Economic ideas for a complex climate policy regime

- Ideas from economic theory have often not taken hold in climate policy due to inadequate recognition of institutions.
- Generally not anticipated in theory, multiple layers of jurisdiction and preexisting regulation stifle price signals.
- Regulation continues to outperform economic ideas in shaping environmental outcomes.
- Proposals to dismantle regulatory institutions and replace them with markets may be naive.
- Economic ideas may have their greatest influence by infusing existing institutions with the greater use of incentives.

The parsimony of economic theory provides general insights into an otherwise complex world. However, the most straightforward organizing principles from theory have not often taken hold in environmental policy or in the decentralized climate policy regime that is unfolding. One reason is inadequate recognition of a variety of institutions. This paper addresses three ways that the standard model may inadequately anticipate the role of institutions in the actual implementation of climate policy, with a U.S. focus: multilayered authority across jurisdictions, the impressionistic rather than deterministic influence of prices through subsidiary jurisdictions, and the complementary role of prices and regulation in this context. The economic approach is built on the premise that incentives affect behavior. We suggest that an important pathway of influence for economic theory is to infuse incentive-based thinking into the conventional regulatory framework. In a complex policy regime, incentives can be shaped by shadow prices as well as market prices.