Saving the economy and the planet

Ralf Martin 10 December 2008

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The actual global crisis (economic) and the potential global crisis (environmental) are connected; or at least they should be.

Some worry that the current crisis may make an environmental disaster more likely by making governments and companies less inclined to implement the necessary regulatory framework and make the required investments. As George Monbiot put it, we might be remembered as “the generation that saved the banks and let the biosphere collapse”.

But there is a more hopeful version of the two-crisis connectedness. The current mess might actually help us to address climate change and other environmental problems.

The global economic crisis as a lesson in the global ‘tragedy of the commons’

The global economic crisis illustrates how one global system can suffer from failures that build up slowly over a long time as a result of behaviour that each nation found individually rational, or at least politically expedient. It also showed that such crises can be extremely costly to address after it is “too late”, even those that would be relatively cheap to deal with early on. The parallels with climate change are obvious.

The global response to the economic crisis as an opportunity

If governments who back aggressive action on climate change are cleaver, they can capitalise on the current political momentum and willingness to implement drastic “all it takes” policy measures. We now have a window of opportunity to set the world on the right track for addressing climate change.

Most governments are now discussing or already implementing plans for fiscal or spending stimuli to soften the impact of economic recession. Clearly it would be good if these government handouts could come in the form of much needed investments required for making the transition to a carbon free economy. A good idea for Europe, for example, would be any contribution towards an integrated super conducting electricity grid that can simultaneously harness and distribute solar energy from northern Africa and offshore wind energy from Northern Scotland and other places.

How much fiscal stimulus per euro spent?

Policy makers might be worried that that such spending has only a very indirect effect on output and employment. Moreover they might be more inclined to implement measures that are more directly felt in the purses of voters. A measure in this spirit could be subsidies for energy saving refurbishments of houses which would help the hard hit building industries as well as the house owners by reducing energy bills.

Climate change policies to avoid untenable fiscal positions

The key concern is how it is going to be paid for and if we are heading for a “tax bombshell” in the near future.

Climate change policy might be just the silver bullet we now need. Economists have been advocating environmental tax reform for a long time (e.g. David Pearce). Most taxes in most countries are levied on income and labour. Rather than taxing people for being productive it would make vastly more economic sense to tax damaging activities such as pollution instead.

In economic equilibrium this must be good for jobs and bad for pollution. Thus, it would be the ideal policy to implement now in an effort to boost employment. But even better, it is also a sustainable stimulus package that does not require any extra borrowing.

Fixing the regressive features of pollution taxes

The standard argument against pollution taxes is of course that they are likely regressive; i.e. poorer people spend a larger fraction of their income on energy and thereby pollution. However, there are clever ways to deal with this. For example, it is also true that poorer people receive a larger fraction of their income in wages. Thus, if any CO2 or energy tax is used to reduce wage taxes in particular then the net effect for wage earners must be positive.

Some simple arithmetic (detailed here) would suggest that this could increase the income of the average wage earner by as much as 21%. Because poorer people are also more sensitive in their consumption to changes in income this could provide an additional boost for the economy.

Conclusion

The damage being wreaked by the global economic crisis, is nothing compared to the “environmental credit crunch” that could occur, at least according to climate change campaigners. Governments should seize this chance to promote fiscal stimulus that is also pro-environment and take the occasion to embrace pollution taxes (perhaps starting in 2 years) to help kept down the national debt levels.


1 See for example Wier, M., Birrpedersen, K., Jacobsen, H., and Klok, J. (2005). Are CO2 taxes regressive? Evidence from the Danish experience. Ecological Economics, 52(2):239-251.
2 e.g. the WWF.

 

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Topics:  Environment

Tags:  climate change, fiscal stimulus, pollution tax

Research Economist, Centre for Economic Performance, LSE

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