How Adam Smith's theory of moral sentiments could be applied to cap-and-trade greenhouse-gas emissions.

News and commentary about environmental issues.
Sept. 25 2008 11:53 AM

Adam Smith Meets Climate Change

How the theory of moral sentiments could be applied to cap-and-trade greenhouse-gas emissions.

Adam Smith. Click image to expand.

Despite all the attention to domestic oil drilling, Obama and McCain are not that far apart on climate change—both candidates support a cap-and-trade system to limit U.S. greenhouse-gas emissions. And neither candidate has told us much about how they will get the rest of the world on the cap-and-trade bandwagon. That challenge deserves more focus—unless we can entice fast-growing emitters like China, India, and Brazil into a climate change treaty as full participants, even complete energy independence in this country will be little consolation in a warming world. We think Adam Smith may have had a suggestion for how to think about this problem—and it's more than just an invisible hand.

For 30 years now, officials have been groping toward a system in which greenhouse-gas emitters all around the world can trade permits. GHG reductions achieve the same global atmospheric benefit regardless of where they occur, but because industries and firms have different costs of reduction, it makes economic sense to allow them to trade permits. That way we can lower emissions for less money.

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But a crucial sticking point is figuring out how to initially allocate emissions permits among the various countries of the world. Generally speaking, richer nations want permit allotments that track historic emissions rates—essentially locking in their economic advantage by awarding permits based on how much a country is already emitting. Developing countries, in contrast, want permits allocated according to population size, with every person on the planet getting equal emissions rights. Some representatives from poorer nations also point to the fact that countries have not contributed equally to the existing problem of global warming. They argue that the countries most responsible for the current state of affairs, like the United States, should get the fewest permits, since they have already spent their share of the planet's GHG budget.

Whatever the merits of the arguments, any attempt to load this kind of ethical discussion into the decision of how to allocate GHG permits spells diplomatic disaster. It leads back to the same game of GHG chicken we've been playing for years.

And that's where Adam Smith comes in. In addition to his famous arguments in favor of markets and liberalized trade, Smith also had a well-worked-out theory of moral behavior, one that was not so neatly separated from his economic thought as we treat it today. For example, Smith's arguments in favor of free trade included an assumption that owners of capital would naturally prefer domestic to foreign industry, even if the latter offered higher returns. Smith thought this was a good thing because it reflected the moral sentiments that ultimately help make markets work.

Today, capital chases investment opportunities all over the globe with little sense of social allegiance. Nevertheless, other ways of fulfilling Smith's vision have emerged: Firms, activists, and others have sought to reinfuse the market with moral content by giving consumers information about the circumstances in which products are produced. Sweatshop-free clothing, shade-grown coffee, fair-trade bananas, electricity generated from renewable resources—demand for these kinds of goods and services is spreading throughout the marketplace and blurring boundaries between citizen and consumer, government and economy, local and foreign. The market is starting to look as morally rich as it did to Adam Smith, only on a global basis.

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