Why Are Economists So Keen to Put a Price on Carbon? An Accessible Introduction to Economic Reasoning on Climate Policy

The true contribution of economics to climate policy is marred by many misconceptions. This paper aims to help non-experts better understand economic insights by progressively introducing key concepts. We start with perfectly functioning markets, where prices act as powerful guides to channel scarce resources toward their best use from a social point of view. We then recognize that, in many real cases, markets fail to deliver their promise because prices are either absent or do not reflect social values. Anthropogenic greenhouse gas emissions constitute a particularly acute type of market failure affecting both the whole world and future generations. The fundamental source of this failure is the absence of a price on emissions, and economic research has followed two major routes. On the one hand, economists run complex simulation models to estimate the missing price, which can be used as a social yardstick to guide policy choices. On the other hand, they evaluate policy instruments able to reorient market forces toward more climate protection. Two instruments with a strong potential to influence behavior deserve particular attention: the carbon tax and cap-and-trade (or emissions trading) systems. Despite practical complications and the lack of international coordination, both policies have recently made encouraging progress.