Professor Lawrence Goulder

The Stanford Challenge

 Carbon dioxide—a gas largely produced by burning fossil fuels—collects in the earth's atmosphere, where it traps heat. The rate at which this long-lived gas is being emitted by power plants, refineries, automobiles, and other sources far outpaces its dissipation. As a result, carbon dioxide is building up in the atmosphere at an alarming pace: Since 1800, atmospheric carbon has increased by approximately 30 percent, and by 2100, in the absence of emissions-control policies, experts project that levels will increase by at least 30 percent and by as much as 150 percent. Climate scientists believe that carbon and other "greenhouse gasses" are contributing to the earth's gradual warming, and most agree that a continued warming trend would lead to more extreme weather, including droughts, floods, and rises in sea level. In light of this potential for serious consequences, many researchers and policymakers think that reducing carbon dioxide emissions should be a top priority today.

Because fossil fuels serve as the world's main source of energy and the lifeblood of many large and influential industries, political and industry leaders have had difficulty agreeing on methods of reducing emissions. In order to create a politically viable carbon emissions plan, says Lawrence Goulder, the Shuzo Nishihara Professor of Environmental and Resource Economics, we must find a way to avoid placing big costs on the industries that source and process these fuels.

"Some interest groups—particularly fossil-fuel suppliers and industries that intensively use these fuels—can veto a climate policy," Goulder says. The challenge is "to design a policy that not only achieves environmental goals, but also is relatively cost-effective and has some chance of getting through politically." That's why his goal is to develop a carbon plan that protects profits for energy firms, but that does not substantially raise overall costs to taxpayers and the economy as a whole.

An environmental economist whose work incorporates political considerations, Goulder has studied the outlines of a range of emissions-reduction plans, including flexible, market-based approaches. One policy that has found some favor on both sides of the aisle in Congress and from both Republican and Democratic presidents is "cap and trade." Since the 1990s, cap-and-trade policies have been introduced for various emissions, including sulphur dioxide, the main source of acid rain. In that case, the policy helped reduce the gas at a much lower cost than would have been possible otherwise.

How does cap and trade work? The government places a cap on the overall level of allowed emissions, and then distributes a specific number of permits—each equal to a unit of the target substance—to emission-heavy industries. Those plants that are able to reduce emissions below the required amount end up with excess permits that can be traded or sold to other companies. The plants that face especially high costs in order to limit their emissions have the option of purchasing permits rather than installing expensive new equipment, decreasing their cost of compliance. Thus the system rewards both sellers and buyers, while keeping total emissions within the overall cap. And it lowers the cost of pollution control for society as a whole by allowing market forces to promote emissions reductions by those plants that can do it the most cheaply.

Cap-and-trade policies for carbon dioxide emissions have been under discussion for some time, says Goulder, who is carefully watching a newly launched trading system in Europe. But the United States has yet to formulate a policy to reduce carbon dioxide emissions, despite several legislative attempts. Goulder believes that an important way to enhance the political feasibility of such plans is to come up with a specially designed cap-and-trade system that manages to avoid placing significant costs on coal, oil, and natural gas suppliers or on the industries that rely heavily on these fuels.

Goulder's proposal has sparked considerable interest in Washington, D.C., and in several states that are considering their own climate-change initiatives. The 2000 Economic Report of the President highlighted his cap-and-trade plan, and several congressional committees have invoked his research in putting forward their own climate-change policies. Goulder is encouraged by the steady increase in congressional support for a cap-and-trade system, and believes that the odds are better than even that Congress will approve such a system within the next five years. Decision makers in the European Union and in China have also expressed interest in Goulder's approach.

Goulder's proposal is straightforward. The government would auction off a majority of carbon dioxide emissions permits, gaining revenue in the process. But roughly 10 percent of the permits would be given away. According to Goulder's analysis, that small portion of free permits would be sufficient to maintain the profits of energy firms, thus enhancing the prospects for political success. At the same time, the plan would add just 10 percent to the cost of the program for the government and taxpayers. "The trade-off isn't too severe," Goulder says.

Goulder's work employs "general equilibrium" models that consider interactions among various households, industries, and government sectors in the economy. He relies both on analytical models—mathematical formulas that show a general economic picture—as well as numerical models, which are solved on a computer and encompass greater complexity and detail.

Goulder's influence in public policy goes beyond his cap-and-trade proposal. He is currently providing decision makers with analyses of policies to encourage the purchase of less-polluting and more fuel-efficient automobiles. He is a member of the Environmental Economics Advisory Committee of EPA's Science Advisory Board, and he chairs a panel for the same body that is assessing the "Second Generation Model" for evaluating the costs of U.S. climate policy. Internationally, Goulder is participating in conferences in Beijing to evaluate the potential of a range of tax-policy approaches to pollution control.