April 10, 2009
Why a carbon cap should be the next US stimulus
Bridges vol 21, April 2009 / OpEds & Commentaries
The United States and many other countries' stimulus packages include provisions for green investments. That's good. After all, the economic and climate crises are intimately related. They share a similar structure - with greenhouse gas emissions and energy waste replacing toxic debt as the element that has gotten us into trouble. But green stimuli alone are not enough. A cap on carbon could provide the missing link.
President Barack Obama's stimulus package contains provisions to the tune of $100 billion in direct appropriations and tax breaks for green energy and energy efficiency. McKinsey, the management consultancy, estimates that the United States alone will require $1 trillion in added investment by 2020 to guide it onto a low-carbon pathway and meet climate policy goals. We cannot have one stimulus per year, every year between now and 2020, to meet the climate goals.
Similarly, we cannot depend on government spending alone to jump-start the economy. As a number of economists have argued, the key to pulling the US and world economies out of the Great Recession is what Larry Summers has called "the universal demand agenda." Where will that demand come from? Even if 10 stimuli might be out of the question, US lawmakers have already been talking about a second one. But government spending alone cannot be the answer.
A successful recovery will depend on massive investment by the private sector. That is where a cap on emissions comes in. The credit crunch obviously provides the biggest barrier to investment. But as the supply of credit begins to loosen up, we must also do everything we can to stimulate demand for investment. While the economy collapses, businesses - especially in the energy and manufacturing sectors - have held back investments in part because they are waiting for clear rules of what is going to happen in climate policy. By passing climate legislation that puts a cap on carbon, Congress can clear up regulatory uncertainty and help get capital flowing into clean energy.
Yes, consensus model estimates project that the economy would grow slightly more slowly under climate policy than under "business as usual" - although this effect amounts to only a few months of growth over two decades; and when you do an economic model that far into the future, the margin of error is likely too big to know if the cap will have any effect. Moreover, none of those models include the huge cost of allowing climate change to accelerate unchecked. Once you take the costs of inaction into account, it is far better, from an economic point of view, to act and act quickly.
Yet, most importantly, the "business as usual" path of these models is a Panglossian world with full employment of resources like labor, land, and capital. In such a world, any government policy is bound to be a drag on growth, since the modeled economy is humming along at full speed. This is clearly not the world we live in at the moment with skyrocketing unemployment, boarded-up homes, and shuttered factories. In the world of the Great Recession, a government policy that stimulates investment - like a cap on carbon - could well boost growth rather than slow it.
A carbon cap has another important feature that a carbon tax or other climate policies do not. A cap - even one that goes into effect in, say, 2013 - would help put assets on companies' balance sheets now. Businesses are holding back on investments in part because they need cash on hand to pay back their existing debt, since banks aren't giving out as many loans due to the credit crunch. The exact effect will depend on the detailed accounting rules, but give businesses additional assets and the financing equation will change in favor of increased spending and investment.
This holds true regardless of whether carbon allowances are given away for free or sold in an auction. Most businesses would, of course, prefer free allowances. Yet even auctioned allowances have benefits. The cost of these auctioned allowances would affect company balance sheets at the beginning of the program, while every incremental investment in low-carbon technology increases the value of carbon assets on the books now.
Of course, a carbon cap won't be a free lunch. Emitters will need to find ways to cut global warming pollution. There are lots of low- and even many no-cost opportunities available to do so, but some efforts clearly cost money and require additional investments. The point is that new investment is exactly what we want to have happen right now, when we face such massive underemployment of resources.
Dire economic headlines these days are only matched by equally worrisome news that our climate is changing faster than expected. The United States must lead in finding solutions to both crises. Deploying a cap-and-trade program to repower our economy should be an integral part of the way forward.
Posted by Gernot Wagner on Friday, April 10, 2009. 
