Global Climate Policy Will Have Net Benefits Larger than Anyone Thinks (And Welfare Gains, Strangely, are Likely to Be Much Larger Yet)

Abstract

As with other public goods lacking strong special interest support, global climate policy suffers from two serious theoretical flaws. The first is failure to endogenize the labor-leisure decision when conducting benefit-cost analysis. Recognition that income generated will not remain the same pre-and-post policy results in downward bias in benefit estimation. Much more importantly, there will generally be free riding in input markets in addition to the well-known output demand revelation problem. Since even households with very high marginal values cannot individually increment public goods, too little income will be generated and too much of the income that is generated will be spent on relatively low value ordinary private goods. The ungenerated income would have all been spent on the public good, apart from general equilibrium considerations, resulting in additional — and perhaps large — downward bias in benefits of global climate policy. The reallocation of spending from relatively low value private goods to higher value public goods may further greatly increase willingness-to-pay for policies to stabilizing global climate.