The logic of carbon pricing

The new IB Economics syllabus expects a lot from students on

 

• Negative externalities of production
• Common pool resources
• Government intervention in response to externalities and common pool resources including carbon pricing

This piece (see link below) by Max Roser published in June 2021 on carbon pricing in Our World in Data is exactly what an IB Economics candidate (HL and SL) should read to understand the logic behind it.

Quoting from the article:

Consequences include the negative economic impacts of climate change through its effects on people’s livelihoods, and the damage to infrastructure through rising sea levels, thawing permafrost, and extreme weather events. They pose a large threat to the life of animals and ecosystems on our planet and include the destruction of coral reefs, forest fires, the loss of ice shields, and the expansion of deserts. They include an increase in extreme weather events, like heat waves, droughts, floods, and storms. And especially for the world’s poorest people they pose a threat to their lives, as they increase the risk of hunger and food insecurity.

Climate change isn’t the only negative consequence of burning fossil fuels. The air pollution that is caused by burning fossil fuels kills an estimated 3.6 million people in countries around the world every year. 

This is the price we are already paying for burning fossil fuels.

 The author goes on to explain that

There are two ways in which a carbon price can be implemented: a carbon tax or a ‘cap and trade’ system:

In a ‘cap and trade’ system the carbon price changes over time. A maximum level of pollution (a ‘cap’) is defined and manufacturers need licenses to emit carbon. How expensive these licenses are is determined by a trading system. The price of a license increases as emissions approach the cap. 

A carbon tax is simply a levy that is applied to all goods and services which lead to carbon emissions in their production. 

In both systems the price of any product increases with the amount of carbon emitted in the production of it. The result is that products with a low carbon footprint (like taking the train or solar energy) do not get more expensive, while goods that do create a lot of emissions (like a flight or coal energy) do get more expensive.

This helps us reduce emissions and pollution in two ways: it makes carbon-intensive goods much more expensive, meaning consumers will opt for cheaper low-carbon alternatives when they are available; and in markets where they’re not available yet producers will be incentivised to develop low-carbon alternatives.

The link for this excellent Max Rosen article is here: The Argument for a Carbon Price

Carbon pricing can take the form of either a carbon tax or a 'cap and trade' system.  An excellent (brief and simple) article comparing the two is by Charles Frank of Brookings:

A carbon tax is one way to put a price on emissions. Cap-and-trade is another. A carbon tax and cap-and-trade are opposite sides of the same coin. A carbon tax sets the price of carbon dioxide emissions and allows the market to determine the quantity of emission reductions. Cap-and-trade sets the quantity of emissions reductions and lets the market determine the price. Which of the two is better?

Frank breaks down his simple analysis into four sections:

• which has greater uncertainty and imposes more risks?
• which is easier and less costly to administer?
• which is more likely to be politically palatable?
• what mix of policies combines the best of cap-and-trade and a carbon tax?

There are of course real world examples for students to use.

The link to this Brookings article is here: Pricing Carbon: A Carbon Tax or Cap-and-Trade

Finally, Ian Parry,  the Principal Environmental Fiscal Policy Expert at International Monetary Fund, has these has this list of Five Things to Know about Carbon Pricing for IB Economics students.  Brief and easy.

PS: Complementary to the above is of course ending fossil fuel subsidies.  Students can check out this one: greenhouse gas emissions we should not pay people to burn fossil-fuels, again by Max Roser at Our World in Data.

Hope these help IB Economics students thinking about this issue and tackling effectively related exam questions.

Nota Bene!👇

I just read an Opinion in the New York Times by Paul Krugman written on 16/8/22 and titled 'Why We Don’t Have a Carbon Tax'.  I decided to add his opinion here to help students have a (slightly) different view in related Paper 1 essay questions.  

Bottom line is that he does not  consider carbon pricing a panacea to the climate change challenge we face.  He writes about the Inflation Reduction Act that Biden in the US just signed (according to Krugman 'despite its name, [it] is mainly a climate bill') which 'relies almost entirely on subsidies intended to promote clean energy, offering tax credits for renewable energy, aid to keep nuclear plants operating, incentives to buy electric vehicles and make homes more energy efficient and more'. He continues arguing that 'an exclusive focus on carbon taxes was “dubious economics and bad political economy.'  A carbon tax would be bad political economy because 'people aren’t just consumers and taxpayers, they’re also workers. And any policy that reduces greenhouse gas emissions will displace jobs in fossil fuel industries.'  It would be interesting to point here to the objection that Larry Summers voiced in the roundtable concerning this displacement (go to 34:53) where at 35:17 he ask the rest to put this displacement issue in perspective saying that 'there are only 50000 coalminers in the United States of America right now.  That is one sixth of the number of manicurists...'! Following Krugman's arguments he concludes the piece by writing 'Does this mean that we should never impose a carbon tax? No, not at all. [But,]There’s still a good case for giving people a direct financial incentive to limit emissions, and such a thing may become politically possible as the economy decarbonizes and green energy becomes a more powerful interest group.'

This excellent (short and sweet) complementary article to the above can be reached by clicking here: 

Why we don't have a carbon tax (of course, he is referring to the US). Enjoy!

PS1: The 2019 Twitter thread Krugman refers to in the article is here 

PS2: Olivier Blanchard, the senior fellow at PIIE (also ex-chief economist at the Fund and MIT professor) another heavyweight also weighs in on the carbon tax vs green subsidies debate sparkled by IRA 'climate bill'; Blanchard argues that carbon pricing (carbon taxes) are necessary as (a) a subsidies only approach may prove way too costly for the Government (b) the effectiveness of such subsidies varies significantly and (c) carbon taxes are needed to finance such subsidies

This debate is great for IB Economics students.  The debate is now on Twitter:

 Olivier Blanchard here

and Paul Krugman here