Why 3508 Economists Are Probably Wrong

On January 17, 2019, the Wall Street Journal published a statement signed by 3508 American economists, including four former chairs of the Federal Reserve, 27 Nobel laureates in economics, 15 former chairs of the Council of Economic Advisers, two former secretaries of the US Department of Treasury, and several economists who were my professors twenty years ago. The statement is so short that it is worth it to reproduce it in full.

Economists’ Statement on Carbon Dividends

Global climate change is a serious problem calling for immediate national action. Guided by sound economic principles, we are united in the following policy recommendations.

I. A carbon tax offers the most cost-effective lever to reduce carbon emissions at the scale and speed that is necessary. By correcting a well-known market failure, a carbon tax will send a powerful price signal that harnesses the invisible hand of the marketplace to steer economic actors towards a low-carbon future.

II. A carbon tax should increase every year until emissions reductions goals are met and be revenue neutral to avoid debates over the size of government. A consistently rising carbon price will encourage technological innovation and large-scale infrastructure development. It will also accelerate the diffusion of carbon-efficient goods and services.

III. A sufficiently robust and gradually rising carbon tax will replace the need for various carbon regulations that are less efficient. Substituting a price signal for cumbersome regulations will promote economic growth and provide the regulatory certainty companies need for long-term investment in clean-energy alternatives.

IV. To prevent carbon leakage and to protect U.S. competitiveness, a border carbon adjustment system should be established. This system would enhance the competitiveness of American firms that are more energy-efficient than their global competitors. It would also create an incentive for other nations to adopt similar carbon pricing.

V. To maximize the fairness and political viability of a rising carbon tax, all the revenue should be returned directly to U.S. citizens through equal lump-sum rebates. The majority of American families, including the most vulnerable, will benefit financially by receiving more in “carbon dividends” than they pay in increased energy prices.

This statement by such an impressive array of economists is to be celebrated. It would be nice if it were a step toward the implementation of policies to slow down the progress—now fast and accelerating—toward climate change planetary catastrophe. The statement reveals a whole new stance of the economic profession, miles away from the time when economists were almost at the vanguard of climate change denialism. Because, it must be remembered, even after the Kyoto Protocol had been signed in 1997, in 2004 the so-called Copenhagen Consensus led by the climate-change skeptic Bjørn Lomborg and including nine prominent economists among them four Nobel laureates, ranked global warming as a not very important issue and concluded that plans to deal with climate change were too expensive. It must be remembered too that in a reedition of the Copenhagen Consensus only ten years ago, the same panel of economic experts, slightly changed, downplayed again the importance of climate change. Now over 3500 economists assert that global climate change is a serious problem calling for immediate national action. And furthermore, they recommend a specific course of action, a revenue-neutral carbon tax increasing every year until the goals in emission reduction are met.

For sure, this statement should be considered a personal victory of James Hansen, the NASA climatologists who started asking for a tax scheme exactly like this—Hansen explained his plan as a “carbon fee with full reimbursement”—long ago. Over the past decade Hansen advocated for this type of carbon tax while strongly opposing the cap-and-trade policies for CO₂ recommended by many economists. Perhaps it is not by chance that Paul Krugman, who repeatedly argued for cap-and-trade policies, is not among the 3508 signatories of the Wall Street Journal statement.

Cap-and-trade policies involve the distribution by the government of permits to pollute, and the establishment of a cap for pollution, to be lowered in the near future. This will supposedly stimulate polluters to both reduce pollution and buy and sell permits to pollute. A cap-and-trade policy to curb emissions has been in place in the European Union since 2005, under the name of the European Emissions Trading Scheme (ETS), which also covers non-EU countries such as Norway, Iceland, and Switzerland. Though some European companies made millions by trading permits in the context of the ETS, the system has had very poor evaluations in terms of effectiveness to cut emissions. Prices of permits for emissions—a key indicator of how the scheme is affecting markets—have been volatile since the system started and most of the time oscillated below €10 per tonne of CO₂. But it is usually agreed that permit prices below €35 or €40 will have no effect at all on emissions or investment plans. In the US, though a variety of plans are under study, California is the only state where a policy to reduce emissions has been in place for a while—a cap-and-trade scheme that started in 2013. Regretfully, there is no evidence that the policy is having any effect. Indeed, emissions in California increased in 2013–2015 while decreasing in most of the states and in the nation at large. The period during which the Californian scheme to cut CO₂ emissions has been in place is short, but the preliminary estimates do not provide any evidence that it has been effective. The opinion of James Hansen that cap-and trade policies are useful to “fleece the public out of billions of dollars,” but not to curb emissions, seems to be supported by the facts.

Experience with carbon taxes is much more limited. The Canadian province of British Columbia implemented a carbon tax in 2008 and Alberta implemented one in 2017, but these Canadian carbon taxes differ from the scheme proposed by Hansen—and now by the 3508 US economists—in that they are not revenue-neutral by design, though the provincial governments implementing them claimed to make them revenue-neutral by cutting other taxes. The policy put in place in British Columbia has had mixed evaluations in terms of its effectiveness in cutting emissions. At any rate, these experiences are quite recent and none of them has been a national policy, so that there is only a limited experience to assess their efficiency to accomplish the purpose of reducing emissions.

Given the evidence piling up from Europe and California that cap-and-trade schemes are not effective for curbing emissions, any rational person who is not a climate-change denier would be open to other policies. Therefore, the statement of the 3508 economists advocating a carbon tax is to be welcomed. However, considering the position on climate change of the Trump Administration, the odds that such a tax be implemented in the near future look quite slim.

Leaving aside the merits of the proposal or the prospects that it will be implemented in the near future, it seems to me these economists are likely to be mistaken in one aspect of their statement. The economists say that a “sufficiently robust and gradually rising carbon tax” not only will replace the need for less-efficient carbon regulations but “will promote economic growth.” In my view, this is very likely, wrong. Let me explain why.

“Economic growth” refers to the growth of gross domestic product, GDP, a number that measures the aggregate economic activity in money units. Since data has been available, CO₂ emissions and GDP have been strongly linked, both in each country and in the global economy. Overall emissions tend to follow GDP very closely: when GDP rises emissions are generally higher and when GDP decreases during recessions, emissions decline. Though the correlation is not absolute, the link is very strong and observable in the data of past decades for basically all countries and the world economy. There are indeed a few countries in which emissions have declined at the same time that GDP has increased, for specific reasons such as deindustrialization or nuclearization, but these nations are exceptions that prove the rule. Because of this strong link, it seems quite clear that something that shrinks emissions will also shrink GDP.

Geoscientists and climatologists have explained that climate change is due to human activities, because humans produce greenhouse gases, mainly CO₂. That does not mean that every human activity contributes to climate change. Human activities that produce emissions of greenhouse gasses are generally economic activities, that is, activities that produce monetary value and contribute to GDP. Activities such as driving or flying, eating in restaurants, buying books, furniture, or houses—all involve the consumption of commodities to which value has been added and therefore are economic activities contributing to GDP. However, human activities such as reading books borrowed from a library or a friend, strolling in a public park, playing music, cards, or chess with acquaintances, or making love are not economic activities, because they do not contribute added value to GDP. What is important here is that economic activities almost always imply important uses of exosomatic energy, i.e. energy not generated by the body itself. Given the present ways to produce that kind of energy, economic activities require the burning of fossil fuels. Conversely, non-economic human activities generally imply zero or almost zero CO₂ emissions.

Now, if the carbon tax with full reimbursement proposed by the economists were to be implemented, what would be the expected effect on emissions and economic growth? The economists say emissions will fall and GDP will grow. This is very doubtful because of the strong link between economic activities and emissions, but let’s have a closer look.

First of all, because of the tax, the price of energy would rise since most energy is generated from fossil fuels, and most prices would increase to some extent, because basically all commodities are produced with substantial inputs of energy. This increase in prices will tend to reduce consumption and overall demand. Second, beyond the short run, the rise of energy prices would represent a stimulus for the development of zero-emission sources of energy, such as wind, solar, or nuclear. Third, because of the tax “dividends” that would be distributed to the public, mostly of lower income, the latter would benefit in the short run “by receiving more in ‘carbon dividends’ than they pay” in increased prices; this will tend to compensate for the reduction in consumption due to increased prices.

However, the combined net effect of that redistribution of income and increase in prices is not obvious a priori. The experience of taxation from the 19th century to the present demonstrate quite solidly that taxes, almost without exception, reduce consumption. However, because of the so-called Veblen effect, for some luxury goods the quantity demanded increases when the price rises. Would this operate for air flights, cars, or electricity when their prices increase significantly because of a carbon tax? We actually do not know. The extrapolation of past experiences can be misleading, even more because in many aspects the carbon tax would be an economic experiment without precedent. At any rate, it seems unarguable that the most likely net effect of the increased prices of fossil fuel-derived energy and added purchasing power would, in the short run, be a shift of the use of time toward non-economic activities. That is, activities not implying the use of commodities, and an increase in the rate of saving. We would expect fewer air flights and less driving, more naps, more chatting with friends, eating more at home and out less often, and reading more old books and watching old DVDs rather than shopping for new items. Both a rising saving rate and a drop in consumption would curb profits of firms and effective demand, with a consequent decline in investment and a reduction in economic growth. Of course, all that that assumes that the tax would have a sufficient effect on emissions. It might be that the tax is so small that it will have no effect on economic growth, but if that is the case, it will also very likely be ineffective with respect to emissions.

The scale of the economic consequences to be expected from a carbon tax with full reimbursement, like the one proposed, is such that it would be arrogant and irresponsible to think that previous taxation experiences could be directly applied to forecast its results with great confidence. It seems quite obvious that, given the strong link between GDP and emissions, the most likely effect in the short run will be a change of both numbers in the same direction. If that is the case, the proposed scheme will reduce emissions and GDP and the 3508 economists would be wrong about continuing growth.

Apart from effects on consumption patterns, it must be remembered that fossil fuels have key roles in our world. They are hardly substitutable in domestic and international transportation, trade, and tourism—key components of almost any national economy today, as is proven, for instance, by the fact that driving-related jobs are number one in most states of the US. Furthermore, in the context of the global economy, countries such as Russia, Saudi Arabia, Venezuela, Norway, Iran, Australia, and many others depend on fossil fuels for maintaining their level of income. Given these constraints, a scheme to strongly tax fossil fuels and return the revenue to the public—which as proposed by the 3508 economists would be extended from the United States to the rest of the world—would represent a major tinkering with key flows of money within and between countries.

The rub of the issue is that the carbon tax is one of the most ambitious plans of social engineering ever proposed. Precaution is a big must in social engineering and many reservations should be made about the likely consequences of such kind of plans, because our ability to predict the consequences of tinkering with social arrangements is, demonstrably, very low. Social engineering has been usually repudiated by economists. In the tradition of Adam Smith’s “invisible hand,” the market is supposed to be the institution that harmonizes individual actions so that they produce a symphony of economic efficiency and not a cacophony. According to the classical tradition in economics, conscious social action is basically unneeded. But the invisible hand is highly visible (pun intended) in point 1 of the economists’ statement. These 3508 economists want to have it both ways. They tell us that “a carbon tax will send a powerful price signal that harnesses the invisible hand of the market.” For what? To create a green capitalism in which CO₂ emissions will no longer be produced because of the influence of an increasingly heavy carbon tax. But a “harnessed invisible hand” is no longer either invisible nor “of the market.” What we have here is the implicit acknowledgement by 3508 economists that climate change demonstrates a huge failure of the market economy, one that demands social engineering

Maybe that is a good start. The time to deal with climate change is getting shorter and shorter. If major climate disasters like the droughts and wildfires worldwide of the past three years and the recent flooding in Africa become more frequent, as it is to be expected, chances are that “every man for himself” will become increasingly the determinant of individual and collective actions. And then, in the midst of desperation, riskier “solutions” than social engineering to ameliorate the total disruption of planetary climate will become more attractive. I am of course referring to geoengineering, i.e., the development of large-scale physical or chemical procedures to alter solar radiation reaching the earth or the ability of the atmosphere to capture heat, or some other “tinkering” with the components of the Earth climate system.

For the moment, the most important issue is not whether the proposed plan will curb emissions, because another question comes first: Will it be put in place? I think not, because our social and economic system imposes many constraints on what actually can be done.

Karl Marx, Marion King Hubbert, and Nicholas Georgescu-Roegen highlighted a number of key aspects of capitalism that make it a system with an expiration date, but most economists are oblivious to these aspects and think this system can continue happily growing for eternity. That is the main reason why in this statement the 3508 economists are very likely wrong. I also might be wrong in my expectation that the carbon tax will not be implemented in the near future, indeed, I hope to be wrong.

Sources and references

For details on the so-called Copenhagen Consensus, see my chapter with O. Carpintero, “Dynamics and economic aspects of climate change”, Chapter 3 in Kang MS, Banga SS, eds., Combating Climate Change: An Agricultural Perspective. New York, CRC Press, 2013.

For the lack of effectiveness of schemes that have been tried to curb emissions, see Spash CL, “The Brave New World of carbon trading” (New Political Economy, 2010 Vol. 15, No. 2, pp. 169-95) and Tapia JA, Spash CL, “Policies to reduce CO₂ emissions: Fallacies and evidence from the United States and California” (Environmental Science & Policy 2019, Vol. 94, pp. 262-6). For the link between economic growth and CO₂ emissions, see Tapia JA, Carpintero O, Ionides E, “Climate change and the world economy: short-run determinants of atmospheric CO₂” (Environmental Science & Policy 2012, Vol. 21, pp. 50-62), and Tapia JA, “Fairy Tales About Climate Change” (brooklynrail.org/2019/03/field-notes/Fairy-Tales-About-Climate-Change).

Those interested in the views of Karl Marx should read the three volumes of his key work, Capital—A Critique of Political Economy, or at least the first one. Georgescu-Roegen’s key work is The Entropy Law and the Economic Process (Harvard University Press 1971) though his “Energy and Economic Myths” (Southern Economic Journal, Vol. 41, No. 3, pp. 347-381, 1975) says much of what is pertinent here. The geophysicist Marion King Hubbert exposed very clearly the absurdity of the key element of economic thought in most of its varieties in his chapter “Exponential growth as a transient phenomenon in human history” (in Societal issues, scientific viewpoints, ed. by Strom MA, American Institute of Physics, 1987).