Alan Krueger, Assistant Secretary of the Treasury for Economic Affairs, suggested in a recent speech a useful metaphor to distinguish different kinds of economic indicators. Some indicators are like the gauges on the dashboard of the car — industrial production, unemployment, inflation and so on.  They give the latest bits of information on the business cycle outlook, for businesspeople, government policy-makers, economic forecasters, and anyone else who wishes to follow such developments at high frequency. Many of these numbers are collected on a monthly basis. Other statistics are like the results of 10,000 mile checkups – the poverty rate, infant mortality, life expectancy, carbon emissions, natural resource depletion, the crime rate, traffic congestion, leisure time, and other measures of inequality, health, the environment and the quality of life.  They supplement market-measured activity and are needed in order to get a comprehensive feel for welfare and the longer term sustainability of the economy. This second category of statistics is more often collected on an annual basis.

GDP is the single indicator that gets the most attention. Lately much of that attention has been very critical. In late September, the most recent in a long line of critics weighed in. This group was weighty indeed: the Commission on the Measurement of Economic Performance and Social Progress was created by French President Nicolas Sarkozy, chaired by Joseph Stiglitz, chair-advised by Amartya Sen, and coordinated by Jean-Paul Fitoussi.  Nobel-Prize winners abound. The Commission believes that we have been focusing too much on market-measured output:   “By their reckoning, much of the contemporary economic disaster owes to the misbegotten assumption that policy makers simply had to focus on nurturing growth, trusting that this would maximize prosperity for all. “What you measure affects what you do,” Mr. Stiglitz said…”If you don’t measure the right thing you don’t do the right thing.” (New York Times, Sept. 23, 2009.)

I certainly agree that the non-market variables are important, both in the sense that they should be measured well and in the sense that policy-makers should put some priority on them as objectives. But I question whether the measurement issue and the objective issue are as closely linked as many would have it. I especially question any claims that the role of GDP should be in practice be replaced with a single concept that factors in these other measures of the health, inequality, the environment, etc.    GDP is a comprehensive measure of market output, is available quarterly, and belongs on the dashboard. The other variables are typically available only annually, and there is no way to know how to aggregate them into a single number, let alone to aggregate them together with the standard economic measures. By all means, take the 10,000 mile checkups seriously. But don’t remove GDP from the dashboard.

I am not sure I see the claim that the measurement problem is the reason for the myriad errors our national policy makers have made in recent years (notwithstanding the Bush Administration’s notorious downgrading of science). We have perfectly good tools for helping to make decisions about environmental regulation, for example, in the form of cost benefit analysis.  GDP measurement issues have nothing to do with that. Perhaps you believe that a Republican Administration may want to pressure the EPA to count some environmental damages at zero or suppress the evidence entirely; perhaps you believe that a Democratic Administration may want to count some economic costs at zero or abandon cost benefit analysis entirely. Yes, that would have a big effect on the policy decision. But what does any of it have to do with GDP?

In the same newspaper reporting Joe’s comments, I read of a development that has received mysteriously little attention: according to numbers from the Energy Information Agency, greenhouse gas emissions fell sharply in 2008 (by more than 2 ½ %), are falling even more in 2009 (about 6%), and in the next few years are almost certain to remain easily below the levels of 2005.   (See the chart below.)  The oil price spike in 2008 deserves some credit. Some might wish to try to give some credit to policy too. But there can be no doubt that the main reason for the sharp fall in emissions is the recession. A simple statistic for the unitiated: although CO2 emissions in an average year rise by 0.8%, they fell that much in both 1991 and 2001, the last two recessions, in addition to the much larger drop in the much larger recent recession. That is not a coincidence.

How should one value a 9 percent fall in emissions against a 3.8% fall in real GDP (from the 2007Q4 peak to the 2009Q2 apparent-trough)? I strongly suspect that a majority of Americans, no matter how well-informed regarding the science, would think that the output loss outweighs the climate benefit by far. A minority, in favor of very drastic action on climate change, might implicitly choose the other way. (I myself am in favor of pretty serious action, but not in favor of policies that impose huge economic costs, either because they are too drastic or are designed in an inefficient way. And of course engineering a recession would be a very inefficient way to do it.) Are Joe Stiglitz and Amartya Sen among those who think we are better off on balance? I have no idea. To ask the question is to help illuminate why attempts to sum everything up into a single number, such as “Green GDP,” fail.

Incidentally, if Joe does think that the estimated 9 percent fall in emissions outweighs the 4% loss in GDP, then he doesn’t think that our current situation constitutes a “contemporary economic disaster,” but, rather, a gain in welfare.  It would then logically follow that any policy decisions that got us into this situation (whether attributable to incomplete information about banking activity or inequality or anything else), were good, not bad!

Source: US Energy Information Agency

[Readers wishing to post comments are referred to SeekingAlpha.]

National leaders are meeting at the United Nations in New York today, to discuss the climate change negotiations.    Talks will continue at the G-20 meeting in Pittsburgh later in the week.   But hopes look very bleak for progress sufficient to produce at Copenhagen in December a successor treaty to the Kyoto Protocol.   The biggest roadblock is the familiar game of “After you, Alphonse.”  The United States will not accept quantitative emission targets unless China, India and other developing countries do the same, at the same time.    But the developing countries will not cut their emissions below the Business as Usual path (BAU) unless the rich countries go first. 

My own proposal for how to break the deadlock is a plan that tries in a politically realistic way to assign emission targets, leaving no country feeling it is being asked to incur an economic cost that is unfair or too large.    The targets are derived from a family of formulas   The specific detailed example of the plan that I have given in the past attained an environmental target by the year 2100 of CO2 concentrations equal to 500 ppm.  It did so without violating the political constraints, which included the constraint that no country is asked to accept an ex ante target that costs it more than 1% of income in present value, or more than 5% of income in any single budget period.

The G-7 leaders, meeting in Italy in June 2009, set a more aggressive collective goal, corresponding approximately to concentrations of 380 PPM.   I have recently been trying to hit that goal, working with Valentina Bosetti, within the same political constraints and framework of formulas.    To achieve the more aggressive environmental goal, we advance the dates at which some countries are asked to begin cutting below BAU.  We also tinker with the values for the parameters in the formulas (parameters that govern the extent of progressivity and equity, and the speed with which latecomers must eventually catch up).   The resulting target paths for emissions are run through the WITCH model to find their economic and environmental effects.   We find that it is not possible to attain the 380 ppm goal, subject strictly to our political constraints.  We are, however, able to attain a concentration goal of 460 ppm with somewhat looser political constraints. 

Some may conclude from these results that the more aggressive environmental goals are not attainable in practice, and that our earlier proposal for how to attain 500ppm is the better plan.   We take no position on which environmental goal is best overall.   Rather, we submit that, whatever the goal, our approach will give targets that are more practical economically and politically than approaches that have been proposed by others.

[Readers wishing to post comments are referred to the SeekingAlpha version.]

On her visit to India two days ago, Secretary of State Hillary Clinton was publicly rebuffed when she raised the problem of global climate change.    The Indian environment minister declared “we are simply not in the position to take legally binding emissions targets.”

No single country can address this problem on its own.  Hence the international negotiations that will take place in Copenhagen in December to try to find a successor treaty to the Kyoto Protocol.   But the international effort has run into a seemingly insurmountable roadblock.     On the one hand, the US Congress is clear: it will not impose quantitative limits on US emissions of greenhouse gases if China, India, and other developing countries don’t impose quantitative limits on theirs.   Indeed, that is why the Senate was unwilling to ratify the Kyoto Protocol ten years ago. The logic seems completely reasonable:  why should US firms bear the economic cost of cutting emissions if carbon-intensive activities would just migrate to countries without caps and global emissions continue their rapid rise?   On the other hand, the leaders of India and China are just as clear:   they are unalterably opposed to cutting emissions until after the United States and other rich countries go first.   And why should they?   The industrialized countries created the problem of global warming, in the process of getting rich;  the poor countries should not be denied their turn at economic development.  As the Indians point out, Americans emit more than ten times as much carbon dioxide per person.      

A total impasse.  Or is it?   I see one — and only one – practical solution to this apparent Catch-22:   The United States agrees to binding emission cuts — something like those in the Waxman-Markey bill that passed the House of Representatives on June 26;  and, simultaneously, China, India, and other developing countries agree to a path that immediately imposes on them binding emission targets — but targets that in their early years simply follow the so-called Business-as-Usual (BAU) path.    BAU is defined as the rate of increase in emissions that these countries would have experienced anyway, in the absence of an international agreement, as determined by experts’ projections.

The idea of developing countries committing only to BAU targets would provoke outrage from both environmentalists and US business interests, because it does not obligate these countries to cut emissions.  But both of those groups should realize that this commitment would be far more important than it sounds. It would preclude the carbon leakage which, absent such an agreement, would undermine the environmental goal.  It would mitigate the competitiveness concerns of carbon-intensive industries in the rich countries.  

This approach recognizes the reality that it would be irrational for China and India to agree to substantial cuts in the short term.   Indeed these countries, for their parts, will probably react with outrage at being asked to take on binding targets of any kind at the same time as the United States.   But they should also come to realize that they would actually gain in strictly economic terms from such an agreement, by acquiring the ability to sell emission permits at the world market price.

Of course an environmental solution also requires that China and the others subsequently make cuts below the Business as Usual path in future years, and eventually make cuts in absolute terms.   This can be done in such a way that the developing countries are not asked to make cuts that are different in nature than those made by Europe, the United States, and others who have gone before them, taking due account of differences in income.  But no country – rich or poor – will make sacrifices in any given period that impose huge economic costs on it.   It is time to stop making sweeping proposals that assume otherwise, and to pursue instead the narrow thread of the politically possible.

The effects of a changing global climate show up gradually, decade by decade. The effects of a changing US political climate have also been showing up gradually, year by year. A watershed was reached June 25, when the US Congress for the first time approved a bill to limit emissions of Greenhouse Gases (GHGs), by a vote of 219 to 212. But the Senate hurdle will be tougher.  The attempt to address Climate Change still has a very long way to go.

The problem

Climate Change is of course a global externality. Due to the free-rider problem, no single country, especially the United States, is likely to act on its own. The best solution is a multilateral treaty in which all countries commit to serious action together. In December of this year, a Conference of Parties to the UN Framework Convention on Climate Change will meet in Copenhagen, in the hope of negotiating a successor treaty to the Kyoto Protocol.

Three critical attributes were missing from the Kyoto Protocol. These attributes need to be included in any realistic attempt to tackle the reduction of year-2100 GHG concentrations to levels considered less dangerous by scientists:

i) Comprehensive participation – that is, acceptance of quantitative limits on emissions – by all major countries, including the US and developing countries.

ii) A credible framework that can establish a path for emissions reductions extending throughout the century, not just five years ahead.

iii) Some reason to think that all countries will be willing to join and then comply. This precludes targets that impose enormous economic costs on any major countries in any decades relative to the alternative of dropping out of the treaty.

For ten years — since I worked on Kyoto in the Clinton Administration — I have been thinking about how to design such a framework for assigning quantitative limits across countries. I now have a complete proposal to offer. It builds on the foundations of Kyoto, in that it accepts the framework of national targets for emissions and internationally tradable permits. But it attempts to solve the most serious deficiencies of that agreement: incomplete country participation, the need for long-term targets, and the economic incentive for countries to fail to abide by their commitments.

Although there are many ideas to succeed the Kyoto Protocol, the existing proposals are typically based on just one or two out of the following three philosophical approaches:

· science (e.g., capping global concentrations at 450 ppm) or

· equity (e.g., equal emissions per capita across countries) or

· economics (weighing the economic costs of aggressive short-term cuts against the long-term environmental benefits).

My emissions reductions plan is a bid to offer a more practical alternative: in addition to those three considerations, it is based heavily on politics.

More specifically, any future climate agreement must in practice comply with six important political constraints.

1) The US will not commit to quantitative targets if China and other major developing countries do not commit to quantitative targets at the same time, due to concerns about economic competitiveness and carbon leakage.

2) China and other developing countries will not make sacrifices different in character from those made by richer countries that have gone before them.

3) In the long run, no country can be rewarded for having “ramped up” its emissions high above the levels of 1990.

4) No country will agree to participate if the present discounted value of its future expected costs is more than, say, 1% of GDP.

5) No country will continue to abide by targets that cost it more than, say, 5% of GDP in any one budget period.

6) If one major country drops out, others will become discouraged and the system may unravel.

The proposal

The proposed plan sets the emissions caps using formulas that assign quantitative emissions limits to countries in every five-year period from now until 2100. Operationally, four political constraints are particularly important in specifying the formulas.

· First, “carbon leakage” is precluded, by including all countries from the beginning

· Yet developing countries are not asked to bear any cost in the early years.

· Even later, developing countries are not asked to make any sacrifice that is different from the earlier sacrifices of industrialized countries, accounting for differences in incomes.

· Finally, no country is asked to accept targets that cost it more than 1% of GDP cumulatively, nor more than 5% of GDP in any given budget period.

Under the formulas, rich nations begin immediately to make emissions cuts in line with what their leaders have already committed to.  Developing countries agree to maintain their business-as-usual emissions in the first decades, but over the longer term agree to binding targets that ultimately reduce emissions well below business as usual. This structure precludes energy-intensive industries from moving operations to developing countries (i.e., leakage) and gives industries a more level playing field. However, it still preserves developing countries’ ability to grow their economies; they can even raise revenue by selling emission permits. In later decades, the emissions targets asked of developing countries become stricter, following a numerical formula. However, these emissions cuts are no greater than the cuts made by rich nations earlier in the century, accounting for differences in per-capita income, per-capita emissions, and baseline economic growth.

More specifically, the formula incorporates three elements: a Progressive Reductions Factor, a Latecomer Catch-up Factor, and a Gradual Equalization Factor.

· The Progressive Reductions Factor requires richer countries to make more severe cuts (relative to their business-as-usual emissions) than poor countries.

· The Latecomer Catch-up Factor requires nations that did not agree to binding targets under Kyoto to make gradual emissions cuts to account for their additional emissions since 1990. This factor prevents latecomers from being rewarded with higher targets, or from being given incentives to ramp up their emissions before signing the agreement.

· Finally, the Gradual Equalization Factor addresses the fact that rich countries are responsible for most of the carbon dioxide currently in the atmosphere. During each decade of the second half of the century, this factor moves per capita emissions in each country a small step in the direction of the global average of per capita emissions.

The formulas, for some convenient parameter values, turn out to imply that global emissions peak around 2035.  (See graphs below.) This targets result in a world price of carbon dioxide that reaches an estimated $20-$30 per ton in 2020, $100-$160 per ton in 2050, and $700-$800 per ton in 2100, according to economic simulations using the WITCH climate model courtesy of Valentina Bosetti. Most countries sustain economic losses that are under 1% of GDP in the first half of the century, but then rise toward the end of the century. The simulations also show that atmospheric concentrations of CO2 stabilize below 500 ppm in the last quarter of the century, and world temperatures increase by about 3 degrees. Each of the six political constraints listed above is satisfied.

Conclusion

The framework here allocates emission targets across countries in such a way that every country is given reason to feel that it is only doing its fair share, comparable to what  others have done before it. Furthermore, the framework – a decade-by-decade sequence of emission targets determined by a few principles and formulas – is flexible enough that it can accommodate major changes in circumstances during the course of the century. The hope is that only such a combination of continuity and flexibility can make the process dynamically consistent, i.e., credible.

Most climate scientists say that 500 ppm is not a sufficiently aggressive goal. We (my collaborator, Bosetti, and I) have not yet been able to achieve year-2100 concentrations of 450 ppm while obeying the same political-economic constraints. But we are still working on it. Stay tuned.

The detailed proposal is “An Elaborated Proposal for Global Climate Policy Architecture: Specific Formulas and Emission Targets for All Countries in All Decades,” NBER WP, April 2009. Forthcoming, 2009, in a volume edited by Joe Aldy & Rob Stavins for  the Harvard Project on International Climate Agreements, Cambridge University Press. Editors’ summary of the volume is at Post-Kyoto International Climate Policy, Cambridge University Press.   (See also Stavins’ blog, especially, for analysis of the Waxman-Markey bill.)

[Readers wishing to post comments are referred to the version of this post on the RGE site.]

I was recently asked by the National Journal to comment on what I thought was a desirable path for tax reform, if one could wish away political constraints that normally handcuff politicians.   My answer was, of course, to tax energy, particularly carbon emissions, and use the revenue to reduce other taxes.  As I and many others have noted often in the past, taxes on oil or gasoline hit many birds with one stone.

Discussion of energy taxes has always been political suicide. But here are several twists that could potentially increase the ability of the electorate to swallow them politically:

1) The energy taxes would not go into effect until the economy fully recovers from the current recession, thereby avoiding an abortion of the recovery. But the plan would be announced in the near future (thereby sending desirable allocational signals to firms building power plants or pursuing renewable energy research).

2) Such measures could be on stand-by, to be enacted in the event of a major unfortunate geopolitical setback in the Middle East or a tragic terrorist event, which would galvanize public opinion to do something sensible for the first time about the extent of US dependence on oil imports.

3) A tax on, e.g, gasoline could be designed to put a floor under the current price. The status quo always generates less political resistance than a tax that raises the price.

4) The revenue from the first penny per gallon could be earmarked to fund the deficit in social security benefits of those retiring in 2027, for example. They were born in 1962, and know who they are. The revenue from the second penny could be used to finance the benefits of those retiring in 2028, and so on. (Numbers are illustrative. I haven’t done the actual calculations.) The result would be to create a constituency for keeping the tax in place, namely those whose retirement benefits are funded with the proceeds.

Politicians are often tempted to think that a policy to help one goal, say air quality, must also help lots of other goals, say economic growth.  Economists are more likely to presume tradeoffs, and to use the principle of targets and instruments.  That principle says that you cannot expect to hit more than one bird with one stone, except by coincidence.

At the American Economic Association meetings in San Francisco, January 3, I was on a panel titled “Energy and the Environment: Policy Advice for the New Administration” (along with some real energy experts; I am a relative latecomer to the area).  Within the framework of targets and instruments, I proposed a matrix such as the one that appears below. (more…)

(Incidentally, the July Snowmass presentations regarding Integrated Assessment models of the effects of such emission-reduction policy plans, which I plugged in my preceding blog post, are now accessible to the public.)

But issues of competitiveness and how to address it have risen to the top in the climate change policy debate among politicians.      The Lieberman-Warner bill - would have required the president to determine what countries have taken comparable action to limit GHG emissions;  for imports of covered goods from covered countries, the importer would then have had to buy international reserve allowances – equivalent to a tariff.  (The same with some of the bill’s competitors such as the Bingaman-Specter “Low Carbon Economy Act” of 2007.) 

In theory, there is a possible legitimate role for border adjustments in facilitating a multilateral regime such as the Kyoto Protocol.  One might think of penalties on carbon-intensive imports:

1.      as sanctions to apply pressure on non-participants,

2.      as a calibrated “countervailing duty” to equalize a distortion that will otherwise see carbon-intensive activities migrate to less-regulated countries (a phenomenon known as leakage)   or

3.      as political reassurance to domestic firms worried about their international competitiveness.

If designed properly, they need not necessarily be inconsistent with the WTO (World Trade Organization).    There are precedents, most importantly (and most ironically) the famous/infamous shrimp/turtle case.

But U.S. politicians are unlikely to do it properly.   They may be unaware that the US is more likely to end up as the target of such tariffs than as the enactor – to end up as the defendant, rather than as the prosecutor.   The European Union is way ahead of us in cutting back GHG emissions under the Kyoto protocol, and its EC Directive earlier this year had similar language calling for penalties aimed at shirking competitors.   That’s us.  The difference between their provisions for dealing with shirkers and ours is that their system is already in operation, while for the time being, we are the shirkers.  So US politicians had better look before they leap on this one.

The Brookings Institution had a conference in June that was well-focused on this set of policy issues, organized by Lael Brainard.  Interested readers can link to the papers at Climate Change, Trade and Competitiveness: Is a Collision Inevitable ?    Mine was titled  “Addressing the Leakage/Competitiveness Issue In Climate Change Policy Proposals,” in the panel on Proposals to Deal with Leakages.   

 The issues are reminiscent of larger fears on the part of anti-globalizers — that the WTO and free trade are obstacles to environmental regulation more generally — fears that I think are largely misplaced.   With well-designed multilateral policies, we can work to protect the global environment while simultaneously preserving the economic advantages of free trade.

I am also working on a broader project to address the design of climate change policy architecture as part of the HPICA initiative at Harvard directed by Joe Aldy and Rob Stavins.

[Any readers wishing to comment on this blog post: I suggest you go to the RGE version.] 

Ten years ago this summer, President Clinton’s Council of Economic Advisers, of which I was a Member, responded to requests from the Congress, which was then under Republican control, to explain in analytical terms what would be the economic effects of the Kyoto Protocol on climate change that had just been negotiated among the members of the UN Framework Convention on Climate Change.  Our response was a document called the Administration Economic Analysis.   It relied on some of the leading Integrated Assessment Models, and showed that the costs of Kyoto could be relatively low provided international trading of emission permits were freely allowed, and provided developing countries participated in the system.    Not zero costs, as wishful thinking by some techno-optimists would have it.  Not prohibitive costs, as some skeptics would have it.   But moderate costs — relatively low if measures could be implemented sensibly.

Integrated Assessment Models are designed to assess both the economic costs and the environmental benefits of action to reduce emissions of greenhouse gases.   For 15 years, the Energy Modeling Forum (EMF), under the leadership of John Weyant at Stanford University, has periodically brought together the modelers to compare results and exchange ideas.   It was gratifying when we discovered that the economic model we had used to estimate costs was near the middle of the pack of ten leading academic models according to the EMF, in terms of the estimated impact on energy costs  for example, contrary to suspicions that we must have low-balled the estimates.

Exactly ten years ago, in August 1998, I attended the Energy Modeling Forum’s annual workshop in Snowmass, Colorado, Climate Change Impacts and Integrated Assessment.   My assignment then was to explain the Administration Economic Analysis to this group.  Unlike most American economists, I believe that something along the lines of the Clinton-Gore version of Kyoto offers the most promising path to address the problem of Global Climate Change.