California: The green guinea pig

California has a chance to show the world how to balance greenhouse gas reduction with economic prosperity – if they can get it to work.

Now that the Republicans control the House of Representatives and Prop 23 has died, the California Air Resources Board (ARB) takes center stage with its rollout of AB32. Without being overly dramatic, California now stands as the world’s best laboratory for figuring out how to balance greenhouse gas reduction policies while encouraging economic prosperity for all. There will be no one “action hero” here who saves the day for us all. In a state with over 35 million people, each of us will face the new rules of the game embedded in AB32. How we adapt to this new regulatory environment will yield crucial information concerning the true costs of decarbonizing our economy.

Given today’s fossil fuel using economy, we face a nasty tradeoff between economic growth, and exacerbating natural resource depletion and the threat of climate change. China has recently engaged in a green big push of investment as its powerful state government offers cheap land and low interest loans to green businesses. AB32 will help to level this competitive playing field. It sends a clear credible signal to California’s venture capitalists that those companies that can develop a new generation of low carbon products ranging from solar panels to electric vehicles will enjoy soaring sales. This green tech competition between China and California will only spur on the decoupling of greenhouse gas production from world GNP.

While specific firms such as a Tesla may win or lose this competition, the world economy can only gain. As China and California both invest more in the green economy, the probability of a fundamental breakthrough in “green tech” increases. Once a new idea is developed it is a public good that can be replicated around the world. Yes, California produces just a fraction of the world’s greenhouse gas emissions but if AB32 stimulates “green” innovation then this could be a global game changer. Economists have long noted that human ingenuity can substitute for natural capital. Up until now, investment in the “green economy” has lagged. AB32 will address this funding gap.

While the innovation induced benefits from AB32 could be quite large, the Air Resources Board needs to be vigilant about keeping its regulatory costs low. Today, Republicans tend to oppose climate change regulation. They will be more favorably inclined as the reality of climate change starts to be apparent and if the ARB can credibly demonstrate the low regulatory costs and “green job” creation of complying with this regulation.

The costs of AB32 compliance hinge on how California’s diverse households and firms respond to its new rules. In a diverse state, some nimble firms will easily adapt. New startup firms will pop up to participate in our nascent green economy. Some will succeed but many will fail. There will be incumbent firms who will suffer because of AB32. Such firms are likely to be energy intensive and capital constrained. Thus, they will not be easily able to change their ways. In cases such as this, the ARB will face challenges over whether it engages in “tough love” or whether it offers exemptions for businesses that can demonstrate that they are a “hard luck” case.

The Air Resources Board would be wise to collect much more micro data about real world firms and households in California. Rather than relying on national data bases, a serious investment should be made in data collection to learn more about Californian residential, industrial and commercial electricity consumption, by working with the state’s electric utilities, and to study transportation choices made by households and businesses. Armed with such data, the state’s university researchers will be able to help the ARB identify the profile of different types of households and firms who will face the greatest challenges in adapting to the new regulation.

In the recent past, there has been an economic growth versus the environment tradeoff. Republican Administrations have ratcheted down regulation thinking that such red tape strangled economic growth. The authors of Proposition 23 were well aware that during bad times that people are likely to support costly environmental regulation. While it is surely the case that there have been many cases of regulatory over reach, I would argue that California remains a center of human capital and vast wealth because of our state’s unique quality of life. If AB32 can cost effectively enhance our state’s quality of life then it is possible that Prop 23’s defeat will help us to achieve the “win-win” of economic growth and a green future.

Matthew E. Kahn is a Professor of Economics at UCLA's Institute of the Environment and Sustainability. He is the author of Climatopolis (Basic Books 2010) and Green Cities: Urban Growth and the Environment (Brookings Institution 2006).

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