Nordhaus and Romer
By Scott Sumner
Tyler Cowen has some good introductions into the work of the new Nobel Laureates, William Nordhaus and Paul Romer. While both have done lots of outstanding work; I’ll just offer a few random comments on the implications of their ideas for policy.
Nordhaus has done some very influential modeling of the problem of global warming. He calculates the optimal carbon tax at roughly $40 per metric ton. I believe that’s equivalent to about 36 cents per gallon of gasoline. Of course carbon taxes apply to more than just gasoline, most notably the fossil fuels burned in the process of generating electricity, as well as other energy intensive industries such as steel, cement, and the heating of buildings.
I’ve always been struck by the modest size of this estimated optimal tax. To put the number in perspective, Western European countries typically have gasoline taxes that are several dollars per gallon. Alternatively, the price of gasoline in California is roughly a dollar higher than in Oklahoma. An optimal carbon tax would not require a dramatic adjustment in our lifestyles, as evidenced by the fact that Californians continue to rely on the automobile, despite high gas prices. This isn’t to say the effects of a carbon tax are not in some sense “large”, they are. Indeed if they were not large then they would not be effective. Furthermore, the optimal carbon tax is expected to rise substantially over time. Rather my argument is different; an optimal carbon tax does not cause a dramatic change in lifestyles. You can have a carbon tax and still maintain a modern, auto-centric, industrial economy.
In the past, I’ve argued that the GOP should do a deal with the Democrats, agreeing to a carbon tax in exchange for an equal reduction in other more highly distortionary taxes, such as the corporate income tax. You could adjust the progressivity of the payroll tax to make the change both tax revenue neutral and progressivity neutral. Also keep in mind that carbon use has some pretty severe externalities beyond “global warming”, so even if you don’t believe in the former being a huge problem, a tax on carbon is almost certainly less distortionary than a tax on capital. (Think of all the people that die from air pollution, for instance.)
Today, the GOP has already done one half of that deal, without permission of the Democrats. They’ve done the tax cut. What remains is to fill the revenue gap by either cutting entitlement spending, adding a VAT, or adding a carbon tax. I doubt the political will for entitlement cuts exists, and I’d prefer a carbon tax to a VAT. You might ask, “How about letting the national debt as a share of GDP grow without limit?” Do you believe in the tooth fairy?
Paul Romer did important work on the role of ideas in economic growth. Recently, there’s been a lot of concern about the rise of China’s high tech industries—will they become a rival to the US? Here’s Russ Roberts interviewing Romer on a closely related example:
Russ Roberts: So those articles that talk about the threat to our prosperity of 200 million Indian engineers or 200 million Indian software designers are missing the boat.
Paul Romer: Yes, or even worse, the threat to our biotechnology industry if everybody else develops a biotechnology industry. What do we care about?
We don’t care about whether our biotechnology industry makes a profit. What we care about is whether we have a drug that treats Alzheimer’s for somebody who might otherwise have a miserable quality of life. The emphasis on the importance of non-rival goods, such as ideas and discoveries, means that there are gains from scale, from trading with bigger and bigger markets that don’t max out. You keep getting more and more benefits from having more people to trade with. This sounds similar to the usual rationale for trade but it’s really quite different.
If China steals our ideas there are two offsetting factors to consider. The theft is bad in the sense that it discourages innovation, by reducing profits. The theft is good in the sense that ideas can be copied at virtually zero marginal cost, and hence transferring ideas to China can dramatically boost human welfare. In the interview, Romer is somewhat agnostic on exactly where to draw the line on intellectual property rights. So am I.