Why William Nordhaus was right about climate change policy

As every economist knows if climate change is a problem that requires a solution then that solution is a carbon tax. Within that, however, is an argument which can be described as Stern v Nordhaus. No, this is not about discount rates, rather, about the capital cycle.

Stern said we should have the $80 tax and have it now. This is to internalise those externalities upon everything. But this means that we suddenly make uneconomic things which still have considerable useful life in them.

Nordhaus, on the other hand, points out that climate change is a long term problem. We can - and should - thus reduce the cost of dealing with it by using up that installed base and only replacing it with emissions free technology when we come to replace it anyway. Thus the carbon tax should start small - $10 say - and ramp up over time to something that forces new tech when we are replacing anyway - say $240.

Nordhaus was and is right:

However, this won’t be enough for the sector go green. Chris McDonald, chief executive of the Metals Processing Institute, estimates it would cost between £6bn and £7bn to decarbonise the UK’s steel plants, assuming they were replaced by new facilities. Eurofer says the entire EU and UK steel industry going green by 2050 would push up production costs by between 35pc and 100pc per tonne.

“It will be a huge challenge to fundamentally transform how steel is produced,” says Gareth Stace, director of UK Steel, warning his energy-hungry industry already faces higher costs than rivals in Europe.

Whether or not the UK should be producing virgin steel is an interesting question. There are those that say we must be able to do so on security grounds and the like. But we don’t mine iron ore here and we’re not going to start - again - either. So having a capacity to manufacture from raw materials doesn’t provide that security anyway.

But assume that we must have that capacity. We can use, as we currently do, blast furnaces and coking coal and that has high emissions. We can also use the much newer technology of direct reduction. This requires hydrogen and we’ve not a green supply of that yet but perhaps we will have. This has very low to no emissions.

The Stern to Nordhaus question is when should we replace those blast with direct? Given the long term nature of the problem when we’re about to tear down the old ones anyway, whenever that happens to be. Build the new plant with the new technology, yes, but why blow up a few £ billions worth of perfectly functional plant before we have to?

That means that we don’t in fact have a £6 to £7 billion bill to decarbonise. Now the cost of direct reduction systems is their cost minus the money we’re not going to spend on rebuilding or creating anew blast furnaces. A bill that, when properly calculated, is probably negative.

Of course, we could instead drop the idea of making iron and steel from virgin material altogether and just reprocess scrap in electric arc furnaces but then where’s the fun in that? It’s obvious, economic and requires no government - following that path would allow no strutting upon the national stage, would it, nor dipping into the pockets of the populace?