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Communications > Sustainability Plus > Posts > Nobel Prize-winning Economist: How to Build a Green Economy

Yes, it's a long read, but for anyone interested in gaining a clearer perspective on the ongoing debate about how best to green the U.S. and world economy, it's an important one.

Nobel Prize winning economist and New York Times columnist Paul Krugman, who steadfastly maintains that climate change is an established fact, asks a question that has been raised across the political spectrum: Is it possible to make drastic cuts in greenhouse-gas emissions without wrecking our economy?

For his part, Krugman says such a goal is achievable and that an economic policy based on the principles of Cecil Pigou, the father of environmental economics, is the way to do it. Pigou's basic dictum — that economic activities that impose unrequited costs on other people should not be be banned, but they should be discouraged — should form the cornerstone of worldwide market-based efforts to address climate change.

The best market incentive approach would be a system of tradeable emissions permits — a cap and trade approach.

In this model, a limited number of licenses to emit a specified pollutant, like sulfur dioxide, are issued. A business that wants to create more pollution than it is licensed for can go out and buy additional licenses from other parties; a firm that has more licenses than it intends to use can sell its surplus. This gives everyone an incentive to reduce pollution, because buyers would not have to acquire as many licenses if they can cut back on their emissions, and sellers can unload more licenses if they do the same. In fact, economically, a cap-and-trade system produces the same incentives to reduce pollution as a Pigovian tax, with the prices of licenses effectively serving as a tax on pollution.

Krugman points out that similar legislation, popularly known as the Waxman-Markey bill, was passed by the U.S. House of Representatives last year.

That brings us back to the original question. If cap and trade is the most economically feasible approach, what effect will it have on the U.S. economy?

Restricting emissions would slow economic growth — but not by much. The Congressional Budget Office, relying on a survey of models, has concluded that Waxman-Markey "would reduce the projected average annual rate of growth of gross domestic product between 2010 and 2050 by 0.03 to 0.09 percentage points." This is, it would trim average annual growth to 2.31 percent, at worst, from 2.4 percent. Overall, the Budget Office concludes, strong climate-change policy would leave the American economic between 1.1 percent and 3.4 percent smaller in 2050 than it would be otherwise.

Based on economic modeling, the world economy would fare slightly better, Krugman says. But that raises another question: What happens if emerging economic powers such as China, India and Brazil refuse to adopt and implement cap-and-trade policies?

Krugman says the United States and European Union would be well within their rights to impose carbon tariffs — "taxes levied on imported goods proportional to the carbon emitted in manufacture of those goods."

Suppose that China refuses to reduce emissions, while the United States adopts policies that set a price of $100 per ton of carbon emissions. If the United States were to impose such a carbon tariff, any shipment to America of Chinese goods whose production involved emitting a ton of carbon would rest in a $100 tax over and above any other duties. Such tariffs, if levied by major powers — probably the United States an the Euorpean Union — would give noncooperating countries a strong incentive to reconsider their positions.