How Do You Create A Climate Friendly Economy?

The effects of climate change are already being profoundly felt worldwide. Extreme temperatures, rising sea levels, and more frequent natural disasters have already imposed a steep social and economic cost on global communities. Despite this, the global economy’s shift away from carbon-intensive forms of energy production has been fairly slow. Policymakers have tried to accelerate the adoption of green energy through targeted taxes and regulations that discourage the use of carbon-based fuels. But what types of state policy can decrease emissions without burdening the economy?

In this case study, you will examine several different types of green reforms and evaluate their environmental and economic effects. While it is easy to look at a problem like climate policy one-dimensionally (i.e. considering only emissions or economic effects), an approach that accounts for the tradeoffs associated with new regulations/taxes forces us to consider competing demands and decide which societal goals should be met first. Can we pursue significant emission reductions without harming the global economy, and if not how can we minimize the adverse effects of aggressive climate policy?

As greenhouse gasses pass through the earth’s atmosphere, they are radiated as heat. Greenhouse gasses in the atmosphere, such as carbon dioxide, methane, and nitrous oxide absorb a portion of this heat, trapping it near the earth’s surface. Human activity since the industrial revolution has dramatically increased the amount of greenhouse gasses, particularly carbon dioxide, in the atmosphere. This has already led to a 1.2 °C increase in global temperatures since the Industrial Revolution, and, given current trends and commitments made under the Paris Accords, warming will reach 2.7 °C by the end of the century. These temperature increases directly contribute to other extreme weather events, such as increased frequency of droughts, heatwaves, and hurricanes.

Rising global temperatures could also have significant economic effects. Drastic temperature changes alter the fertility of soil, so areas that were once hubs of agricultural production may find themselves barren if warming continues unabated. Additionally, fish populations may decrease markedly, which would hurt the economic prosperity and food security of coastal communities. Droughts would threaten the water supply in many areas, and forced climate migration will upend global labor markets. Many climate scientists agree that by keeping warming below 1.5 °C, humanity can avoid the worst effects of climate change. However, to keep warming that low, humans would have to halve their carbon emissions by 2030, and achieve complete carbon neutrality by 2050. This will require collective global action and bold policymaking.

Given the need for dramatic action to limit climate change, policymakers and climate activists have proposed a number of potential reforms to limit greenhouse gas emissions. One reform climate activists have proposed to curb emissions is the carbon tax. Under a carbon tax, polluters are required to pay a set dollar amount for every ton of carbon dioxide they emit. Carbon taxes are a type of Pigouvian tax: a tax levied “on a market transaction that creates a negative externality, or an additional cost, borne by individuals not directly involved in the transaction.” Greenhouse gas pollution contributes to climate change, which affects us all through severe weather events. However, those social costs are not factored into the market price of carbon-based fuels. A Pigouvian tax corrects this instance of supposed market failure by increasing the market price of carbon-based fuels to reflect their true cost. Businesses will then adapt to the newly inflated price by using untaxed alternative energies, causing demand for carbon-based fuels to decrease. As of June 2022, 36 carbon tax regimes were in place around the world.

Another popular reform is cap and trade schemes. Under cap and trade, governments set a hard limit on the amount of greenhouse gasses a firm or industry is allowed to emit, but allow them to buy and sell carbon allowances amongst each other. Firms that keep emissions low can sell their excess allowances for a profit, while firms that exceed their allotted emissions must pay a hefty price. Emissions permitted get lower each year, incentivizing companies to innovate and adopt energy-efficient technologies to meet their targets. Richard Schmalensee and Robert Stavins, environmental economists at MIT and Harvard University respectively, find that when cap and trade programs have accurate monitoring and significant violation penalties they are a more environmentally effective and cost-effective means of reducing emissions than other policy interventions. China launched its carbon market in 2017, and since then it has expanded to “cover more than 2,600 companies in regions with a population of more than 258 million.”