Policy Options for Addressing Climate Change

Economists (including myself) have long recommended carbon-pricing policy instruments – principally carbon taxes or carbon cap-and-trade systems – for achieving meaningful reductions of carbon dioxide (CO₂) emissions in large and complex economies. However, such economy-wide policies are not in favor in the United States within the Biden administration, despite some interest in the Congress. Rather, a set of alternative (second-best) options – such as a Clean Electricity Standard (CES) – are receiving more attention.

Fortunately, economists have developed models with which both economy-wide carbon-pricing systems and sectoral policies, including a CES and increased gasoline taxes, can be consistently analyzed and compared. Stanford University Professor Lawrence Goulder has analyzed a relatively broad set of such climate policy options available to government, and he discusses his analysis and its implications in the newest episode of “Environmental Insights: Discussions on Policy and Practice from the Harvard Environmental Economics Program,” a podcast produced by the Harvard Environmental Economics Program. Listen to our conversation here.

In these podcasts, I converse with leading experts from academia, government, industry, and NGOs. Larry Goulder, the Shuzo Nishihara Professor of Environmental and Resource Economics at Stanford University, is well qualified to talk about the economics of climate change policy. Also, I’m pleased to note that he is my long-time colleague, co-author, and good friend.

Goulder, who graduated from Harvard College with an A.B. in philosophy in 1973 and from Stanford University with a Ph.D. in economics in 1982, served on the faculty of the Department of Economics at Harvard before returning to Stanford’s economics department in 1989. Along the way, he spent a year studying music composition at Ecole Normale de Musique de Paris with the late, great Nadia Boulanger.

Larry Goulder’s research has spanned a range of energy, environmental, and other issues, including green tax reform, the design of environmental tax systems, and climate change policy. He is co-author with Mark Hafstead of Resources for the Future of a book I highly recommend, “Confronting the Climate Challenge: US Policy Options,” published by Columbia University Press in 2018.

In this book, Goulder and Hafstead examine alternative climate change policy options available for lawmakers through the lens of a general equilibrium framework, considering both the aggregate benefits and costs of various policies as well as the distribution of policy impacts across industries, income groups, and generations. Included in the set of policy instruments they examine are carbon taxes, CO₂ cap-and-trade, a clean energy (electricity) standard, and increased gasoline taxes.

In our conversation, Goulder explains that the research shows that price-based approaches such as carbon taxes or cap-and-trade would be the most cost-effective methods to achieve desired changes, but also that a clean energy standard could have significant impacts.

“The reasons it does pretty well … have to do with interactions between this policy and preexisting taxes in the U.S. economy,” Goulder says. “I think this result is quite relevant to current policy discussions, since today there’s a lot of focus on the CES, the Clean Energy Standard, as a way of addressing climate change. And even though our results tend to favor a carbon tax, we find that the CES could do pretty well, as well.”

When I ask Larry to assess the Trump Administration’s environmental policy portfolio, he says that he can find little to be positive about, noting that the administration caused substantial damage, some of which will be long-term.

“The reversal or elimination of some of the Obama efforts was very problematic, in particular a signature effort by the Obama administration, its Clean Power Plan, which would have put limits on the emissions of CO₂ per unit of electricity generated by power plants throughout the U.S. I think dismantling that is a real problem,” Goulder remarks. “I must say also just the general tenor of the Trump Administration to deny the science and to deny, in particular, the idea that there is serious human-caused climate change is very problematic to the extent that it reinforces political opposition to dealing with this immense problem.”

Some of Goulder’s recent research has examined the impacts of China’s new emissions trading system, in which trading was launched just last month (and which was discussed in some detail in a recent webinar by Valerie Karplus, and featured in my previous blog post). I ask Larry to provide a brief assessment.

“This is going to be the largest emissions trading system in the world; it will more than double the amount of carbon dioxide covered by emissions pricing. And it is also using an approach that has some attractions in terms of keeping costs down,” he says. “The tradable performance standard approach used in China is somewhat less cost effective than would be an equivalently scaled cap-and-trade system, but it’s a tremendous step forward that China is taking this national level effort, that it’s employing a tradable system, and that it’s intent on achieving very significant reductions.”

My complete conversation with Larry Goulder is the 26^th episode in the Environmental Insights series, with future episodes scheduled to drop each month. You can find a transcript of our conversation at the website of the Harvard Environmental Economics Program. Previous episodes have featured conversations with:

Gina McCarthy, former Administrator of the U.S. Environmental Protection Agency
Nick Stern of the London School of Economics discussing his career, British politics, and efforts to combat climate change
Andrei Marcu, founder and executive director of the European Roundtable on Climate Change and Sustainable Transition
Paul Watkinson, Chair of the Subsidiary Body for Scientific and Technological Advice (SBSTA) within the United Nations Framework Convention on Climate Change
Jos Delbeke, professor at the European University Institute in Florence and at the KU Leuven in Belgium, and formerly Director-General of the European Commission’s DG Climate Action
David Keith, professor at Harvard and a leading authority on geoengineering
Joe Aldy, professor of the practice of public policy at Harvard Kennedy School, with considerable experience working on climate change policy issues in the U.S. government
Scott Barrett, professor of natural resource economics at Columbia University, and an authority on infectious disease policy
Rebecca Henderson, John and Natty McArthur University Professor at Harvard University, and founding co-director of the Business and Environment Initiative at Harvard Business School.
Sue Biniaz, who was the lead climate lawyer and a lead climate negotiator for the United States from 1989 until early 2017.
Richard Schmalensee, the Howard W. Johnson Professor of Management, and Professor of Economics Emeritus at the Massachusetts Institute of Technology.
Kelley Kizier, Associate Vice President for International Climate at the Environmental Defense Fund.
David Hone, Chief Climate Change Adviser, Shell International.
Vicky Bailey, 30 years of experience in corporate and government positions in the energy sector.
David Victor, professor of international relations at the University of California, San Diego.
Lisa Friedman, reporter on the climate desk at the The New York Times.
Coral Davenport, who covers energy and environmental policy for The New York Times from Washington.
Spencer Dale, BP Group Chief Economist.
Richard Revesz, professor at the NYU School of Law.
Daniel Esty, Hillhouse Professor of Environment and Law at Yale University.
William Hogan, Raymond Plank Research Professor of Global Energy Policy at Harvard.
Jody Freeman, Archibald Cox Professor of Law at Harvard Law School.
John Graham, Dean Emeritus, Paul O’Neill School of Public and Environmental Affairs, Indiana University.
Gernot Wagner, Clinical Associate Professor at New York University.
John Holdren, Research Professor, Harvard Kennedy School.

“Environmental Insights” is hosted on SoundCloud, and is also available on iTunes, Pocket Casts, Spotify, and Stitcher.

Renewable Energy Standards: Less Effective, More Costly, but Politically Preferred to Cap-and-Trade?

The new Congress is beginning to consider various alternative energy and climate policies in the wake of last year’s collapse in the U.S. Senate of consideration of a meaningful, economy-wide CO₂ cap-and-trade scheme. Among the options receiving attention are various types of renewable portfolio standards, also known as renewable electricity standards or clean energy standards, depending upon their specific design. These approaches, which focus exclusively on one sector of the economy, would be less effective than a comprehensive cap-and-trade approach, would be more costly per unit of what is achieved, and yet – ironically – appear to be much more attractive to some politicians who strenuously opposed cap-and-trade.

True enough, these standards can be designed in a variety of ways, some of which are better and some of which are worse. But the better their design (as a CO₂ reducing policy), the closer they come to the much-demonized cap-and-trade approach.

In an op-ed which appeared on November 24^th in The Huffington Post (click here for link to the original op-ed), Richard Schmalensee and I reflected on this irony. Rather than summarize (or expand on) our op-ed, I simply re-produce it below as it was published by The Huffington Post, with some hyperlinks added for interested readers.

For anyone who is not familiar with Dick Schmalensee, please note that he is the Howard W. Johnson Professor of Economics and Management at MIT, where he served as the Dean of the Sloan School of Management from 1998 to 2007. Also, he served as a Member of the President’s Council of Economic Advisers in the George H. W. Bush administration from 1989 to 1991. By the way, in a previous blog post, I featured a different op-ed that Dick and I wrote in The Boston Globe in July of last year (“Beware of Scorched-Earth Strategies in Climate Debates”).

– – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –

Renewable Irony

by Richard Schmalensee and Robert Stavins

The Huffington Post, November 24, 2010

One day after the election, the White House press secretary Robert Gibbs said that a national renewable electricity standard could be an area of bipartisan energy cooperation, after President Obama had said cap-and-trade was not the only way “to skin the cat.” It is ironic that while cap-and-trade — a sensible approach to reducing carbon dioxide emissions linked with climate change — is dead and buried in the Senate, considerable support has emerged for an approach that would be both less effective and more costly. A national renewable electricity standard would mandate that a given share of an electric company’s production come from renewable sources (most likely wind power), or, in the case of a “clean energy standard,” from an expanded list including nuclear and hydroelectric power.

One irony is that cap-and-trade is a market-based approach to environmental protection, which harnesses the power of the marketplace to reduce costs imposed on business and consumers, an approach championed by Republican presidents beginning with Ronald Reagan. Within its narrow domain, the renewable standard approach, which involves nationwide trading of renewable energy credits, is also market-based. Whereas cap-and-trade would raise the cost of fossil fuel, as its opponents have stressed so effectively, renewable standards would raise the cost of electricity, which its supporters seem reluctant to admit. If renewables really were cheaper, even with Federal subsidies, it wouldn’t take regulation to get utilities to use them.

A second source of irony is that renewable or clean electricity standards are a very expensive way to reduce carbon dioxide (CO₂) emissions — much more expensive than cap-and-trade. These standards would only affect electricity, thereby omitting about 60 percent of U.S. CO₂ emissions. And even then, the standards would provide limited incentives to substitute away from coal, the most carbon-intensive way to generate electricity. Even more problematic, renewable/clean electricity standards would provide absolutely no incentives to reduce CO₂ emissions from heating buildings, running industrial processes, or transporting people and goods. And unlike cap-and-trade, which would also affect oil consumption, the electricity standards would make no contribution to energy security. Only a very tiny fraction of U.S. oil consumption is used to generate electricity.

Increasing renewable electricity generation is no more than a means to an end for one part of the economy. Cap-and-trade keeps our eyes on the prize: moving the entire economy toward climate-friendly energy generation and use.

Those who believe that renewable electricity standards would create a huge number of green jobs have forgotten the lesson of Detroit: a large domestic market does not guarantee a healthy domestic industry. At the end of 2008, for instance, the U.S. led the world in installed wind generation capacity, but half of new installations that year were accounted for by imports. And a recent Lawrence Berkeley Laboratory study of the impacts of the economic stimulus package incentives for renewable electricity investments estimated that about 40 percent of the (gross) jobs created by new wind-energy investments were outside the United States, where many wind turbines are manufactured.

A sounder approach, for those concerned about green jobs, would focus on the long-term determinants of economic growth, such as technological innovation. That’s where cap-and-trade — which creates broad-based incentives for technology innovation — holds another edge over renewable electricity standards.

It is often argued that if cap-and-trade is dead, enacting renewable or clean electricity standards is better than doing nothing at all about climate change. While that argument has some merit, since the risks of doing nothing are substantial, there is a real danger that enacting these standards will create the illusion that we have done something serious to address climate change. Worse yet, it could create a favored set of businesses that will oppose future adoption of more efficient, serious, broad-based policies — like cap-and-trade.

If a national renewable electricity standard is nonetheless inevitable, it should not impose excess costs on businesses or consumers. It should pre-empt state renewable portfolio standards, since with a national standard in place, states’ programs simply impose extra costs on their citizens without affecting national use of renewables at all. And any national program should allow unlimited banking to encourage early investments. No environmental or economic purpose is served by limiting banking to two years, as current Senate legislation would do.

Carbon cap-and-trade has been killed in the Senate, presumably because of its costs. Renewable electricity standards or clean energy standards would accomplish considerably less and would impose much higher costs per ton of emissions reduction than cap-and-trade would. This does not sound like a step forward.

Richard Schmalensee is the Howard W. Johnson Professor of Economics and Management at the Massachusetts Institute of Technology; Robert N. Stavins is the Albert Pratt Professor of Business and Government at the Harvard Kennedy School.