Calculating a Cost/Benefit Ratio for Climate Change Policy

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Jason Furman, chairman of the President’s Council of Economic Advisors, talks about climate change policy

Measuring the costs and benefits of the Obama Administration’s latest climate change policies shows a lopsided dollar advantage in favor of action, says Jason Furman, chairman of the President’s Council of Economic Advisors. “The benefits are in the range of $50 billion to $90 billion a year and the costs are in the range of $8 billion or $9 billion a year.” Furman also spoke about the economics of America’s clean energy future at an event hosted by the Penn Wharton Public Policy Initiative.

In this Knowledge@Wharton interview, Furman discusses the economics of environmental policies and some more general economic policies he says could help to reverse the problem of wage stagnation.

An edited transcript of the conversation appears below:

Knowledge@Wharton: The Chairman of the President’s Council of Economic Advisors, Jason Furman, joins us today to talk about climate change and the administration’s policies for addressing it. In June 2013 President Obama announced his plans for addressing climate change over the second half of his administration. What’s been happening in the ensuing 15 months and is the administration on track with what it hopes to accomplish?

Furman: We’ve been working really hard since the President first announced that climate action plan, and that plan has three parts, which involve almost all the agencies in the federal government. The first is to reduce the amounts of carbon we emit; the second is to be able to better deal with the changes that climate change will bring, because we can slow it, but, we can’t stop it; and third is to better enlist the world in that effort.

If you look at just the last week, you see things in a lot of those different areas. Last week, we had a number of companies at the White House talking about how they could phase out their use of hydro fluorocarbons, increase their use of solar, and this week, the discussion at the United Nations will help advance that third prong of the climate action plan — engaging with the rest of the world.

Knowledge@Wharton: Recently, 12 states — mostly coal-producing — sued the EPA, claiming that the rules the administration would like to impose on greenhouse gas emissions would affect the coal-fired plants in these states drastically and cause some of them to close. There have been protests by coal miners [against this. On the other side] there are charges … that either pollutants and/or greenhouse gases are wafting over state lines into their territory, and they are trying to stop to that. Where does this all stand?

Furman: I’m an economist, not a lawyer, so, let me give you an economic perspective, although I should say that the lawyers that I talk to think this is clearly in the statute….

But, it’s very much sound economic policy and it’s consistent with what we always try to do in environmental regulation, which is look at the costs and look at the benefits. Electricity is responsible for 32% of our greenhouse gas emissions. That’s larger than any other source of greenhouse gas emissions. Most of those emissions are coming from coal-fired power plants. When we look at that, we think, there’s a number of things you can do to improve. You could have more efficient coal-fired power plants. You could shift to a transition fuel, like, natural gas. You could, instead, build capacity in renewables, or you could use less electricity.

“You could have more efficient coal-fired power plants. You could shift to a transition fuel, like, natural gas. You could, instead, build capacity in renewables, or you could use less electricity.”

The combination of those four tools means that we could bring our emissions down, and we could bring them down in a very cost-effective way.  Twitter The benefits of bringing them down are many multiples of the cost, both direct health benefits, like reductions in asthma and premature death, and then, in longer-term benefits from mitigating some of the potentially worst impacts of climate change.

Knowledge@Wharton: The standard argument often when you discuss environmental issues is that there has to be some kind of a trade-off between the good effects that might come from these kinds of things and the negative economic effects. But, how do you think about trading off these things? There would be some jobs lost and maybe there are jobs created somewhere else — but there are some winners and losers, even if the winners might outweigh the losers.

Furman: First of all, I’d look at the costs and the benefits, and here, the benefits are in the range of $50 to $90 billion per year and the costs are in the range of $8 or $9 billion per year, so, it’s many multiples of benefit to cost ratio. I would then note that there’s a lot of ways in which this will help the economy and create jobs, whether that’s in natural gas or renewables, and you see jobs booming in those sectors of the economy.

I certainly think that preventing asthma, premature death, respiratory illness, all of that can actually help make people more productive and help the economy. The IMF has a recent study that has documented that. And finally, most importantly, there’s the economic cost of inaction, those are really large — the more we delay, the more they are. If we wait an extra decade, the costs go up about 40%. If we wait an extra decade and don’t do as much, the temperature goes up an extra degree Centigrade, and the costs go up by the equivalent of $150 billion for the United States. So, there are a lot of costs to inaction.

Knowledge@Wharton: When projections are made for the growth of alternative energies, a lot of times, you see simple, straightforward projections — you see straight line projections. It strikes me that that doesn’t take into consideration unexpected breakthroughs — there are likely to be some breakthroughs, even if we don’t know what they’re going to be by definition.

“There’s the economic cost of inaction…. If we wait an extra decade, the costs go up about 40% … the temperature goes up an extra degree Centigrade, the costs go up by the equivalent of $150 billion for the United States.”

Furman: Right.

Knowledge@Wharton: Also, you can reach a tipping point. Some argue that’s the point we’re at now. Solar energy costs, per dollar, per watt of electricity generated, have been dropping something like 5% to 7% a year for 30 years, almost in a predictable way. Now it’s getting very close to parity in terms of cost with fossil fuels. What’s your view on this? Are we likely to see a sudden and dramatic increase in reductions in costs that would cause people to want to use these alternate sources more? And what is your growth projection for alternative energy use over the next couple of decades?

Furman: In the past few years we’ve seen wind — power produced by wind — grow threefold, and solar grow tenfold, and I expect they’re going to continue to grow rapidly. Twitter  I’m not the best person to predict just how rapidly, but what I can tell you is that if we have the right public policies in place, that would help. And those public policies are appropriate, because you have an externality here, which is other forms of power-produced carbon, which creates a world-wide harm; renewables don’t.

In the face of that externality, policies like the production tax credit we have in the tax code, the investment tax credit — those two benefit wind and solar, and clean power for existing power plants. A lot of states are going to figure out how they want to adopt that rule and implement it. I think many of them will create incentives for renewables. All of this will help provide an impetus to accelerate the work on renewables.

Knowledge@Wharton: I would be remiss if I had the chairman of the President’s Council of Economic Advisors here and didn’t ask what you see coming ahead for the economy. In terms of GDP growth over the next two, three, four quarters, what do you think is going to happen?

Furman: We’ve seen growth speed up in the second quarter; the indications are good for the third quarter. I never want to venture a quarter-by-quarter forecast, but one of the things I think we have going for us, and it’s one that I hope we don’t interrupt and mess up, is a somewhat more predictable fiscal environment, with less of the type of uncertainty that hurt the economy in the past, and a more neutral fiscal policy, without the types of large, fiscal contractions that were helping to go against our growth before. If we can continue that, then there’s every reason to believe the private sector can continue to make its contributions to growing our economy and bringing the unemployment rate down.

Knowledge@Wharton: And on the percentage basis for GDP?

Furman: I don’t have a particular forecast for you, but, we’re still in the phase of growth, where we get extra growth by bringing our unemployment rate down, putting more people to work and adding to our growth rate. After we’re fully recovered, then growth will only come from expanding the economy’s potential, which depends more on the types of technologies we have at our disposal and the quality of the capital investments we’re making. But, right now we’re in the final stages of the cyclical recovery and that will be boosting growth in the near term.

“We need to expand our growth rate, we can do that with immigration reform, business tax reform, investing in infrastructure, improving education, expanding trade….”

Knowledge@Wharton: There has been an interesting study recently from the Organisation for Economic Co-operation and Development, The World Bank and the International Labor Organization. It looks at wage stagnation, which has been a problem in the U.S., but also around the world. In a nutshell, the idea is that a lot of companies or economies are having relatively decent productivity gains, but those gains are not flowing much down to workers, whose wages haven’t increased much, if at all, for a long time. That not only has an effect on the workers, but it also has the effect of driving down the potential of the economy. What’s your view? Particularly, in the U.S., what are some of the causes, what could be some of the solutions?

Furman: I’d love to spend an hour with you on that topic. If you look at family incomes, there have been three important things that have happened. First productivity growth matters a lot, and it isn’t as fast as it was in the 1950s and 1960s. It’s a lot faster than the 1970s and 1980s, but, it still could be faster.

The second is the big increase in inequality that we’ve seen since the late 1970s, and the fact that a lot of the gains in the economy are going either to higher earners or to the business side … and the labor share of income has been falling since about 2000.

The final issue is one that I don’t think is fully appreciated, but, even against those two forces, family incomes continued to rise in the 1970s, 1980s and 1990s, and that’s because there was pressure on wages, but a lot more households had two earners rather than one, as women came into the workforce in droves.

Now that, which was helping to compensate and offset some of these other changes has stopped, and women’s labor force participation has basically flattened out and started to fall. That means that we’re feeling the productivity growth and the inequality even more than the ways in which it was masked in the 1970s, 1980s and 1990s, which is creating a very serious challenge for the typical family’s income and one that I think needs to be the central focus of economic policy. It’s not one that has a one-part agenda or even a three-part agenda; it’s more like as many parts of an agenda as you can throw at the issue, because it’s a big one.

Knowledge@Wharton: What are some of the potential tools that could address this problem?

Furman: We need to expand our growth rate, we can do that with immigration reform, business tax reform, investing in infrastructure, improving education, expanding trade, and I think we need to make sure that more of the benefits of that growth are shared across the board.

The minimum wage is one particularly powerful tool we have to do that; another one is expanding the earned income tax credit for workers without children or for non-custodial parents. I think we just need to keep working on every aspect. I’m not a person who says, “Let’s just focus on distribution, let’s focus on growth,” I think we need to focus on both….

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