Using the Market to Address Climate Change: Insights from Theory & Experience

Emissions of greenhouse gases linked with global climate change are affected by diverse aspects of economic activity, including individual consumption, business investment, and government spending. An effective climate policy will have to modify the decision calculus for these activities in the direction of more efficient generation and use of energy, lower carbon-intensity of energy, and a more carbon-lean economy. The only technically feasible and cost-effective approach to achieving this goal on a meaningful scale is carbon pricing: that is, market-based climate policies that place a shadow-price on carbon dioxide emissions. We examine alternative designs of three such instruments: carbon taxes, cap and trade, and clean energy standards. We note that the U.S. political response to possible market-based approaches to climate policy has been, and will continue to be, largely a function of issues and structural factors that transcend the scope of environmental and climate policy.