Why Hayek Would Endorse a Carbon Tax

Writing for this publication in March, Mark Sagoff speculated on Friedrich Hayek’s attitude toward carbon pricing, had Hayek lived long enough for climate change to become the pressing issue it has today. He concluded that Hayek’s views on carbon pricing — whether in the form of a tax or permit trading — would be negative.

I, too, am a Hayek enthusiast. A signed copy of his Constitution of Liberty holds pride of place on my office bookshelf. But in a commentary for the Niskanen Center a couple of years ago, I asked the same question as Sagoff did and came to the opposite conclusion. Why is it that he and I, starting from the same Hayekian texts, ended up with opposing answers to the same question?

The problem does not lie with Hayek, nor with Sagoff’s Hayek scholarship — I dispute neither. Nor is Sagoff a climate change denier. He recognizes that fossil fuels are the principal cause of climate change and that we need a fix. Our differences lie in the conclusions we draw from the same premises.

Climate Change is a problem of scarcity and coordination

The first difference stems from Sagoff’s reluctance to see climate change as a problem of scarcity. “Climate change,” he says, “presents a problem not of scarcities but of consequences... Future generations, however hot and miserable, will have lots of coal, gas, and petrol.” True enough: after all, the “peak oil hypothesis” has been soundly debunked. But that theory is an engineer’s view of scarcity.

As economists see it, though, scarcity depends not on physical abundance but on whether we can have more of something without trading away the opportunity to have less of something else. In this case, the scarce good is the capacity of the atmosphere to harmlessly absorb CO2. Thus, the opportunity cost of more CO2 emissions now is a hotter and more miserable world in the future.

Given this understanding of scarcity, we can frame change as a problem of coordination. That is how Hayek would see it. As Sagoff correctly points out:

"For Hayek and others of the Austrian School, economic problems arise with and are resolved by the discovery and coordination of bits of knowledge and know-how, which are dispersed across society... It is always a discovery problem, that is, a problem of how people may act not on the knowledge they have but on the knowledge they find, create, and apply…"

Sagoff cites Hayek’s famous article “The Use of Knowledge in Society”^{“The Use of Knowledge in Society.” American Economic Review XXXV, no. 4 (September 1945): 519-530, https://www.econlib.org/library/Essays/hykKnw.html.}to support his point but somehow misses half of what Hayek was trying to say. The first half of Hayek’s message (which Sagoff emphasizes repeatedly) is that central planners go wrong when they forget that problems of discovery and coordination require knowledge of “time and place.” Such knowledge can be known only to people “on the spot.”^{“The Use of Knowledge in Society,” IV.}It cannot be fully communicated to or by central authorities because either it is too complex or it is implicit in, say, a builder’s gut feeling about a home site, a farmer’s smell of the soil, or a manager’s reading of body language.

The second half of Hayek’s message, in contrast, concerns the problem of communicating the information that the “man on the spot” needs in order to fit local decisions into a wider pattern. In Hayek’s view, the price system is the key to making global information available locally. For instance, if the price of an input you use for your farm or factory goes up, you don’t need to know why — you need only to know that this good has somehow become scarcer, so you should find a way to use less of it. Similarly, if the price of something you produce goes up, you don’t need to know why, only that you should put your local knowledge to work to find new ways to produce more.

Hayek’s point, then, is that problems of coordination and discovery cannot be solved effectively without both kinds of knowledge — local knowledge of time and place and global knowledge carried by markets.

Markets without prices, or prices without markets?

But what if we can’t have both — what if we have to choose between markets without prices and prices without markets. Which is the lesser evil?

Right now, we have markets without prices. Consumers pay no more — and often much less — for carbon-intensive goods than for green alternatives. Entrepreneurs see no more profits in finding low-carbon alternatives than in continuing business-as-usual pollution. Earnest environmentalists beg us to “go green,” but the numbers on the gas pump say, “Fossil fuels are cheap! Fill ’er up!”

Assigning a price for carbon — even one set by government rather than by supply and demand — would be a clear improvement. It would incentivize both producers and consumers to put their knowledge of time and place to work to make the economy greener. And how could that not be better than the status quo?

Sure, the government’s price might not be “optimal” — whatever that means. But we can be absolutely sure that any price under discussion would be better than a perceived price of zero, which is what we have now. Did Elon Musk know the optimal price of his product when he sold his first Tesla? Of course not — he trusted his intuition. But he knew for certain that he should not give his cars away for free.

Naturally, it would be even better if we could enhance market sensitivity to carbon prices at the same time we introduced them. Right now, for example, regulated utilities often have inadequate incentives to produce or buy green energy even when they can get it. Even if a Midwest utility wanted to buy cheap wind power from North Dakota, it would face regulations that block the construction of newtransmission lines. Therefore, any new green energy market should be nationwide. Prices and freer markets are still the best option of all.

Hayek, in The Road to Serfdom, recognized that where there are no prices, market competition will not produce the goods and services we need. He saw pollution as one of the cases in which the market becomes ineffective. “In such instances we must find some substitute,” he said, but that “does not prove that we should suppress competition where it can be made to function."^{Hayek, The Road to Serfdom (Routledge, 1944), 40, http://digamo.free.fr/roadto.pdf.}

Sagoff points out that innovators are already working on new, green technologies even without a carbon price. But if such a price were introduced (any nonzero price, whether “optimal” or not), those innovators would be more richly rewarded and would work that much harder. Even Hayek would not want us to let the perfect be the enemy of the good.

Read Mark Sagoff's rebuttal here or Sagoff's original essay here.