Externalities should be handled with care

The Financial Times has an interesting interview with Esther Duflo, who was awarded the Nobel Prize in Economics in 2019. She argues that developed nations have a moral duty to compensate poor countries for the damage done by carbon emissions:

If you combine these three numbers, you get basically the money value of the cost of carbon in the air. [University of Chicago economist] Michael Greenstone and his team estimated it to be $37 a tonne. So, take $37 a tonne, multiply by 14bn tonnes a year of carbon emissions — that’s the total footprint, including consumption, of Europe and the US. And you get about a little over $500bn a year. That’s the damage that we impose on poor countries, just the mortality damage. Just from the rich part of the world to the poor part of the world.

So that’s what I call a moral debt. This is not what it would cost to adapt; this is not what it would cost to mitigate. This is what we owe.

She advocates raising these funds by taxing the rich:

The minimum tax on corporations has been fixed at 15 per cent [under an international agreement]. But originally, the number that was proposed was 25. So I’m thinking, well, there is maybe a bit of margin. And if you went from 15 to 18 per cent, you could raise about $200bn a year.

And then, in February, the G20 discussed the proposal of Gabriel Zucman and the EU Tax Observatory of a tax on the super-rich — a tax of 2 per cent yearly on the wealth of the 3,000 richest billionaires. That would raise $300bn. So if you combine these two, you get to your $500bn.

I am sympathetic to her claim that Western carbon emissions have hurt poor countries, although as a utilitarian I don’t think in terms of “moral debts”.  What does that phrase actually mean?  Does it mean that transferring $500 billion from the rich world to the poor world would make the world a better place?  If so, then why not say so?  Why speak in terms of moral debts?

By now I may have antagonized both sides, supporters of Duflo’s proposal and conservatives that are skeptical of utilitarianism.  So let’s examine some specific flaws in Duflo’s approach to public policy.

Duflo is correct that rich countries have imposed large negative externalities on poor countries, by warming the Earth’s climate.  But she overlooks the fact that rich countries have also imposed large positive externalities on poor countries, or that these positive externalities are an order of magnitude larger than the negative externalities.  Here are three obvious examples:

1.  Western technology has caused the population of poor countries to be vastly larger than it would have been without contact with the West.

2. Western technology has caused life expectancy in poor countries to be much longer than it was before being exposed to this technology.

3.  Western technology has caused per capita GDP in poor countries to be far higher than it would have been without this technology.

So if we were to take seriously the idea that externalities cause moral debt, then we would be forced to conclude that the poor world should pay vast reparations to the rich world.  To me, this idea seems absurd.  To be sure, many people I speak with favor forcing China to pay far more for technology they have taken from Western firms. But these people are often silent on the West’s “moral debt” for paper, the compass, gunpowder, the printing press, and all the other Chinese inventions that helped to shape the modern world. 

History is almost infinitely complex, and thus any attempt to develop a ledger of net moral debits and credits based on positive and negative externalities will end up foundering on a host of arbitrary judgments.

A second problem is that Duflo’s proposed tax makes no sense if the underlying problem is externalities.  Economic theory suggests the optimal remedy for negative externalities is to impose a tax equal to the external cost—in this case a carbon tax.  (This is assuming that transactions costs prevent a voluntary solution.)  Instead, Duflo proposes a tax on the rich, which would do little or nothing to address the problem of global warming.

In my view, Duflo’s proposal is an illustration of what can go wrong when you replace utilitarian reasoning with deontological reasoning.  When it comes to public policy, it is not useful to think in terms of “moral debts”.  Rather there are policies that boost aggregate global utility and policies that reduce aggregate global utility.  A policy that slows capital accumulation while doing nothing to address global warming is not likely to boost global utility.

PS.  I am not arguing that victims should never be compensated for damages they receive.  Rather I am suggesting that compensation schemes should be judged on utilitarian grounds.  Thus our legal system is based on the premise that people and companies are generally liable for specific damages imposed on others.

PPS.  I suppose a wealth tax on billionaires sounds “progressive”, especially if the money is given to “poor countries”.  But people like Bill Gates donate a larger share of their wealth to poor countries than do rich governments, and it’s likely that (dollar for dollar) his donations are more effective than those of governments.  In fairness, Duflo suggests donating the money directly to the people in poor countries (which is much better than the approach used in many government run foreign aid programs), but I suspect that once governments become involved the money will end up moving from one government to another.