The U.S. House of Representatives may be on the verge of passing the most significant environmental measure since 1990. The bill, named for its sponsors, representatives Howard A. Waxman (D-Calif.) and Edward J. Markey (D-Mass.), would for the first time impose caps on carbon dioxide emissions, which contribute to global warming. It also would allow companies to buy credits from each other, permitting them to exceed their greenhouse gas limits.
While the so-called cap-and-trade mechanism (or some kind of carbon pricing) is needed, it isn't enough. To really avert climate change, the government needs to adopt an explicitly green innovation policy. Unfortunately, green innovation is getting short shrift in this bill and in Washington generally.
Four prevailing doctrines shape U.S. economic policy today: Keynesian economics; two versions of neoclassical economics (conservative supply-side economics and liberal "Rubinomics"); and the new kid on the block, "innovation economics," about which BusinessWeek Chief Economist Michael Mandel wrote a cover story last September.
Both conservative and liberal neoclassicists oppose any government allocation of scarce goods and services. They prefer a market tool such as emissions trading that would set a price for carbon pollution, believing—incorrectly—that companies seeing potential profits would then develop needed technologies. The two camps differ slightly in how to determine a carbon price. In line with their faith in markets, most supply siders who worry about global warming favor carbon taxes, while liberal neoclassicists favor cap and trade.
Latter-day Keynesians, true to the principals of Keynes himself, also back cap and trade, though they regard it as a form of necessary regulation—government sets limits and companies have no choice but to comply. They also don't give much thought to explicitly spurring green innovation because they believe that strict caps in and of themselves would fix things.
Innovation economists see efforts to reduce emissions of carbon dioxide and other greenhouse gases as fundamentally an innovation challenge. They are less sanguine than neoclassicists about the power of price signals alone to bring about a solution, believing that the profit motive works only when there are adequate alternatives to shift to. Without viable electric cars, for example, people will still drive gasoline-powered cars, no matter how much fuel costs, although they might switch to more fuel-efficient models.
Moreover, they believe that even if the price signal is "correct," the innovation that's needed is often delayed because of market failures such as externalities—situations where innovators can't get the full reward from their innovations. Consequently, adherents of innovation economics say that the government must spend more on research and development to develop cost-effective noncarbon or low-carbon energy alternatives.
So who is right? Putting a price on carbon emissions would certainly help. But it's wishful thinking to believe that raising the price by $20 to $40 a ton would make a big difference. A case in point is the Netherlands. Gasoline there costs approximately $8 a gallon today—$5 of which comes from various taxes, amounting to a de facto carbon tax. This is equivalent to $400 per ton for carbon, vastly higher than the price that the Waxman-Markey proposal would bring about.
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