Eco-nomics: Krugman on Building a Green Economy

Hei Yubai/European Pressphoto Agency

A two-fer! - unintentionally. Here is Paul Krugman's new piece in The New York Times Magazine in which he both explains the basic economics of market efficiency, externalities, Pigovian taxes and carbon emissions, and then discusses the economics of trying to do something about global climate change as a result of carbon emissions.  Not surprisingly, he is in favor of carbon taxes.  And lest you think that this is a polar liberal opinion piece, economists from the other end of the political spectrum are also in favor of carbon taxes - Greg Mankiw for example.

It is long (and good) read, here are a couple of excerpts that capture the gist of the second part:

What you hear from conservative opponents of a climate-change policy, however, is that any attempt to limit emissions would be economically devastating. The Heritage Foundation, for one, responded to Budget Office estimates on Waxman-Markey with a broadside titled, “C.B.O. Grossly Underestimates Costs of Cap and Trade.” The real effects, the foundation said, would be ruinous for families and job creation.

This reaction — this extreme pessimism about the economy’s ability to live with cap and trade — is very much at odds with typical conservative rhetoric. After all, modern conservatives express a deep, almost mystical confidence in the effectiveness of market incentives — Ronald Reagan liked to talk about the “magic of the marketplace.” They believe that the capitalist system can deal with all kinds of limitations, that technology, say, can easily overcome any constraints on growth posed by limited reserves of oil or other natural resources. And yet now they submit that this same private sector is utterly incapable of coping with a limit on overall emissions, even though such a cap would, from the private sector’s point of view, operate very much like a limited supply of a resource, like land. Why don’t they believe that the dynamism of capitalism will spur it to find ways to make do in a world of reduced carbon emissions? Why do they think the marketplace loses its magic as soon as market incentives are invoked in favor of conservation?

Here he addresses something I have talked about repeatedly to explain why new technology innovation, induced by Pigovian taxes, would be vital if we want to address the big problem emerging economies like China, India and Brazil pose in their profligate use of carbon.

For those who think that taking action is essential, the right question is how to persuade China and other emerging nations to participate in emissions limits. Carrots, or positive inducements, are one answer. Imagine setting up cap-and-trade systems in China and the United States — but allow international trading in permits, so Chinese and American companies can trade emission rights. By setting overall caps at levels designed to ensure that China sells us a substantial number of permits, we would in effect be paying China to cut its emissions. Since the evidence suggests that the cost of cutting emissions would be lower in China than in the United States, this could be a good deal for everyone.

But what if the Chinese (or the Indians or the Brazilians, etc.) do not want to participate in such a system? Then you need sticks as well as carrots. In particular, you need carbon tariffs.

A carbon tariff would be a tax levied on imported goods proportional to the carbon emitted in the 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 result in a $100 tax over and above any other duties. Such tariffs, if levied by major players — probably the United States and the European Union — would give noncooperating countries a strong incentive to reconsider their positions.

He then goes on to address the issue of uncertainty, echoing the Frank piece from yesterday, but addresses the gradualist versus 'big bang' approaches.

Beeronomics: Krugman, the Nobel Prize and Beervana

So this blog post has been brewing in my head for a while now (rim-shot please), but now that Paul Krugman is in Sweden to collect his much-deserved Nobel, let's think about how his ideas explain Beervana.

[From Paul's NY Times page: The marquee for his talk at the Bagdad - Paul , Beer, Oregon - get it?]

Paul's most influential insights came from the idea that there may be increasing returns in trade. When applied to trade this insight helped explain why we see two-way trade in things like cars and was the principle reason he won the Nobel. But this insight quickly spilled over into other areas as well - for example, why is Silicon Valley still the center for high tech industry given that it is perhaps the most expensive place on earth to do business? Paul's answer has a lot to do with heads starts and learning curves: It may be cheaper to move Silicon Valley to Bangalore if you could do it overnight, but you can't - it takes time to build up the knowledge base and skilled work force and while that is happening, Silicon Valley can compete the nascent Bangalore away. This helps explain that while Bangalore has been able to chip away a little bit at Silicon Valley's dominance it hasn't done that much. This story is half trade and half economic geography. Economic geography talks about increasing returns that come from concentration: part of why Silicon Valley is so successful is because of the close connection inventors, entrepreneurs and venture capitalists have by virtue of being neighbors and part is the concentration of skilled workers to populate the firms.

So what does this have to do with Beervana - Portland (and Oregon's) disproportionate number of breweries and beer drinking? Well the same stories about Silicon Valley can be told here: brewing and beer drinking are both learning processes and ones that benefit from concentration. Brewing takes skill and practice and a there are a lot of knowledge spill-overs that comes from brewers talking and sampling each others products. Beer drinkers have to learn about the ingredients, how they taste and develop a palate and taste for the more robustly flavored beers. So the punchline is you tend to have concentration rather than dispersion and that places that get early starts tend to hold onto that advantage - familiar themes from Paul's work.

So really, beer drinkers of Oregon, this Nobel's all about you! Let's toast to that...

By the way, just to complete the circle - Beervana blogger Jeff Alworth left a comment on the same Krugman blog page that includes the picture above.

Krugman Wins Nobel

I am often asked by my non-economist friends (yes, I do have some) what I think about New York Times columnist Paul Krugman.  They know him only as a sometimes acerbic left-of-center political commentator that occasionally veers off into partisan rants. [Though he would defend himself by saying that stuff that he was accused of engaging in hyperbole about early on in the Bush administration has proven to be essentially correct] Usually they want to know what kind of economist he is - especially since his column is now only occasionally about economics.

What I have always said is that Krugman is a lock to win a Nobel Prize - he is that good an economist.  I did think it was going to be another decade or two before he won it, the Nobel is not awarded posthumously so they tend to try and make sure that the old folks get it before they perish (but they are now catching up and the winners are getting younger).  As a trade theorist, Krugman made perhaps the most significant contributions of the second half of the 20th century.  He showed how increasing returns to scale could provide a rationale for trade and helped explain the trade patterns seen in the real world.  The simple example is this: old style trade theory (Ricardo and Heckscher-Ohlin) shows how comparative advantage (through either natural productivity advantage - Ricardo - or through differences in natural endowments - HO) can cause some goods to flow from country A to country B and other goods to flow from county B to country A.  This is all correct and immensely powerful - it still provides the basic rationale for trade, that everyone can benefit through efficient allocation of production.  But these theories fail to explain why we see cars from Germany shipped to the US and US cars shipped to Germany, for example, nor do they explain why so much production occurs in so few countries.  Krugman, by applying insights from industrial organization (or essentially, the study of firm behavior) developed theories that explained these patterns of trade.  Economies of scale and product differentiation when applied to trade go a long way to explain these patterns. Krugman made the first major contributions to this theory and figured out how to do it in a tractable way theoretically.  

What is especially beautiful about his work, and what has echoes in his popular writing, is how simple and elegant his models are - something I strive for in my work.  In the modern era, where a lot of credit is given for elaborate mathematical tricks in models (economics training is highly mathematical these days) it is rare to see such elegance.  And herein lies the essence of Paul Krugman - a man with extraordinary economic insight that is able to translate that insight simply and plainly.  I think this is a prize that is richly deserved and I am delighted to see him win it.  This has nothing to do with Krugman the political commentator and one always wonders how much politics comes into play with the Nobel committee's decisions.  Krugman was going to win the Nobel anyway, but I thought he would win it with others and in another ten years.  On the eve of the US election, is it coincidence that one of the highest profile leftist commentators in America gets the Nobel?  I wonder....