True Value

As the debate over energy legislation heats up in the Senate in anticipation of the Copenhagen negotiations, legislators on both sides of the aisle are turning toward models of climate change and the economic impact of new legislation. Ignoring the climate models for the moment—while they are important, I have neither the space nor the expertise to comment substantively on them—a deeper look at the economic models shows that members of both camps use these tools to support dramatically different conclusions. This underlines the only fundamental truth of models: Their results are entirely dependent upon the assumptions made during their creation. This is problematic, since the assumptions behind economic models do not include accurate costs of inaction.

This miscalculation is not a function of the models themselves; rather, it is an illustration of a larger problem with the system of costs (prices) in our economic system. This is neither a new problem nor an issue that only concerns environmentalists. In fact, it is the basis for an entire branch of academia. The economics of public goods, and more accurately the environment, are devoted to examining how a system based on private property can accurately price damage to public property. Consider a basic environmental example: water pollution. Before the Clean Water Act, companies could dump pollutants into waterways—a practice most people would acknowledge as a negative impact—but because no one in particular owned the rivers, no one could force the companies to pay for the damage their pollution was causing. Thus, the goods that company sold were under-priced due to the “free” disposal of waste. The CWA attempted to correct this by forcing companies to internalize the costs of water pollution, and, where it is enforced, it has succeeded.

The problem of inaccuracy in pricing applies on a much larger scale. Obviously, climate change serves as the largest current example of this, as legislators and regulators attempt to attach a value to carbon released in the creation or use of products. Without some sort of cap-and-trade regime or carbon tax, there is no mechanism forcing companies or consumers to internalize the damages of the pollution released into the atmosphere, and thus prices remain artificially low. Opposition to climate-change legislation criticizes the proposed bills for causing increases in the costs of electricity and other goods. What they fail to see, or simply ignore, is that these increases are not a premium added to the price of a good so that an unknown entity will profit. Instead, increases re-value goods so that their prices accurately reflect the true costs of production.

For centuries our economic system, and in turn the system of pricing, has treated environmental goods as a zero on balance sheets. The labor, infrastructure, and materials involved in production all had a cost associated with them that was reflected in the final price of the good. By systematically ignoring damage to the environment, our economic system employs a terribly inefficient pricing system. While the cost of damaging nature may not be easily quantifiable, it is clearly not zero. Indeed, certain estimates recommend that we value services provided by the environment to the global economy at as much as $33 trillion.

Accurately reflecting these values in prices is not simply a question of making adjustments to balance sheets or introducing legislation like the CWA that would internalize the costs of carbon in goods—although that would be a good start. Changing the current system will require that consumers recognize that there is a cost to damaging the environment, a cost that they must pay through a higher price for certain goods or by accepting a severely degraded environment. Regulation alone cannot accomplish this revaluation of the environment. The scope of the inefficiency is simply too broad; from carbon emissions to mountain-top removal, hundreds of thousands of production steps involve environmentally damaging activities whose consequences are not priced into the final value of the good. In fact, these practices generally make goods cheaper by moving measurable costs—increased wages paid for the additional labor required by underground mining, for example—to the unmeasured realm of environmental damage.

True pricing reform entails a shift in our worldview. It requires that we look beyond price tags and see the life-cycle costs of the goods we purchase. The government cannot mandate this through climate-change policy or pollution controls—it requires that citizens educate themselves in order to become conscious of their purchases’ environmental impacts. Opponents of the climate-change bills are correct: This will lead to higher prices. But these are prices that we can pay now, or we can accept continued environmental destruction. Either way, they will be paid.

A. Patrick Behrer ’10 is an economics concentrator in Eliot House. His column appears on alternate Thursdays.