Global Warming and Economic Externalities

Given the scientific evidence that human emissions of greenhouse gases (GHG) contribute to global warming which will have real economic consequences through climate change, and the fact that until recently there is neither a market price for GHG emissions nor alternate institutions to impose limits on emissions, we regard GHG emissions as an uncorrected negative externality. Economic equilibrium paths in the presence of such an uncorrected externality are inefficient; as a consequence there is no real economic opportunity cost to correcting this externality by mitigating global warming. Mitigation investment using resources diverted from conventional investments can raise the economic well-being of both current and future generations. The economic literature on GHG emissions misleadingly focuses attention on the intergenerational equity aspects of mitigation by using a hybrid constrained optimal path as the business-as-usual benchmark. We calibrate a simple Keynes-Ramsey growth model to illustrate the significant potential Pareto-improvement from mitigation investment, and to explain the equilibrium concept appropriate to modeling an uncorrect negative externality.