Negative abatement costs, explained

Ted Gayer, co-director of economic studies at the Brookings Institution, published a lazily-reasoned and lazily-researched article dwelling on the apparent impossibility of GHG emissions reduction opportunities with negative marginal costs:

But Krugman oversells the affordability claim by linking to a widely cited report by McKinsey & Company. The main point of the McKinsey study is provided in their Exhibit B, which illustrates a rather peculiar finding that there are a significant number of pollution abatement options that can be achieved at “negative cost.” This finding violates the basic principles of economics. If firms (or consumers) could reduce emissions at negative cost, then they would do so. To say otherwise is to say that they are willingly or ignorantly passing up profits...

Gayer's original post has already been picked apart by luminaries such as Avent, DeLong, and Krugman, but in the interest of documenting this information for myself, I'm going to write out the possibilities Gayer acknowledges, followed by the ones he doesn't.

Gayer can think of four reasons why the McKinsey study might find negative costs:

1. The cost estimates are wrong (i.e. incorrect assumptions)
   


2. The cost estimates are incomplete


3. The private discount rate is incorrectly estimated


4. Firms are behaving irrationally (which he goes on to say is not realistic)

Thankfully, the relevant McKinsey report is available online, and had Gayer bothered to skim it, he would have found starting on p24 this helpful list of potential explanations for negative marginal costs, without invoking irrational behavior:

1. Agency issues (e.g. landlord-tenant)


2. Ownership transfer issues


3. Pricing distortions (e.g. via electricity price regulation)


4. Higher hurdle rates (e.g. consumer's cost of capital could be higher than a corporation's)


5. Constrained access to capital


6. Adverse bundling (e.g. efficient washing machine has other "gold-plated" features unaffordable to non-premium customers)


7. Local product and service availability


8. Improper installation or use
   

Beyond these, it is not hard to believe that well-documented behavioral biases (risk aversion, lack of awareness, habit) play a role in some cases.

Krugman also helpfully points out the considerable existing economic literature on principal-agent problems in energy efficiency.

Gayer's response is also a textbook example of responding to weaker criticisms, and ignoring the stronger ones.

For what it's worth, Gayer seems to support a market-based mechanism (cap-and-trade or a carbon tax) and fear a centralized, command-and-control approach by the government, which are both eminently reasonable positions (which I share, for what it's worth). But arguing flimsily against the existence of negative-cost GHG abatement opportunities like he does is an ineffective way of making that case.