Once you get past the gratuitous dig about “junk science,” Paul Krugman’s column today about reducing carbon emissions makes a lot of sense.

As a card-carrying economist, I cringe when “green economy” enthusiasts insist that protecting the environment would be all gain, no pain.


Let’s talk first about those costs.

A cap-and-trade system would raise the price of anything that, directly or indirectly, leads to the burning of fossil fuels. Electricity, in particular, would become more expensive, since so much generation takes place in coal-fired plants.

Electric utilities could reduce their need to purchase permits by limiting their emissions of carbon dioxide — and the whole point of cap-and-trade is, of course, to give them an incentive to do just that. But the steps they would take to limit emissions, such as shifting to other energy sources or capturing and sequestering much of the carbon dioxide they emit, would without question raise their costs.

If emission permits were auctioned off — as they should be — the revenue thus raised could be used to give consumers rebates or reduce other taxes, partially offsetting the higher prices. But the offset wouldn’t be complete. Consumers would end up poorer than they would have been without a climate-change policy.

He then goes on to suggest that these costs would not be very high and is critical of those who say the costs will be higher:

To be sure, there are many who insist that the costs would be much higher. Strange to say, however, such assertions nearly always come from people who claim to believe that free-market economies are wonderfully flexible and innovative, that they can easily transcend any constraints imposed by the world’s limited resources of crude oil, arable land or fresh water.

So why don’t they think the economy can cope with limits on greenhouse gas emissions? Under cap-and-trade, emission rights would just be another scarce resource, no different in economic terms from the supply of arable land.

Now Krugman is a very smart guy — he did win a Nobel Prize in Economics after all. Yet he seems rather dismissive of the unintended consequences of the policies he puts forward to limit emissions. The beauty of markets is that people and businesses will adapt to any change in incentives. But despite this adaptive capacity, bad, poorly thought out policy is still likely to result in bad or unwelcome outcomes.

If you raise costs in one market, say by introducing a cap-and-trade system, economic activity will tend to shift to other markets which do not face such costs. That is why it is so important to include countries like China in any agreement on greenhouse gases.

Politicians will not sit idly by as economic activity in their jurisdictions shifts to carbon havens. They will be under enormous pressure to do something, raising the possibility of new trade barriers and other protectionist measures using climate change as the pretext.

The great risk is that such measures would induce retaliatory actions and result in a trade war, which is the last thing the global economy needs at this juncture. While pushing the global economy into deep depression would have the salutary effect of reducing global GHG emissions, the cost of such reductions would be very high. Krugman knows better.


Update: Peter Dorman, of the left-leaning EconoSpeak, criticizes Krugman from another angle, noting his failure to consider the capital-trashing aspect of cap-and-trade.