A little micro before midnight

Carbon, we are told, needs to have a price affixed to it for two fundamental reasons. One, it sends a market signal that investment in clean technologies is a smart move and, two, it internalizes the cost of CO2 emissions and other types of terrestrial/atmospheric pollution. That's one macroeconomic principle and one microeconomic one. Let's discuss the latter.

First of all, it is undeniable that the combustion of carbon fuels has external costs - we do not pay them when we burn and use the fuel, but we do pay for them in some way. Not to be too dramatic, but the biggest way we pay for them is with our lives - pollution, wars, extreme weather due to climate change, etc. These external costs of course also place a tab on our health care system, our military and really all echelons of society and the economy. So, naturally, we should simply internalize those costs - as with a carbon tax or cap-and-trade system - and pay them up front. This is a basic microeconomic approach to what's called a Pigovian effluence.

Here's the problem though, microeconomically speaking. Internalizing costs has a direct effect on the price and cross-price elasticity functions of any good or service. Since this is energy we're talking about, we could create a function describing its elasticity with basically every single good and service on the planet - agriculture, business, travel, bricks, clicks, everything. And, as you might have guessed, energy is not going to be very price elastic - we will use a similar amount of it no matter the cost. Why? Because we have to. The global economy has a momentum, and it is fueled by carbon energy. The buying and selling and consuming and disposing of all goods and services has evolved over the past couple centuries based on an energy infrastructure built almost entirely on carbon, and we ignored the external costs when we built it. To fully internalize them now would, as critics of a carbon price have said, slow the momentum of the global economy. We'd still, especially in the first few years, be using more or less the same amount of energy - we'd just be paying more for it. Since the marginal cost of clean technology is so much greater than that of carbon, we'd be stuck with more expensive energy no matter what. That leaves less money to spend on other things, and that's where macroeconomics comes in and shatters the consumer economy*.

Now we really don't want to keep paying these external costs, but to internalize them fully would put such a stranglehold on all economic activity so as to dramatically slow the pace of globalization, poverty alleviation and growth. What's the alternative, then, if the imperative is to decarbonize the economy? Well, the logical action if you can't make dirty energy more expensive is to make clean energy cheap**. I could (and will, in future posts) go on and on about this, but it essentially involves a suite of reforms and investments in technology, infrastructure, and education. These elements fall outside the realm of micro, so I'll stop here.

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*This logic game assumes some parameters that I have no business taking for granted. For instance, I'm assuming that we have perfect information on the external costs of carbon; that we can and do fully internalize them; that we do not couple a carbon pricing scheme with other, complementary energy policies to encourage the development of clean technologies; and that there is some legislative body/bureaucratic agency combination in the world that could effectively impose such a price on carbon.

**Also, it's worth pointing out that I am actually a proponent of carbon pricing, but only if it's done right - another topic for another post.