A better approach to climate change for states

Since 2019, my home state New Mexico has committed to an active climate policy. It is a member of the U.S. Climate Alliance and has pledged to reduce its greenhouse gas (GHG) emissions of at least 45 percent by 2030 from 2005 levels. One major action was the passage of the Energy Transition Act, which contains bold renewable energy and zero-carbon electricity mandates. Several states have similar central-planning features.       

Nobel Laureate Ronald Coase once coined the term “blackboard economics” to describe the difference between what economists consider an ideal state and the outcome based on real-world government actions dominated by self-interest politics, real-world dynamics, and high uncertainty. What blackboard economics tells us is especially germane for different climate actions. Climate policy, whether initiated in New Mexico or elsewhere, certainly falls into the space where government action could easily inflict adverse outcomes.   

With the obstacles and other problems faced by conventional climate policy, such as targeted subsidies for clean energy, attention should refocus on institutions that (1) provide market signals for individuals to accommodate climate change and (2) respond to serious market problems in a cost-beneficial manner. These institutions include:

• adaptation based on the pricing mechanism and other market forces
• companies satisfying consumer and investor demands for clean products
• government assistance for basic research (which is inherently underfunded by the private sector) in clean-energy technologies and climate engineering that mitigates the sensitivity of climate change to the level of GHG emissions.

Regretfully, each of these so far has taken a back seat to GHG mitigation policies in New Mexico and elsewhere. 

Markets can address climate change with advantages over top-down government actions. The false presumption is that because producers and consumers fail to account for the social cost of GHG emissions in their decisions, a market failure exists that can be correctable only by the government. This thinking invites valid criticism but, regretfully, it has dominated the narrative so far in states on how to address the climate problem.  

One glaring observation is that the primary motivation for the hurried phase-out of fossil fuel is rent seeking where special interest groups are the true drivers of proposed change. A good example is interest groups pressuring the state utility regulators and legislatures to rely on customer-funded subsidies to foster energy efficiency, distributed generation, electric vehicles and other clean-energy technologies. Although these actions would undoubtedly reduce GHG emissions, they pose “unfairness” questions for utility customers who do not benefit and, as evidence has shown, subsidies are almost economically inefficient. Regretfully, the evidence confirms that an increasing number of states have been at the forefront of bad policies that will lead lower-income people to suffer disproportionally in addition to combating climate change at an excessive cost.   

To illustrate, a major action so far to attack climate change at the state level is renewable portfolio standards (RPS). Over 30 states mandate a certain percentage of electricity generation comes from renewable sources, mainly wind and solar.

A study conducted by analysts at the University of Chicago showed that these standards are driving up electricity prices (which has a regressive effect) and represent a high-cost alternative to reducing carbon dioxide (CO₂) emissions. One result was that “electricity prices increase substantially after RPS adoption. The estimates indicate that in the seventh year after passage average retail electricity prices are 1.3 cents per kWh or 11% higher, totaling about $30 billion in the RPS states. And, 12 years later they are 2.0 cents, or 17%, higher.”

Another result was that “the cost per metric ton of CO₂ abated exceeds $115 in all specifications and can range up to $530, making it at least several times larger than conventional estimates of the social cost of carbon.” Other studies show also that clean energy requirements at the state level have driven up the price of electricity and represent a cost-inefficient alternative to reducing CO₂.   

Compared with government mandates and other central planning actions, markets are more flexible in adapting to changing and unexpected developments. This lowers the chances for costly mistakes that government often makes in its central-planning endeavors. Especially for climate change where massive uncertainties over the physical and economic effects prevail, flexibility and adaptability are key factors for sound decision-making. 

Under a market-based approach, the decision to spend money on combating climate change hinges on the preferences of consumers, investors and even employees. Climate action would rely on the value the market places on climate change. A bottom-up approach places the top priority on pricing and market incentives. Its flexible rules accommodate the demands of individual market players. For example, markets allow companies to charge a higher price for carbon-free or low-carbon products as consumers reveal their demands for a cleaner environment. Investors can choose companies that best align with the value they place on reducing climate change. They can vote by buying or selling company stock. When companies are pursuing activities that lower their carbon footprint, they are directly responding to the preferences of investors, consumers and even employees.  

As a cardinal rule, any public-policy dialogue should steer away from “rhetorical heat” and toward “analytical light.” This is especially true for climate change. But, of course, executing climate policy on the evidence and rational decision-making is easier said than done, and it has especially been absent in the ongoing dialogue on climate change in the states. 

Kenneth W. Costello is a regulatory economist, an independent consultant and a contributor to the recently published book “Adapt and Be Adept.” Costello resides in Santa Fe, New Mexico.