Infernal Ramblings
A Malaysian Perspective on Politics, Society and Economics

A Pigovian Solution to Global Warming

Written by johnleemk on 1:59:13 pm Mar 10, 2007.

Economist Arthur Pigou is not a well-known man. Despite being the main developer of a cornerstone of modern welfare economics — the concept of externalities — initial criticisms of his work by people such as the eminent John Maynard Keynes meant that he never received full credit throughout his lifetime for the work he did.

Pigou's genius was that he managed to explain how the market can fail to bring about a socially optimum outcome, and posit a way by which the government can rectify these externalities. His solution, now eponymically known as Pigovian subsidies/taxes, was to subsidise or tax away the divergence between social costs/benefits and private costs/benefits.

Pigou's work is relevant to the modern global warming debate because it is widely agreed that what we are seeing presently is not a socially optimum outcome. Even if you don't believe in global warming, pollution should be a concern because of the costs it imposes on society, such as the various illnesses it brings about.

These social costs, which are not accounted for by firms when performing their cost-benefit analysis, result in a distorted market where priority is given to means and factors of production that harm society as a whole. To internalise these externalities, a Pigovian solution is necessary.

In this light, a carbon tax makes eminent sense. Carbon dioxide is generally agreed to be the main cause of global warming, although reasonable arguments have been put forth for other possible factors such as methane. Whatever the case, carbon here is merely an example — the idea is to tax anything that contributes to global warming.

If a carbon tax were implemented, the rising prices of relying on polluting forms of transportation and production would result in a reallocation of resources. People would adjust their lifestyles and firms would change the way they work.

We often talk about the need for people to change the way we live in order to halt global warming. But let's face it; thanks to the tragedy of the commons, where the benefits that accrue from a lifestyle change are benefits enjoyed collectively and implicitly instead of individually and explicitly, hardly anyone is going to change without a real incentive to do so.

Carbon taxes provide that real incentive. When the real costs of how we live and behave are factored into the prices we pay in cold, hard cash, it's impossible to ignore them and put them aside.

Unfortunately, implementing this simple solution isn't too easy. Most people are unaware that orthodox economic theory actually supports a carbon tax, and this would seem to include politicians as well.

Making matters worse, of course, are business lobbyists who will stop at nothing to keep taxes down. Not much can be done about them (at least legally). The best we can do is attempt to shout louder than they do.

I think, however, that the biggest problem is really the tragedy of the commons again. Any country that unilaterally imposes a carbon tax will immediately be at an absolute disadvantage to the rest of the world. Its comparative advantages, too, will shrink, because of the rising costs of production in that country.

The result is that nobody dares to be the first mover to implement a carbon tax, because it's simply not worth it. The resulting migration of businesses and capital elsewhere would greatly harm the economy. The only jurisdictions where severe environmental regulations have passed are those where even the businesses are run by hippies, e.g. California.

So, how can this tragedy be resolved? It would seem that a cartel is the answer — the world's governments have to get together and agree to implement the tax at the same time. This way, there will be no reduction in absolute or comparative advantage for anyone.

The trouble is that cartels are notoriously prone to failure. It's much easier for a single monopoly to act, rather than for an oligopoly of several firms to collude. It would thus seem that the answer to our problem is to monopolise and centralise power in a world government.

This, however, opens up a whole new can of worms. There has to be some other way to effect reform in economic policy towards the environment. If we can find this way, it just may be that another Nobel Prize will be in the offing.

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Infernal Ramblings is a Malaysian website focusing on current events and sociopolitical issues. Its articles run the gamut from economics to society to education.

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