Review of Environmental Economics and Policy 9 (2), 2015, pp. 239-245, CESifo Working Paper No. 5385, June 2015.
The climate problem is one of mankind’s biggest challenges. Averting disaster requires nothingless than worldwide collective policy action. However, policies that ignore the laws of eco-nomics may prove futile, if not downright counterproductive. In particular, policies aimed atreducing future demand for fossil fuels could backfire by inducing resource owners to bringforward their extraction plans, thus accelerating global warming. I have called this behaviourthe Green Paradox.Economists and policy makers alike long overlooked the possibility of a Green Paradoxbecause the behaviour of resource owners played no specific role in the economics of climatechange. Although it has long been recognized that the anthropogenic carbon accumulating inthe atmosphere is basically the same as the carbon taken from the ground and that, except forsequestration, no technical devices exist that could change the proportions accumulating in thesea, biomass, and atmosphere, this has rarely been incorporated into climate models oraddressed by policy makers in the past. Instead the focus was on the demand side of themarket.Itwasthoughtthattomitigatetheclimate problem, it would be effective and sufficientto require better insulation of homes, to extract higher mileage from car engines, to subsidizegreen energy through tariffs, to morally discredit fossil fuel consumption, to tax the use of fossilfuels, or to subsidize the development of green technologies, because it was taken for grantedthat supply would follow demand. Resource suppliers were perceived to be like car producers,facing flat marginal cost curves and producing what is demanded at given prices. However,unlike cars, fossil resources sold in the market are already there (i.e., in the earth’s crust) andthus cannot be“produced”in the normal sense of the word. Extraction and exploration costsare typically small relative to user costs. This means that we cannot assume that the supplyreactions of resource owners will be elastic.Fortunately, the period of ignoring the obvious appears to be coming to an end. Although thesupply-side view of the climate problem is not yet widely recognized by the public, both theIntergovernmental Panel on Climate Change and the literature on the economics of climatechange are now giving at least as much weight to the supply side as to the demand side. Thefocus is on the intertemporal dimension of supply decisions, merging the traditional theory of exhaustible resources with the theory of climate change. Exhausting the stock of carbon re-sources in the ground and accumulating waste carbon in the atmosphere are now viewed andmodelled as a single decision.