Market Failure Due to Externalities 463A simple fact explains why international cooperation is necessary to address
the problem of global warming. GHGs entering the atmosphere from any par-
ticular point source are distributed equally around the globe within 12 months.
The degree of global warming depends on the total amount of GHGs, regard-
less of their source. The atmosphere, like many other environmental resources
(the open seas, fishing stocks, endangered species), belongs to no countries and
all countries. Thus, global warming represents the ultimate externality.
Countries can reduce emissions by a variety of means: reining in heavy
industry (at the cost of reducing the rate of economic growth), using cleaner
energy sources (including nuclear power), adopting more fuel-efficient tech-
nologies, turning toward greater conservation measures, and replanting forests.
However, all of these measures are costly. It is in no single country’s interest to
institute unilateral reductions in GHGs. Yet, all countries potentially could ben-
efit if multilateral reductions were undertaken.
In principle, the solution to the global warming problem is the same as for
any externality. The externality (in this case, total GHG emissions) should be
reduced up to the point where the marginal benefit (in terms of a cooler Earth)
from any additional reduction just matches the marginal cost (the cost of reduc-
ing emissions, including possibly reduced economic growth). Indeed, starting
with the 1992 Environmental Summit in Rio de Janeiro, the nations of the world
have explored targets and timetables for global emissions reductions. An alter-
native means of achieving efficient reductions is the implementation of a global
“carbon” tax, whereby fossil fuels, automobile emissions, and the like are taxed
according to the amount of CO 2 they contribute to the atmosphere.
However, two aspects make the global warming problem particularly diffi-
cult. The first is the uncertainty about the magnitudes of benefits and costs.
Some policy makers call for significant GHG cuts (25 to 40 percent) by 2050,
emphasizing the large benefits of reducing global warming and manageable
costs. Other experts call for modest reductions, pointing out that the cost of
reducing emissions beyond 15 to 25 percent increases exponentially. As yet,
there is no consensus on the optimal amount of GHG reductions.
The second problem is distributional. The wealthy, industrial countries
tend to place the highest value on environmental preservation. (After all, envi-
ronmental protection is a normal good; as income increases, more of it is
desired.) These countries also produce the lion’s share of emissions. However,
many of the opportunities for low-cost emission reductions reside in the devel-
oping world. Thus, there is a mismatch: the developed world lacks the oppor-
tunities for low-cost reductions, while the developing world lacks the financial
resources to pay for reductions. Thus, payments (or other forms of aid) from
industrial nations to developing ones would seem to be a prerequisite for a
worldwide reduction plan.
The Kyoto Treaty, supported by more than 160 nations in 1997 and reaf-
firmed in 2001 and 2007, is an initial step in addressing global warming. By
this agreement, the major industrialized nations promised to reduce emissionsc11RegulationPublicGoodsandBenefitCostAnalysis.qxd 9/29/11 1:34 PM Page 463