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Simplifying carbon-emissions economics

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The name is a takeoff on Noah Smith’s clever writing about “101ism,” in which economics writers present basic Economics 101 concepts about supply, demand and how great markets are as gospel, and ignore the many ways in which economists have learned to qualify those conclusions in the face of market imperfections. His point is that while Econ 101 can be a very useful guide, it is sometimes (often) misleading when applied to the real world.

My point is somewhat different: Even when Econ 101 is right, that doesn’t always mean that it’s important – and certainly not that it’s the most important thing about a situation. In particular, economists may delight in talking about issues where Econ 101 refutes naïve intuition, but that doesn’t at all mean that these are the crucial policy issues we face.

The example I think of most is in my original home field of international trade. Comparative advantage says that countries are made richer by international trade – even if one trading partner is more productive than the other, and the less productive country can only export thanks to low wages. The economist Paul Samuelson once declared this the prime example of an economic insight that is true without being obvious – and to this day, you see furious attempts to refute it. So comparative advantage has, for generations, been considered one of the crown jewels of economic analysis.

There are a variety of reasons why, despite this big insight, free trade may not always be the right policy – that’s Mr. Smith’s 101ism. But I want to make a different point: Even if comparative advantage is a profound insight, does this make free trade versus protectionism a front-burner issue? How important is this insight, anyway?

And the answer – the one that emerges from standard trade models – is that it’s not as important as many people seem to think. Yes, protectionism reduces world income. But if you want to argue that trade liberalization has been the principal driver of growth, or anything along those lines, well, the economic models don’t support that. If you want enormous benefits from trade, you have to invoke things like technology transfer that aren’t in the very analysis that gives the case for free trade such prestige.

And in fact, you see a lot of this type of argument. There’s a kind of bait and switch going on, in which people invoke the gains from trade to say that free trade is good, then tell scary stories about how protectionism would destroy millions of jobs and cause a global depression, which doesn’t make much sense – and in any case has nothing to do with the classical analysis of the gains from trade.

It seems to me that there’s something similar involved in discussions of carbon pricing.

Econ 101 tells us that if you want to reduce emissions of a pollutant, the most efficient way to do that is to put a price on emissions so that all possible routes to reduction are taken, and the marginal cost is the same for all routes. It’s a real insight, and one that has had positive impacts on real-world policy – cap-and-trade programs, for example, have done a very good job of reducing acid rain.

That said, there are reasons Econ 101 may not be right here. There is some evidence that consumers aren’t hyper-rational when it comes to conservation, and that they may pass up conservation opportunities even when they could save themselves money – and in that case laws rather than prices might be the right way to make consumers change. And to the extent that we’re talking about innovation, the Econ 101 case says nothing at all: The efficiency case for carbon pricing is about making the best use of existing technology, not about providing incentives to develop better technology.

But let’s leave all this aside and ask: How important is it that our carbon-emissions strategy take the form of a universal or near-universal price on carbon?

The answer, in principle, is that it depends on the complexity of the required response. If reducing emissions has to involve movement on many fronts, anything that looks like an administrative solution – for example, telling power companies what they can or cannot do – is going to be much more costly than carbon pricing that exploits all the possibilities. But if a large part of the solution is going to involve a fairly limited set of measures – such as putting a quick end to the practice of burning coal to generate electricity – broad-based carbon pricing is much less central. And what I gather from reading various analyses of our prospects is that we’re closer to the latter than to the former: The problem of limiting climate change isn’t all that complex. End coal-burning, and you’ve gone a significant way forward. A few other big initiatives get you another substantial part of the way.

The point is that just because Econ 101 makes a smart, counterintuitive point doesn’t make that point of central importance. People should know what’s in their economics textbooks, but never imagine that it’s the be-all and end-all of what matters.

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