Climate policy and the second best

Generally I have been in the market camp on climate change policy. I have tended to accept the arguments of those as Andrew Leigh who contend that:

the Gillard Government proposes to start with a carbon price (in which the market determines the quantity of pollution), before transitioning to a fully flexible emissions trading scheme (in which the market determines the carbon price). Both have the advantage that they allow millions of households and businesses to find the most cost-effective way to reduce carbon pollution. For the first time, it also becomes profitable for entrepreneurs to find ways to reduce carbon emissions…One of the essential lessons from first year economics is that the best way of addressing a negative externality is to put a price on it. But getting the design right will be critical. For households, we need to craft an appropriate assistance package. For businesses, it will be vital to ensure that emissions-intensive trade exposed industries can remain competitive. And for energy generators, it will be important to provide certainty as they go about transforming themselves into cleaner producers.

However it has occurred to me that it may be more complex than this. Alan Kohler declares:

there needs to be some kind of specific government intervention to manage the transition from brown coal to gas: there needs to be the “pull” of a higher electricity price to make gas profitable; the “push” of compensation for the brown coal generators to close, just as Telstra is being paid to switch off its copper network to make way for the next generation of networking; and gas reserves need to be reserved for domestic power generation. The two years now remaining until there is another federal election is an incredible dangerous period for Australia. Without the certainty of a clear, bipartisan plan, there will be no investment in electricity generation, and inevitable power shortages before the end of the decade.

Leigh Ewbank argues for a broader focus. There is broader point here about markets. If two people exchange goods and services they make each other better off. However it doesn’t follow that the totality of individual exchanges will necessarily produce desirable outcomes (does the left forget the first point and the right the second? Marx has some interesting brief thoughts on this early in the 1861-63 Economic Manuscripts). Fiancial markets are an example princiapl-agency problems underlay the Global Financial Crisis. Is it the same for ensuring that ‘lumpy’ investments are built? Perhaps Kohler is correct. Perhaps an example of the theorem of the second best from welfare economics:

in an economy with some uncorrectable market failure in one sector, actions to correct market failures in another sector with the intent of increasing overall economic efficiency may actually decrease it. In theory, at least, it may be better to let two market imperfections cancel each other out rather than making an effort to fix either one. Thus, it may be optimal for the government to intervene in a way that is contrary to usual policy. This suggests that economists need to study the details of the situation before jumping to the theory-based conclusion that an improvement in market perfection in one area implies a global improvement in efficiency.

This conclusion is relevant to current debate about the future of economics after the GFC on which see Paul Krugman, should economic inquiry take a more inductive approach? Graeme Snooks’ Economics Without Time is very interesting on the late nineteenth debate between inductive economic historians such as W. J. Ashley and deductive economists such as Alfred Marshall. However he ignores the Marxist debate of which Maurice Dobb’s Poltical Economy and Capitalism is a clasic expression, on Dobb see also his 1948 essay on Marxism and social science here.

One thought on “Climate policy and the second best

  1. ashaktur says:

    Talking of Snooks, you should see his latest book “The Coming Eclipse, or the Triumph of Climate Mitigation over Solar Revolution” which brings his inductive approach to bear on the issue of Climate Change. The thing that can always be said of Snooks is that he brings fresh and exciting perspective on issues that no one else is able to bring and the Climate Change issue is no exception. Among the points he raises: 1) once the climate science is accepted, Climate Change is an area for economists not scientists to debate 2) orthodox economic approaches to climate change (e.g. Stern, Garnaut) are wrong because they fail to adequately model the dynamics of human society 3) what is required to analyse climate change from an economic standpoint is realist dynamic theory which can take a longrun view, not short run static orthodox economics 4) orthodox theory massively underestimates the cost of climate mitigation – Snooks makes a compelling argument that actual costs of mitigation may be more than 100 times that estimated by Garnaut et al as a full climate mitigation program would significantly delay the Solar technological revolution which Snooks sees coming within the next 40-50 years – Snooks demonstrates the costs of doing this by making an analogy with the last great technological revolution (the industrial revolution) and the costs to the world economy had that been delayed 100 years.

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