Raymond J. Kopp gathers shopping lessons for the U.S. government from a price-cutting pro.
Seemingly everyone has an opinion of Walmart, and quite often these opinions diverge. But just about everyone would agree that Walmart sources its products in a manner that permits it to sell them at very low prices. The primary reason is that Walmart is itself a great shopper—for any given product, the company looks globally for the best price and encourages suppliers to compete with one another.
In late 2009, the United States pledged to the international community that it would substantially reduce its carbon dioxide (CO2 ) and other greenhouse gas emissions by 2020, and the president restated this goal in the 2011 Economic Report of the President. Now that U.S. policymakers are in the market for CO2 reductions, it would behoove them to take some shopping lessons from Walmart.
Always Shop for the Best Price
Although the U.S. Senate did not follow the House of Representatives in 2009 in passing comprehensive climate legislation to reduce CO2 emissions, the U.S. Environmental Protection Agency (EPA) is moving ahead with the regulation of CO2 under authority contained in the Clean Air Act (CAA). Despite its 2009 rejection of an overarching climate policy, the Senate now is considering energy legislation in the form of a clean energy standard that would reduce emissions (primarily from the electric utility sector) by requiring a growing percentage of the nation’s electricity to be generated from zero or low CO2 -emitting electricity generation technologies.
Each of these actions—regulatory and legislative—is essentially equivalent to buying reductions in CO2 emissions, and the price being paid is the cost CO2 emitters (and eventually the general public who purchase and use energy) must pay to comply with these new regulations and standards. And either way, the more cheaply emitters can comply with the regulations, the lower will be the energy price increases faced by U.S. households and businesses, and the greater will be the growth of the U.S. economy and jobs.
"The more cheaply emitters can comply with CO2 regulations, the lower will be the energy price increases faced by U.S. households and businesses."
The Importance of Supplier Flexibility
The effect of a reduction in a ton of CO2 emissions on the global climate system is the same no matter where that reduction takes place, whether from a power plant in Ohio or across the border in Mexico. The irrelevance of the emissions location gives rise to an important feature of welldesigned climate policy—supplier flexibility. A policy with supplier flexibility is one that enables reductions in CO2 emissions to take place where they are the least expensive.
In the marketplace for CO2 reductions, the cost of the reduction can vary a great deal, so shopping for the least-cost option can have a significant effect on energy prices, economic growth, and employment. For example, the Energy Information Administration (EIA) conducted a series of economic analyses of the House-passed climate legislation—the American Clean Energy and Security (ACES) Act of 2009. In one analysis, EIA allowed reductions in emissions to take place wherever they were least expensive, whereas in a second case, reductions could take place only within the United States.
A comparison of the results is striking. As Figure 1 portrays, the cost of complying with the requirements of the ACES Act in 2020 for the last ton of CO2 reduced would have been $52 if all reductions had to take place in the United States, compared to $31.75 (a savings of more than $20) when emitters of CO2 could shop the global market for reductions. EIA estimated the cost savings gained though global shopping to be worth $19 billion in 2020 in terms of enhanced U.S. gross domestic product.
These cost savings are not the result of arcane and dubious economic analyses but rather common sense known to every American consumer—you can find a deal if you shop around.
The Importance of Source Flexibility
Just as it does not matter where CO2 emissions are reduced, it does not matter how they are reduced. The effect is the same whether a ton of reductions is from a U.S. power plant or a fleet of automobiles. The result is source flexibility. Well-designed policies incorporating source flexibility consider all sources of emissions as candidates for reductions and then choose those sources with the lowest cost.
The importance of source flexibility in controlling the cost of CO2 reductions is best exemplified by the releases of CO2 from the clearing of tropical rain forests for agriculture and timber production. Using conservative assumptions, a recent RFF study by Erin Myers Madeira and colleagues finds that 100–125 million tons of these deforestation-related CO2 emissions can be reduced annually at $10 per ton. Figure 2 compares the cost of CO2 reductions from reduced deforestation in tropical countries to the estimates provided by EIA of reducing CO2 emissions solely in the United States. The deforestation costs are one-fifth the domestic U.S. cost—like buying a $1,000 plasma TV for $200.
Empowering the Shoppers
The greater the reductions we demand from our energy sector, the greater will be the cost—an economic fact of life. The way to contain the cost within reasonable bounds is to exercise supplier and source flexibility, and by far the best way to do that is to purchase emissions reductions generated through reductions in tropical deforestation. Regulation of CO2 emissions is now the law of the land in the United States under the CAA. As it traditionally has been applied, it generally lacks source and supplier flexibility; however, legal scholars and CAA experts are split in their opinions regarding EPA’s flexibility under the act. Some argue that EPA might have flexibility in its interpretation of the CAA and could provide regulated entities with the ability to purchase CO2 reductions from overseas forestry projects.
As Congress continues to develop policies to promote clean energy within the United States, it has the ability to empower CO2 emitters to reduce their emissions at the least cost globally. Clean energy standards, such as those proposed by the president and under discussion within Congress, would require increasingly greater portions of U.S. electricity to be generated from sources that emit low amounts of CO2 . Such standards could easily accommodate supplier and source flexibility by allowing the purchase of CO2 reductions from overseas forestry projects in lieu of investments in prohibitively expensive low-carbon energy projects.
Beyond PriceIn addition to cost-effectiveness, reducing tropical deforestation is a preferred emissions reduction policy for three reasons:
- An estimated 18–25 percent of annual global greenhouse gas emissions come from deforestation, so reduced deforestation offers a way to substantially cut emissions.
- Although it takes a very long lead time and huge sums of capital to transform our energy infrastructure, policies to reduce deforestation can be implemented quickly, and emissions reductions can be achieved just as fast. Although we are investing in new, low-carbon energy systems to reap carbon dioxide reductions in the future, we can thus meet our immediate emissions reduction commitments now by investing in policies to reduce deforestation.
- Tropical forests are home to the bulk of the world’s biodiversity. Reducing tropical deforestation not only reduces carbon dioxide emissions and protects the global climate, but it carries with it the side benefit of maintaining plant and animal habitat.
Perhaps most importantly, the fiscal policy debate now under way in Washington quite likely could result in fundamental U.S. federal tax reform. It is a well-known economic fact that lowering distortionary taxes (such as payroll taxes) has tremendous benefits in terms of enhanced economic growth and job creation. Putting a price on CO2 emissions and using the resulting revenue to lower labor taxes on a neutral dollar-for-dollar basis would both enhance growth and reduce CO2 emissions. Building in a tax credit system based on CO2 reductions from reduced tropical deforestation would lower revenues a bit but enhance the economic efficiency of the CO2 pricing policy.
CO2 regulatory regimes are available in many flavors. To get the most environmental protection for every dollar spent, the regimes need to be flexible in where and how emissions reductions are achieved. Currently, the least-cost reductions come from reduced rates of deforestation in tropical counties. If Walmart were in charge, that’s where it would be shopping.
Air Resources Board. 2011. Compliance Offset Protocol for U.S. Forest Projects. Sacramento, CA: California Environmental Protection Agency.
Burtraw, Dallas, et al. 2011. Opportunities for Flexibility and Cost Savings within EPA’s Greenhouse Gas Rules. Workshop summary. Washington, DC: Resources for the Future.
Burtraw, Dallas, et al. 2011. Greenhouse Gas Regulation under the Clean Air Act: A Guide for Economists. Review of Environmental Economics and Policy 5(2): 293–313.
Madeira, Erin, Michael J. Coren, and Charlotte Streck. 2010. The Feasible Supply of RED Credits: Less Than Predicted by Technical Models. Issue brief 10-18. Washington, DC: Resources for the Future.
U.S. Energy Information Administration. 2009. Energy Market and Economic Impacts of H.R. 2454, the American Clean Energy and Security Act of 2009. Washington, DC: U.S. Department of Energy.