A Changed Prognosis for Climate Change Policy

The financial crisis, and more fundamentally, the global economic downturn, will have a big impact on our near-term efforts to deal with energy security and climate change.

On the energy security front, oil prices, pressured by expectations of lower global demand, have fallen even faster and farther than the stock markets. As a result, states like Russia, Venezuela, and Iran are struggling to meet budget obligations they made when they felt far more flush. This is a stark reminder that the resource flows accompanying high oil prices matter a lot. But rather than breathing a sigh of relief (though that can be excused), we should take this as an opportunity. Now is the time to put in place the investments that might prevent future global growth from sending so much money into the hands of so few. We need to do this both by diversifying sources of transportation fuel and by increasing the efficiency with which the world consumes that fuel.

The political climate for implementing policies along these lines is very different from what it was a year ago. Most U.S. citizens worry about oil only when they’re paying a lot for gasoline at the pump--and with the price of gas steadily falling, political pressure for action may wane. Economists’ preferred solution to excessive consumption--a gasoline tax--is not politically palatable, nor is it necessarily wise fiscal policy during a period of economic malaise. And the production side is not promising either: The financial crunch may discourage overdue investment in oil and gas production, leaving us facing another big economic shock when global economies eventually heat up.

There are, though, a few new opportunities for U.S. action. Capitol Hill is seriously considering a bailout or guided bankruptcy for the automakers, but a deal may well come with a mandate for producing more fuel-efficient vehicles attached. And a larger package of long-term infrastructure investments, including funds to speed the spread of "smart grid" systems, might be accelerated; such a "smart grid" would be a down payment on a transportation system in which ultra-fuel-efficient plug-in hybrid electric vehicles played a big role.

When it comes to climate change, emissions growth will slow along with economic activity, but not in a way that has any meaningful impact on the urgency of confronting climate change. Meanwhile, with credit hard to come by, investment in alternative energy may temporarily slow. (Worse, the tax credits that typically drive investment in solar and wind, recently extended as part of the U.S. bailout package, have suddenly become all but useless as struggling companies find themselves with little if any tax burden to write off.) At the same time, governments will struggle with competing priorities--and many may choose to kick the climate can down the road.

Yet just as on the energy security front, the environment for climate action has been radically transformed. A year ago, the U.S. debate was focused on establishing a cap-and-trade system to limit greenhouse gas emissions. While such a system will be needed early in the next decade, it may take a backseat in near-term policy discussions. The politics of putting in place what is essentially an energy tax would be devilish right now, even though no serious proposal for U.S. cap and trade envisions the system coming into effect until at least 2012. That same time lag, though, implies that legislative action on a cap-and-trade bill could probably be delayed without much penalty.

As with efforts to reduce U.S. dependence on foreign oil, the economic downturn is likely to shift near-term U.S. climate policy from taxes and regulation to government spending. The idea of a "green stimulus" package has become popular in Washington, though analysts are hard-pressed to come up with much green spending that would have an impact quickly enough to provide genuine fiscal stimulus. (That does not mean that policymakers and activists won’t try to fill a stimulus package with attractive-sounding green measures, such as investment in a new electricity grid. It will be important to make sure that such a package provides, as its core goal, genuine stimulus, with efforts to green the legislation secondary.) At the same time, a longer-term economic recovery package may soon be on the way--and here, government spending on green infrastructure and worker training could be a valuable component, speeding the way to a low-carbon economy and ultimately making the targets in an eventual cap-and-trade program easier to reach.

One final note: The financial crisis has made the phrase "market mechanism" a bit less magical that it seemed a year ago. In addition to a near-term switch from talking about gas taxes and carbon caps to looking at government spending, we may see a medium-term shift to greater openness toward traditional regulation. This means that things like Renewable Portfolio Standards, CAFE (fuel efficiency) standards, and the like may become more popular. This is not all bad--well-crafted CAFE standards, for example, can be as useful as gas taxes--but it does demand that we proceed with great care. Smart market mechanisms like cap and trade are likely to be the most economically productive ways to move us to a low-carbon economy. It would be a shame if our current economic troubles led us to inflict further economic pain on ourselves.