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Column | May 07, 2016 | Rick van der Ploeg

Political Economy of Green Paradoxes

Political Economy of Green Paradoxes

Five years ago, Cees Withagen was successful in obtaining the prestigious Advanced Instigator Grant of the European Research Council and was kind enough to ask me to join in. Green Paradoxes occur in second-best settings where politicians do not do the honourable thing and fail to price carbon upfront. Instead, they either postpone carbon pricing, leaving it for future governments, or opt for the carrot rather than the stick, subsidising renewable energies such as wind or solar instead. Such second-best climate policies make owners of oil fields and gas wells worry that their reserves will become less profitable in the future when carbon is priced more vigorously and renewable energies are serious competitors.

They therefore react by pumping oil and gas out of the ground more quickly— especially if fossil fuel demand reacts strongly to energy prices and supply of reserves does not— thereby accelerating global warming. However, these second-best climate policies are effective in locking up more fossil fuel in the crust of the earth and thus in limiting cumulative carbon emissions and peak global warming.

It can be shown that second-best climate policies are only counterproductive in terms of lowering social welfare if oil and gas demand react strongly to energy prices and reserves do not, and if the social rate of time impatience is quite high. Otherwise, second-best climate policy is effective. Coal is the dirtiest of fossil fuels, so it might be best to have a moratorium on coal production. We contrasted second-best and first-best climate policies in the context of Ramsey growth and analysed carbon capture and sequestration and the best response to climate catastrophes.

Much of the work on this project has been teamwork. Gerard van der Meijden showed that in general equilibrium, second-best policies typically lead to a drop in interest rates. This softens the adverse effects on short-run global warming, as oil and gas owners will pump less vigorously. Gerard also investigated directed technical change and green growth. Jacob Janssen studied income redistribution and climate policies, thus telling us what a fair carbon tax might look like. Niko Jaakkola and David Von Below looked at intergenerational trade-offs and climate-debt deals to persuade current generations to make the sacrifices to curb future global warming. Niko also investigated dynamic games with limit pricing used by dominant oil producers to keep out developers of renewable energy. Karolina Ryszka looked at unilateral climate actions and carbon leakage. Mark Kagan investigated the battle between oil importers trying to grab oil rents and oil producers trying to grab climate rents. He also studied climate sceptics.

Cees has spearheaded a rich agenda on the economics of natural resources and climate policy and still has many strings to his bow. He is currently working on how to sustain international cooperation and on the vexed issue of double limit pricing. It is scandalous that Cees, who is full of energy, has to retire. However, I have no doubt he will be unstoppable— even more so when retired.

Rick van der Ploeg is a TI Fellow, Professor of Economics at the University of Oxford and Research Director of the Centre for the Analysis of Resource Rich Economies (OxCarre).