I have been discussing the following assertion by Paul Krugman (speaking for a larger community of environmental economists):
Restricting emissions would slow economic growth — but not by much. The Congressional Budget Office, relying on a survey of models, has concluded that Waxman-Markey “would reduce the projected average annual rate of growth of gross domestic product between 2010 and 2050 by 0.03 to 0.09 percentage points.”I pointed out on Monday that if you assume trend economic growth of 3%/year (since we are being told that the effect on growth is less than 0.1%, and thus probably less than the measurement error), and noting that Waxman-Markey has the goal of an 83% reduction in the absolute level of carbon emissions by 2050, this implies that the carbon efficiency of the economy has to improve by 7%/year between now and 2050 on average.
This morning, I made the graph above which shows US historical experience with the price of carbon and the rate at which carbon efficiency improves.
What I did was to take data from the BP Statistical Review for 1965-2008, which gave me US consumption of coal, oil, and natural gas. I (approximately) corrected to give the carbon content of each fuel*. I then took prices of each fuel over time, and produced a weighted average price per tonne of carbon (where the weight of each fuel price was based on the amount of carbon input into the economy via that particular fuel type). This allows us to get an approximate price that the rest of the economy paid to use fossil fuel carbon, and we can look at the trends of this over time, along with the levels of carbon emissions and GDP (here real chained GDP from the Bureau of Economic Analysis).
This allows to try to draw conclusions from the natural experiments that fluctuations in energy prices have created in recent decades. (One could argue that this is a strange combination, since the price of carbon in the different fuels varies enormously, but it mimics the spirit of trying to reduce carbon emissions by a single carbon price).
To give some feeling for the data, here is the price of carbon (RHS), together with the quantity of carbon emissions and the level of GDP (with both the latter two on the LHS expressed as a ratio to the 1965 value).
As you can see, a massive -- roughly five-fold -- increase in the price of carbon in the 1970s did cause the two lines to diverge (there's considerable debate about the extent of the split between actual efficiency improvements and offshoring of the most carbon intensive parts of the production process). A slightly smaller run-up in prices since 1998 has (so far) failed to have as much impact.
To get a better feel for this, we can look at the ratio of GDP produced per tonne of carbon emitted. The year on year change in that is below, along with the price of carbon again on the right side:
This is the quantity that would have to improve at 7% a year for 40 years for Krugman's rough consensus to be correct. I have shown that level as the red line - the actual data are in green. (Note, the red line is to be interpreted relative to the LHS efficiency gain scale, not the price scale). As you can see, we have never gotten particularly close to 7%, even when carbon prices increase by factors of four or five. Also, once prices go back down, the levels of efficiency gain drop off again.
In particular, stare at the efficiency trend from 1998-20008. Efficiency gains are pretty much about flat at about 2 1/2% per year despite the huge price increase during that interval.
My conclusion is to get to 7% and stay there, energy prices would need to increase by a large but imprecisely known factor - probably at least another factor of 2 or 3 from 2008 levels, and then stay there instead of falling back down.
This is the rough equivalent of hitting the economy over the head with a hammer in the hope of bringing it to its senses.
I predict that, if carbon prices are used as the main tool to address carbon emissions, one of two things will happen. Either
- Carbon prices will go extremely high in order to bring the required efficiency gains, and this will bring about one or a series of recessions (and thus a massive political backlash)
- So many fudges will be built into the scheme that carbon prices will not go high enough, and then the gains will fall far short of desired.
*Gruesome methodological detail: I took oil to be 85% carbon by weight, used the coal figures expressed in MTOE and corrected those by 85% also, and took 1 bcm of natural gas to be 725 tonnes of NG, then multiplied by 12/16 for carbon content. My prices came from BP for oil (expressed in $2008 by them), from the EIA for coal (expressed in $2000 by them, but corrected to $2008 using BEA GDP deflators), and from the EIA for natural gas (corrected with GDP deflators for inflation to $2008) . All of this is a bit rough and ready and absolute values could be off by O(10%), but the methodology is consistent over time so trend analysis should be fine.