The Economics of Climate Change

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Paul Krugman has a very good story in this weekend’s New York Times Sunday Magazine about the economics of climate change. He explains terms like externality and cap-and-trade, but also does a detail analysis of the cost of action, the cost of inaction, a little foreign affairs, etc. I would suggest reading the article, which is quite clear — I learned a lot and I bet you will too.

Kurgman describes a Pigovian tax:

… economic activities that impose unrequited costs on other people should not always be banned, but they should be discouraged. And the right way to curb an activity, in most cases, is to put a price on it. So Pigou proposed that people who generate negative externalities should have to pay a fee reflecting the costs they impose on others — what has come to be known as a Pigovian tax.

As well as cap-and-trade in detail:

In this model, a limited number of licenses to emit a specified pollutant, like sulfur dioxide, are issued. A business that wants to create more pollution than it is licensed for can go out and buy additional licenses from other parties; a firm that has more licenses than it intends to use can sell its surplus. This gives everyone an incentive to reduce pollution, because buyers would not have to acquire as many licenses if they can cut back on their emissions, and sellers can unload more licenses if they do the same.

One of the most interesting arguments he points out is the following:

So what I end up with is basically Martin Weitzman’s argument: it’s the nonnegligible probability of utter disaster that should dominate our policy analysis. And that argues for aggressive moves to curb emissions, soon.

Basically, the probability of complete catastrophe is small, but its implications are so big, that we should act against climate change no matter what. If you’re interested in this argument, I’d suggest reading Martin Weitzman’s paper The Extreme Uncertainty of Extreme Climate Change: An Overview and Some Implications [PDF].

He ends the article with the call the action:

We know how to limit greenhouse-gas emissions. We have a good sense of the costs — and they’re manageable. All we need now is the political will.

The article reminded me of Bill Gates’s TED talk, which I watched recently. The description: “Bill Gates unveils his vision for the world’s energy future, describing the need for “miracles” to avoid planetary catastrophe and explaining why he’s backing a dramatically different type of nuclear reactor. The necessary goal? Zero carbon emissions globally by 2050.” You can watch the video here: