The climate crisis and the failure of economics

Why our economic model fails to explain how we got here on climate.

The first intro-to-economics class often starts with the question: why are diamonds expensive and water cheap? After all, we need the latter to survive.

The answer, of course, is scarcity, a concept at the core of economics. Diamonds are rare and water literally falls from the sky. Were there no scarcity, we wouldn’t need economics. But given that scarcity exists, we have a price system to signal the economic value of stuff — how much of it there is and how badly we want it.

And yet, there’s a key area where prices fail us every day. They fail us every time you fill up your gas tank: Fossil fuels are severely underpriced.

What do I mean by that? I mean that fossil fuels are imposing costs on our environment, our economy, and our future that are not being captured by their price.

That underpricing has consequences. Energy costs are so low and so unresponsive to the environmental challenge we face that they send us a signal to literally keep cruising along, ignoring the pressing reality of climate change.

How is it that a discipline fundamentally based on scarcity has failed to accurately price in the damage we’re doing to our most important, scarce resource: the environment? Naomi Klein writes that the climate crisis is “born of the central fiction on which our economic model is based: that nature is limitless.”

But I don’t think the economic model fails because it denies scarcity and embraces limitless nature. It fails because of its interaction with two things in particular: 1) our tendency to focus on the present at the expense of the future; and 2) the toxic cycle of profit and influence that distorts policy making and blocks the accurate pricing of carbon.

This diagnosis matters because we need to either unjam the model and attach a sustainable price on carbon or recognize that politics as currently practiced won’t allow us to do that, in which case we’ll need to figure out other, bolder ways to fight climate change. The Green New Deal may well play a role in that alternative vision.

When price sends the wrong signal

One can’t overestimate the centrality of price signaling in market economics. The work of two of the most towering figures in the field — Friedrich Hayek and Milton Friedman — was largely premised on respecting the information in market-formed price signals and critiquing government actions that allegedly distorted such signals. In this framework, minimum wages, for example, are a huge problem as they distort/inflate the price of low-wage labor. Taxes on wages or capital similarly distort behaviors to work and invest.

But the real world shows the theory has often been found wanting. There are literally hundreds of places, both here and abroad, where minimum wages appear to have little distortionary effects on labor markets. Most recently, Trump’s big tax cut for the rich hasn’t led to anything close to the investment boom its opponents promised. To be sure, most card-carrying economists, myself included, still believe prices convey useful information. It’s just that a ton of empirical research reveals that life is a lot more complicated than the simple theory suggests.

When it comes to the environment in general and fossil fuels in particular, the price system isn’t merely failing to work. It’s sending wrong signals, and fatefully so. This is not because fossil fuels themselves are scarce. It’s because their price fails to reflect their contribution to global warming. One recent study put the gap between what fossil fuels (not just gas, of course) do cost and what they should cost, given the environmental damage they inflict, at over $5 trillion, or more than 6 percent of global GDP, per year.

Over the last decade, energy costs grew on an annual basis at a mere 1.4 percent, a touch slower than overall prices, which were up 1.5 percent per year. Last month, the average price of a gallon of gas was $2.59; 10 years prior, in September 2009, that price — in nominal terms — was an almost identical $2.55.

How can that be? Given the increasing awareness of the urgency of climate change over the past 10 years, fossil fuel costs should be higher and they should be growing faster than overall prices, signaling their contribution to global warming.

Why is the price system failing so miserably in such an important facet of our lives and our children’s lives?

Discounting the future

One hint to the answer is embedded in that phrase: “our children.” Whenever you hear a plea made on behalf of a future concern — or, in the case of climate, a present concern that is expected to worsen as time proceeds — recognize that you’re bumping up hard against our unfortunate bias toward the present.

In some ways, discounting the future makes sense. A dollar a year from now will have less buying power than a dollar today because of inflation.

That’s how too many of us appear to think about the future of the environment. And by so doing, we’re unmotivated to spend more now to stave off destruction later, a preference expressed in the resistance of policy makers and elected officials to enact policies to fight climate change.

Sixteen-year-old Greta Thunberg put not too fine a point on this shortcoming in her speech to the United Nations last month: “We are in the beginning of a mass extinction, and all you can talk about is money and fairy tales of eternal economic growth. How dare you!”

Those “fairy tales” to which Thunberg refers are often told by long-term economic projections that typically leave out the costs of climate change. Sen. Bernie Sanders (I-VT) recently upbraided the Congressional Budget Office for suggesting the economic impact of climate change would be “small” or “modest” in coming decades. The CBO responded by pointing out that relative to GDP growth, damage estimates over the next few decades look pretty small, though it admitted that “even if the economic costs are modest 50 or 60 years from now, they may no longer be modest 80 or 90 years from now.”

There are, of course, cost estimates that could get us to dial back our tendency to discount the future. A 2006 report from the United Kingdom predicted that “if we don’t act, the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year, now and forever,” with the largest burden falling on poor countries. A recent and, given its source, somewhat miraculous example is a report from the Trump administration’s Environmental Protection Agency warning of significant losses to hours of work, heat-related deaths, property loss, destruction of roads, rail, bridges, and so on, valued at over $200 billion per year, by the end of this century.

But while these studies garner headlines for a few days, they’ve changed neither our proclivity to discount future threats nor the prices of fossil fuels.

When polluters buy politicians

So, market-driven price signals aren’t working, and our bias for the present is part of the problem. Still, under the rubric of “market failures,” contemporary economics should be equipped to deal with this type of a short circuit.

That is, when markets and people interact in ways that are harmful for human welfare, there’s a well-established economic rationale for the government to step in and fix the problem by “internalizing the externality,” meaning making the persons or institutions that are, in this case, polluting the environment pay for the damage they’re doing to the rest of us. If the price system isn’t picking up the true cost of the damage and short-sighted people — which is most of us — are okay with that, then there’s a role for government to realign the higher social cost of fossil fuels with its lower actual cost.

And yet, this realignment has yet to occur. Why not?

Part of the explanation is the toxic intersection of capitalism and money in politics. As the great fortunes of those in energy extraction industries show, capitalism creates a lucrative platform from which to profit from the failure of price signals today and our unwillingness to worry enough about tomorrow.

By itself, that wouldn’t be enough to protect the capitalists from government action to make them internalize the damage they’re imposing on the world. But when you add in the final ingredient — the fact that we have more private money in politics than any other advanced economy — you can see why we’re in this increasingly hot mess.

Is this fixable?

There is no analytical solution to this set of problems. More accurate estimates of the costs and their timing are surely useful but they will not fix the price signals or get people to react with requisite urgency.

The solution must be political — and it is here where there’s some hope.

Good, socially minded economists, even Nobel laureates, have argued for pricing carbon more accurately, but thus far they’ve been ignored. Clearly, a different approach is necessary. Which is why we really should take the Green New Deal seriously.

The GND potentially works precisely because it does not try to hit the problem head-on. It doesn’t adjust price signals by taxing carbon or try to convince people that there’s a big problem out there beyond their discounting horizon.

Instead, the GND puts action against climate change in an immediate and broad social justice context that recognizes the urgency of present needs — better jobs (many in green sectors, a way in which action on climate can be pro-growth, for the record) and health care — while plotting an ambitious course to 100 percent renewable and emission-free electricity in the relatively near future.

This is not the place to debate the viability of the GND’s goals. It is, of course, possible that the well-resourced politics that has blocked everything else so far will be able to block the GND’s initiatives, too.

But what I take from the above analysis — from the broken price signals, future discounting, and corrupt politics that have heretofore blocked the path forward — is that something big, different, and oriented toward both future crises and present injustices is required. This is what it will take to override the powerful forces jamming the economic model and, in so doing, reveal the true scarcity of our natural resources and the sustainable path to preserve them.

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities and was the chief economic adviser to Vice President Joe Biden from 2009 to 2011.