The Role of Economics in Climate Change Policy

In this article we examine the key economic characteristics of climate change and argue that economic theory provides good guidance on the design of an efficient and politically realistic policy. Because climate change involves vast uncertainties and has potentially enormous distributional effects, neither of the standard market-based instruments is a viable approach: a tradable permit system would be inefficient and an emissions tax would be politically unrealistic. However, a hybrid policy, combining the best features of the two, would be an efficient and practical approach. We then compare our hybrid proposal to the Kyoto Protocol and argue that it overcomes the Protocol’s shortcomings.