourselves and our descendants. However, this book is not focused on specific environmental concerns arising from our economic activity. Instead, the point is to illustrate the framework that economists use for approaching pollution problems. For any such concern, from landfill siting to chemical regulation to loss of species diversity, three general questions must be answered:

1. How much pollution is too much?
2. Is government up to the job?
3. How can we do better?

When, as is increasingly common, the issue is an international one, a fourth question must also be addressed:

4. Can we resolve global issues?

To this point, Chapter 1 has both outlined the questions raised and provided a sketch of the answers that arise when one grapples with the economics of environmental protection. As indicated, there is often lively debate among economists regarding the right answers. But what we do agree on is the centrality of these four questions. The rest of the book moves on to explain and explore a number of possible solutions. We hope that the reader will come away better equipped to address the local, national, and global environmental problems that we and our children will have to overcome in the 21st century.

1. 1.0 This book explores four key economic questions about the environmental challenges of the 21st century, starting with the civilizational challenge posed by climate change.
2. 1.1 Global warming, arising from the accumulation of greenhouse gases and the resulting “carbon blanket,” poses a potentially severe threat to human welfare and natural ecosystems. Changing rainfall patterns that accompany warming may lead to reductions in agricultural output, particularly in poor countries, and major changes in natural ecosystems, including accelerated species extinction and higher rates of disease. Sea level will also rise. Although scientists largely agree that global warming is already a reality, the magnitude of warming will ultimately depend on positive and negative feedback effects. Economists need to answer four questions to address a problem like global warming.
3. 1.2 The first question is, How much pollution is too much? With respect to global warming pollution, economist Stern argues for deep cuts; Nordhaus advocates a start-slow, ramp-up approach. Both analysts engaged in a comparison of the costs and benefits of action. How to weigh the two? There are three basic standards. An efficiency standard relies solely on benefit–cost analysis; safety and ecological sustainability standards argue for reducing pollution to much lower levels. This is fundamentally an ethical debate over the proper way to weigh both costs and benefits. Initial attempts to define an efficient level of global warming have also provoked a technical debate over to what extent and how fast we can adopt energy efficiency and other cleaner energy technologies.
4. 1.3 Government action is necessary to reduce pollution in a market economy—but, is government up to the job? Two basic obstacles to effective government action are imperfect information and the opportunity for political influence. Conservatives view environmental regulation as a necessary evil best kept at the absolute minimum; they believe that government action primarily serves special interests. By contrast, progressives see no way around an activist government role in environmental protection. From the progressive point of view, government failure results primarily from the influence of big business and development interests.
5. 1.4 Command-and-control regulation is the dominant approach to pollution control today. In response to the question How can we do better? many economists have advocated adoption of incentive-based regulatory approaches, such as pollution taxes or cap-and-trade. Another option is the direct promotion of clean technology through actions such as R&D funding, infrastructure investment, zoning laws, and efficiency standards. Conservatives dispute the ability of government to achieve environmental goals by promoting clean technologies.
6. 1.5 The final question of resolving global issues often requires international agreement. Such agreements, in turn, face two major obstacles. The first of these is the public good nature of environmental agreements. Once an agreement is signed, the incentives to free-ride are great. Second, poor countries often cannot afford to invest in environmental protection. At the same time, they cannot afford not to; economic growth may lead to unsustainable development. In practice, this means funds to resolve global pollution problems must come from rich countries. A cap-and-trade system for controlling global ${\text{CO}}_2$ emissions (1) provides a way to fund poor-country efforts and (2) provides rich countries with the right incentives to seek out less-polluting technology.

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