Capitalism is under fire. Whatever people think capitalism is, increasing numbers are turning against it. Environmentalists see greed and pollution everywhere, seemingly working in concert to impoverish the entire Earth. Lately, too, some on the political right seem to be having second thoughts, as they grow increasingly irritated with investment firms offering funds focused on environmental, social and governance considerations, or ESG factors. For detractors of all stripes, a growing concern is that there is, in some vague way, “too much capitalism.”
We do not have too much capitalism. In fact, what we need in this moment of environmental crisis is, in a sense, more capitalism. What is needed now is a new, muscular, and re-directed capitalism oriented toward new industries and technologies that improve environmental conditions. The cornerstone of capitalist economies is market prices, and what is needed is a new set of prices that reflect all costs, including environmental harm. These taxes would include, for example, a carbon tax, a cattle head tax, a nutrient water pollution tax, and other levies that reflect some social or environmental damage resulting from human activity.
Proposing environmental taxes is nothing new. The idea of a Pigouvian tax—one levied on a unit of pollution—has been around for almost a century, even if the practice of environmental taxation has endured a very slow uptake. But this article makes a different point. The need for environmental taxes is not so much, as previous writers have argued, to reach some optimal level of pollution, balancing marginal costs and marginal benefits. The point is that capitalism is a powerful, transformative, and disruptive force that is steered by market prices. Guiding capitalist economies in a new, sustainable direction requires changing market prices. Environmental taxes are the way to change market prices, and hence to change direction. Globally, there are few things more entrenched than fossil fuel industries; dethroning them will require something powerful and disruptive, more so than even governments. What else is out there, other than capitalism, that is up to the task?
The history of capitalism is one of disruption. One need only briefly consider what the internet did to travel agencies, what Amazon has done to retailing, and what social media has done to news media, to appreciate the power of market forces in a capitalist society. These changes are clearly not unalloyed causes for celebration. In fact, one might even argue that humankind might be better off without some of them. But they are illustrations of the disruptive power of capitalism. In all of these cases, a change in prices—sometimes a modest one—was enough to cause massive change. Investors, sensing opportunity from these price changes, quickly pumped money into ventures to exploit them. Backed by investors, these companies quickly and brutally moved to displace incumbent businesses.
This kind of disruption has already occurred in the energy sector in the United States, in a way that has actually produced some climate benefits: the advent of hydraulic fracturing. Commonly called fracking, it is the cracking of geologic formations to extract previously unreachable bubbles of oil and natural gas. The result was a significant decrease in their prices. For electricity generation, inexpensive natural gas rapidly replaced coal, a much more greenhouse-gas-intensive fossil fuel. According to the U.S. Energy Information Agency, more electricity was generated in 2019 by renewable energy sources than by coal, the first time that was true since 1885.
It is also worth noting that in the roughly 35 years before fracking, the Environmental Protection Agency had been steadily tightening regulation of air pollution from coal-fired power plants. By no means where those efforts wasted or undesirable. Cost-benefit analyses of the Clean Air Act show that the health benefits of regulation were orders of magnitude greater than the compliance costs. There is no telling how polluted the world would have been without the law. But the Clean Air Act was never going to be an effective way to phase out coal production and combustion in the United States. Because of the inherently political nature of regulation, it was never going to be as powerful of a force as market prices.
Reducing coal consumption in the United States is only an intermediate step, however. Climate change is more serious than cautious, conservative scientists have predicted, and humankind cannot rely on natural gas for very long at all. Natural gas must serve as a very short bridge to a renewable energy future. Moreover, there are still roughly 50,000 jobs in the United States concerned with the extraction, distribution, and processing of coal. At the risk of sounding callous, these jobs must go. Society can no longer pay people to continue to engage in such a destructive industry. There are ameliorative steps that can and should be taken. A federal job retraining and relocation program, the Trade Adjustment Assistance Program, is in place to help workers affected by international trade, and it can be extended to coal workers. In fairly short order, this remedial help will have to extend to workers in the natural gas and petroleum industries as well.
It is wrenching to think about people out of work, and the collapse of communities and social networks. It is just difficult to transition lives, and to fully restore the well-being of displaced workers. But paying people to worsen climate change is an unaffordable folly.
How did we get to this point of environmental crisis? People blame capitalism for the profit motive that seems to have driven the fossil fuel industries to their excesses. But that is mistaken thinking. Capitalism is a system of economic governance, not political governance. A working definition is in order: capitalism is a system of private property whereby ownership of the means of production can be separated from the means of production itself. Capitalism is so powerful because it provides a way of linking money and ideas, sometimes far-flung money and speculative ideas. Capitalism is an extremely efficient way of allocating resources. It is a system that places market economy prices at its conceptual center, rather than straining against them, as socialist economies do. Prices are so ubiquitous and so remorseless in their assessment of scarcity that they provide instantaneous signals of value. Markets fail, of course, sometimes spectacularly, tragically, and globally. But capitalism only leans into what appears to be a default for human nature: the weighing of alternative uses of resources, and their conversion into a metric: a price. How the social consequences of capitalism are managed is determined by policy choices. Capitalism is an exceptionally powerful engine, but it still needs to be steered by political choices.
What are the political decisions that have given rise to the current environmental crises? One choice that almost all countries still make, almost unconsciously and to varying degrees, is to favor short-term economic growth over long-term sustainability. No one would revel in saying it that way, but the preference is unmistakable. Climate change was first pronounced publicly as an environmental threat by President Lyndon Johnson, in a 1965 address to Congress. Some may blame the climate misinformation spread by oil companies and Republicans, but the blame for fossil fuel supremacy and the climate crisis should be widely shared. Democrats and their voters clearly hold the higher ground on environmental issues, but public opinion polls, and the everyday choices made by both red and blue voters, suggest that environmental concerns are superficial, still falling well below kitchen table economic concerns. President Biden, facing worrying political signs ahead of the 2022 midterm elections, released 180 million barrels of oil from the Strategic Petroleum Reserve, because of concern over high gas prices. It is no exaggeration to say that American democracy was on the ballot in last year’s midterm elections, and no exaggeration that keeping gasoline prices low and keeping up consumption (and concomitantly, emissions) seemed still to be a significant national priority.
Having said that capitalism is not the cause of the manifold environmental crises facing humankind, it is important to acknowledge that it has, due to its enormous power, amplified the political choices steering it. In fact, it is fairly important to explicitly identify a critical weakness: while capitalism is not the root of the world’s ills, the capital procured is, in fact, a substantial cause.
The reason for that is this: while capitalism is a system of economic governance that has as its goal the movement of resources to their most profitable use, the capital formed in capitalist ventures—the power plants, the pipelines, the refineries, the offshore oil rigs, and the vast fossil fuel-centered energy infrastructure—are potentially working against this goal. Expensive brick-and-mortar assets, once paid for, create an enormous incentive to maintain the current mode of operations. The status quo may direct resources not to their highest and best uses, but to existing ones. Pricey assets create their own political economy. The result of investment in expensive capital is rigidity in production, an antithesis of capitalism. Joseph Schumpeter identified “creative destruction” as the defining feature of capitalism. The whole point of capitalism is to always have a competition for precious resources, so as to ensure optimal deployment. Capitalism is not the entrenchment of legacy industries.
The global fossil fuel-centered economy originated in the development of the steam engine, but widespread production owes a good deal to the first U.S. tax subsidies for oil, passed in 1913. The subsidies were small. But they were able to create a price differential, enough to induce petroleum exploration. And despite their smallness, year after year, these subsidies cumulated, as did the capital purchased to pursue these industries. The capital improved; innovation made oil capital more productive and efficient. Crude wells gave way to pumpjacks, and they have given way to the small fracking wells that are now commonly used to extract oil and gas in the United States. The oil industry is now famously or infamously powerful, with trillions and trillions of dollars of assets worldwide.
Capital cumulates. Small capital makes a profit, which is used to improve capital, and is invested in bigger, more-efficient capital. This is eventually converted into larger capital, and eventually, it is so large, systemic, and ubiquitous that it is considered infrastructure. Environmentalists complain that legal systems protect corporations; they are actually protecting the capital.
This point might be more compelling if one considers another form of capital. Human capital is the education and the job training obtained by people throughout their working lives. It includes formal education, but it also includes the training provided by employers to operate the expensive capital assets acquired to produce fossil fuels. Human capital is much more valuable than physical capital, an order of magnitude greater in terms of its value toward production of goods and services.
Consider also, that human capital is much more precious to individuals than even physical capital is to their corporate owners. In a lifetime, an individual only has a few chances to acquire human capital. To render that capital anachronistic is to impoverish. Offshore oil rigs can employ people with just a high school diploma, and can pay them $50,000 to $100,000 per year to work for six months as a roughneck. With a college degree, one can earn over $125,000 to be a subsea engineer, again for six months’ work. What are the options for these workers if they lose these lucrative jobs? For corporations, writing off physical capital is bad for business; for people, it is existentially threatening. Politicians compete over their commitment to protecting jobs for this reason.
The upshot of this bit of irony—that capitalism is not the problem but that capital investments are—is that capitalism can be a highly path-dependent phenomenon. I contend that fairly modest subsidies dating back to 1913, small but ongoing, have spawned a behemoth industry with enormous political and economic power. Just its sheer size and its collection of physical and human capital is enough to send Republican politicians scampering to curry favor. Make no mistake: it is nothing short of a miracle that the modern oil industry can float a $500 million oil rig out on the ocean, drop a tube 10,000 feet to the seabed below, puncture it and extract oil in an extremely high-pressure and unpredictable environment. But those productivity miracles are also a curse: this productivity is also a source of inertia, crowding out investment in other forms of energy production and all efforts at conservation. The efficient and productive global oil industry is a product of capitalism, but has now become an anathema to it.
What are we to do, then? How can capitalism be steered in a sustainable direction but also prevented from entrenching a new set of industries?
A new direction must be set by changing prices. Existing prices fail to account for environmental harm, and as a result, have directed entrepreneurial energy toward harmful, entrenched capital. A new set of prices must reflect the harm to the environment, but they should also minimize the potential for entrenchment. The straight subsidization of say, wind energy, may appear a century from now to be as foolish as the original oil subsidies of 1913. As much as is possible, a new set of prices should be narrowly tailored to address the environmental harm, so that the price is neutral as between technologies and methods of reducing that damage.
A new set of prices reflecting environmental impacts will no doubt produce new winners, but as long as prices closely hew to the environmental harms, they will minimize (and perhaps avoid) the picking of winners. A system of subsidies, such as those in the new Inflation Reduction Act, will indeed reduce emissions, and is certainly preferable to inaction. But a better role for government is to evaluate the harm from pollution and establish environmental tax rates representing that amount. Such action is more within the skill set of government agencies than choosing, via subsidy policy, the technologies to address environmental harms. While there remain areas in need of prescriptive government regulation (and perhaps even subsidies), the focus of governmental action should be on the harm side, leaving the technological choices for reductions to the private sector.
Environmental taxes are needed to introduce a new set of prices to steer the engine of capitalism in a more sustainable direction. The world must very soon adopt something like a global carbon tax. But there are other taxes that can and should be levied. A cattle tax is one. If we were to weigh all of the cows on Earth, the total would be greater than the combined weight of every other mammal—every human, dog, cat, whale, dolphin, horse, pig, bear, etc.—by a factor of fourteen to one. Given the greenhouse gas emissions from bovines, which regurgitate methane as part of their digestive process, a head tax on cows would also be an important step forward.
As noted earlier, environmental taxation is not at all a new idea. But previous work has centered on a tax that internalizes previously externalized social costs. Since then, economists have been arguing that environmental taxes are the most efficient way of accounting for the environmental harms of polluting industrial activities. But I make a different argument. I am saying that there is another, little-appreciated justification for environmental taxes: the need to provide a new direction for economies. Capitalism is steered by prices. If we wish the entrepreneurial energies of an economy to change direction and begin to find new ways to protect the environment, we must supply the prices to incentivize new activities and innovations in new areas.
The traditional way of reducing pollution is to regulate the sources. That means, as compared with environmental taxation, issuing rules governing their operation. Some of those rules can seem tantalizingly like a price, since they involve compliance costs. Those rules typically even provide some flexibility as to compliance methods or technologies. Polluting firms may have options for reducing their emissions to mandated levels.
But regulations lack the one thing effected by environmental taxes: a marginal price on pollution. This characteristic of making compliance cost proportional to pollution amounts is what gives environmental taxation its secret power. By scaling compliance cost to pollution levels, environmental taxation activates a different part of the corporation, and a different part of the brain. Compliance can be a creative endeavor, but is not inherently so. By contrast, minimizing a tax bill, which is the task induced by environmental levies, presents many more possibilities for reducing pollution, and thus fosters the creative process. It pains me, as a lawyer, to say this, but in terms of creative solutions, I would rather have the business and engineering parts of a firm working on it than the legal team.
This potential of environmental taxation for fostering creativity and generating innovation are cause for optimism. Innovation is a difficult thing to study empirically, as there is never a counterfactual baseline against which to measure induced innovation. But the evidence is highly suggestive. High prices induce the search for avoidance, and for alternatives. Two resource-poor countries serve as examples.
Sweden has no fossil fuel reserves. Its electricity is derived from nuclear power, hydropower, biomass burning, and some imported natural gas. Yet rather than rely on importing fossil fuels, Sweden has doubled down on its ability to innovate: it has a carbon tax of about $150 per ton. That high price has spawned a new generation of energy innovation. Sweden has created a robust energy loop that uses agricultural waste and woody biomass to generate energy. It has pioneered energy efficiency measures, including the deployment of district heating, the sharing of heat among buildings. It has gasoline cars, but cities are planned differently, and transportation is considered differently. In a country that is two-thirds as dense as the United States, people drive about half as much.
The other country that has responded to extreme resource scarcity with innovation is Israel. Israel receives enough natural rainfall to provide every person with 55 cubic meters of water per year. That doesn’t even account for the needs of agriculture or industry. Needless to say, water is extremely costly in Israel. Households pay typically orders of magnitude more than residents of the United States. And yet, Israel prospers. Compared to arid California, Israel is not quite as prosperous in terms of GDP per capita, but it is far superior in creating wealth from water: it generates 3.5 times as much GDP per unit of water. Israel, a technologically sophisticated country, uses artificial intelligence to spot leaks in sewer pipes—sewer pipes! Upon discovery of a potential leak, small robots are deployed (because people don’t generally like to crawl in sewage pipes) to go and plug the leak with the injection of an industrial putty. Drip irrigation was invented in Israel, and despite its water paucity, it is a net exporter of many of the crops grown in the country.
In both Israel and Sweden, scarcity led to high prices, which led to innovation.
Taxes are, of course, politically toxic. And these environmental taxes will shift jobs from some industries to others, to the great consternation of those coming out on the losing end. But this is always the way things have been in healthy capitalist societies. Creative destruction has always been a feature, not a bug.
Humankind stands not so much at a crossroads but a precipice. At some point, painful measures will have to be undertaken. The sooner those measures are made, the less painful they will be, because entrenched industries continue to further entrench themselves. Meanwhile, the pain of not taking those measures grows in the form of increased climate damages and climate risks, and other kinds of environmental catastrophes. Presidential economic advisor Herb Stein once said, “If something can’t go on forever, it will stop.” And the libertarian icon Milton Friedman once said, “Only a crisis produces real change when that crisis occurs, the actions that are taken depend on the ideas that are lying around. . . .
I believe our basic function is to develop alternatives to existing policy and keep them alive and available until the politically impossible becomes the politically inevitable.”
It is odd to think that Milton Friedman once thought of himself as an underdog. Fifty years hence, it seems clear that his ideas have actually been carried too far. But it is surely cause for hope that Friedman preached a form of economic thinking that had no natural allies, and was able to launch a decades-long movement. Environmental taxation may yet go from being impossible to inevitable. TEF
