Greenhouse Gas Emissions and Transactions Costs

In this series of posts, I have been looking at the climate change issue from the point of view of an intelligent and consistent political conservative – one that believes in individual responsibility and free markets.

Morally, a conservative believes that individuals have inalienable rights to life, liberty, and property. These rights represent a moral prohibition on others against acting in ways harmful to one's life, health, liberty or property, and a duty to provide compensation to victims for harms done.

Economically, it means that individuals must cover the costs of their actions and not force those costs on others without their consent. This provides an incentive to avoid actions where the social costs exceed the social benefits, allowing Adam Smith's invisible and to operate for the good of the community.

Applying these to climate change, the conservative challenge is to come up with a system where the harm-doers with respect to greenhouse gas emissions cover the cost of the harms inflicted on others.

One option is to have each and every greenhouse gas emitter negotiate with each and every person potentially harmed and purchase the risks associated with those potential harms.

Unfortunately, the transaction costs for this type of system are prohibitively high.

In free market economics, transaction costs represent a type of economic inefficiency. It gets in the way of mutually beneficial market transactions.

Person 1 has A but would prefer B. Person 2 has B but would prefer A. Both have reason to exchange A for B. Unfortunately, this beneficial trade has to overcome the barrier of transaction costs. They have to negotiate a trade. And they need to engage in the physical activities that make the trade possible. All of these costs are examples of transactions costs.

Lowering the height of the transaction cost barrier means that more mutually beneficial market transactions can take place.

So, we need a system that accomplishes three objectives.

(1) Internalizes the cost of harms done into the incentives faced by the harm doers.

(2) Compensates those harmed for the harms done (respecting their rights to life, liberty, and property).

(3) Lowers transaction costs.

All of these help the free market's invisible hand work its magic.

There are two policy options that meet these criteria. In cases of perfect knowledge, and application, these options are functionally identical and there is no reason to choose one or the other.

One option is to have the harm doers pay a fee equal the best estimate of harms done - thus internalizing those costs. The revenue is then used to provide compensation to those harmed. This will render some actions too costly - but only those that produce harms that those who benefit are unwilling to cover. The prohibitive transaction costs of having to negotiate trillions of individual contracts is replaced by the lower costs of negotiating the tax.

The other option is "cap and trade". This option fixes the quantity of harmful activity permitted and then auctions off permits to engage in that activity. If the correct level of activity is selected, the revenue that the government receives from auctioning these permits is equal to the value of the harm done. Furthermore, the receipts go to those harmed as compensation for the harms suffered.

Certainly, there will be disputes as to the magnitude of these harms. Harm-doers will have an incentive to deny or minimize harms, while others will have an incentive to magnify the harms suffered or to claim harms that do not exist.

This is a practical problem. However, it is not a problem that is unique to this particular set of circumstances. All of criminal and civil law has to deal with these types of issues - plaintiffs who make exaggerated claims of harm and defendants seeking to minimize or deny those claims. If this were a lethal objection, then it would be a lethal objection to the whole of civil and criminal law.

However, these incentives do not provide a moral excuse for making false claims in order to try to milk the system. It does not justify trying to manipulate the system so as to profit from inflicting harms on others. Nor does it justify trying to manipulate the system by using it to get others to compensate for harms that do not exist. The moral objection to these types of activities still stands. Those people deserve our contempt and condemnation.

None of this counts as socialism. None of this represents anything an intelligent and morally consistent conservative must reject. There is a point at which I would break off of this line of argument and go places an intelligent and consistent conservative would not go, but we have not reached that point yet.