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The Economics of Carbon: In Conversation with Matthew Kotchen

Environmental economist Matthew Kotchen talks about the social cost of carbon, the world of offsets, and the importance of connecting academics and policymakers — a challenge he is tackling through the Environmental and Energy Policy and the Economy Initiative.

By Dylan Walsh ’11 MEM

Globally, carbon emissions from fossil fuels hit a record high in 2022. In the United States, after a dip from pandemic lockdowns, emissions again began trending upward. At the same time, 2022 marked the first year that energy generated from renewables surpassed that generated by coal.

In short, the news is mixed. But for YSE Professor of Economics Matthew Kotchen, whether shorter-term indicators are progressive or regressive, the implications remain the same. We need smart initiatives that reduce the amount of carbon we are putting in the atmosphere, and these must be informed by sound research, he says.

In a recent conversation with Canopy, Kotchen discusses the most promising approaches to climate change mitigation as well as the work he is spearheading to close the gap that so often separates academics and policymakers.

Do you have an opinion on specific policy that would be most efficient and equitable for reducing emissions? Is that different from what you consider politically feasible?

Any economist would answer that question by saying some sort of pricing mechanism would be most efficient. And many people will counter that pricing mechanisms are not the most equitable because they can be regressive or progressive depending upon design. But people often forget that when you impose a carbon price, you actually generate revenue that can accomplish the redistribution goals that people want.

Having said that, there are other policies that can be relatively cost effective and efficient, like what’s in the Inflation Reduction Act. Is it as efficient as carbon pricing? I think not. But is it better than nothing? Certainly.

People who oppose pricing often talk about the effects on gross domestic product and employment. How valid is that concern?

Some research has found no adverse effects of carbon pricing or a carbon tax on economic growth. That doesn’t mean that there would never be an effect. In many of these cases, the prices were relatively modest. There are also compelling arguments for why imposing a carbon tax could increase economic growth, by stimulating new sectors of the economy, for example.

But we should keep in mind that climate change has costs. If you do it right, your carbon prices would help offset those other costs and you’d come out ahead. Just looking at whether prices have adverse effects on economic growth is only looking at the cost of the policy while ignoring the benefits.

What is the most frequently misunderstood aspect of reducing carbon emissions?

I think that you can go a long way reducing emissions at relatively modest costs before it starts to bite. The sorts of policies we need in place to solve our longer-term climate challenges are of course important, but I think that you can implement some policies right away that could have quite a big impact at a cost that’s worth incurring to avoid some of the damages associated with climate change.

How do carbon offsets figure into these calculations?

All kinds of governments, corporations, and academic institutions have pledged to reduce their emissions. Now the time has come to show progress. Given this, I think we are on the verge of seeing an explosion in the market for offsets — in fact we already are. Figuring out how to set these markets up so that they’re effective and delivering what they promise is becoming, I think, one of the most important areas of climate change research right now, from both a policy and economics perspective.

Switching gears, how did the Environmental and Energy Policy and the Economy Initiative get started?

Through the National Bureau of Economic Research, I put together a proposal to fund an annual conference in Washington, D.C., in May at the National Press Club and an academic publication where we commission six papers per year that are presented in front of an influential policy community. The idea is to create research that looks at trade-offs of different policy options to provide impartial evidence that improves decision-making. It’s important that we not advance a partisan agenda. None of the papers can make a specific policy recommendation. They lay out alternatives, talk about the trade-offs, and try to inform what decision-makers should consider when evaluating options.

What are some of the successes you’ve seen come out of the effort?

There’s a lot of interest in papers being submitted. Our acceptance rate from proposals is about 6% or 7%. We’ve had a couple of papers that I know have directly affected EPA analysis of policies and rulemakings. Examples include the ways in which benefits and costs are measured related to climate change and transportation policy. Having analysts and decision-makers at the conference, interacting with authors, and providing feedback has been a really gratifying part of the initiative.

Is there something from the recent past that makes you particularly hopeful about climate change?

Well, political administrations come and go, and there are bumps along the road, but I feel like the bodies of research in this area get progressively stronger and deeper, and this moves the needle in an enduring way.