Tuesday, 12 August 2014

Economic perspectives on climate change mitigation: Part 1 climate change as a free-rider problem

By Judd Ormsby 

This is the first of a series of posts on climate change and the different perspectives offered from within economics. This first post sets the scene by framing climate change as a free-rider problem.

Most weekends I like to drive out to Makara Beach, about a half hour drive from where I live. I like to sit in the caf√©, order a cheese and onion toasted sandwich, drink coffee, and eat chips. It’s an enjoyable way to spend a Sunday. But it’s likely one of the most emissions-intensive ways to spend my time. I know climate change is a problem. I know that it makes economic sense for us to mitigate. I know that climate change might even alter my enjoyment of trips to Makara or lower my future earnings through its effect on the economy in general. But I also know that whether or not I go out to Makara will make no detectable difference to the Earth’s climate. My carbon emissions may be high but they are a drop in the ocean of global emissions. When mitigating my carbon emissions is costly I have an enormous incentive to ‘free-ride’. The cost could be in terms of money, in the case of investing in a solar panel for my home, or it could be in terms of the quality of my leisure, in the case of my visits to Makara.

This is the nature of a free-rider problem: the fruits of our individual labours are distributed among many, so that the individual benefit – our slice of our own labour – is small. Thus standard neo-classical economic theory would predict that we all end up behaving individually in a way that makes us worse off as a group. These same dynamics make free-riding so attractive for countries. People often say that New Zealand emissions only make up 0.14% of global emissions so whether we reduce emissions or not won’t matter – this is exactly the free-rider problem. Break the world into groups of people who make up 0.14% of emissions and then everyone can argue that what they do doesn’t matter. We then all pollute, and are all made worse off than if we had jointly mitigated.

The standard solution to free-rider problems is regulation by an external authority. This could be in the form of price signals that ‘internalize’ costs and benefits of actions, e.g. a tax on bad behaviour, a subsidy for good behaviour, or a cap and trade programme. Or it might be in the form of strict rules that directly prohibit certain behaviours or technologies, such as rules requiring vehicles to meet a certain level of fuel efficiency.

The key component of the ‘standard’ solution is that the regulation (of whatever form) is enforced by an external body. For example the government enforces rules and regulations around fishing in New Zealand. But since climate change is a global problem the standard solution is not possible: we don’t have a global external authority – there simply is no world government. The closest thing we have to an external authority is the United Nations, but it isn’t a world government because, among other things, it has limited power to enforce its resolutions and sanctions. Does this mean we are doomed to complete inaction?

In my next post I will discuss the empirical evidence of cooperation despite these incentives to free-ride.

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