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Free Market Strategies to Confront Global Warming


The debate is over

Challenges to the Economic Approach:

The Case for Market Intervention
-Are Markets Free?
-Missing Information
-Why do Prices Matter?
-The Promise of Correcting the Market

Free Market Strategies

Carbon Taxes

Emissions trading: Cap and Trade

Economic Adaptation

Further Information

Comments & questions to:

The Case for Market Intervention

Are Markets Free?
    The basic argument for “altering” the free market is similar to the “hands-off” argument, except for one assumption.  Is the market free or not?  If one thinks that the existing market for goods is free, that is to say that it allows for open competition and participation, than it would make sense to leave the market alone.  However, if one sees the market as highly distorted, as many in environmental economics feel, the argument for taxes etc. makes a lot more sense.  As Paul Hawken puts it “To argue today that the free market should control the extraction and sale of natural resources ignores the state of the commons and the free market.  The market works to the benefit of the whole of society when it includes all costs and benefits. ”  The concept that markets will reflect the value of a product in the price (one pays more for a better product) is limited by the information available to determine prices.  If information is missing, than prices will not reflect the true value of a product, be that greater or less than the market price.  One example is fair trade coffee.  The argument for it is that the social conditions that the coffee is produced under give the coffee more values than non fair trade and the price is therefore higher.  The challenge of reforming the market is to incorporate all relevant information into prices and determine what they are worth.

Missing information

    "In the United States, the gasoline pump price was over $2 per gallon in mid-2005.  But this reflects only the cost of pumping the oil, refining it into gasoline, and delivering the gas to service stations.  It does not include the costs of tax subsidies to the oil industry, such as the oil depletion allowance; the subsidies for the extraction, production, and use of petroleum; the burgeoning military costs of protecting access to oil supplies; the health care costs for treating respiratory illnesses ranging from asthma to emphysema; and, most important, the costs of climate change. ”-Lester Brown

The economic term for “missing information” in a market is known as an externality.  This comes from the idea that the benefit or harm from a certain action is not borne by the person taking the action.  The most common example of an externality related to the environment is pollution.  A company will traditionally make their product and price it according to how much it cost to make, plus their profit margin.  The smog that the company emits in the process is generally not included in the price.  While the benefit from burning the smog forming fuel goes entirely to the company doing it, the cost is being borne by many in the form of health problems, acid rain and of course global warming.  The goal is to then internalize the externality, to incorporate the dispersed cost of the pollution and put it back in the price and therefore make the producer bear the full cost of their actions.  In ecological economics the focus is on looking at environmental impacts of individuals actions and adjusting accordingly.

Why do prices matter?
    If one accepts that these important values are being left out of prices, then there are two major challenges that must be considered.  How does one value the externality and how does one correct for the externality?  The latter will be discussed more later, but the imperative is aptly described that:

"Where harm and suffering exist because of market dealings -when the real cost of that market are not factored into the price of goods and services- we require the government as representative of citizenry to step in to prevent those abuses, one way or another. " 

When confronting the challenge of valuing things like human and environmental sustainability, we are often left in the odd and morally questionable activity of pricing animals, plants and quality of life.  The crux is that these values are often determined by use value, that a life is valued by the economic benefit others gained from them.  A person is valued then, by the value of the labor they produce.  This clear profanation of the idea of value and traditional morals by anyone’s standard has caused many to reject the use of prices to account for clearly non-monetary values, like life and sustainability.  It is important to distinguish between turning something or someone into a commodity through use value and using prices to reflect value.
    A central concept in economics is the effect of price on behavior, or incentives.  It is obvious to anyone that people buy products that are the cheapest if they have a choice (most of the time).  It makes perfect sense; if two products are equivalent and one costs more than the other, someone is going to buy the cheaper one because they will be getting more for their money.  This is not universal of course.  For example, many people choose to buy more expensive fair trade coffee instead of generic brands.  It could be argued that this is not an exception at all because for that person, the two kinds of coffee are not longer equivalent and have become separate products.  The important aspect to consider is that people make decisions based on price and generally expect price to reflect value.  The distinction it is important to make is that quality of prices that we base decisions on and putting monetary value on things is different.  Relative price differences act as signals to a person that one good is worth more than the other and shape their decisions.  To put a tax on coal plants and make them more expensive than wind power, for example, is not as important as a price tag on the many negative effects of burning coal as it is as an incentive that changes behavior.  If the goal is to decrease the use of coal power because wind is a better alternative and prices will cause people to choose wind over coal, then the relative price difference operates as an effective mechanism to guide ethical decisions.

The Promise of Correcting the Market

    "Putting an appropriate price on carbon – explicitly through tax or trading, or implicitly through regulation – means that people are faced with the full social cost of their actions. This will lead individuals and businesses to switch away from high-carbon goods and services, and to invest in low-carbon alternatives." 
–The Stern Review

    There is great potential in using market mechanisms to confront global warming.  While carbon markets are a new idea, the mechanisms are proven in many environmental and non-environmental contexts.  There are peculiarities to any market, but people have used markets for a long-time and understand how they work.  Beyond this, market based solutions pass the costs of mitigating carbon on the users themselves.  When the real price of using a resource is expressed in a market, users begin to understand the cost of the resource and are allowed to decide the most efficient way to reduce emissions.  Allowing consumers to decide means that overall costs of reducing emissions would be much lower than a ‘command and control’ measure.  The relative advantages and nuances of the two strategies: carbon taxes and emissions trading will be discussed in the next two sections.

Last updated:  2/2/2006


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