Economics of demand-side and supply-side climate policies

A portfolio of policies that curbs demand for fossil fuels and reduces their supply can effectively reduce global greenhouse gas emissions that fuel climate change, suggests a paper to be discussed at the Brookings Papers on Economic Activity (BPEA) conference on September 25.

The paper summarizes the trade-offs between available climate policies, broadly categorizes them into demand-side and supply-side policies, and emphasizes that reducing emissions in the United States does little good if it causes emissions to increase elsewhere.

“Carbon is a global pollutant. It doesn’t matter whether it comes from a smokestack here or in India. Thinking globally about emissions reductions is paramount,” the author, Ryan Kellogg of the University of Chicago, said in an interview with the Brookings Institution.

He notes that governments around the world have adopted starkly different approaches. The European Union discourages fossil fuel demand with a large and comprehensive carbon emissions pricing program (taxing greenhouse gas emissions). In the United States, the Biden administration aimed to reduce fossil fuel supply by discouraging drilling on public land and investment in oil and gas transportation. It also enacted subsidies to boost clean energy supply. (Many of these steps have since been rolled back under the Trump administration.) China, through government industrial policy, has become the leading manufacturer of solar photovoltaics, batteries, and electric vehicles.

“The economics suggests a portfolio of policies rather than a single tool,” Kellogg writes.

Because energy markets are global, demand-side carbon emissions pricing that decreases domestic fossil fuel consumption will depress global fossil fuel prices, thereby increasing fossil fuel consumption abroad, the author notes. He writes that this emission “leakage” can be countered by combining emissions pricing with supply-side carbon extraction pricing (for instance, taxing coal, oil, and gas production at the point of extraction), which increases global fuel prices. Supply-side policies in practice, however, have instead narrowly targeted fossil fuel transportation infrastructure or extraction on only federal lands, and the author writes that these policies often fail to effectively reduce emissions because producers substitute to other fuels and transport modes.

The author discusses how barriers to long-distance transmission of clean energy in the United States handicap the effectiveness of demand-side carbon pricing or clean electricity subsidies. He emphasizes the need for reforms to transmission planning and utility governance that target the current system’s bias toward small, local projects over long-distance transmission.

Additionally, the author discusses how federal investments in clean energy research and development could reduce global emissions by encouraging adoption of clean technology in growing low- and middle-income countries.

Climate policies’ distributional consequences help inform political support for, or opposition to, them. The author writes that domestically, carbon emissions pricing primarily burdens current energy users, carbon extraction pricing primarily burdens energy producers and their local communities. Globally, emissions mitigation primarily benefits poorer countries that are already experiencing extreme heat and are least able to adapt to climate change. Among these countries, the author writes that demand-side policies will benefit fossil fuel importers and harm fossil fuel exporters, while supply-side policies will do the opposite.

The joint challenges of reducing global emissions, addressing market and regulatory imperfections, and navigating distributional outcomes imply that the paper’s analysis “does not yield an unambiguous recommendation between demand-side and supply-side climate policy,” writes the author. “Climate policies must instead make trade-offs along many dimensions.”