Friday, May 1, 2009

A Krugman Contradiction on Carbon Caps

As the vast army of loyal readers of this blog knows, I’m a strong proponent of capping carbon emissions. But I also think it is extremely important to be honest and accurate about the economic burdens a cap would generate so we can minimize, accommodate and distribute them fairly. Along those lines, I am happy to see that Paul Krugman is relaying the important research message that the income effects of a carbon cap would be minimal for at least the next several decades. Opponents of forceful measures to slow down climate change want us to confuse the transfers induced by a cap (which would be large) with the economic costs (small), so we need to get the message out at every opportunity that action is affordable.

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.


hapa said...

joe romm wrote up the krugman article here:

heads up, i passed him your article and he said, "I don't agree with that analysis. May have to blog on it."

that aside, if PK is talking about increasing productive spending during a downturn instead of promising green ponies, does that change your response?

Peter Dorman said...


Green stimulus is fine, no quarrel. The problem comes when PK touts the incentive for new private sector investment without giving consideration to the fate of old investment. This is not an idle theoretical question, by the way; the fate of many, many workers (many still unionized even now) hangs in the balance. I don't raise this because I'm trying to throw sand in the gears of climate action, but because (1) I think it's a solvable problem if we address it (which means facing it), and (2) failure to come clean on this issue discredits environmentalists -- rightfully -- in the eyes of labor.

But if Romm has an argument I haven't considered, I'm all ears.

hapa said...

yes, i understood that in your first statement.

i am personally acutely aware that there is good solid historical reason for public skepticism about the distribution of the costs and benefits of green transition. i talk about it frequently, both from the angle of owners who don't want their apple carts (of either gold or glory) knocked over, and the angle of a general public that was running to stand still before a single bank imploded, no small thanks to past broken promises.

i mean, who can promise that "this time will be different," when nobody can even pretend to promise that the US establishment will act prudently in the face of biosphere collapse?

people don't need revenue neutrality, they need their loads lightened, they need their futures brightened.

anyway i'm just as interested in what joe has in mind. i'll give you 3:1 it's got something to do with the costs of inaction.

Peter Dorman said...


Interesting: I've put my name to cost-of-inaction reports at the state level here in WA about how climate change is going to maul us if we don't make a serious effort to lower carbon emissions. But this is an argument against, well, inaction, not against the sort of policy analysis that can help us act better.

hapa said...

from reading joe for a couple years, and actually from having had a direct exchange with him about the need for net-more-affordable transition in-re devaluation (his side argued for financing; we were having a "different information" moment between bear stearns and the hammer fall), the only way i can remember him hitting the net-cost nail on the head was proposing to convert coal-fired plants into solar-thermal-assisted biomass burners.

Gar Lipow said...

This is one reason I argue for really large scale public investment. If we put hundreds of billions per year into green infrastructure we can can make up for premature depreciation of old capital.

hapa said...

i would prefer that approach to the one where we buy the coal plants and make them national parks

converger said...

In theory, your concern about throwing away existing capital stock makes sense. In practice, it does not.

If we do this thing, we are embarking on a two generation long infrastructure replacement project. We start by shutting down the zombie coal plants, the ones whose economic book value is zero and only continue to exist because they use loopholes in the Clean Air Act (not unlike loopholes being proposed in current climate legislation) to operate with zero emissions control of sulfur dioxide, nitrogen oxides, mercury, fine particulates, and a alphabet soup of toxics and heavy metals. The rest of the coal plants can run until their book life is zero. Then they disappear.

The rest of the infrastructure change looks similar. Going forward, you do it right. Where it makes economic sense to retrofit to best available technology, you do it (about half of the carbon reduction things that we can do to existing infrastructure are already cheaper than free). When old, yucky stuff wears out, you stop using it, having extracted most or all of its initial economic value. Over forty years, we get a shiny new low-carbon infrastructure, and hit our target.

It's complicated, but not complex. And it's not that expensive if we start doing the right thing sooner, rather than later.

Peter Dorman said...


(1) It's not just about coal. A lot of what we produce and where and how we produce it is tied to fossil fuel prices. (2) I'm not arguing against taking urgent action to reduce carbon emmissions. I am only saying that writedowns and job losses will loom in many industries, and we need to anticipate and offset them. In particular, environmentalists need to be able to look a worker from a threatened industry in the eye and say, I've considered your legitimate concerns, and part of my proposal directly addresses them. I can't say I see a whole lot of that right now.