WASHINGTON, NOVEMBER 20, 2009--In the United States, Congress and the Environmental Protection Agency are currently moving forward with plans to regulate greenhouse gas (GHG) emissions. These plans appear likely to achieve less and cost more than could other policy options. Further, at the upcoming United Nations meetings in Copenhagen, governments will attempt to draft a new global climate policy regime. The U.N. proposals on the table also seem needlessly costly. At a November 20 event sponsored by the AEI Geoengineering Project, a group of economists and climate experts probed why such seemingly inferior approaches gain favor.

Kevin A. Hassett, director of economic policy studies at AEI, moderated the discussion. He observed that many economists favor carbon taxes because they can achieve more emission reductions per dollar of cost than can command-and-control options. Yet climate policy design has largely rejected carbon taxes. "Why is it, then," he asked the panel, "that we find ourselves in this situation?"

W. David Montgomery of Charles River Associates and AEI resident fellow Lee Lane addressed this issue in their paper "Political Institutions and Greenhouse Gas Controls." Montgomery noted the benefits of combining a stable, broad-based carbon tax with a long-term commitment to basic and applied energy research. Such a system could slow climate change at far lower costs than would current proposals which, he argued, add costs because they feature redundant measures, designed-in carbon price volatility, and unnecessary haste in setting emission reduction targets."Addressing the problem of climate change," Montgomery continued, "entails long-term gains and near-term costs." Enacting legislation with these costly features will require Congress to include many favors to special interests that  will raise the legislation's costs and lower its net benefits.

Montgomery also noted that, globally, low emissions per dollar of GDP are strongly linked to market institutions. In China and other developing countries, distorted markets and a weak rule of law have boosted emission intensity. It is unclear that these structural problems can be surmounted without a more sweeping regime change. Hence, in both developed and developing nations, measures to control greenhouse gas emissions will accomplish less and cost more than the taxes modeled by the Intergovernmental Panel on Climate Change (IPCC).

Lee Lane, codirector of the AEI Geoengineering Project, said at the international level many barriers impede meaningful cooperation on climate issues. Transaction costs, for example the costs of making, monitoring, and enforcing an agreement, are a central problem. Climate accords entail high transaction costs for several reasons. For instance, to produce effective treaties, many parties must agree, and nations have differing priorities and preferences on climate. "Furthermore," he added, "no third party exists to enforce participation or compliance." Then too, the economies of countries like China are very opaque to outsiders; therefore, other nations cannot be sure China will fulfill its commitments. This uncertainty raises the costs of monitoring and enforcing an agreement. The relatively modest net benefits of GHG controls, he observed, have not been large enough to exceed the sum of the costs of climate change and the transaction costs of making and enforcing a global accord.

Lane also focused upon how the United States might fare from global climate agreements like those that will be considered at the upcoming Copenhagen meetings. He argued that the United States would be among the least likely countries to benefit because of its capacity to adapt to climate change, its weakened bargaining position due to domestic politics, and the barrage of demands for wealth transfers to developing nations. Lane then offered some predictions as to what a future GHG control regime will entail. The main features of such a regime will be patchy and ineffective global controls, an exchange of First World controls for Third World no-regrets measures, and tight controls only where environmental activism is strong and governments are responsive. U.S. controls will be needlessly costly. Lane called for a new agenda for climate policy analysis. Such an agenda, he said, should feature a greater focus on institutions and transaction costs. He went on to propose that climate policy should shift towards adaptation and research on geoengineering as possible responses to ineffective GHG control policies.

John Joseph Wallis, professor of economics at the University of Maryland, responded with thoughts about applying to climate policy insights derived from new institutional economics. He noted that the assumptions of neoclassical economics can produce distorted results. Thus, in many markets, transaction costs are both positive and substantial. When they are, institutions will affect outcomes. "Institutions," Wallis stated, "are the rules that govern both economic and political behavior." Such rules, he continued, do not automatically produce the best policy outcomes; governments have their own interests as well. These interests may clash with those of the governed. "In any time frame, governments must find it in their interests to implement policies," he observed, "and most governments do not feature democracies. One shared element will be whether the implementation of a policy generates fiscal returns or fiscal benefits to the government."

Dr. Peter S. Heller of the Paul H. Nitze School of Advanced International Studies at Johns Hopkins University offered additional comments. Heller pointed out that in Europe some integrated assessment models of climate have become more sophisticated. These models can more closely replicate institutional impacts on climate policies than do some of the models discussed in the Lane/Montgomery paper. Even so, these models still embody a somewhat narrow view of costs and benefits. They are also pessimistic about the chances of a "grand coalition" forming to produce an effective climate agreement. "Such a coalition," Heller said, "would not be stable, as there are too many incentives for free riders." Heller went on to suggest that resource-rich countries may well attempt to prevent a coalition from forming, as it would harm their interests by limiting the demand for fossil fuels. Heller continued by noting that greater emphasis on the political economy of adaptation will be crucial; it will give us a better understanding of the ways in which we might cope with climate change. In this and other regards, he suggested that application of institutional economics to climate policy should extend well beyond the Lane/Montgomery paper's focus on emission controls.