On the capital stock front, though, Krugman is missing half the story. He says
Right now, the biggest problem facing our economy is plunging business investment. Businesses see no reason to invest, since they’re awash in excess capacity, thanks to the housing bust and weak consumer demand.
But suppose that Congress were to mandate gradually tightening emission limits, starting two or three years from now. This would have no immediate effect on prices. It would, however, create major incentives for new investment — investment in low-emission power plants, in energy-efficient factories and more.
To put it another way, a commitment to greenhouse gas reduction would, in the short-to-medium run, have the same economic effects as a major technological innovation: It would give businesses a reason to invest in new equipment and facilities even in the face of excess capacity. And given the current state of the economy, that’s just what the doctor ordered.
Yes but: the flip side of this new investment demand is accelerated depreciation (i.e. devaluation) of existing capital. This is not a minor matter. The capital stock we have in the present is the result of decades of systematic mispricing of scarce environmental goods, including the capacity of the global carbon cycle. If we correct those prices, many existing assets will have to be written down. The new-technology story is disingenuous: technological breakthroughs typically spur net investment because they create far more opportunities than they destroy, but the purpose of a carbon cap is above all to reduce the use of many existing technologies, and innovation is a (hopefully) mitigating byproduct. If you want a better analogy, think of what happened to the capital stock of eastern European countries in the years immediately following 1989. Suddenly their economies were open to international trade, and they were loaded with production facilities that cranked out goods that no one would buy any more. The result was a massive writeoff that plunged millions into unemployment.
It doesn’t have to be this way here. Certainly less of our capital stock is at risk from a carbon cap than in the eastern European case. Even more important is the fact that we are in a position to anticipate the problem; 1989 was a big unexpected shock. But we can’t plan ahead if we don’t see what’s coming. This is why it isn’t helpful to highlight the capital-replacing side of climate mitigation without taking note of the likely hit to existing investments. And to return to the current crisis, we should know by now that there are significant feedbacks from asset values to incomes, employment and even system stability.