Insights on climate and energy from the newest Nobel Prize winner

Economics is present throughout the scientific study of global warming.

Can it really have been three years since I opined at length through a series of blogs on the free market perspective on climate change? Yet here we are, struggling to work through the U.S. EPA’s Clean Power Plan proposal.

Today we celebrate the accomplishments of French economist Jean Tirole, winner of this year’s Nobel Prize in Economic Sciences. His work is particularly relevant for those of us concerned with the leadership of electric utilities, their regulators, and the growing number of us who are trying to respond to the growing impacts of global warming. Below are a few tidbits from his work that relate to each of these issues.

Writing on regulatory capture, Tirole and of his several colleagues have explored the balance between the altruistic regulator, who wants to “do the right thing,” and the self-interested (even corrupt) regulator who has been “captured” by the monopoly that s/he is entrusted to oversee. (See p. 18 of the Economic Sciences Prize Committee’s background paper). Confronting the dismal view of mainstream economists, Jean Tirole and his colleagues argued that some regulators may not be entirely self-interested, but may have both their own interests and social motivations at heart.

Working in the Southeast, we have certainly seen this entire range of regulator perspectives. In Alabama, regulators don’t even review Southern Company’s electric rates in a formal, transparent proceeding. Next door in Georgia, however, regulators have overruled Southern Company’s objections to expanding investments in solar power. As a result, Georgia regulators have helped to bring cheap, clean solar and wind power to the state.

Writing on an international climate change agreement, Tirole foreshadowed EPA’s struggle to optimize regulation of emissions from the electric sector, explaining that:

When non-price instruments, such as standards, are used, economic instruments should still be introduced whenever possible so as to introduce rationality into the design of these standards. This can be accomplished in two ways. First, public policies should state the implicit price of carbon implied by the standard: what would be the level of tax or the price of permits that would give rise to an equivalent abatement? The comparison for instance with the market price may be instructive. Second, a standard imposes at the margin high costs on some emitters and low costs on others. It is therefore desirable to set up a market in which those who under-comply can purchase credits from those who (are then induced to) over-comply.

The debate over whether to use standards, taxes or caps has been on for over a decade.

The EPA’s proposed Clean Power Plan is a “standard,” not an economic instrument. But in reading the EPA’s proposal, it is clear that Tirole’s perspective is infused throughout, with references to what he describes as an “implicit price of carbon” and “equivalent” reductions in greenhouse gases throughout. For example, one of the critiques of standards that he discusses is that “they mostly concern equipments, but not the use of these equipments.” By considering the dispatch rates of natural gas plants, and including emissions reductions induced by energy efficiency, the EPA has attempted to address this critique and “introduce rationality” into the regulatory scheme.

But Tirole clearly views standards as “only a second best,” with a strong preference for relying on (or appending) a free market solution to reducing greenhouse gas emissions.  In moving forward with the Clean Power Plan, the US EPA is making an effort to reduce emissions by complying with the legal requirement to regulate greenhouse gas emissions while still proposing a “remarkably business-friendly” rule.

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1 Comment

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Ideally, a phased in tax on greenhouse gas emissions as CO2eq. To make it business friendly use the revenue to help the regulated businesses make the changes they need to make to bring their business into compliance.

Comment by Grace Adams on October 14, 2014 2:48 pm

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