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Confusion in the Senate Regarding Allowance Allocation?

According to an October 22nd story in Environment & Energy Daily (“Climate: GOP Fence Sitters Voice Concerns Over Allocations” by Darren Samuelson), several key swing-vote Senate Republicans — including Senator Lisa Murkowski, ranking member of the Energy and Natural Resources Committee — are voicing skepticism about the Senate’s Boxer-Kerry climate bill’s cap-and-trade system because of the free allocation of some of the allowances to various recipients in the private (and public) sector. Although the testimony by a group of very knowledgeable economists (see below) made some important points about the implications of alternative allocation mechanisms in a cap-and-trade system, the questions and comments from some members of the Senate Committee suggest that there is lingering confusion on some points that are absolutely central to the debate. This is important because debate is now advancing on “The Clean Energy Jobs and American Power Act” (Boxer-Kerry), S. 1733, an important (but not sole) element of which is the carbon cap-and-trade system.

First, I want to acknowledge that there are sound reasons for considering allocation mechanisms other than free allocation — for example, auctioning allowances (more about this below) — but the distribution of those allowances that are freely allocated need not be a great source of concern. In some respects, the new debate is repeating the confusion which was prevalent in the press and the blogosphere about the allowance allocation in the Waxman-Markey legislation in the House of Representatives (H.R. 2454).

It is important to distinguish the above question of whether to employ free allocation or auction, from the question how to allocate the total number of freely allocated allowances among various potential recipients. As Denny Ellerman of MIT pointed out at the Senate Energy and Natural Resources Committee hearings, “it is not enough to simply say that allowances should be auctioned or allocated freely. The real issue is the use to which the newly created value will be directed and the households that will thereby ultimately receive the benefit of the allowance value.” This is a point which I carefully explained and quantified in a post on May 27th (“The Wonderful Politics of Cap-and-Trade: A Closer Look at Waxman-Markey.”)

Rather than being a “massive corporate give-away” of 80% of the allowances to private industry — as it was frequently characterized — the H.R. 2454 allowance allocation would result in precisely the opposite, namely, about 80% of the value of allowances accruing to consumers, small business, and public purposes, and some 20% accruing to covered, private industry, a split which is roughly consistent with the recommendations from independent economic research. (I want to acknowledge that estimates by Lawrence Goulder (Stanford) and his colleagues suggest that H.R. 2454 would convey more than 20% of the allowance value to industry. Perhaps in some future blog post, I can look at these alternative estimates, particularly in the context of analysis of the emerging Senate legislation, S. 1733.)

Directly to Senator Murkowski’s and others’ concern — how the total number of freely allocated allowances is divided up among various potential recipients — does not with some relatively minor exceptions (see list below) — affect either the environmental performance or the overall social cost of the system.

The division of the free allowances among recipients largely affects the distribution of costs, rather than aggregate social cost or the degree of environmental performance. To this point, the independence of the equilibrium allowance allocation from the initial allocation in a cap-and-trade system was demonstrated by David Montgomery in a path-breaking article in 1972 in the Journal of Economic Theory, and is a more or less direct consequence of principles established by Nobel laureate Ronald Coase in 1960 in “The Problem of Social Cost.” This independence does not, however, hold in all situations, a topic which Robert Hahn and I are currently analyzing for a conference to be held at the University of Chicago in December. Examples of such specific conditions include particular types of transaction costs, market power, conditional allowance allocations, non-cost minimizing behavior by firms, and differential regulatory treatment of firms. We are investigating this topic both theoretically, and empirically, assessing the impacts of initial allowance allocations on the performance of actual and planned cap-and-trade systems in the United States, Europe, Australia, and elsewhere.

Let me emphasize again that I am not talking about the decision regarding whether to freely allocate or auction the allowances. That decision certainly can affect aggregate social costs, because if some of the allowances are auctioned and if the revenue thereby generated is used to cut distortionary taxes, then the social cost of the overall policy (cap-and-trade plus tax cut) can be less than it would be if the allowances were freely allocated. This is a well-known distinction both from theory and empirical analysis, with much of the relevant academic work having been done by Stanford University Professor Lawrence Goulder.

So, many economists have long favored a system whereby allowances are auctioned and the auction revenue is used to cut distortionary taxes (on capital and/or labor), thereby reducing the net social cost of the policy. But recent interest by Senate Energy and Natural Resources Committee Chairman Jeff Bingaman (D-NM) and others seems to be moving in the direction of a so-called “cap-and-dividend” approach. In such a system (which was originally raised several years ago in the “Sky Trust” proposal), all allowances would be auctioned to complying firms, and the auction revenue distributed to U.S. households on a per capita basis. This can address some of the distributional issues that would be raised by using the auction revenue to fund tax cuts (which could favor higher income households), but it would eliminate the efficiency (cost-effectiveness) gains associated with the tax cut approach. In fact, Stanford’s Goulder has estimated that the tax-and-dividend approach would cost 40% more than an approach of combining an auction of allowances with ideal income tax rate cuts. By “ideal,” I mean cutting those distortionary taxes which would lead to the lowest net cost.

In general, there are sound reasons to seek to compensate consumers for the energy price increases that will be brought about by a cap-and-trade system for climate change, but it is important not to insulate consumers from those price increases (which — as Professor Gilbert Metcalf of Tufts University pointed out at the Senate hearings — dilutes the price signal and thereby reduces the effectiveness and drives up the cost of the overall policy). So, in my language, “compensation” is fine, but “insulation” is not.

Distinct from that issue, however, is the politically salient question of how to distribute (that is, who gets) those allowances which are freely allocated. This is the issue on which I have focused. In this regard, the deal-making that took place in the House and will take place in the Senate for shares of the free allowances is an example of the useful, important, and fundamentally benign mechanism through which a cap-and-trade system provides the means for a political constituency of support and action to be assembled (without reducing the policy’s effectiveness or driving up its cost).

Beyond this, the ultimate political question associated with the allocation mechanism may be whether there is greater (geographically and sectoraly based) political support for the partially free allocation and targeted use of auction revenue, which characterizes the Waxman-Markey (H.R. 2454) approach, or greater (“populist”) political support for the full auction combined with lump-sum rebate which characterizes the “cap-and-dividend” approach. Alas, the textbook economics preference — full auction combined with cuts of distortionary taxes — may be a political, if not, academic orphan.

Cap-and-Trade versus the Alternatives for U.S. Climate Policy

Let’s credit Senator Lisa Murkowski (R-Alaska) for raising questions in the National Journal about the viability of cap-and-trade versus other approaches for the United States to employ in addressing CO₂ and other greenhouse gas emissions linked with global climate change.

Senator Murkowski says that only one approach – cap-and-trade – has received significant attention in the Congress. Let’s put aside for the moment the fact that most of the 1,428 pages of H.R. 2454 – the American Clean Energy and Security Act of 2009 (otherwise known as the Waxman-Markey bill) – are not about cap-and-trade at all, but about a host of other regulatory approaches (several of which are highly problematic, as I’ve discussed in a previous post). We can also put aside the fact that both conventional regulatory approaches and carbon taxes have been discussed repeatedly in numerous House and Senate committees over the past decade, and received detailed attention from a succession of U.S. administrations.

So, let’s not quibble about the Senator’s claim that cap-and-trade is the only approach that has received serious attention. Instead, let’s address the key substantive questions which Senator Murkowski raises, because they are important questions: Is cap-and-trade the most effective way of addressing climate change? And are there other approaches capable of achieving the same results at lower cost? From my perspective, as a card-carrying environmental economist, these are indeed the key questions.

While political leaders in the European Union, Canada, Australia, New Zealand, Japan, and the United States (Congress) move toward cap-and-trade systems as their preferred approach for achieving meaningful reductions in emissions of CO₂ and other greenhouse gases, many people – including some of my fellow economists — have been critical of the cap-and-trade approach in the climate context and have endorsed the use of carbon taxes. The Senator is correct that we should reflect on the merits of that alternative approach.

But, first, what about conventional regulatory approaches, that is, performance standards and technology standards?

Conventional Regulatory Standards

In short, experience has shown that such standards cannot ensure achievement of emissions targets, create problematic unintended consequences, and are very costly for what they achieve.

Why can conventional standard not ensure achievement of reasonable emissions targets? First, standards typically focus on new emissions sources, and do not address emissions from existing sources. Think about greenhouse gas standards for new cars and new power plants, for example. Second, standards cannot possibly address all types of new sources, given the ubiquity of energy generation and use (and hence CO₂ emissions) in a modern economy. Third, emissions depend upon many factors that cannot be addressed by standards, such as: emissions from existing sources and unregulated new sources; how quickly the existing capital stock is replaced; the growth in the number of new emissions sources; and how intensively emissions-generating plants and equipment are utilized.

Next, what about those unintended consequences? First, by reducing operating costs, energy-efficiency standards – for example — can cause more intensive use of regulated equipment (for example, air conditioners are run more often), leading to offsetting increases in emissions — the “rebound effect.” Second, firms and households may delay replacing existing equipment if standards make new equipment more costly. This is the well-known problem with vintage-differentiated regulations or “New Source Review.” Third, standards may encourage counterproductive, unintended shifts among regulated activities (for example, from purchasing cars to purchasing SUVs under the CAFE program). All of these unintended consequences result from the problematic incentives that standards can create, compared with the efficient incentives created by a cap-and-trade system (or a carbon-tax, for that matter).

If you favor a regulatory approach, then you may welcome what’s coming from EPA as a result of the Supreme Court ruling of a few years ago combined with the Administration’s endangerment finding. For my part, I don’t welcome it; I worry about it, because the set of regulatory approaches that could be forthcoming will accomplish relatively little, do so at an unnecessarily high cost, and hence play into the hands of opponents of progressive climate policy. (More about that in some other, future post.)

Putting a Price on Carbon

To virtually all participants in the policy world, it has become increasingly clear that the only approach that can do the job and do it cost-effectively is one which involves at its core putting a price on carbon. That leaves cap-and-trade and carbon taxes. Let me take these in turn.

Cap-and-Trade

Let’s step back from the debate regarding the details of the Waxman-Markey House bill or the new Senate proposal by Senators Boxer and Kerry, and think about the essence of the cap-and-trade approach. (For some of those details, however, please see my previous posts, where I have commented on various aspects of Waxman-Markey and described a proposal I developed for The Hamilton Project of an up-stream, economy-wide CO₂ cap-and-trade system to cost-effectively achieve meaningful greenhouse gas emissions reductions.)

Here are the basics. First, aggregate emissions from regulated sources are capped, and the cap is enforced through a requirement for affected firms to hold emissions allowances. Importantly, allowance trading minimizes costs of meeting the cap. It does this because allowances migrate to the highest-valued uses, covering emissions that are the most costly to reduce. So, the emission reductions undertaken are those that are least costly to achieve. In essence, the uniform market price of allowances creates incentives for all covered sources to reduce all emissions, and do so cost-effectively.

A cap-and-trade system can be more environmentally-effective and more cost-effective than standards. First, in terms of environmental-effectiveness, a cap-and-trade system can ensure achievement of emissions targets. Cap-and-trade allows policymakers to set specific overall emissions targets. And a well-enforced system guarantees achievement of those targets, because emissions will not exceed available allowances. An economy-wide, upstream cap-and-trade system on the carbon content of fossil fuels can cover all fossil-fuel-related CO₂ emissions without needing to regulate each emissions source individually.

In terms of cost-effectiveness, a well-designed cap-and-trade system minimizes emission reduction costs. Unlike NO_x, SO₂, and other pollutants, GHG emission reductions have the same effect no matter how, where, or when they are achieved. This makes the climate change problem unique in the degree to which compliance flexibility can be used to lower costs without compromising environmental integrity. Hence, a cap-and-trade system can minimize costs while still meeting environmental objectives by offering three forms of flexibility: what flexibility; where flexibility; and when flexibility.

In regard to “what flexibility,” many types of actions offer low-cost emission reductions, and a cap-and-trade system allows emission reductions through whatever measures are least costly. By contrast, standards can target only certain identified emission reduction measures, leaving other cost-effective opportunities untapped. Furthermore, predictions of what measures are cost-effective may be wrong.

In regard to “where flexibility,” the costs of emission reductions vary widely across industries, across facilities, and even across users of the same equipment. A cap-and-trade system exploits this variation in costs by achieving reductions wherever they are least costly. By contrast, standards would only be cost-effective if they accounted for all of the variation in costs across sectors, technologies, and regulated entities — but it is completely infeasible for standards to do this. Emission reduction costs across sectors and technologies change over time, making the flexibility offered by a cap-and-trade system even more valuable. Also, lower-cost opportunities to reduce emissions may exist in other countries. Importantly, a cap-and-trade system creates a common currency (emissions allowances) that makes it possible to link with other systems.

A cap-and-trade system also minimizes costs through “when flexibility.” Costs can be reduced through flexibility in the timing of emission reductions by avoiding: premature retirement of capital stock or lock-in of existing technologies; and unnecessarily costly reductions in one year due to unusual circumstances when less-costly offsetting reductions can be achieved in other years. A cap-and-trade can incorporate “when flexibility”
without compromising cumulative emissions targets through: allowance banking and borrowing; and multi-year compliance periods.

Beyond such “static cost-effectiveness,” cap-and-trade creates incentives for technology innovation, and thereby lowers long-run costs. By rewarding any means of reducing emissions, a cap-and-trade system provides broad incentives for any innovations that lower the cost of achieving emissions targets. Although standards may encourage development of lower cost means of meeting the standards’ specific requirements, they do not encourage efforts to exceed those standards.

Several cap-and-trade systems have been successful at achieving environmental goals and cost savings: the phase-out of leaded gasoline in the 1980s; the phase-out of ozone depleting substances; and the Clean Air Act amendments of 1990 SO₂ allowance trading program to cut acid rain by 50%. Perceived shortcomings in other cap-and-trade systems reflect design choices, not problems with the policy instrument itself. This applies both to California’s RECLAIM program, and the pilot phase of the EU Emissions Trading Scheme (which is operating successfully in its real, Kyoto phase).

In summary, compared with conventional standards, a cap-and-trade system can be more environmentally-effective and more cost-effective. As with any policy instrument, however, careful design is important.

Taxing Carbon

As I mentioned, it is clear that the only approach that can do the job and do it cost-effectively is one that involves putting a price on carbon. So, what about the other carbon-pricing approach — a carbon tax?

I am by no means opposed to the notion of a carbon tax, having written about such approaches for more than twenty years. Indeed, both cap-and-trade and carbon taxes are good approaches to the problem; they have many similarities, some tradeoffs, and a few key differences. I am opposed, however, to the confused and misleading straw-man arguments that have sometimes been used against cap-and-trade by carbon-tax proponents.

While there are tradeoffs between these two principal market-based instruments targeting CO₂ emissions — a cap-and-trade system and a carbon tax – the best (and most likely) approach for the short to medium term in the United States is a cap-and-trade system. I say this based on three criteria: environmental effectiveness, cost effectiveness, and distributional equity. So, my position is not capitulation to politics. On the other hand, sound assessments of environmental effectiveness, cost effectiveness, and distributional equity should surely be made in the real-world political context.

The key merits of the cap-and-trade approach I have described above are, first, the program can provide cost-effectiveness, while achieving meaningful reductions in greenhouse gas emissions levels. Second, it offers an easy means of compensating for the inevitably unequal burdens imposed by a climate policy. Third, it provides a straightforward means to harmonize with other countries’ climate policies. Fourth, it avoids the current political aversion in the United States to taxes. Fifth, it is unlikely to be degraded – in terms of its environmental performance and cost effectiveness – by political forces. And sixth, this approach has a history of successful adoption and implementation in this country over the past two decades.

Having said this, there are some real differences between taxes and cap-and-trade that need to be recognized. First, environmental effectiveness: a tax does not guarantee achievement of an emissions target, but it does provides greater certainty regarding costs. This is a fundamental tradeoff. Taxes provide automatic temporal flexibility, which needs to be built into a cap-and-trade system through provision for banking, borrowing, and possibly a cost-containment mechanism. On the other hand, political economy forces strongly point to less severe targets if carbon taxes are used, rather than cap-and-trade – this is not a tradeoff, and this is why environmental NGOs are opposed to the carbon-tax approach.

In principle, both carbon taxes and cap-and-trade can achieve cost-effective reductions, and – depending upon design — the distributional consequences of the two approaches can be the same. But the key difference is that political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table. But political pressures on a cap-and-trade system lead to different allocations of allowances, which affect distribution, but not environmental effectives, and not cost-effectiveness.

Proponents of carbon taxes worry about the propensity of political processes under a cap-and-trade system to compensate sectors through free allowance allocations, but a carbon tax is sensitive to the same political pressures, and may be expected to succumb in ways that are ultimately more harmful: reducing environmental achievement and driving up costs.

The Bottom Line

The Hamilton Project staff concluded in an overview paper (which I highly recommend) that a well-designed carbon tax and a well-designed cap-and-trade system would have similar economic effects. Hence, they said, the two primary questions to use in deciding between them should be: which is more politically feasible; and which is more likely to be well-designed?

The answer to the first question is obvious; and I have argued here that given real-world political forces, the answer to the second question also favors cap-and-trade. In other words, it is important to identify and design policy that will be “optimal in Washington,” not just from the perspective of Cambridge, New Haven, or Berkeley.

In “policy heaven,” the optimal instrument to address climate-change emissions may well be a carbon tax (largely because of its simplicity), but in the real world in which policy is developed and implemented, cap-and-trade is the best approach if one is serious about addressing the threat of climate change with meaningful, effective, and cost-effective policies.

Can Countries Cut Carbon Emissions Without Hurting Economic Growth?

In the September 21st issue of the Wall Street Journal, the editors pose the following question: can countries cut carbon emissions without hurting economic growth? In his introductory essay, Michael Totty frames the issues as follows:

“There’s little doubt: Cutting greenhouse gases will be costly. But that leads to two big questions. First, how costly? And second, can nations afford it? As policy makers around the world take action to avoid a predicted climate catastrophe, the debate is turning to the costs of reducing carbon-dioxide emissions. Energy-efficiency measures are often pricey, and alternative energy sources are more expensive than the fossil fuels they replace. A steep price on carbon emissions will ripple through the economy. Does that mean a serious effort to tackle global warming is incompatible with economic growth? Or can we make significant cuts in greenhouse-gas emissions without causing serious damage to the economy?

We put the question to a pair of experts. Robert Stavins, a professor of business and government at Harvard University and director of Harvard’s environmental economics program, says the answer to the second question is yes: Making the necessary cuts need cause little more than a blip in world-wide growth if smart policies are used.

Steven Hayward, a fellow at the American Enterprise Institute for Public Policy Research, says no: Energy use — and the carbon dioxide it emits — is so central to the world’s economy that major cuts can’t be made without significant damage.

Of course, the answers can depend in large part on how “significant cuts” and “serious damage” are defined. Many scientists, the European Parliament and the Waxman-Markey climate legislation approved by the U.S. House of Representatives have set a goal of cutting carbon emissions about 80% by 2050, so that was picked as constituting significant cuts.

As the accompanying essays show, such a definition leaves plenty of room for disagreement.”

I encourage you to read the entire Journal Report on Environment in the Wall Street Journal (there’s an excellent Q&A on carbon offsets by Bob Curran) and to check out my affirmative response, “Yes: The Transition Can be Gradual — and Affordable,” as well as Steven Hayward’s well-articulated negative response, “No: Alternatives are Simply Too Expensive.”

Understandably, the editors wanted to highlight differences between us in order to develop a concise and clear debate. I find it interesting, however, that in an audio interview/debate at the Wall Street Journal web site (Podcast: Crafting a Global Policy), which was by nature more free-wheeling and less limited by space constraints, there is a remarkable amount of agreement between Mr. Hayward and me on a number of key issues.

For now, in today’s post — liberated from space constraints — I want to expand a bit on my WSJ essay, in which I responded, yes, the transition can be gradual and affordable.

Can the nations of the world meaningfully address the threat of global climate change without inflicting unjustifiable damage to their economies? The answer that has emerged with increasing clarity is a resounding “yes.”

Although “The Day After Tomorrow,” the 2004 disaster epic about the greenhouse effect’s apocalyptic consequences, had less scientific basis than “The Wizard of Oz,” scientific reality is disturbing enough. Man-made emissions of greenhouse gases — including carbon dioxide (CO₂) from the combustion of fossil fuels — are very likely to change the earth’s climate in ways that most people will regret. World energy trends are unsustainable — environmentally, economically, and socially.

The global recession has slowed emissions growth, but the world is on a path to more than double global atmospheric greenhouse gas (GHG) concentrations to 1,000 parts per million (ppm) in CO₂-equivalent terms by the end of the century, resulting in an average global temperature increase of 6 degrees Centigrade. But increased temperatures — which might well be welcome in some places — are only part of the story.

The most important consequences of climate change will be changes in precipitation (causing, for example, 75 to 250 million people in Africa to be exposed to increased water stress due to climate change by 2020, with rain-fed agriculture yields falling by as much as 50%), disappearance of glaciers throughout the world (and decreased snowpack in areas ranging from the western United States to Asia), droughts in mid to low latitudes (with severe effects in Australia), decreased productivity of cereal crops (at lower latitudes, especially in tropical regions), increased sea level, loss of islands and 30% of global coastal wetlands, increased flooding (in all parts of the world, but greatest in Asia), greater storm frequency and intensity (both typhoons and hurricanes), risk of massive species extinction (20 to 30% of all species, including massive coral mortality), and significant spread of infectious disease. On the other hand, climate change will also bring some health benefits to temperate areas, such as fewer deaths from cold exposure. But such benefits will be greatly outweighed by negative health effects of rising temperatures (cardo-respiratory, diarrhoeal, and infectious diseases, and increased morbidity and mortality from heat waves, floods, and droughts), especially in developing countries.

These impacts will have severe economic, social, and political consequences for countries worldwide, ranging from malnutrition and mass migration (hundreds of millions of people displaced) to national security threats. Bottom-line, comprehensive estimates of economic impacts of unrestrained climate change vary, with most falling in the range of 2 to 5% of world GDP per year by the middle of the century. The best estimates of marginal damages of emissions (again, by mid-century) are in the range of $100 to $175 per ton of CO₂(in today’s dollars).

The world is already experiencing the adverse effects of increasing concentrations of GHGs in the atmosphere, with concentrations already about 60% above pre-industrial levels, greatly exceeding the natural range over the past 600,000 years. Just one example: the Greenland ice sheet has been losing mass at a rate of 179 billion tons per year since 2003.

To have a coin toss’s 50-50 chance of keeping temperature increases below 2 degrees Centigrade — the level at which the worst consequences of climate change can be avoided — it will be necessary to stabilize atmospheric concentrations at 450 ppm. (Even this would result in significant sea-level rise, species loss, and increased frequency of extreme weather, according to the U.N. Intergovernmental Panel on Climate Change.) Consistent with the 450 ppm goal is a long-range target of cutting U.S. emissions 80% below 2005 levels by 2050, which happens to be the target of legislation passed earlier this year by the U.S. House of Representatives, H.R. 2454, the so-called Waxman-Markey bill.

Now, to the heart of the WSJ question: will a serious effort to tackle global warming is incompatible with economic growth? My response was and is that the nations of the world do not have to wreck their economies to avert the crisis. If appropriate and intelligent policies are employed, the job can be done at reasonable and acceptable cost.

Critics argue that the Waxman-Markey legislation — to cut U.S. emissions 80% below 2005 levels by 2050 — will mean big, disruptive changes to our infrastructure and untold economic damage. But they make a couple of basic errors. For one thing, they seem to think we’d have to replace the entire infrastructure quickly, paying trillions of dollars to shift to cleaner power. They also seem to assume that we have to choose between much more expensive energy and no energy at all.

The move to greener power doesn’t have to be completed immediately, and it doesn’t have to be painful. The right transition plan will increase consumers’ bills gradually and modestly, and allow companies to make gradual, well-timed moves.

How would this work? One way is via a combination of national and multinational cap-and-trade systems. Companies around the world would be issued rights by their governments to produce carbon, which they could buy and sell on an open market. If they wanted to produce more carbon, they could buy another company’s rights. If they produced less carbon than they needed, they could sell their extra rights. What’s more, companies could earn more rights by creating appropriate “offsets” that mitigated their carbon use, such as planting forests. Nations could add carbon taxes to the mix.

The effect would be to send price signals through the market — making use of less carbon-intensive fuels more cost-competitive, providing incentives for energy efficiency and stimulating climate-friendly technological change, such as methods of capturing and storing carbon, as well as safe nuclear power.

[NUKES_STAVIN]

Julian Puckett

Robert Stavins

More Efficient

True, in the short term changing the energy mix will come at some cost, but this will hardly stop economic growth. As economies have grown and matured, they have become more adept at squeezing more economic activity out of each unit of energy they generate and consume. Consider this: From 1990 to 2007, while world emissions rose 38%, world economic growth soared 75% — emissions per unit of economic activity fell by more than 20%.

Critics argue we can’t possibly increase efficiency enough to hit the 80% goal. In a very limited sense, that’s true. Efficiency improvements alone, like the ones that propelled us forward in the past, won’t get us where we need to go by 2050. But this plan doesn’t rely solely on boosting efficiency. It brings together a host of other changes, such as moving toward greener power sources. What’s more, making gradual changes means we don’t have to scrap still-productive power plants, but rather begin to move new investment in the right direction.

As for how much this will cost, the best economic analyses — including studies from the U.S. Congressional Budget Office and the U.S. Energy Information Administration — say such a policy in the U.S. could cost considerably less than 1% of gross domestic product per year in the long term, or up to $175 per household in 2020. (As the Obama administration is fond of saying, that’s about the cost of one postage stamp per household per day.)

In the end, we would be delaying 2050’s expected economic output by no more than a few months. And bear in mind that previous environmental actions, such as attacking smog-forming air pollution and cutting acid rain, have consistently turned out to be much cheaper than predicted.

The best economic experts have validated the wisdom of adopting climate policies: from Yale’s William Nordhaus, who has supported moderate carbon taxes to cut emissions as an “insurance policy” against the most serious consequences of climate change, to MIT’s Richard Schmalensee and Columbia’s Glenn Hubbard, who have endorsed the climate policy recommendations of the bipartisan National Commission on Energy Policy, to Harvard’s Martin Weitzman, who has argued for much more aggressive policies because of the risk of particularly catastrophic outcomes. And a diverse set of CEOs, including the heads of some of the largest U.S. corporations, acting as part of the U.S. Climate Action Partnership, have called on the government “to quickly enact strong national legislation to require significant reductions of greenhouse gas emissions.”

Critics are wary of raising energy prices, arguing that no nations have grown wealthy with expensive power. But historically, it is the scarcity and cost of energy that have prompted technological changes as well as the use of new forms of power. What’s more, critics challenge the price estimates the experts have set out. They say that the predictions depend on extensive — and unrealistic — cooperation among nations. In particular, they say, developing nations won’t sign onto plans for curbing emissions, for fear of losing their economic momentum.

Indeed, we do need a sensible international arrangement in place to achieve low costs, and the economic pain will be much greater if we don’t set up an international carbon market. But it can be done. Many nations have already initiated such emissions-control policies. And the world can be brought together in a meaningful, long-term arrangement that is scientifically sound, economically rational and politically pragmatic.

Road to Cooperation

Because the benefits of any single nation taking action to address global climate change are spread worldwide, unlike the costs, it may never be in the self-interest of a single country to take unilateral action. This is the nature of a global commons problem. For this reason, international cooperation is required; this is the point of climate negotiations among some 190 countries, which will continue in Copenhagen this December. It is also the motivation for the U.S. administration’s Major Economies Forum, which brings together the 17 largest economies, accounting for 80% of GHG emissions.

Europe has already put significant climate policy in place, and Australia, New Zealand, and Japan are moving to have their policies in place within a year. But without evidence of serious action by the U.S., there will be no meaningful future international agreement, and certainly not one that includes the key, rapidly-growing developing countries — Brazil, China, India, Indonesia, Mexico, South Africa, and South Korea. U.S. policy developments can and should move in parallel with international negotiations.

Understandably, developing countries have a very different perspective than the currently industrialized world regarding climate policy. After all, the vast majority of the accumulated stock of man-made greenhouse gases in the atmosphere is due to economic activity in the richer countries over the past century and more. But the share of global emissions attributable to developing countries is significant and growing rapidly. China surpassed the United States as the world’s largest CO2 emitter in 2006. And developing countries are likely to account for more than half of global emissions by the year 2020, if not before. China, Korea, and others are beginning to take action.

Most important, all of the key countries of the world can be brought together in a meaningful and pragmatic arrangement. Such a post-Kyoto international agreement can expand the scope of action to include key developing countries, but with targets linked via an appropriate formula with economic growth, so that emissions can be reduced around the world, while emissions (and job) leakage from the industrialized to the developing world is avoided, and economic growth continues in all parts of the world.

Reducing Costs

The longer we put off serious action, the more aggressive our future efforts will need to be, as greenhouse gases and carbon-spewing capital assets continue to accumulate. Plants built today will determine emissions for a generation. In the steel sector — where plant lifetimes typically exceed 25 years — more than half of all plants in the world are now less than 10 years old. The picture is similar in the cement industry, as well as more broadly throughout the economy. For every year of delay before moving to a sustainable emissions path, the global cost of taking necessary actions increases by hundreds of billions of dollars.

Critics argue that we can afford to wait because the world of tomorrow will be wealthier and better able to absorb the costs. But acting sooner, such as by adopting the emission caps proposed in the U.S. House legislation, will lower the ultimate costs of achieving the target, because there will be more time allowed for gradual transition — which is what keeps costs down. Perhaps most important, the costs of failing to take action — the damages of climate change — would be substantially greater.

Getting serious about climate change won’t be free, and it won’t be easy. But if state-of-the-science predictions about the consequences of continued delay are correct, the time has come for sensible and meaningful action.