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Public Policies Against Global Warming,” by Hans-Werner Sinn, CESifo Working Paper #2087, August 2007

Harold Hotelling in 1931 demonstrated how owners of non-renewable natural resources would extract that resource to maximize profits. Take the case of an oil field. Owners would optimally extract oil today if the expected return on the proceeds from the sale of that oil (e.g. by investing them in the stock market) exceeds the expected return they would get by leaving oil in the ground (i.e. the expected increase in the price of oil). Oil would remain in the ground as long as the expected increase in oil prices exceeded what returns owners could expect in other markets.

This decades old insight has profound implications for public policies in the fight against global warming. If climate change has been caused by escalating atmospheric concentrations of carbon dioxide, then mitigating further change requires a reduction in the amount of CO2 released into the air. Since it is virtually impossible to continue producing energy by burning fossil fuels without pumping more CO2 into the atmosphere (with the exception of sequestration and afforestation), then effective public policies against global warming require that carbon resources remain underground.

Ironically, imposing carbon taxes and similar policies may increase the rate at which oil is presently being extracted. Taxes will reduce the price suppliers of oil can receive for their oil. Many carbon tax proposals also recommend a gradual increase in the tax over time. Oil producers can therefore expect a higher return by selling oil sooner, rather than by leaving it in the ground for sale in the future. This problem will be exacerbated when extraction costs are low relative to oil prices.

Notwithstanding possible faster extraction, carbon taxes in the United States would lower the supply price of oil on world markets. Other countries that do not impose similar taxes will increase their consumption of oil, partially offsetting the demand reductions in the U.S. sought by the taxes. The authors offer a number of possibilities to reduce the rate of oil extraction, including paying owners of oil to keep it in the ground, and a strengthening of property rights for resource owners.

Viewed in this light the war in Iraq, far from being a war for oil, could have been one of the most effective policies to combat climate change in the past decade. The destruction of numerous refineries, pipelines and other infrastructure during the war has kept a significant amount of oil in the ground, to the considerable benefit of the climate. Or, perhaps U.S. foreign policy has been detrimental to combating climate change. The U.S. policy of democratization has made the property rights of resource owners less certain, thereby encouraging them to extract as much oil today as possible. Rather than repudiation, it might have been better to support and stabilize the regime of Saddam Hussein and other resource owning dictators around the world!

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