Saving Energy, and Its Cost

There once was a time when the government relied on a very blunt way of regulating the economy. It told companies and individuals what they could do and what they could not do. These were the days of command-and-control regulation.

But then came the market revolution of the last three decades. With the Soviet empire collapsing, the United States economy growing more rapidly than Europe’s, and newly market-friendly China and India booming, people saw the drawbacks of command and control. Governments were usually better off avoiding outright bans and instead giving people incentives to behave in productive ways.

The classic example was environmental policy.

Most famously, a 1990 bill signed by the first President Bush forced coal plants to buy permits if they were going to emit the sulfur dioxide that caused acid rain. With the price of emissions suddenly higher, the plants looked for innovative ways to reduce pollution — and succeeded more rapidly and cheaply than experts had predicted.

Sen. Richard Lugar (L) and Sen. Lindsey Graham (R) talk to reporters about Lugar's new "Practical Energy and Climate Plan" legislation.
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Sen. Richard Lugar (L) and Sen. Lindsey Graham (R) talk to reporters about Lugar's new "Practical Energy and Climate Plan" legislation.

This history is the basic argument for putting a price on carbon today, and the next several weeks are likely to determine whether that happens. The chances of Congress’s passing a permit — or cap-and-trade — system that applies to the whole economy are low. But it could still create a version that covered power plants, if not factories and transportation. That would be no small thing.

“There is a little bit of a window,” says Jason Grumet, an energy expert and the head of the Bipartisan Policy Center in Washington. The BP spill has focused attention on energy policy, and Congress still has seven weeks before its August recess. “Setting a price on carbon in the power sector,” Mr. Grumet added, “is the most significant opportunity we have to achieve domestic greenhouse gas reductions.”

Unfortunately, the great economic strength of market systems like cap and trade also happens to be their political weakness. They set prices and allow people to react. In the process, market systems acknowledge that reducing pollution may actually cost a little bit of money.

Politicians don’t like to admit this, because voters don’t like it. Accepting higher costs is especially hard when the economy is weak. So Congressional Democrats have been repackaging their energy bills to make them look less and less market-oriented. Senator John McCain, who supported a permit system for carbon as the Republican presidential nominee, no longer does. Senator Lindsey Graham, the South Carolina Republican, has reversed his position as well.

What does Mr. Graham now favor? A series of command-and-control regulations. He has introduced a bill with Senator Richard Lugar, an Indiana Republican, that would mandate specific standards for cars, trucks, homes and offices. It would also give the energy secretary the power to award loans to companies he thought could do a good job of setting up programs to retrofit buildings. State officials would do the same for factories. The bill, in short, puts more faith in government than the market.

This approach can certainly reduce the carbon emissions causing climate change. Fuel economy rules have cut per-mile gasoline use by 40 percent since 1975. As a result, vehicles have made more progress on energy efficiency than office buildings, houses and apartments. That’s one reason a cap-and-trade system for power plants — which provide energy to offices and homes — has such potential to reduce carbon emissions.

The Lugar-Graham bill focuses on offices and homes, too, and would make a difference. But it wouldn’t make as much of a difference, and it also has other drawbacks.

In a market system, businesses and consumers have a clear incentive to reduce their carbon use, and they can choose the cheapest way to do so. Some would decide to retrofit current buildings and homes to make them more energy-efficient. Some would buy new, more efficient machinery or appliances. Some would switch to alternative energy and, in the process, create a much bigger market for it.

“Instead of leaving it up to the government to identify the solution and tell people what to do, you are leaving that decision to the people who know best,” says Nathaniel Keohane of the Environmental Defense Fund. “A bureaucrat would never have enough information to do as good a job.”

Under a command-and-control system, businesses and consumers have to focus not just on carbon use but also on the details of the government’s rules: the intricacies of vehicle and building standards, the types of appliances that qualify for subsidies, the fine print of the Energy Department’s loan applications. Each bit of compliance brings costs.

It’s just that those costs are hidden in a thicket of bureaucracy. The fuel economy rules, for example, have raised the price of minivans, pickup trucks and S.U.V.’s by limiting how many can be sold. But the price increase has not been obvious, as it would be with a gas tax. We can pretend prices are no higher than they otherwise would have been.

In some ways, it is not fair to pick on Mr. Lugar, Mr. Graham and the other senators, both Democratic and Republican, who support the command-and-control approach. It is far better than nothing. The ideal energy policy, in fact, would include some ironclad rules and regulations, because people do not always respond rationally to prices. Consultants at McKinsey & Company argue that many families and businesses could already save money by taking simple energy-saving steps, yet they don’t do so. Building standards could overcome their inertia.

But relying only on rules, regulations, standards, loan programs and research financing seems inadequate to the task we’re facing. The last 12 months have been the warmest 12-month period on record, NASA says. Nine of the 10 warmest calendar years occurred in the last decade.

The market is the most powerful tool available for dealing with the costs and risks of a hotter planet. Given how loudly politicians like to proclaim their belief in the market, it sure would be nice if they could figure out a way to make it part of the solution.