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Theory meets reality; wins

Greenhouse_Gas_Emissions_Executive_Summary.pdf - Google Docs_1262106150597.jpeg

Krugman oversells the affordability claim by linking to a widely cited report by McKinsey & Company. The main point of the McKinsey study is provided in their Exhibit B, which illustrates a rather peculiar finding that there are a significant number of pollution abatement options that can be achieved at “negative cost.” This finding violates the basic principles of economics. If firms (or consumers) could reduce emissions at negative cost, then they would do so. To say otherwise is to say that they are willingly or ignorantly passing up profits.

That's from a Brookings Institution report on handling carbon emissions through the EPA. But it's more interesting for what it says about the state of economics than about the state of climate change policy. The authors argue that there literally can't be firms that could reduce pollution while enhancing profits because theory predicts those firms would already have done so. This is a bit like coming to a road that's not on your map and deciding the road is in the wrong.

Brad DeLong recommends the authors read "On the Impossibility of Information-Efficient Markets," a paper by Sanford Grossman and Joseph Stiglitz. I always like recommending Larry Summers' unpublished observation "THERE ARE IDIOTS. Look around." And you don't even need to believe in idiots to believe that some firms may not have perfect knowledge of all pollution-abatement technologies and their likely costs and benefits. Not every widget-maker employs a carbon-reductions specialist. Sheesh.

Anyway, the McKinsey report is here (pdf). The disputed exhibit is atop this post. Click on it for a larger version.

By Ezra Klein  |  December 29, 2009; 12:00 PM ET
Categories:  Climate Change , Economics  
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But who really cares about low-cost, low-impact items like residential electronics? The horizontal axis matters too.

Posted by: tl_houston | December 29, 2009 12:32 PM | Report abuse

An ungated copy of the Stiglitz-Grossman paper can be found here:

Posted by: rwclayton7 | December 29, 2009 12:44 PM | Report abuse

This year I installed a geothermal heat pump to replace failing 20 year old units. I've been looking at these for a while, but the Obama stimulus package tax credits were the only thing that brought it within range of feasibility.

Even so, that is not money currently in my pocket. It is money that I will get back eventually. Eventually, this system will be profitable for me, after combining federal and state tax credits and power company rebates. But not today. Today I am $30,000 poorer because I had to pay for the system today but I'll get the money back only over time. Had I not had $30,000 handy to finance something like this, it wouldn't really matter how profitable it might end up being. I still wouldn't be able to do it.

And that in the end is what is wrong with Brookings' analysis. Profit is not the only factor. Affordability of up front costs counts a lot as well.

Posted by: pj_camp | December 29, 2009 1:26 PM | Report abuse

Anyone who thinks firms never "ignorantly pass up profits" has probably never worked at a firm.

Posted by: kuri | December 29, 2009 1:26 PM | Report abuse

Corporations explicitly include the issue described by pj_camp in their calculations. $100 per year for 10 years is worth a lot less than $1000 right now. It's the concept of "present value". Typically the "present value" of future revenue (or savings) is discounted 10% per year, or thereabouts.

Posted by: tl_houston | December 29, 2009 3:18 PM | Report abuse

Ezra, as usual you are correct. There are a lot of reasons that companies (and private individuals) don't make energy-saving investmentst that will have negative costs over the long term (or even in the short term, like just one year.) The McKinsey report actually discusses them. In fact, there is quite a large body of research on this. Sounds like the Brookings authors didn't do much research.

Posted by: bubba777 | December 29, 2009 3:28 PM | Report abuse

The problem with talking about THESE negative cost investments is that there are also OTHER negative costs investments that compete for a company's time and capital.

An NPV analysis or like will reveal which investment, at least from an accounting standpoint makes the most sense.

I'm tired of the people like Amory Lovins who talk about energy efficiency as the "free lunch you're paid to eat". Businesspeople are not THAT stupid. If they all put climate abatement at the top of their list, yes much of these would get done. But it isn't at the top of the list of most people.

Posted by: michaelterra | December 29, 2009 11:32 PM | Report abuse

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