A New Day for U.S. Climate Change Policy?

There is certainly much enthusiasm and great expectations on both sides of the Atlantic Ocean regarding what can be expected from the new U.S. administration’s climate change policy.  I offered somewhat modest expectations in an essay posted at this blog in mid-January before the Biden-Harris team was inaugurated.  But now – in early April – major appointments have been made, executive orders announced, and new policies floated.  So, this is a good time take a preliminary look at what has been accomplished in the first 10 weeks or so of the administration.

For that purpose, an exceptionally qualified observer is my friend and colleague, and most recent podcast guest, Jody Freeman, the Archibald Cox Professor of Law at Harvard Law School, where she founded both the Environmental and Energy Law Program and the School’s Emmett Environmental Law Clinic (which was directed for many years by Wendy Jacobs, who sadly passed away in February after a long illness).

Professor Freeman worked in the Obama administration, and before that she was closely involved in the Massachusetts vs. EPA court case that eventually led – via a U.S. Supreme Court decision – to EPA’s endangerment finding in the Obama years, which precipitated policy action on climate change under the authority of the Clean Air Act.  You won’t be surprised that she pulls no punches in her comments on the Trump administration’s moves in the environmental realm, nor in her judgments and hopes regarding the Biden administration.  You can hear our complete conversation in the Podcast here.

In these podcasts – “Environmental Insights: Discussions on Policy and Practice from the Harvard Environmental Economics Program – I talk with well-informed people from academia, government, industry, and NGOs.  Jody Freeman very much belongs in this group, as one of the world’s leading authorities on environmental law, a former Federal government official, and a participant in deliberations in private industry.

Jody Freeman has this to say about the previous administration:

“The Trump Administration unraveled, weakened, or rescinded every climate regulation that the Obama Administration had put in place. And they went beyond that to weaken many other environmental rules too. And so, it’s an across-the-board effort to pull environmental protection back as much as possible and weaken the agencies that are responsible for putting rules in place to protect public health and to address climate change.  In environment, climate, energy, it’s really hard to think of a major policy that was left untouched.”

On the other hand, Professor Freeman commends the Biden Administration’s early actions to reverse much of the climate policy damage caused by the previous administration.

“The president signed two sweeping executive orders on climate change within the first month. And they encompass everything you could possibly do with the agencies of the federal government, from how the Treasury Department finances overseas projects to how the Agriculture Department sends money to farmers. The administration is on the hunt for all of the policies that any agency can use to support its clean energy agenda.”

However, looking ahead, she recognizes that the Biden administration probably does not have the necessary votes in the Senate to pass any meaningful legislation placing a price on carbon.  Short of that, she says there are many other actions the administration can take on climate and energy policy.

“Presidents like to use executive branch power. So, you can count on the Biden Administration to be trying to deploy all of the levers, all of the tools that it can use. And they include adopting new rules … for power plant emissions of CO2, adopting new rules for car and truck emissions, adopting sector by sector rules that EPA has the authority to do.  There are other agencies too, like the Department of Energy, which sets appliance efficiency standards. The Department of the Interior regulates extraction of oil and gas on public lands. You’ve already seen them freeze new leases on public lands, and they’re going to favor wind and solar siting on public lands.”

When I ask her about the negative perception of the fossil fuel industry among many climate policy advocates in the United States, Professor Freeman, who sits on the Board of Directors of ConocoPhillips, remarks that there are signs of progress on the horizon.

“I think the industry is in a moment of transition. I do see, for example, the European oil and gas companies are already making pledges and investments in alternative business models.  By no means are we down the road far enough or fast enough, but you can see that they’re starting to think about becoming different kinds of companies over time. And I think the U.S. companies are following suit.”

My complete conversation with Professor Freeman is the 22nd episode in the Environmental Insights series, with future episodes scheduled to drop each month.  You can find a transcript of our conversation at the website of the Harvard Environmental Economics Program.  Previous episodes have featured conversations with:

“Environmental Insights” is hosted on SoundCloud, and is also available on iTunes, Pocket Casts, Spotify, and Stitcher.

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The Future of European Climate Change Policy

In my previous blog post, on January 14th, I offered my personal views regarding “International Climate Change Policy & Action in the Biden Administration.”  Today, I’m pleased to turn to a parallel assessment of future European climate change policy by Ottmar Edenhofer, a greatly-accomplished German economist, admired by academics, as well as leaders in government, industry, and non-governmental organizations.

Professor Edenhofer’s presentation, “The European Green Deal – Reform or Regulatory Tsunami?” and our subsequent discussion is the most recent webinar in our series, Conversations on Climate Change and Energy Policy, sponsored by the Harvard Project on Climate Agreements (HPCA).  As you know, in this webinar series we feature leading authorities on climate change policy, whether from academia, the private sector, NGOs, or government.  A video recording (and transcript) of the entire webinar is available here.

Ottmar Edenhofer is Professor of Economics at the Technical University of Berlin, the Founding Director of the Mercator Research Institute on Global Commons and Climate Change, and Co-Director and Chief Economist of the Potsdam Institute for Climate Impact Research.  He has been a major contributor to scholarship on the economics of energy and climate change, and served as Co-Chair of Working Group III of Fifth Assessment Report of the Intergovernmental Panel on Climate Change, where I had the pleasure of working under his leadership.  He is a key advisor of the German Government, as well as the European Union.  He holds a Ph.D. in economics and a B.A. degree in philosophy (a pairing of degrees which –  I’m delighted to say – he and I share).

In his presentation and the discussion that follows, Ottmar Edenhofer offers a frank assessment of the European Green Deal’s potential to significantly address the impacts of global climate change. 

“It’s a very good time to talk about the European Green Deal because now the prospects that United States and Europe could work closer together on climate change or climate policy and energy policy are very good,” Ottmar notes, referring to the change in U.S. administrations and recent remarks by European Commission President Ursula von der Leyen reaffirming the European Union’s (EU’s) intent to reduce its target for emission reductions from 40 percent to 55 percent by the year 2030 and to achieve net carbon neutrality by the year 2050.

Calling it a “huge task,” Edenhofer outlines the actions that would need to occur to achieve such ambitious goals, including enhanced efforts to decarbonize the power sector, accelerated electrification for end-users, increased investments in bio-energy and semi-synthetic fuels, and advancements in carbon dioxide removal technologies. Using the EU’s climate policy impact assessment as a framework, he walks us through three different policy scenarios, ranging from one that relies heavily on regulation to one structured primarily around carbon pricing.

Characterizing the heavily regulatory approach as a “high-risk scenario,” he instead promotes the idea of an “intermediate step” in a which a mix of policy measures and carbon pricing are deployed to move toward the goal of a 55-percent carbon emissions reduction, and toward a longer-term strategy of using carbon pricing alone as the primary driver in CO2 reduction efforts.

“The crucial question therefore is, how can we design this intermediate step, and this is really the most important debate around this reform proposal,” he says, noting that several issues would need to be addressed.  “The intermediate step has to address the distributional issues and guarantee the stability and manage the political economy challenge between the sectors.”

Professor Edenhofer suggests that the intermediate step that may gain the political support necessary to succeed would be one that would allow for two separate emissions trading systems – one for the energy and industry sector, and the other for transportation and buildings.

“Meanwhile we could define gateways between these two systems. “Creating such gateways might have a two-fold effect – the first one is that market participants already anticipate that there are gateways and they anticipate these enterprise expectations, and this could lead to a convergence of the different prices across the sectors. And secondly, this is a starting point to manage the division of labor among the sectors, and this could be a credible pathway toward a carbon-price scenario when we have one ETS with one credible CO2 price scenario.”

In his presentation, Edenhofer also acknowledges the role that fiscal federalism could play in affecting the future direction of climate policy in Europe. While arguing that carbon pricing could generate roughly 800 billion euros between now and 2050, he notes that the funding base would shrink over time as emissions decrease, and therefore would not serve as a stable revenue source.  He has answers for this challenge as well.

After his presentation, Professor Edenhofer responds to questions from the virtual audience of more than 200 people. One question focuses on the impact of the new Biden-Harris Administration in Washington on global efforts to address climate change.

“The good thing is they are back in the Paris Agreement.  The announcement alone that the U.S. is committed has already helped.”

All of this and much more can be seen and heard in the full webinar here.  I hope you will check it out.

Previous webinars in this series – Conversations on Climate Change and Energy Policy – have featured Meghan O’Sullivan’s thoughts on Geopolitics and Upheaval in Oil Markets, Jake Werksman’s assessment of the European Union’s Green New Deal, Rachel Kyte’s examination of “Using the Pandemic Recovery to Spur the Clean Transition,” Joseph Stiglitz’s reflections on “Carbon Pricing, the COVID-19 Pandemic, and Green Economic Recovery,” Joe Aldy describing “Lessons from Experience for Greening an Economic Stimulus,” and Jason Bordoff commenting on “Prospects for Energy and Climate Change Policy under the New U.S. Administration.”

The next bi-monthly HPCA Conversation on Climate Change and Energy Policy will take place in March.  You can register in advance for that event at the HPCA website.

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Both Are Necessary, But Neither is Sufficient: Carbon-Pricing and Technology R&D Initiatives in a Meaningful National Climate Policy

For many years, there has been a great deal of discussion about carbon-pricing – whether carbon taxes or cap-and-trade – as an essential part of a meaningful national climate policy.  It has long been recognized that although carbon-pricing will be necessary, it will not be sufficient. Economists and other policy analysts have noted that policies intended to foster climate-friendly technology research and development (R&D) will also be necessary, but likewise will not be sufficient on their own.

Some recent studies and press accounts, which I reference below, have identified these two approaches to addressing CO2 emissions as substitutes, rather than complements.  That is fundamentally inconsistent with decades of research, and so my purpose in this essay is to set the record straight.

Carbon Pricing:  Necessary But Not Sufficient

First of all, why is there so much talk among policy analysts and policy makers – not simply among academics – about carbon‑pricing as the core of a meaningful strategy to reduce CO2 emissions?  Why, in fact, is this approach so overwhelmingly favored by the analytical community?  The answer is simple and surprisingly pragmatic.

First, there is no other feasible approach that can provide meaningful emissions reductions, such as the 80 percent reduction in national CO2 emissions by 2050 that was part of the legislation passed by the U.S. House of Representatives and proposed in the Senate and part of the Obama administration’s conditional pledge under the Copenhagen Accord.  Because of the ubiquity and diversity of energy use in a modern economy, conventional regulatory approaches –standards of various kinds – simply cannot do the job.  Only carbon pricing – either in the form of carbon taxes or cap-and-trade – can significantly tilt in a climate-friendly direction the millions of decentralized decisions that are made in our economy every day.

Second, carbon-pricing is the least costly approach in the short term, because abatement costs are exceptionally heterogeneous across sources.  Only carbon-pricing provides strong incentives that push all sources to control at the same marginal abatement cost, thereby achieving a given aggregate target at the lowest possible cost.

Third, it is the least costly approach in the long term, because it provides incentives for carbon-friendly technological change, which brings down costs over time.

For these reasons, carbon-pricing is a necessary component of a truly meaningful national climate policy.  [I’ve written about this in many previous blog posts, including on June 23, 2010, “The Real Options for U.S. Climate Policy.”]  However, although it is a necessary policy component, carbon-pricing is not sufficient on its own. This is because there are other market failures that dilute the impacts of price signals on decision makers.

Technology R&D Policies:  Also Necessary, Also Not Sufficient

The most important of these “other market failures” is the public good nature of information.  Companies carrying out research and development (R&D) incur the full costs of their efforts, but they do not capture the full benefits.  This is because even with a perfectly-enforced system of intellectual property rights (such as patents), there are tremendous spillover benefits to other firms.  Decades of economic research – much of it by my former colleague and co-author, Professor Adam Jaffe, now Dean of Arts and Sciences at Brandeis University – has analyzed with empirical (econometric) analysis the remarkable degree to which inventions and innovations by one firm provide valuable information that leads to new inventions and innovations by other firms.

So, firms pay the costs of their R&D, but do not reap all the benefits.  The existence of this positive externality of firms’ R&D – or put differently, the public-good nature of the information generated by R&D – means that the private sector will carry out less than the “efficient” amount of R&D of new climate-friendly technologies in response to given carbon prices.  Hence, other public policies are needed to address this “R&D market failure.”

New path-breaking technologies will be needed to address climate change, and public support for private-sector or public-sector R&D will be crucial to meet this need.  But, at the same time, to address the climate-change market failure itself (that is, the externality associated with greenhouse gas emissions), carbon pricing will be necessary, for all of the reasons I gave above.  This is an application of an important and fundamental principle in economics:  two market failures require the use of two policy instruments.

Empirical analyses have repeatedly verified this crucial point – that combining carbon-pricing with R&D support is more cost-effective than adopting either approach alone.  Included in this set of studies are the following:  Carolyn Fischer (Resources for the Future) and Richard Newell (U.S. Energy Information Administration, on leave from Duke University), “Environmental and Technology Policies for Climate Mitigation”; Stephen Schneider (late of Stanford University) and Lawrence Goulder (Stanford University), “Achieving Low-Cost Emissions Targets”; and Daren Acemoglu (MIT), Philippe Aghion, Leonardo Bursztyn, and David Hemous (Harvard University), “The Environment and Directed Technical Change.”

Complements, Not Substitutes

An interesting, recent column, “Next Step on Policy for Climate,” by David Leonhardt in the New York Times (October 13, 2010, p. B1) might give some people the mistaken impression that technology policies are an adequate, even sensible substitute for carbon-pricing.  That was not the intended message of the column.  In fact, Leonhardt – perhaps the leading economic journalist writing today in the United States ­– indicates clearly in his column that he is skeptical of the notion of thinking of technology subsidies as an adequate substitute for carbon-pricing (in particular, cap-and-trade).  And in a follow-up post at the New York Times’ Economix, he makes clear that “these two policies are not mutually exclusive.”

Nevertheless, Leonhardt’s original column (which included a very nice profile of my colleague, Professor Michael Greenstone of MIT) focused attention on a recent report –  a report that could give the false impression that technology policies would be a sensible substitute for serious carbon-pricing.  The report in question – “Post-Partisan Power” – received significant coverage, primarily because of its sponsorship:  a combination of a prominent Republican-oriented Washington think tank, the American Enterprise Institute (AEI), and an equally prominent Democratic-oriented Washington think tank, the Brooking Institution (and a third partner, the Breakthrough Institute, a California-based environmental think tank).

The report may well garner some bi-partisan political support, because it promises a free lunch of painless, win-win solutions, a promise that will resonate with many elected officials.  Indeed, the report’s sub-title is “how a limited and direct approach to energy innovation can deliver clean, cheap energy, economic productivity, and national prosperity.”  What’s not to like? And the authors are presumably smart and politically shrewd.  I know that’s the case with the AEI author, Steven Hayward, who I debated last year in the pages of the Wall Street Journal.

To its credit, the report lays out a menu of policies intended to stimulate carbon-friendly technological change, ranging from $500 million of Federal government funding of K-12 curriculum development and teacher training to $25 billion annually of direct Federal funding of energy innovation.

For the reasons I explained above (the “R&D market failure” and the “carbon emissions externality”), both direct technology R&D policies and serious carbon-pricing are necessary, but neither is sufficient on its own.  Unfortunately, this new report ­­– and some of the press coverage surrounding it – makes the claim that such direct government funding of technology innovation is a sufficient and sensible substitute for meaningful carbon-pricing.  That claim is both unfortunate and wrong, as it is supported neither by sound reasoning nor empirical research, as I have described above.

Again, many of the individual technology policy recommendations offered by the AEI-Brookings-BI report are worthy of serious consideration (as a complement, not a substitute for an economy-wide carbon-pricing policy).  But the specifics – indeed, much of the meat – are missing.  “Reform the nation’s morass of energy subsidies” – yes, but exactly which subsidies (all of which have important political constituencies behind them) will be eliminated?  “Recognize the potential for nuclear power” – yes, and both the House and Senate carbon-pricing schemes would have provided tremendous incentives for nuclear power investment.

Overall, there should be concern about how all of this will be funded.  Where will the $25 billion per year come from?  The report appropriately states that this should not come from general revenues, and thus add to the Federal debt.  “Phasing out current subsidies for wind, solar, ethanol, and fossil fuels” could be meritorious on its own, but how much does this generate, and does it even pass a political laugh-test?  Interestingly, beyond this, despite considerable rhetoric about moving beyond debates about carbon-pricing, the report recommends that in order to avoid adding to the Federal debt, it would be necessary to impose new taxes, including increased royalties for oil and gas extraction, a tax on imported oil, a tax on electricity sales, and a “very small carbon price” (presumably from a modest carbon tax or unambitious cap-and-trade system).

The actual numbers would be helpful, and the political feasibility remains a serious question.  The political challenges that emerged in the effort to pass cap-and-trade climate legislation will not magically disappear if there’s an attempt to induce Congress to approve $25 billion in funding.  As Tom Friedman noted on October 12th in the New York Times, Congress has not come close to fully funding the outstanding requests for about $4 billion for ARPA-E (energy) research.

More broadly, despite the attraction of the AEI-Brookings-BI proposal as a potential complement to carbon-pricing (and I am serious that the proposal is of value in that context), one has to be very careful about comparing proposed new policies in idealized form (for example, precisely the right subsidies eliminated and precisely the right new subsidies introduced) with real policies with all their warts (for example, the cap-and-trade bill that was passed by the House last year).  Making such comparisons can lead to flawed analysis and misleading results.

This is not a new issue.  Robert Hahn and I wrote about this generic problem nearly 20 years ago in an article (“Economic Incentives for Environmental Protection:  Integrating Theory and Practice”) which appeared the American Economic Review Papers and Proceedings (May 1992).  At the time, our concern was that this mistake was being made not by the opponents but by the supporters of cap-and-trade and other (then essentially untested) market-based instruments.  We worried that “many analysts use highly stylized benchmarks for comparison that ignore likely political realities,” and suggested that an appropriate “comparison would be between actual command-and-control policies and either actual trading [cap-and-trade] programs … or a reasonably constrained theoretical … program.”

Likewise today, when carrying out comparisons of policy alternatives, it is fine to compare two theoretical, idealized alternatives, or to compare two real-world policies, but it is problematic and usually misleading to compare a theoretical, idealized policy of one type with a real-world example of another type of policy.

The Bottom Line

Carbon-pricing – whether carbon taxes or cap-and-trade – will be an essential part of any truly meaningful national climate policy.  Likewise, to address the “R&D market failure,” direct technology innovation policies will also be required.  Both are necessary.  Neither is sufficient.  These are complements, not substitutes.

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Postscript: Four years ago, the U.S. Congressional Budget Office (CBO) — widely recognized for its non-partisan, first-rate research — produced a study on the same topic as the AEI-Brookings-BI report, but did so with rigor and without ideology.  The CBO report — Evaluating the Role of Prices and R&D in Reducing Carbon Dioxide Emissions (September 2006) — was prepared by Dr. Terry Dinan, a long-time, respected CBO economist, and was peer reviewed by an impressive set of academic and other experts.  Sadly, the CBO paper received little press coverage, despite its high quality and its relevance.  For anyone interested in the topic of this post, particularly those who disagree with my theme, I hope you will read the CBO report.

Also, a reader of this blog post sent me a paper by David Hart and Kadri Kallas (from MIT’s Energy Innovation working paper series) that examines “Alignment and Misalignment of Technology Push and Regulatory Pull.” It’s worth reading in the context of combining carbon pricing and technology R&D policies.

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