How Markets Beat Other Policies At Tackling The Energy-Climate Change Problem

Markets have proven more efficient than regulations and rebates at tackling the energy and climate challenge, a leading environmental economist argued recently in Aspen.
The most popular policies in the United States—rebates for appliance upgrades, energy efficiency and efficient vehicles—may cost society more than the problems they set out to solve, while markets produce the same results cheaply, said Michael Greenstone, the Milton Friedman Professor of Economics at the University of Chicago.
"Somehow we prefer to use these other policies when markets would be less expensive," Greenstone said June 30 at the Aspen Ideas Festival. "Our best hope for confronting this challenge is going to be by turning to markets."
Three Legs
Greenstone is the director of the Becker-Friedman Institute for Research in Economics, director of the Energy Policy Institute of Chicago, and he served as the chief economist of the White House Council of Economic Advisors from 2009-10. He sees the energy challenge as a stool with three legs, all of which should be considered in a successful policy:
Energy access is needed to pull billions of people out of poverty in the developing world. "We basically don't have any historical examples of countries achieving high levels of living standards without lots and lots and energy consumption," he said.
Countries traditionally provide energy access by burning fossil fuels, which produces pollution that's harmful to health.
The same fossil fuels that power economic growth release carbon dioxide, increasing the odds of disruptive climate change.
"The global energy challenge is one of the most urgent problems society faces," Greenstone said. "There are billions of people who live at incredibly low levels of income…. That translates into disease and sickness and shorter lives. Access to energy is critical for those people, and the countries where those people live are going to be rightly focused on finding inexpensive ways to get those people access to energy. A lot of that’s going to come from fossil fuels, and those fossil fuels come with risks to our health and risks to climate change, in terms of increasing the odds of disruptive climate change."
Developed World
In the developed world, popular policies often have a high cost for each ton of carbon dioxide emissions they prevent. For example, Greenstone said, appliance rebates cost $602 per ton of CO2 prevented, rebates for reduced electricity cost $468, rebates for efficient vehicles cost $313, and rebates for home weatherization cost $207.
At the same time, carbon markets in California, New England and Europe cost less than $15 for each ton of carbon pollution they prevent.
The U.S. has estimated the social cost of carbon—the cost of the negative impacts of carbon pollution—at $42 per ton, so the rebates spend hundreds of dollars to solve a $42 problem, while the markets spend much less.
That is if the $42 social cost of carbon is correct. Greenstone led the effort to develop that figure during the Obama Administration, and he is now leading a new effort to improve the figure using more detailed data, specific to 25,000 regions in the world, measuring climate impacts in each region on mortality, labor, energy demand, crop yields, migration and crime.
"You can see that people's ability to work on very hot days appears to decline. Energy demand goes way up, which is not surprising, as people are using cooling techniques. Crop yields go way down. There even appear to be increases in migration, which is costly. And somewhat speculatively, there's increases in crime as well. Our aim is to add all that up and produce a new number."
The new number may make the rebates look less expensive, but if so, it will also make markets look even cheaper.
Developing World
Greenstone challenged the popular idea that solar mini-grids can provide energy access in the developing world, because people there may not want solar mini-grids. And he offered other examples of wayward policies in the developing world:
• To improve energy access, the Chinese government offered people who live north of the Hua River free heat during winter months. The heat was produced by burning coal, and as a result, those people enjoyed warmer winters but suffered from air pollution that reduced their life expectancy by three years. The policy cost China 1.5 billion life-years, Greenstone calculated.
"All of the reductions in life expectancy are coming from cardiorespiratory causes of death that are plausibly related to air pollution," he said.
• In the Indian state of Gujarat, the government enacted a regulation requiring power plants to hire inspectors to report on pollution emissions. The regulation created a labor market for pollution inspectors, but because they were hired and paid by the power plants, the market's incentives discouraged them from reporting violations.
"Basically everyone was in compliance," Greenstone said, and the government regulator doubted the results he received from the inspectors.
Greenstone ran an experiment in Gujarat in which some plants continued on this scheme, to serve as a control group, while others were prohibited from hiring and paying inspectors. Instead, the government hired the inspectors, who were paid from a central pool that plants paid into. In this second group, the inspectors were offered cash bonuses if their reports stood up to verification.
The second group reported many more plants out of compliance.
"Just by changing the operation of this market, you're able to get an incredibly different result," Greenstone said. "In particular, the treatment caused the auditors to become more truthful."
The power plants reacted to the rise in accurate reporting by reducing pollution emissions 28 percent.
"So this kind of tweak in a market really produced an opportunity," Greenstone said. "The regulator adopted this reform, and this is now how the auditing is done in Gujarat. The idea is that you can use markets to achieve whatever your goal is with respect to pollution."
Climate Change
Climate change continues to worsen because the social costs of greenhouse gas pollution are not borne by the markets in which those fuels are sold. Instead, they turn up in health and home insurance rates, in mortality rates, in the costs of lost labor and crime across the economy.
Greenstone did not propose a particular market solution during his Aspen lecture, though he has advocated a carbon tax in the past. Greg Hamra, an audience member from Miami, asked him what he thought of the Republican proposal led by former Reagan and Bush Administration officials James A. Baker III and George Schulz for a carbon dividend.
"The plan is to put actually a $40 tax on carbon emissions and then the government, instead of taking it in and doing whatever it is governments do with money, immediately refunds it to taxpayers with checks," Greenstone said.
"I think there's a great deal of appeal to that. It uses markets to solve what is a really sticky and thorny problem. And another feature of that plan, which I think from an economic-efficiency standpoint has a lot of appeal, is it would get rid of the regulations that are mandating particular ways to get carbon reductions, which led to a lot of those expensive [rebate policies] I pointed to at the beginning of my talk."
Watch Greenstone's talk in Aspen: