Economist's View

Climate Change Legislation and Protectionism

Martin Feldstein opposes border adjustments related to cap-and-trade:

Will Cap-and-Trade Incite Protectionism?, by Martin Feldstein, Commentary, Project Syndicate: There is a serious danger that the international adoption of cap-and-trade legislation to limit carbon-dioxide emissions will trigger a new round of protectionist measures. ... 150 countries are scheduled to meet in Copenhagen in December to discuss ways to reduce CO2 emissions.

Governments have ... focused on a cap-and-trade system as a way of increasing the cost of CO2-intensive products... The cap-and-trade system ... imposes a carbon tax without having to admit that it is really a tax.

A cap-and-trade system can cause serious risks to international trade. Even if every country has a cap-and-trade system and all aim at the same relative reduction in national CO2 emissions, the resulting permit prices will differ because of national differences in initial CO2 levels and in domestic production characteristics. Because the price of the CO2 permits in a country is reflected in the prices of its products, the cap-and-trade system affects its international competitiveness.

When the permit prices become large enough to have a significant effect on CO2 emissions, there will be political pressure to introduce tariffs on imports that offset the advantage of countries with low permit prices. Such offsetting tariffs would have to differ among products ... and among countries (being higher for countries with low permit prices). Such a system of complex differential tariffs is just the kind of protectionism that governments have been working to eliminate since the start of the GATT process more than 50 years ago.

Worse still, cap-and-trade systems in practice do not rely solely on auctions to distribute the emissions permits. ... Such complexities make it impossible to compare the impact of CO2 policies among countries, which in turn would invite those who want to protect domestic jobs to argue for higher tariff levels.

There is no easy answer to this problem. But before rushing to impose tariffs, it is important to remember that cap-and-trade policies would not be the only government source of differences in competitiveness. Better roads, ports, and even schools all contribute to a country’s competitiveness. No one attempts to use tariffs to balance those government-created differences in competitiveness, and there should be no such attempts if a cap-and-trade system is introduced.

If an international agreement to impose a cap-and-trade scheme is adopted in Copenhagen, the countries there should agree as well that there will be no attempt to introduce offsetting tariffs that would ultimately threaten our global system of free trade.

Paul Krugman on what to do if other countries refuse to participate:

Climate, trade, Obama, by Paul Krugman: I think the president has this wrong:

President Obama on Sunday praised the energy bill passed by the House late last week as an “extraordinary first step,” but he spoke out against a provision that would impose trade penalties on countries that do not accept limits on global warming pollution. ...

The truth is that there’s perfectly sound economics behind border adjustments related to cap-and-trade. The way to think about it is in terms of a well-established theory — the theory of non-economic objectives in trade policy — that owes its origins to Jagdish Bhagwati, who certainly can’t be accused of being a protectionist. The essential idea is that if you have a non-economic objective, such as self-sufficiency in food production, you should choose policy instruments to align incentives with that objective; in normal circumstances this leads to consumer or producer intervention, rarely to tariffs.

But in this case the non-economic objective is to reduce greenhouse gas emissions, never mind their source. If you only impose restrictions on greenhouse gas emissions from domestic sources, you give consumers no incentive to avoid purchasing products that cause emissions in other countries; as a result, you have an inefficient outcome even from a world point of view. So border adjustments here are entirely legitimate in terms of basic economics.

And they’re also probably OK under trade law. The WTO has looked at the issue, and suggests that carbon tariffs may be viewed the same way as border adjustments associated with value-added taxes. ... Because it’s essentially a tax on consumers, it’s legal, and also economically efficient, to collect it on imported goods as well as domestic production; it’s a matter of leveling the playing field, not protectionism.

And the same would be true of carbon tariffs.

What’s happening here, I think, is that people are relying on what Paul Samuelson called an economic “shibboleth” — they’re relying on some slogan rather than thinking through the underlying economics. In this case the shibboleth is “free trade good, protection bad”, when what the economics really says is that incentives should reflect the marginal cost of greenhouse gases in all goods, wherever produced — which in this case happens to imply border adjustments.

Paul Krugman: Betraying the Planet

Are the arguments against the need to act to prevent climate change based upon a morally defensible position grounded in science, or, given the predicted consequences of inaction, a morally indefensible position based upon ideology and political interests?:

Betraying the Planet, by Paul Krugman, Commentary, NY Times: So the House passed the Waxman-Markey climate-change bill. In political terms, it was a remarkable achievement.

But 212 representatives voted no. A handful of these no votes came from representatives who considered the bill too weak, but most rejected the bill because they rejected the whole notion that we have to do something about greenhouse gases.

And as I watched the deniers make their arguments, I couldn’t help thinking that I was watching a form of treason — treason against the planet.

To fully appreciate the irresponsibility and immorality of climate-change denial, you need to know about the grim turn taken by the latest climate research.

The ... planet is changing faster than even pessimists expected: ice caps are shrinking, arid zones spreading, at a terrifying rate. And according to a number of recent studies, catastrophe — a rise in temperature so large as to be almost unthinkable — can no longer be considered a mere possibility. It is, instead, the most likely outcome if we continue along our present course.

Thus researchers at M.I.T., who were previously predicting a temperature rise of a little more than 4 degrees by the end of this century, are now predicting a rise of more than 9 degrees. ...

Temperature increases on the scale predicted by ... researchers ... would create huge disruptions in our lives and our economy. As a recent authoritative U.S. government report points out, by the end of this century..., Illinois may have the climate of East Texas, and ... deadly heat waves ... may become annual or biannual events.

In other words, we’re facing a clear and present danger to our way of life, perhaps even to civilization itself. How can anyone justify failing to act?

Well, sometimes even the most authoritative analyses get things wrong. And if dissenting opinion-makers and politicians ... had carefully studied the issue, consulted with experts and concluded that the overwhelming scientific consensus was misguided — they could at least claim to be acting responsibly.

But if you watched the debate..., you didn’t see people who’ve thought hard about a crucial issue, and are trying to do the right thing. What you saw, instead, were people who ... don’t like the political and policy implications of climate change, so they’ve decided not to believe in it — and they’ll grab any argument, no matter how disreputable, that feeds their denial.

Indeed, if there was a defining moment in Friday’s debate, it was the declaration by Representative Paul Broun of Georgia that climate change is nothing but a “hoax” ... “perpetrated out of the scientific community.” ... Mr. Broun’s declaration was met with a round of applause from his Republican colleagues.

Given this contempt for hard science, I’m almost reluctant to mention the deniers’ dishonesty on matters economic. But in addition to rejecting climate science, the opponents of the climate bill made a point of misrepresenting ... studies of the bill’s economic impact, which all suggest that the cost will be relatively low.

Still, is it fair to call climate denial a form of treason? Isn’t it politics as usual?

Yes, it is — and that’s why it’s unforgivable.

Do you remember ... when Bush administration officials claimed that terrorism posed an “existential threat” to America,... [so] normal rules no longer applied? That was hyperbole — but the existential threat from climate change is all too real.

Yet the deniers are choosing, willfully, to ignore that threat, placing future generations of Americans in grave danger, simply because it’s in their political interest to pretend that there’s nothing to worry about. If that’s not betrayal, I don’t know what is.

Climate Plans and Carbon Markets

Jeffrey Sachs says markets alone are not enough to solve the climate change problem, we also need strategic direction from "detailed and coherent" government plans:

Still Needed: A Climate Plan, by Jeffrey Sachs, Scientific American: There is a myth in America that markets, not plans, are the key to success. Markets will supposedly decide our climate future on their own once we institute cap-and-trade legislation to put a market price on carbon emissions. But this is silly: both markets and planning are essential in any successful large-scale undertaking, whether public or private. We need a detailed yet adaptable road map for action that goes far beyond cap and trade. ...

The administration’s climate negotiator has called cap and trade "the centerpiece" of the domestic climate program. A moment’s reflection shows why that cannot be right. Cap and trade will have little effect, for example, on whether the U.S. revives its nuclear power industry, as it should to meet climate objectives. A renaissance for nuclear will depend on regulations, public attitudes, liability laws, and both administration leadership and public education much more than on cap and trade, which would play at most a supporting role.

"Benefit-Cost Analysis is No Help"

How much should we spend to prevent global warming?

Pindyck vs. Weitzman, Greed, Green and Grains: I spent last weekend at an excellent NBER Conference, Climate Change: Past and Present..., a highlight was a fantastic exchange between two proverbial giants on the Big Climate Change Question.

I'm paraphrasing arguments from memory here... And apologies in advance if this seems too technical.

Robert Pindyck went first. He presented a more-or-less standard representative agent macro model of the world economy and built in a lot of assumptions about various kinds of uncertainty surrounding the effect of warming on output. His model had welfare as a function of output and output growth as a function of temperature change. Importantly, it seems, he assumed temperature change could not affect utility in any manner other than output—a seemingly strong assumption in my book (we all study state-dependent utility, no?). He emphasized many assumptions that were generous toward those most worried about cataclysmic consequences of global warming. And in anticipation of Weitzman, he used probability distribution functions of uncertainties with “fat tails.” Pindyck concluded that society’s willingness to pay to prevent or severely limit global warming could be no more than about 2.5 percent of world income, and likely much, much less.

While Pindyck did use some relatively “green” assumptions that might favor a large number, it was also clear the deck was stacked. One key assumption: it makes no difference whether or not the world ends with certainty in 400 years. I had a hard time with that one. Stephen Salant, one of the discussants, had a hard time with it too. He noted that changing this assumption alone could increase willingness to pay to 99 percent of income. ...

Feldstein Hates Cap and Trade

Marty Feldstein doesn't like the cap and trade legislation:

Cap-and-Trade: All Cost, No Benefit, by Martin Feldstein, Commentary, Washington Post: The Obama administration and congressional Democrats have proposed a major cap-and-trade system aimed at reducing carbon dioxide emissions. ... But... The proposed legislation would have a trivially small effect on global warming while imposing substantial costs on all American households. And to get political support in key states, the legislation would abandon the auctioning of permits in favor of giving permits to selected corporations.

The leading legislative proposal, the Waxman-Markey bill that was recently passed out of the House Energy and Commerce Committee, would reduce allowable CO2 emissions to 83 percent of the 2005 level by 2020, then gradually decrease the amount further. ...

A Lump of Coal for Obama

More disappointment with the new leader:

Obama walks a fine line over mining, by Tom Hamburger and Peter Wallsten, LA Times: With the election of President Obama, environmentalists had expected to see the end of the "Appalachian apocalypse," their name for exposing coal deposits by blowing the tops off whole mountains.

But in recent weeks, the administration has quietly made a decision to open the way for at least two dozen more mountaintop removals. ... The list included some controversial mountaintop mines. ...

The administration's decision ... sheds on relations between the mining industry and the Obama White House,... environmentalists ... say they feel betrayed...

The issue is politically sensitive because environmentalists were an active force behind Obama's election, and the president's standing is tenuous among Democratic voters in coal states. ... Moreover,... halting mountaintop mining could eliminate jobs and put upward pressure on energy prices in a time of economic hardship.

Coal advocates have solicited help from officials as high up as White House Chief of Staff Rahm Emanuel. And the issue has sparked contentious debates within the administration, including one shouting match...

Although environmentalists had expected the new administration to put the brakes on mountaintop removal, Rahall and other mining advocates have pointed out that Obama did not promise to end the practice and was more open to it than his Republican opponent, Arizona Sen. John McCain.

A review of Obama's campaign statements show that he had expressed concern about the practice without promising to end it. ... And his EPA administrator, Lisa Jackson, has said that the agency ... would "use the best science and follow the letter of the law in ensuring we are protecting our environment." Soon afterward, the agency in effect blocked six major pending mountaintop removal projects...

But this month, after a series of White House meetings with coal companies and advocates..., the EPA released the little-noticed letter giving the green light to at least two dozen projects. ...

Ed Hopkins, a top Sierra Club official, said some of the projects that have now obtained the EPA's blessing "are ... large and potentially destructive..." "It makes us wonder what standards -- if any -- the administration is using," Hopkins said. ...

Environmentalists were stunned to learn from Rahall's office May 15 that the EPA had given its blessing to 42 out of the 48 mine projects it had reviewed so far -- including two dozen mountaintop removals.

The news came in a letter ... from ... the EPA's acting assistant administrator, who wrote, "I understand the importance of coal mining in Appalachia for jobs, the economy, and meeting the nation's energy needs."

Carbon Offsets

Robert Frank argues for carbon offsets as a complement to carbon taxes or cap-and-trade:

Carbon Offsets: A Small Price to Pay for Efficiency, by Robert H. Frank, Commentary, NY Times: Are carbon offsets a good thing? They are intended to reduce the environmental impact of consumption. Traveling by plane, for example, causes carbon dioxide to be emitted into the atmosphere, so travelers can pay a specialist to offset those emissions some other way — perhaps by planting vegetation or installing renewable-energy technologies. It all sounds reasonable.

Yet carbon offsets have drawn sharp criticism, even ridicule. ... But the criticism is misguided. If our goal is to reduce carbon emissions as efficiently as possible, offsets make perfect economic sense.

Consider the decision of whether to buy a hybrid car. ... Many people drive so little that they wouldn’t save enough on gasoline to recoup the higher cost. Yet many such people buy hybrids anyway, because they think they are helping the environment. Well and good, but they could help even more by buying a standard car and using the savings to buy carbon offsets. ...

Of course, carbon offsets alone won’t eliminate global warming. People also need stronger incentives to take into account the environmental consequences of their actions.

President Obama has proposed attacking the problem with a carbon cap-and-trade system. ... This approach was first used in the United States to address acid rain... Compared with more traditional regulatory measures, the auction method substantially reduced the cost of achieving the law’s air-quality target.

As people learn more about such an approach, they seem less likely to oppose it. ... A carbon cap-and-trade system is functionally similar to a carbon tax. ... Carbon offsets are no substitute for the stronger incentives inherent in carbon taxes or cap-and-trade, but they can reinforce their effects. Both carbon taxes and permit auctions would also generate revenue that could be used to buy additional carbon offsets. ... Carbon offsets, though much maligned, are an excellent idea. If you want to help reduce carbon emissions, consider buying some.

"Moyo's Confused Attack on Aid for Africa"

More "Mud-Wrestling on African Aid":

Moyo's confused attack on aid for Africa, by Jeffrey Sachs, voxeu.org: Ms. Dambisa Moyo's recent Huffington Post article exposes the confusions that underlie her slashing attacks on aid. Most importantly, she seems to believe that sub-Saharan Africa was economically prosperous and then was pushed into poverty by aid. She makes the following statement: "No surprise, then, that Africa is on the whole worse off today than it was 40 years ago. For example in the 1970's less than 10% of Africa's population lived in dire poverty -- today over 70% of sub-Saharan Africa lives on less than US$2 a day."

Let's parse that statement for a moment. World Bank researchers Shaohua Chen and Martin Ravallion (2007) prepare the benchmark under-$2-a-day historical headcount data going back to 1981. According to their figures, headcount poverty under $2 a day was 74% of the population in sub-Saharan Africa in 1981 and 73% in 2005. Other prominent estimates that go back to 1950 or 1970 also contradict Moyo's statement, by showing high and persistent poverty. All of the macroeconomic time series by Maddison (1995), Summers and Heston (1988), and others tell the same story; the majority of Africa's population started out impoverished at the time of national independence in the 1960s and 1970s, and a majority remains impoverished till today.

Paul Krugman: The Perfect, The Good, The Planet

Is the proposed climate change bill good enough to support, or have compromises watered it down so much that it would be better to hold out in the hopes of getting something better?:

The Perfect, The Good, The Planet, by Paul Krugman, Commentary, NY Times: In a way, it was easy to take stands during the Bush years: the Bushies and their allies in Congress were so determined to move the nation in the wrong direction that one could, with a clear conscience, oppose all the administration’s initiatives.

Now, however, a somewhat uneasy coalition of progressives and centrists rules Washington, and staking out a position has become much trickier. Policy tends to move things in a desirable direction, yet to fall short of what you’d hoped to see. And the question becomes how many compromises, how much watering down, one is willing to accept. ...

If we’re going to get real action on climate change any time soon, it will be via some version of legislation proposed by Representatives Henry Waxman and Edward Markey. Their bill would limit greenhouse gases by requiring polluters to receive or buy emission permits, with the number of available permits — the “cap” in “cap and trade” — gradually falling over time.

It goes without saying that the usual suspects on the right have denounced Waxman-Markey: global warming isn’t real, emission limits will destroy the economy, yada yada. But the bill also faces opposition from some environmentalists, who are balking at the compromises the sponsors made to gain political support. ...

Al Gore has praised the bill... A number of environmental organizations ... have also come out in strong support. But Greenpeace has declared that it “cannot support this bill in its current state.” And some influential environmental figures ... oppose the whole idea of cap and trade, arguing for a carbon tax instead.

I’m with Mr. Gore. The legislation now on the table isn’t the bill we’d ideally want, but it’s the bill we can get — and it’s vastly better than no bill at all.

One objection — the claim that carbon taxes are better than cap and trade — is, in my view, just wrong. In principle, emission taxes and tradable emission permits are equally effective at limiting pollution. In practice, cap and trade has some major advantages, especially for achieving effective international cooperation.

Not to put too fine a point on it, think about how hard it would be to verify whether China was really implementing a promise to tax carbon emissions, as opposed to letting factory owners with the right connections off the hook. By contrast, it would be fairly easy to determine whether China was holding its total emissions below agreed-upon levels.

The more serious objection to Waxman-Markey is that ... in the first years of the program’s operation more than a third of the ... emission permits would be handed over at no charge to the power industry.

Now, these handouts wouldn’t undermine the policy’s effectiveness..., polluters ... still have an incentive to reduce their emissions, so that they can sell their excess permits to someone else. ... But handing out emission permits does, in effect, transfer wealth from taxpayers to industry. So if you had your heart set on a clean program, without major political payoffs, Waxman-Markey is a disappointment.

Still, the bill represents major action to limit climate change. ... And by all accounts, this bill has a real chance of becoming law in the near future. So opponents of the proposed legislation have to ask themselves whether they’re making the perfect the enemy of the good. I think they are.

After all the years of denial, after all the years of inaction, we finally have a chance to do something major about climate change. Waxman-Markey is imperfect, it’s disappointing in some respects, but it’s action we can take now. And the planet won’t wait.

Paul Krugman: Empire of Carbon

Paul Krugman says that if we want to save the planet from global warming, China's participation will be required:

Empire of Carbon, by Paul Krugman, Commentary, NY Times: I have seen the future, and it won’t work.

These should be hopeful times for environmentalists. Junk science no longer rules in Washington. President Obama has spoken forcefully about the need to take action on climate change; the people I talk to are increasingly optimistic that Congress will soon establish a cap-and-trade system... And once America acts, we can expect much of the world to follow our lead.

But that still leaves the problem of China, where I have been for most of the last week. Like every visitor to China, I was awed by the scale of the country’s development. Even the annoying aspects — much of my time was spent viewing the Great Wall of Traffic — are byproducts of the nation’s economic success.

But China cannot continue along its current path because the planet can’t handle the strain.

The scientific consensus on ... global warming has become much more pessimistic over the last few years. ... Why? Because the rate at which greenhouse gas emissions are rising is matching or exceeding the worst-case scenarios. And the growth of emissions from China ... is one main reason for this new pessimism.

China’s emissions, which come largely from its coal-burning electricity plants, doubled between 1996 and 2006. ... And the trend seems set to continue: In January, China announced that it plans to continue its reliance on coal... That’s a decision that, all by itself, will swamp any emission reductions elsewhere.

So what is to be done about the China problem?

Nothing, say the Chinese. Each time I raised the issue..., I was met with outraged declarations that it was unfair to expect China to limit its use of fossil fuels. After all, they declared, the West faced no similar constraints during its development; while China may be the world’s largest source of carbon-dioxide emissions, its per-capita emissions are still far below American levels; and anyway, the great bulk of the global warming that has already happened is due not to China but to the past carbon emissions of today’s wealthy nations.

And they’re right. It is unfair to expect China to live within constraints that we didn’t have to face when our own economy was on its way up. But that unfairness doesn’t change ... that letting China match the West’s past profligacy would doom the Earth as we know it.

Historical injustice aside, the ... climate-change consequences of Chinese production have to be taken into account somewhere. And anyway, the problem with China is not so much what it produces as how it produces it. ...

The good news is that the very inefficiency of China’s energy use offers huge scope for improvement. Given the right policies, China could continue to grow rapidly without increasing its carbon emissions. But first it has to realize that policy changes are necessary.

There are hints ... that the country’s policy makers are starting to realize that their current position is unsustainable. But I suspect that they don’t realize how quickly the whole game is about to change.

As the United States and other advanced countries finally move to confront climate change, they will also be morally empowered to confront those nations that refuse to act. Sooner than most people think, countries that refuse to limit their greenhouse gas emissions will face sanctions, probably in the form of taxes on their exports. They will complain bitterly that this is protectionism, but so what? Globalization doesn’t do much good if the globe itself becomes unlivable.

It’s time to save the planet. And like it or not, China will have to do its part.

"Straight Talk about Corporate Social Responsibility"

Nothing here causes me to alter my view that relying upon the goodwill of corporate America as a substitute for government intervention to resolve environmental, foreign aid, and other problems is not going to work:

Straight Talk about Corporate Social Responsibility, by Robert Stavins: Critical thinking about “corporate social responsibility” (CSR) is needed, because there are few topics where discussions feature greater ratios of heat to light. ... Much of what has been written on this question has been both confused and confusing.  Advocates, as well as academics, have entangled what ought to be four distinct questions about corporate social responsibility:  may they, can they, should they, and do they.

First, may firms sacrifice profits in the social interest - given their fiduciary responsibilities to shareholders?  Does management have a fiduciary duty to maximize corporate profits in the interest of shareholders, or can it sacrifice profits by voluntarily exceeding the requirements of environmental law?  Einer Elhauge, a professor at Harvard Law School, challenges the conventional wisdom that managers have a simple legal duty to maximize corporate profits. ...

If a company’s managers decide, for example, to use “green” inputs, devise cleaner production technologies, or dispose of their waste more safely, courts will not stop them..., no matter how disgruntled shareholders may be at such acts of public charity.  The reason is that for all a judge knows, such measures - particularly when they are well publicized - will add to the firm’s bottom line in the long run by increasing public goodwill.  But this line of argument contradicts the very premise, since it is based upon the notion that the actions are not sacrificing profits, but contributing to them.

This leads directly to the second question.  Can firms sacrifice profits in the social interest on a sustainable basis, or will the forces of a competitive market render such efforts transient at best?  Paul Portney, Dean of the Eller College of Management at the University of Arizona, notes that for firms that enjoy monopoly positions or produce products for well-defined niche markets, such extra costs can well be passed on to customers.  But for the majority of firms in competitive industries - particularly firms that produce commodities - it is difficult or impossible to pass on such voluntarily incurred costs to customers..., suggesting that, in the face of competition, such behavior is not sustainable.

This leads to the third question of CSR:  even if firms may carry out such profit-sacrificing activities, and can do so, should they - from society’s perspective?  Is this likely to lead to an efficient use of social resources?  To be more specific, under what conditions are firms’ CSR activities likely to be welfare-enhancing?  Portney finds that this is most likely to be the case if firms pursuing CSR strategies are doing so because it is good business - that is, profitable.  Once again, a positive response violates the premise of the question.  But for more costly CSR investments, concern exists about the opportunity costs... Further, in the case of companies that behave strategically with CSR to anticipate and shape future regulations, welfare may be reduced if the result is less stringent standards (that would have been justified).

Finally, do firms behave this way?  Do some firms reduce their earnings by voluntarily engaging in environmental stewardship?  Forest Reinhardt of the Harvard Business School addresses this question by surveying the performance of a broad cross-section of firms, and finds that only rarely does it pay to be green.  That said, situations do exist in which it does pay... - examples such as Patagonia and DuPont stand out - but the empirical evidence does not support broad claims of pervasive opportunities.

So, where does this leave us?  May firms engage in CSR, beyond the law? An affirmative though conditional answer seems appropriate.  Can firms do so on a sustainable basis?  Outside of monopolies and limited niche markets, the answer is probably negative.  Should they carry out such beyond-compliance efforts, even when doing so is not profitable?  Here - if the alternative is sound and effective government policy - the answer may not be encouraging.  And the last question - do firms generally carry out such activities - seems to lead to a negative assessment, at least if we restrict our attention to real cases of “sacrificing profits in the social interest.”

But definitive answers to these questions await the results of rigorous, empirical research. ...

Paul Krugman: An Affordable Salvation

Setting the record straight:

An Affordable Salvation, by Paul Krugman, Commentary, NY Times: The 2008 election ended the reign of junk science in our nation’s capital, and the chances of meaningful action on climate change, probably through a cap-and-trade system on emissions, have risen sharply.

But the opponents of action claim that limiting emissions would have devastating effects on the U.S. economy. So it’s important to understand that just as denials that climate change is happening are junk science, predictions of economic disaster if we try to do anything about climate change are junk economics.

Yes, limiting emissions would have its costs. ... A cap-and-trade system would raise the price of anything that, directly or indirectly, leads to the burning of fossil fuels. Electricity, in particular, would become more expensive, since so much generation takes place in coal-fired plants.

Electric utilities could reduce their need to purchase permits by limiting their emissions of carbon dioxide... But the steps they would take..., such as shifting to other energy sources or capturing and sequestering much of the carbon dioxide they emit, would without question raise their costs.

If emission permits were auctioned off — as they should be — the revenue ... could be used to give consumers rebates or reduce other taxes, partially offsetting the higher prices. But the offset wouldn’t be complete. Consumers would end up poorer than they would have been without a climate-change policy.

But how much poorer? Not much, say careful researchers, like those at the Environmental Protection Agency or the ... Massachusetts Institute of Technology. Even with stringent limits, says the M.I.T. group, Americans would consume only 2 percent less in 2050... That would still leave room for a large rise in the standard of living, shaving only one-twentieth of a percentage point off the average annual growth rate.

To be sure,... many ... insist that the costs would be much higher. Strange to say, however, such assertions nearly always come from people who claim to believe that free-market economies are wonderfully flexible and innovative, that they can easily transcend ... constraints...

So why don’t they think the economy can cope with limits on greenhouse gas emissions? Under cap-and-trade, emission rights would just be another scarce resource...

Needless to say, people like Newt Gingrich, who says that cap-and-trade would “punish the American people,” aren’t thinking that way. They’re just thinking “capitalism good, government bad.” But if you really believe in the magic of the marketplace, you should also believe that the economy can handle emission limits just fine.

So we can afford a strong climate change policy. And committing ourselves to such a policy might actually help us in our current economic predicament.

Right now, the biggest problem facing our economy is plunging business investment ... since they’re awash in excess capacity...

But suppose that Congress were to mandate gradually tightening emission limits, starting two or three years from now. This would ... create major incentives for new investment — investment in low-emission power plants, in energy-efficient factories and more.

To put it another way, a commitment to greenhouse gas reduction would, in the short-to-medium run,... give businesses a reason to invest in new equipment and facilities even in the face of excess capacity. And given the current state of the economy, that’s just what the doctor ordered.

This short-run economic boost isn’t the main reason to move on climate-change policy. The important thing is that the planet is in danger, and the longer we wait the worse it gets. But it is an extra reason to move quickly.

So can we afford to save the planet? Yes, we can. And now would be a very good time to get started.

Policy and Uncertainty

Robert Stavins:

What Baseball Can Teach Policymakers, by Robert Stavins: ...Uncertainty is an absolutely fundamental aspect of environmental problems and the policies that are employed to address those problems. Any analysis that fails to recognize this runs the risk not only of being incomplete, but misleading as well. ...

To estimate proposed regulations’ benefits and costs, analysts frequently rely on inputs that are uncertain – sometimes substantially so. Such uncertainties in underlying inputs are propagated through analyses, leading to uncertainty in ultimate benefit and cost estimates...

Despite this uncertainty, the most prominently displayed results ... are typically single, apparently precise point estimates of benefits, costs, and net benefits (benefits minus costs), masking uncertainties inherent in their calculation and possibly obscuring tradeoffs among competing policy options. Historically, efforts to address uncertainty ... have been very limited...

Over the years, formal quantitative uncertainty assessments — known as Monte Carlo analyses — have become common in a variety of fields, including engineering, finance, and a number of scientific disciplines...

The first step in a Monte Carlo analysis involves the development of probability distributions of uncertain inputs to an analysis. These probability distributions reflect the implications of uncertainty regarding an input for the range of its possible values and the likelihood that each value is the true value. Once probability distributions of inputs to a benefit‑cost analysis are established, a Monte Carlo analysis is used to simulate the probability distribution of the regulation’s net benefits by carrying out the calculation of benefits and costs thousands, or even millions, of times. With each iteration of the calculations, new values are randomly drawn from each input’s probability distribution and used in the benefit and/or cost calculations. ... Importantly, any correlations among individual items in the benefit and cost calculations are taken into account. The resulting set of net benefit estimates characterizes the complete probability distribution of net benefits.

Uncertainty is inevitable in estimates of environmental regulations’ economic impacts, and assessments of the extent and nature of such uncertainty provides important information for policymakers evaluating proposed regulations. Such information offers a context for interpreting benefit and cost estimates, and can lead to point estimates of regulations= benefits and costs that differ from what would be produced by purely deterministic analyses (that ignore uncertainty). In addition, these assessments can help establish priorities for research.

Due to the complexity of interactions among uncertainties in inputs..., an accurate assessment of uncertainty can be gained only through the use of formal quantitative methods, such as Monte Carlo analysis. Although these methods can offer significant insights, they require only limited additional effort... Much of the data required for these analyses are already obtained...; and widely available software allows the execution of Monte Carlo analysis in common spreadsheet programs on a desktop computer. ...

Formal quantitative assessments of uncertainty can mark a truly significant step forward in enhancing regulatory analysis... They have the potential to improve substantially our understanding of the impact of environmental regulations, and thereby to lead to more informed policymaking.

Macroeconomic policy uses the same type of framework for looking at uncertainty, but with additional twists, the addition of model uncertainty, and the addition of parameter uncertainty within a given model. The steps above are carried out over a variety of different policies, models, and a distribution of parameter values, and the goal is to find the most likely outcomes as well as the distribution of outcomes for each policy. The monetary and fiscal authorities then choose policies that, for example, avoid the chance that the policies will backfire and cause severe problems. But if the true model (or a close approximation to it) is not well represented by the models used in the uncertainty analysis, big policy errors are still possible. That's something we tend to forget when we do these types of analyses characterizing the degree of uncertainty that we face.

The Cost of CAFE Standards

How much does it cost in terms of lost profit per vehicle to mandate a one mile per gallon increase in fuel efficiency? According to this research, not as much as you might think:

The cost of CAFE standards: Not as high as we thought?, Greed, Green and Grains: Yesterday's TREE Seminar featured Jim Sallee of the University of Chicago. Sallee presented an interesting paper that uses a clever yet simple method to estimate the cost to car companies of meeting CAFE standards.
Here's the abstract:

Automakers can comply with fuel economy regulations by exploiting a loophole that gives a bonus to flexible-fuel vehicles. Under certain conditions, firms will equate the marginal cost of using the loophole, which is observable, with the unobservable costs of other compliance strategies, such as selling smaller cars or upgrading technology. After verifying that these conditions hold empirically, we estimate that tightening standards by one mile per gallon would cost automakers $8–$18 in lost profit per vehicle. Our estimates are considerably lower than other recent estimates based on structural identification. Our approach may help reveal compliance costs for other regulations.

So car companies can achieve CAFE standards by either making their cars more fuel efficient or, alternatively, exploiting a loophole that allows them to instead make more "flex fuel vehicles" that can run on both ethanol (E85) or regular gasoline. The CAFE credit they get for these conversions combined with the cost of converting a regular gasoline car to a flex-fuel car turns out to be between $8 and $18 per car per MPG.

Stavins: The Making of a Conventional Wisdom

Robert Stavins wonders why people have become more receptive to market based solutions to environmental problems:

The Making of a Conventional Wisdom, by Robert Stavins: Despite the potential cost-effectiveness of market-based policy instruments, such as pollution taxes and tradable permits, conventional approaches ... have been the mainstay of U.S. environmental policy since before the first Earth Day in 1970.  Gradually, however, the political process has become more receptive to innovative, market-based strategies.  ...[gives examples]...

Why has there been a relatively recent rise in the use of market-based approaches?  For academics like me, it would be gratifying to believe that increased understanding of market-based instruments had played a large part..., but how important has this really been?  In 1981, my Harvard colleague, political scientist Steven Kelman surveyed Congressional staff members, and found that support and opposition to market-based environmental policy instruments was based largely on ideological grounds: Republicans, who supported the concept of economic-incentive approaches, offered as a reason the assertion that “the free market works,” or “less government intervention” is desirable, without any real awareness or understanding of the economic arguments for market-based programs.  Likewise, Democratic opposition was based largely upon ideological factors, with little or no apparent understanding of the real advantages or disadvantages of the various instruments.  What would happen if we were to replicate Kelman’s survey today?  My refutable hypothesis is that we would find increased support from Republicans, greatly increased support from Democrats, but insufficient improvements in understanding to explain these changes.  So what else has mattered?

Thomas Friedman is "Head-Slappingly Wrong"

Here's a (shrill) response from Dave Roberts at Grist to the Thomas Friedman article on greenhouse gas legislation:

Somebody hide Tom Friedman’s ball, Grist: Tom Friedman has been doing great work on green issues for a while now, certainly given them a higher profile than any mere green blogger could. So I guess he’s owed some latitude. But his recent column is just an outright nuclear disaster:  head-slappingly wrong on the merits, politically naive and tone deaf to the point of autism, and timed so poorly as to be malicious. Just about every single sentence is a train wreck. ... [...continue reading...]

“Cap-and-Trade is a Tax"

Thomas Friedman says that opponents of policies to reduce the accumulation of greenhouse gases are going to point out that cap and trade is equivalent to a carbon tax, and make a political issue out of it, so why not go for the real thing?

Show Us the Ball, by Thomas Friedman, Commentary, NY Times: ...Last week, House Democrats, with administration support, introduced a 600-page draft bill ... to reduce greenhouse-gas emissions through a complicated cap-and-trade system. These people have the very best of intentions, but I wish they would step back and ask again: Can cap-and-trade pass? Will it really work? And is it the best strategy, with all the bureaucracy it will require to monitor, auction emissions permits and manage the trading?

Advocates of cap-and-trade argue that it is preferable to a simple carbon tax because it ... “hides the ball” — it doesn’t use the word “tax” — even though it amounts to one. ...

That was true as long as no one thought cap-and-trade could ever pass, but ... opponents are not playing hide the ball anymore. In the past two weeks, you could hear a chorus of Republicans, coal-state Democrats, right-wing think tanks and enviro-skeptics all singing the same tune: “Cap-and-trade is a tax. Obama is going to raise your taxes and sacrifice U.S. jobs to combat this global-warming charade... Worse, cap-and-trade will be managed by Wall Street. If you liked credit-default swaps, you’re going to love carbon-offset swaps.” ...

They could easily kill this effort. So, if the Obama team cares about ... a stronger America and a more livable planet,... I hope it will consider an alternative strategy, message and messenger.

STRATEGY Since the opponents of cap-and-trade are going to pillory it as a tax anyway, why not go for the real thing — a simple, transparent, economy-wide carbon tax? ...

People get that — and simplicity matters. Americans will be willing to pay a tax for their children to be less threatened, breathe cleaner air and live in a more sustainable world with a stronger America. They are much less likely to support a firm in London trading offsets from an electric bill in Boston with a derivatives firm in New York in order to help fund an aluminum smelter in Beijing, which is what cap-and-trade is all about. People won’t support what they can’t explain.

MESSAGE Climate change is a real threat to a healthy planet... But because the worst effects are in the future, many Americans have more immediate concerns. That is why our energy policy should be focused around “American renewal,” not mitigating climate change.

We need a price on carbon because it will stimulate massive innovation in ... energy technology. ... I.T. could be the foundation for a second American industrial revolution, plus it would tip the whole planet onto a greener path. So American economic renewal is the goal, but mitigating climate change would be the great byproduct.

MESSENGER The Obama administration’s carbon tax spokesman — the one who should sell this to the country — should be the president’s national security adviser, Gen. James Jones, not the environmentalists. The imposing former head of the Marine Corps could make a powerful case that ... the country with the most powerful clean-technology industry in the 21st century will have the most energy security, national security, economic security, healthy environment, innovative companies and global respect. That country must be America. So let’s stop hiding the ball and have a strategy, message and messenger that tell it like it is — and make it so.

The tax changes can be made revenue neutral so that there is a change in the incentive to consume goods with high carbon content, but no change (implicit or explicit) in the overall tax burden (e.g. see here for a carbon tax example - a cap and trade equivalent exists). In addition, such rebates, if properly distributed, could help with the political problem Friedman is worried about.

Using Markets to Fix Markets

Robert Stavins on the "enlightened use of markets" to make fisheries sustainable:

Using Markets to Make Fisheries Sustainable, Robert Stavins: Around the world, over-fishing is leading to severe depletion of valuable fisheries. ... According to the United Nations Environment Program, fully 25 percent of fisheries worldwide are in jeopardy of collapse due to over-fishing. Clearly, something needs to be done. Yet, what has long been considered the obvious answer - restrictions on fishing - has been shown time and time again to be the wrong answer. The right answer is enlightened use of markets.

The fundamental cause of the depletion of fish stocks is well known to economists: virtually all ocean fisheries are “open-access,” that is, fishermen - small operations or large corporations - can fish all they want. ... Each fisherman receives the full benefit of aggressive fishing (that is, a larger catch), but none pay the full cost (an imperiled fishery for everyone). One fisherman’s choices have an effect on other fishermen (of this generation and the next), but in an open-access fishery ... these impacts are not taken into account. What is individually rational adds up to collective foolishness, as the shared resource is over-exploited. This is the “tragedy of the commons.” What to do?

Government intervention is, alas, required. Fishermen don’t welcome such regulation in their economic sphere any more than anyone else does. And they have a point. Conventional regulatory approaches have driven up costs, but not solved the problem. And we know why. If the government limits the season, fishermen put out more boats. If the government limits net size, fishermen use more labor or buy more costly sonar. Economists call this over-capitalization. Costs go up for fishermen (as resources are squandered), but pressure on fish stocks is not relieved.

The answer is to adopt in fisheries management the same type of innovative policy that has been used for decades in the realm of pollution control - tradeable permits, called “Individual Transferable Quotas” ( ITQs) in the fisheries realm. Sixteen countries - some with economies much more dependent than ours on fishing - have adopted such systems with great success. New Zealand regulates virtually its entire commercial fishery this way. It’s had the system in place since 1986, and it’s been a great success, putting a brake on over-fishing and restoring stocks to sustainable levels ­- while increasing fishermen’s profitability!

There are several ITQ systems already in operation in the United States, including for Alaska’s pacific halibut and Virginia’s striped-bass fisheries. More important, the time is ripe for broader adoption of this innovative approach, because a short-sighted ban imposed by the U.S. Congress on the establishment of new ITQ systems has expired.

The first step in establishing an ITQ system is to establish the “total allowable catch.” The next step - and a crucial one - is to allocate shares of that total limit to fishermen in individual quotas that are theirs and theirs alone (read: well-defined property rights). Setting the individual quotas will not be easy. The guiding principle should be simple pragmatism - using the allocations to build political support for the system. Making the quotas transferable eliminates the problem of overcapitalization and increases efficiency, because the least efficient fishing operations find it more profitable to sell their quotas than to exploit them through continued fishing. If you can’t catch your whole share, you can sell part of your quota to someone else, instead of buying a bigger boat.

In addition, these systems improve safety by reducing incentives for fishermen to go out (or stay out) when weather conditions are dangerous. ... Further, because ITQ systems eliminate the motivation for government to limit the duration of the fishing season, supplies available to consumers improve in quality. Prior to the establishment of an ITQ system for Alaskan halibut, for example, the government had reduced the fishing season to just two days, but subsequent to the introduction of the system, the season length grew to more than 200 days.

A decade ago, environmental advocates - led by the Environmental Defense Fund - played a central role in the adoption of the sulfur dioxide allowance trading program that’s cut acid rain by half and saved electricity generators and rate-payers nearly $1 billion annually, compared with conventional approaches. The time has come for environmentalists to join forces with progressive voices in the fishing industry and in government to set up ITQ systems that can keep fishermen in business while moving fisheries onto sustainable paths.

The allocation of individual shares is, as noted above, crucial, and the danger in having the government set the individual quotas is that "pragmatism" and the desire to "build political support" will lead to political favoritism in the allocations, that large firms will have an advantage in capturing the quota regulators, etc. For these reasons, and others, it seems like an auction mechanism would work better, at least for the initial allocation, but perhaps there are political objections to auctions that preclude this option (though the fact that such strong political forces exist would argue for a market based allocation mechanism even though those same forces would prevent such a mechanism from being implemented).

"Economists are not Concerned Only with the Financial Value of Things"

Rob Stavins continues his series on myths about environmental economics. Here he takes on the myths that "economists are not concerned only with the financial value of things," and that they pay no attention to distributional equity:

The Myths of Market Prices and Efficiency, by Robert Stavins: In my two previous posts I described a pair of prevalent myths regarding how economists think about the environment: “the myth of the universal market” – the notion that economists believe that the market solves all problems; and “the myth of simple market solutions” – the notion that economists always recommend simple market solutions for social problems. ...

A third myth is that when non-market solutions are considered, economists use only market prices to evaluate them. ... [E]conomists are not concerned only with the financial value of things. Far from it. The financial flows that make up the gross national product represent only a fraction of all economic flows. The scope of economics encompasses the allocation and use of all scarce resources. For example, the economic value of the human-health damages of environmental pollution is greater than the sum of health-care costs and lost wages (or lost productivity), as it includes what lawyers call “pain and suffering.” Economists might use a market price indirectly to measure revealed rather than stated preferences, but the goal is to measure the total value of the loss that individuals incur.

For another example, the economic value of some parcel of the Amazon rain forest is not limited to its financial value as a repository of future pharmaceutical products or as a location for ecotourism. Such “use value” may only be a small part of the properly defined economic valuation. For decades, economists have recognized the importance of “non-use value” of environmental amenities such as wilderness areas or endangered species. The public nature of these goods makes it particularly difficult to quantify the values empirically, as we cannot use market prices. Benefit-cost analysis of environmental policies, almost by definition, cannot rely exclusively on market prices.

Economists try to convert all of these disparate values into monetary terms because a common unit of measure is needed in order to add them up. How else can we combine the benefits of ten extra miles of visibility plus some amount of reduced morbidity, and then compare these total benefits with the total cost of installing scrubbers to clean stack gases at coal-fired power plants? Money, after all, is simply a medium of exchange, a convenient way to compare disparate goods and services. The dollar in a benefit-cost analysis is nothing more than a yardstick for measurement and comparison.

A fourth and final myth is that economic analyses are concerned only with efficiency rather than distribution. Many economists do give more attention to aggregate social welfare than to the distribution of the benefits and costs of policies among members of society. The reason is that an improvement in economic efficiency can be determined by a simple and unambiguous criterion, an increase in total net benefits. What constitutes an improvement in distributional equity, on the other hand, is inevitably the subject of much dispute. Nevertheless, many economists do analyze distributional issues thoroughly. ...  Indeed, within the realm of global climate change policy, much of the economic analysis is dedicated to assessing the distributional implications of alternative policy measures. ...

Having identified and sought to dispel four prevalent myths about how economists think about the natural environment, I want to acknowledge that my profession bears some responsibility for the existence of such misunderstandings about economics. Like our colleagues in the other social and natural sciences, academic economists focus their greatest energies on communicating to their peers within their own discipline. Greater effort can certainly be given by economists to improving communication across disciplinary boundaries. And that is one of my key goals in this blog in the weeks and months ahead.

"Obama’s Chance to Lead"

Stiglitz and Stern hope that the new administration will take global warming seriously:

Obama’s chance to lead the green recovery, by Joseph Stiglitz and Nicholas Stern, Commentary, Financial Times: We face two crises: a deep global financial crisis ... and an even deeper climate crisis... The scale of risk from climate change is altogether of a different and greater magnitude, as are the consequences of mismanaging or ignoring it. ...

The investments necessary to convert our society to a low-carbon economy ... would drive growth over the next two or three decades. They would ensure that growth, with accompanying improvements in standards of living, was sustainable. The path that we have been on is not.

The economic crisis will leave the US and other economies greatly weakened and it will be imperative to increase efficiency. One area in which there is ample room for improvement is in the energy efficiency of businesses, consumers and the government. ...

Private investments are driven by market signals. These signals are distorted because we have been pricing one of the world’s scarcest resources – a “good” atmosphere; or the societal costs of emissions, which lead to a “bad” atmosphere – at zero. Not surprisingly, this has led to inefficient outcomes, with emissions levels too high and too little effort devoted to energy conservation and research.

Providing a strong, stable carbon price is the single policy action that is likely to have the biggest effect in improving economic efficiency and tackling the climate crisis. ... We may not be able fully to resolve the risks of the financial crisis quickly; but we can take actions now that will markedly reduce uncertainties about future carbon policies and prices. ... The problems of global warming cannot be attacked without the participation of all countries. The world has been waiting for the US: there is now reason to believe that it is ready to lead.

Paul Collier: I Don't Buy Economists' Case for Fighting Climate Change

Paul Collier rejects the utilitarian basis for reducing carbon emissions and replaces it with "a rights-based notion of ethics":

I don't buy economists' case for fighting climate change, Paul Collier, Commentary, The Guardian: ...In his Review on the Economics of Climate Change - widely regarded as the most important and comprehensive analysis of global warming to date - Lord Stern argued that in cold cost-benefit terms, it made sense for the present generation to make sacrifices because the benefits to future generations would be so substantial. ...

Necessarily, this approach ... depends .... upon a degree of ethical decency: if we thought only of ourselves, then our cost-benefit calculus would tell us to let the future fry. Stern's analysis rests upon a utilitarian calculus that is standard in applied economics: each person, whether alive or yet to be born, counts as equal, except that giving the same benefit to someone who is rich counts as less valuable than giving it to someone who is poor.

Prior to the publication of the Stern review, the main battleground was scientific: is climate change a reality...? Post-Stern, that battleground has now shifted to ethics. ...[T]he challenges have come from two ethical positions that ... cannot be readily dismissed.

One challenge is the elitism ... in overriding democracy: according to the utilitarian calculus the government should value the interests of the future far more highly than most voters would do. Indeed, if we are guilty of radically undervaluing the future, then this neglect applies not just to carbon emissions, but to all the other ways in which we could help the world of the future. The government should force us to save far more than we do... Are we radically neglecting the future by not saving enough? ...

The other ethical challenge questions the transfer from the poor to the rich that would be implicit in reducing carbon emissions: we, the current generation, are the poor who are to make sacrifices for future generations, who are likely to be much wealthier than we are... And so, on the utilitarian calculus, radical egalitarians should be opposed to curbs on carbon: let the rich fry.

Personally, I doubt whether the utilitarian calculus is the right ethical framework ... to think about global warming... Take the valuation of the future: are we radically undervaluing the interests of future people?

Of course, we cannot tell how the future will feel, but one simple test is to ask ourselves how we feel about the past - are we angry that our great-grandparents did not live more frugally so that we would now be richer? ...

Is there an ethical basis for being concerned about global warming that does not depend upon the notion that quite generally we are radically negligent about future people? I think that there is, but this concern depends upon a rights-based notion of ethics rather than on utilitarianism. Most professional economists will at this point stop reading because they will think that rights are a quagmire. But here goes.

Natural assets such as biodiversity, and natural liabilities, such as carbon, are not owned by the current generation, because we did not create them. We have them because previous generations passed them on to us, and we are obliged to do the same. If we deplete natural assets, or run up natural liabilities, we have an obligation to compensate future generations...

It is fairly obvious that adequately compensating the future for letting it fry is likely to be a more expensive undertaking than curbing our carbon emissions. Remember that future people are likely to be much richer than we are, and so what they would regard as fair compensation would be prodigious. ...

Ultimately, in a democracy our policy decision rules must rest on ethical principles that are widely shared by citizens. I suspect that most people feel that they should reduce carbon emissions, but the key issue is why? Is their motivation better captured by the utilitarian calculus used by economists, or by a sense of custodial obligation towards our natural legacy, of which carbon is but one instance?

"The Myth of Simple Market Solutions"

Macroeconomics gets the headlines, especially lately, but there's a lot more to economics than the study of abstract aggregates used as barometers of economic performance. Robert Stavins follows up on his post arguing that market failure is common in the environmental domain with an explanation of why simple solutions to these problems are often inadequate:

The Myth of Simple Market Solutions, by Robert Stavins: I introduced my previous post by noting that there are several prevalent myths regarding how economists think about the environment, and I addressed the “myth of the universal market” ­– the notion that economists believe that the market solves all problems. In response, I noted that economists recognize that in the environmental domain, perfectly functioning markets are the exception, not the rule. Governments can try to correct such market failures, for example by restricting pollutant emissions. It is to these government interventions that I turn this time.

A second common myth is that economists always recommend simple market solutions for market problems. Indeed, in a variety of contexts, economists tend to search for instruments of public policy that can fix one market by introducing another. If pollution imposes large external costs, the government can establish a market for rights to emit a limited amount of that pollutant under a so-called cap-and-trade system. Such a market for tradable allowances can be expected to work well if there are many buyers and sellers, all are well informed, and the other conditions I discussed in my last posting are met.

The government’s role is then to enforce the rights and responsibilities of permit ownership, so that each unit of emissions is matched by the ownership of one permit. Equivalently, producers can be required to pay a tax on their emissions. Either way, the result — in theory — will be cost-effective pollution abatement, that is, overall abatement achieved at minimum aggregate cost.

The cap-and-trade approach has much to recommend it, and can be just the right solution in some cases, but it is still a market. Therefore the outcome will be efficient only if certain conditions are met. Sometimes these conditions are met, and sometimes they are not. Could the sale of permits be monopolized by a small number of buyers or sellers? Do problems arise from inadequate information or significant transactions costs? Will the government find it too costly to measure emissions? If the answer to any of these questions is yes, then the permit market may work less than optimally. The environmental goal may still be met, but at more than minimum cost. In other words, cost effectiveness will not be achieved.

To reduce acid rain in the United States, the Clean Air Act Amendments of 1990 require electricity generators to hold a permit for each ton of sulfur dioxide (SO₂) they emit. A robust permit market exists, in which well-defined prices are broadly known to many potential buyers and sellers. Through continuous emissions monitoring, the government tracks emissions from each plant. Equally important, penalties are significantly greater than incremental abatement costs, and hence are sufficient to ensure compliance. Overall, this market works very well; acid rain is being cut by 50 percent, and at a savings of about $1 billion per year in abatement costs, compared with a conventional approach.

A permit market achieves this cost effectiveness through trades because any company with high abatement costs can buy permits from another with low abatement costs, thus reducing the total cost of reducing pollution. These trades also switch the source of the pollution from one company to another, which is not important when any emissions equally affect the whole trading area. This “uniform mixing” assumption is certainly valid for global problems such as greenhouse gases or the effect of chlorofluorocarbons on the stratospheric ozone layer. It may also work reasonably well for a regional problem such as acid rain, because acid deposition in downwind states of New England is about equally affected by sulfur dioxide emissions traded among upwind sources in Ohio, Indiana, and Illinois. But it does not work perfectly, since acid rain in New England may increase if a plant there sells permits to a plant in the mid-west, for example.

At the other extreme, some environmental problems might not be addressed appropriately by a simple, unconstrained cap-and-trade system. A hazardous air pollutant such as benzene that does not mix in the airshed can cause localized “hot spots.” Because a company can buy permits and increase local emissions, permit trading does not ensure that each location will meet a specific standard. Moreover, the damages caused by local concentrations may increase nonlinearly. If so, then even a permit system that reduces total emissions might allow trades that move those emissions to a high-impact location and thus increase total damages. An appropriately constrained permit trading system can address the hot-spot problem, for example by combining emissions trading with a parallel system of non-tradable ambient standards.

The bottom line is that no particular form of government intervention, no individual policy instrument – whether market-based or conventional – is appropriate for all environmental problems. There is no simple policy panacea. The simplest market instruments do not always provide the best solutions, and sometimes not even satisfactory ones. If a cost-effective policy instrument is used to achieve an inefficient environmental target — one that does not make the world better off, that is, one which fails a benefit-cost test – then we have succeeded only in “designing a fast train to the wrong station.” Nevertheless, market-based instruments are now part of the available environmental policy portfolio, and ultimately that is good news both for environmental protection and economic well-being.

"The Myth of the Universal Market"

Robert Stavins discusses the conditions required for markets to produce an optimal allocation of resources, and he notes that that "in the environmental domain, perfectly functioning markets are the exception, rather than the rule":

The Myth of the Universal Market, by Robert Stavins: Communication among economists, other social scientists, natural scientists, and lawyers is far from perfect. When the topic is the environment, discourse across disciplines is both important and difficult. Economists themselves have likely contributed to some misunderstandings about how they think about the environment, perhaps through enthusiasm for market solutions, perhaps by neglecting to make explicit all of the necessary qualifications, and perhaps simply by the use of technical jargon.

So it shouldn’t come as a surprise that there are several prevalent and very striking myths about how economists think about the environment. Because of this, my colleague Don Fullerton, a professor of economics at the University of Illinois, and I posed the following question in an article in Nature:  how do economists really think about the environment? In this and several succeeding postings, I’m going to answer this question, by examining — in turn — several of the most prevalent myths.

One myth is that economists believe that the market solves all problems. Indeed, the “first theorem of welfare economics” states that private markets are perfectly efficient on their own, with no interference from government, so long as certain conditions are met. This theorem, easily proven, is exceptionally powerful, because it means that no one needs to tell producers of goods and services what to sell to which consumers. Instead, self-interested producers and self-interested consumers meet in the market place, engage in trade, and thereby achieve the greatest good for the greatest number... This notion of maximum general welfare is what economists mean by the “efficiency” of competitive markets.

Economists in business schools may be particularly fond of identifying markets where the necessary conditions are met, where many buyers and many sellers operate with very good information and very low transactions costs to trade well-defined commodities with enforced rights of ownership. These economists regularly produce studies demonstrating the efficiency of such markets (although even in this sphere, problems can obviously arise).

For other economists, especially those in public policy schools, the whole point of the first welfare theorem is very different. By clarifying the conditions under which markets are efficient, the theorem also identifies the conditions under which they are not. Private markets are perfectly efficient only if there are no public goods, no externalities, no monopoly buyers or sellers, no increasing returns to scale, no information problems, no transactions costs, no taxes, no common property, and no other distortions that come between the costs paid by buyers and the benefits received by sellers.

Those conditions are obviously very restrictive, and they are usually not all satisfied simultaneously. When a market thus “fails,” this same theorem offers us guidance on how to “round up the usual suspects.” For any particular market, the interesting questions are whether the number of sellers is sufficiently small to warrant antitrust action, whether the returns to scale are great enough to justify tolerating a single producer in a regulated market, or whether the benefits from the good are “public” in a way that might justify outright government provision of it. A public good, like the light from a light house, is one that can benefit additional users at no cost to society, or that benefits those who “free ride” without paying for it.

Environmental economists, of course, are interested in pollution and other externalities, where some consequences of producing or consuming a good or service are external to the market, that is, not considered by producers or consumers. With a negative externality, such as environmental pollution, the total social cost of production may thus exceed the value to consumers. If the market is left to itself, too many pollution-generating products get produced. There’s too much pollution, and not enough clean air, for example, to provide maximum general welfare. In this case, laissez-faire markets — because of the market failure, the externalities — are not efficient.

Similarly, natural resource economists are particularly interested in common property, or open-access resources, where anyone can extract or harvest the resource freely. In this case, no one recognizes the full cost of using the resource; extractors consider only their own direct and immediate costs, not the costs to others of increased scarcity (called “user cost” or “scarcity rent” by economists). The result, of course, is that the resource is depleted too quickly. These markets are also inefficient.

So, the market by itself demonstrably does not solve all problems. Indeed, in the environmental domain, perfectly functioning markets are the exception, rather than the rule. Governments can try to correct these market failures, for example by restricting pollutant emissions or limiting access to open-access resources. Such government interventions will not necessarily make the world better off; that is, not all public policies will pass an efficiency test. But if undertaken wisely, government interventions can improve welfare, that is, lead to greater efficiency. I will turn to such interventions in a subsequent posting.

Of course, this point applies generally to all markets, not just those examined by environmental economists. I don't want the government heavily involved in regulating everything, or even most things, but as I have stated here many times, I think we have moved too far toward the "markets can fix everything" attitude, and more could be done and should be done to correct markets that do not satisfy the conditions required to produce optimal outcomes. Despite claims to the contrary, these markets won't fix themselves, at least not within an acceptable time-frame (this is true at the macro level as well), and intervention to push them in the right direction can improve the market's performance and make us better off.

Sachs: 21st-Century Capitalism

Jeff Sachs seems to be pleased with the new administrations commitment to "a new age of sustainable development":

Rewriting the rulebook for 21st-century capitalism, by Jeffrey Sachs, CIF, The Guardian: One of President Barack Obama's historic contributions will be a grand act of policy jujitsu - turning the crushing economic crisis into the launch of a new age of sustainable development. ... Obama is already setting a new historic course by reorienting the economy from private consumption to public investments directed at the great challenges of energy, climate, food production, water and biodiversity.

The new president has taken every opportunity to underscore that the economic crisis will not slow, but rather will accelerate, the much-needed economic transformation to sustainability. ... The fiscal stimulus ... will lay down the first steps of a massive generation-long technological overhaul...

Obama has started with the most important first step: a team of scientific and technological advisers of stunning quality... He has also focused on two core truths of sustainable development: that technological overhaul lies at the core of the challenge, and that such an overhaul requires a public-private partnership for success. Taking shape, therefore, is nothing less than a new 21st-century model of capitalism ... committed to the dual objectives of economic development and sustainability...

Consider the challenge of a bankrupt automobile sector... In the Obama strategy, GM will not be closed to punish it... It's worth far too much as a world leader in the electric vehicles of the 21st century. ...

Conservatives are aghast. The bail-out of the auto industry was hard enough to swallow. Government investments in infrastructure and research and development are viewed with scorn, compared with the tried and true (if disastrously failed) tax cuts of the Bush era. Rightwing pundits bemoan the evident intention of Obama and team to "tell us what kind of car to drive". Yet that is exactly what they intend to do (at least with regard to the power source under the hood), and rightly so. Free-market ideology is an anachronism in an era of climate change, water stress, food scarcity and energy insecurity. Public-private efforts to steer the economy to a safe technological harbour will be the order of the new era.

There is plenty of room for blunders... Government activism can founder on the shoals of massive budget deficits, tax-cutting populism pushed by the right, politically motivated investments such as corn-based ethanol..., and more. Yet Obama is absolutely correct that we have no choice but to try. ...

Paved with Good Intentions?

Tim Haab at Environmental Economics:

Ten things a preeminent environmental economist thinks he knows about green stimulus, Environmental Economics: Alan Randall, world renowned environmental economist..., had the honor of being named a Fellow of the Association of Environmental and Resource Economists... In his 'acceptance speech', Alan was given three minutes to espouse his wisdom on a topic of his choosing.  He chose to touch on green stimulus and the bogusity--I made that up--of the green jobs justification.  Here is what he said...

Ten Things I Think I Know (by Alan Randall)

1. In ordinary times, good economic policy involves macroeconomic restraint and getting the prices right – including the prices for public goods and infrastructure.
2. These are not ordinary times, but there is a silver lining – recessions tend to be good for the environment.
3. In these extraordinary times, the ordinary rules of macroeconomics should be suspended – better to throw buckets of money at the problem now, and take care of the inevitable inflation when it shows up.
4. Stimulus packages tend to be not so good for the environment. Perhaps, then, the ordinary rules of environmental economics should be suspended, too – we can always clean-up the mess when the economy turns around.
5. But some kinds of environmental mess are not easily reversed – it may take a long time to recover from that kind of recovery.
6. A green stimulus package makes sense, so long as we understand green as a metaphor – bio-energy is literally green but is having a hard time shaking its metaphorical brownish tinge.
7. Suppose we know what we mean by green – we still need clarity about what we mean by stimulus. Surely not just jobs – arguments that begin with jobs are almost always disreputable: they tend to assume it doesn’t matter whether the jobs involve useful work.
8. Switching to more labor-intensive green energy sources may constitute a green jobs program. But a coherent green stimulus package should be about jump-starting the recovery by jump-starting the new century. That means tilting toward 21^st century green infrastructure.
9. Even if the times call for suspending the macroeconomic rules, the rules of micro and public economics should remain in place – it is hard to find a good argument for failing to get (and keep) the prices right. Environmental economists are notorious for being too environmental for most economists and too economic for most environmentalists.
10. I have just turned things up a notch – if you go along with me, we are now also too rigid about the microeconomics to suit the macroeconomists, and too flexible about the macroeconomics to suit the microeconomists.

Dean Baker:

Road to hell, by Dean Baker, Comment is Free: There is no doubt that the US needs a really large stimulus package... We need a boost to the economy yesterday, which means that we should be looking for projects that can be started in 2009, or 2010 at the latest... "Shovel ready" is the catch phrase for the stimulus package.

But just because we can do something does not mean that we should do it. Some infrastructure spending will actually be harmful to the environment and the economy over the long-term. This is stimulus that we better do without.

Specifically, there are many ready-to-go projects on the books for further highway construction. While not all highways are bad, highways that promote the pattern of sprawl that we have seen in many metropolitan areas over the last 30 years are bad. We should not be making it easier for people live long distances from their jobs... This would directly counteract efforts in other areas to reduce ... greenhouse gas emissions. ...

We know that some of the money in the stimulus package will not be well spent. ... This is a necessary cost of getting money out the door quickly. But, it is possible to prevent projects that are not just wasteful, but actually counterproductive, from being included in the stimulus package. It should not require too much analysis to identify highway projects that are likely to promote sprawl. Such projects should be excluded from a fast-track stimulus package. ...

The amount of stimulus required to offset the impact of the collapsing housing bubble and the plunging stock market is substantial, but there are good ways to spend large amounts of money. The huge shortfalls incurred by state and local governments are an obvious place to start. ...

There is a wide range of "green" initiatives that President-elect Barack Obama can include in the stimulus package in addition to weatherising buildings. For example, he could provide subsidies to public transportation agencies to cover the cost of lower transit fares. He could also pay people (presumably mostly lower-income people) to turn in older, more polluting cars and get them off the road. Such measures can both help reduce greenhouse gas emissions and boost the economy.

The other obvious way that Obama can boost the economy is with healthcare spending. ... Obama could usefully spend much more money subsidising Medicare for people who do no currently have insurance. This will be an important downpayment on healthcare reform.

There are other ways in which Obama could spend more money on stimulus. As Keynes noted more than 70 years ago, if we can't find ways to spend money, we can always pay people to dig holes and fill them up again. This is of course wasteful, but paying people to dig holes will put money into the economy.

Digging holes and filling them again would be a better route than letting the economy slide even deeper into a recession. It is certainly better to have wasteful spending than to spend money on items than can actually do harm, like building highways that promote sprawl. In other words, the construction of the road to hell should not be part of the stimulus package.

Are Green Jobs Bogus?

Tim Haab at Environmental Economics weighs in on the question of whether green fiscal policy can create jobs:

Weighing in on green jobs, by Tim Haab: I've intentionally laid low in the brewhaha over green jobs...  But Mark Thoma's post raises some questions that I don't know the answers to, but am willing to opine about, so I'll put in my two cents. 

Disclaimer:  I'm nowhere near as versed in macroeconomics as John is...  I've never even taught a macro course.  Take that for what it's worth.  Onward...

My questions center around the seemingly conflicting (but not mutually exclusive) goals embedded in the green jobs/economic stimulus discussion.  As Mark points out, one goal is broadscale economic stabilization.  My take on John's original intent is a discussion of reductions in short-term unemployment (goal 2) and long-term job creation (goal 3).  Many of the comments focus on the use of green subsidies to alleviate environmental externalities (goal 4a) and dependence on fossil fuels (goal 5b). 

With these five goals in mind, I'd like to lay out what seems to me an inherent inconsistency in using the broad umbrella of 'economic stimulus' to meet all five goals.

To me, the big question is what are immediate needs/goals to reduce the length of the recession versus long-term desires for an economically efficient energy sector.  The inconsistency arises from using policies designed to induce long-term shifts in technology (subsidizing green technologies) under the mask of meeting short term goals (reduce unemployment and stabilize the economy).

I agree with Mark that in times of high unemployment, public investments in any industry won't result in crowding out of private investments in the short-run, and might generate temporary increases in employment.  But

1) although there's no consensus on a definition of a depression, one tell-tale sign is high unemployment.  7% is not high. and,

2) any net job gains in new industries for currently unemployed workers must mean fewer jobs in the industries those workers came from which may or may not be an efficient allocation of resources (one of John's points), and

3) public investments take time to create jobs--it's not a short term quick fix.  Especially with something like investments in new technologies (green?) where the sector is still in the R&D mode and not yet ready to build the infrastructure.

So what do we end up with?  A quick expenditure of public funds on an industry where the technology is not yet developed.  It doesn't seem to me that the employment effects are going to happen very quickly so the end result is inconsistent with the original goal of short-term economic stimulus.  It doesn't seem to me this is going to result in short-term economic stabilization.  I could be wrong.

But, you say, the end result is more green jobs (and a bigger green sector) and fewer brown jobs and that's a good thing right?  Maybe, but there are easier ways to reach that rather than hide behind the mask of saving the economy.  This is probably where my free-market tendencies come out, but if the goal is to achieve the socially optimal (efficient) balance between green and brown industries, then the simplest way to go about it is to get the relative prices right (capture all of the costs and benefits in the price) and then let the incentives that creates establish the right balance. 

Will public investment in green industries have the same effect?  Again, maybe, if designed optimally, but it's not a short-run fix for unemployment or stabilization.

I guess my broader point is that I perceive a time inconsistency between the short-term economic stimulus goals of stabilizing incomes/reducing unemployment and the long-term goals of reducing environmental externalities.  Using strategies designed for the latter won't necessarily achieve the former.

But then again, I'm a micro-economist.  I'm probably wrong.

For the reasons I explained here, I don't necessarily agree with point 2. If the employment of idle resources in the short-run enhances growth prospects, then the number of jobs and hence employment can increase overall. In that case, it's possible for jobs to grow in all sectors. That may not happen -  I'm not saying it will - and I don't think long-run job growth is the primary goal of short-run stabilization policy, but it's not out of the realm of possibility.

Taylor: Why Permanent Tax Cuts Are the Best Stimulus

John Taylor is not ready to give up on tax cuts, nor is he ready to adopt traditional Keynesian ideas:

Why Permanent Tax Cuts Are the Best Stimulus, by John B. Taylor, Commentary, NY Times WSJ: The incoming Obama administration and congressional Democrats are now considering a second fiscal stimulus package, estimated at more than $500 billion, to follow the Economic Stimulus Act of 2008. As they do, much can be learned by examining the first.

The major part of the first stimulus package was the $115 billion, temporary rebate payment... The argument in favor of these temporary rebate payments was that they would increase consumption, stimulate aggregate demand... What were the results? ...[C]onsumption shows no noticeable increase at the time of the rebate [see chart]. Hence, by this simple measure, the rebate did little or nothing to stimulate consumption, overall aggregate demand, or the economy.

These results ... correspond very closely to what basic economic theory tells us. According to the permanent-income theory of Milton Friedman, or the life-cycle theory of Franco Modigliani, temporary increases in income will not lead to significant increases in consumption. However, if increases are longer-term, as in the case of permanent tax cut, then consumption is increased...

After years of study and debate,... the permanent-income model led many economists to conclude that discretionary fiscal policy actions, such as temporary rebates, are not a good policy tool. Rather, fiscal policy should focus on the "automatic stabilizers" (the tendency for tax revenues to decline ... and transfer payments such as unemployment compensation to increase in a recession), which are built into the tax-and-transfer system, and on more permanent fiscal changes that will positively affect the long-term growth of the economy. ...

What ... can Congress and the incoming Obama administration do to give the economy a real boost on Jan. 20? Here are a few fairly bipartisan measures worth considering:

First, make a commitment, passed into law, to keep all income-tax rates were they are now, effectively making current tax rates permanent. This would be a significant stimulus to the economy...

Second, enact a worker's tax credit equal to 6.2% of wages up to $8,000 as Mr. Obama proposed during the campaign -- but make it permanent rather than a one-time check.

Third, recognize explicitly that the "automatic stabilizers" are likely to be as large as 2.5% of GDP this fiscal year, that they will help stabilize the economy, and that they should be viewed as part of the overall fiscal package even if they do not require legislation.

Fourth, construct a government spending plan that meets long-term objectives, puts the economy on a path to budget balance, and is expedited to the degree possible without causing waste and inefficiency.

Some who promoted the first stimulus package have reacted to its failure by saying that we must now switch to large increases in government spending to stimulate demand. But government spending does not address the causes of the weak economy, which has been pulled down by a housing slump, a financial crisis and a bout of high energy prices, and where expectations of future income and employment growth are low.

The theory that a short-run government spending stimulus will jump-start the economy is based on old-fashioned, largely static Keynesian theories. These approaches do not adequately account for the complex dynamics of a modern international economy, or for expectations of the future that are now built into decisions in virtually every market.

I'll note in passing that the New Keynesian model incorporates expectations of the future, and accounts for complex dynamics as well as any model, so the criticism in the last paragraph is really about policy justified by traditional Keynesian theory, not the more modern version. But more to the point, I don't think anything he said rules out positive net present value investments in infrastructure. We should make these investments in any case if we want the economy to grow robustly, now just happens to be a good time to have the construction and maintenance work done since people need jobs, inputs to production are relatively cheap, and the political atmosphere is accommodating.

Update: Paul Krugman:

Conservative crisis desperation: So we’re having a crisis, reflecting the policy failures of the past 8 years. But the usual suspects insist that the crisis is all the more reason to persist with those policies — indeed, make them permanent.

Thus, John Taylor — a very good economist, when he wants to be — insists that we must respond to the economy’s temporary weakness with a permanent tax cut. Let us reason together. Does it make sense to let one recession dictate tax policy in perpetuity? What happens if there’s a boom; can we increase taxes (no, because then the cut wouldn’t have been permanent.) What if there’s another recession? Do we permanently cut taxes again? Is there a tax-cut ratchet (or maybe racket)? Think this through, and it makes no sense at all.

And Taylor’s argument against the obvious answer — government spending as stimulus — is pure gobbledygook:

The theory that a short-run government spending stimulus will jump-start the economy is based on old-fashioned, largely static Keynesian theories. These approaches do not adequately account for the complex dynamics of a modern international economy, or for expectations of the future that are now built into decisions in virtually every market.

Translation: la la la I can’t hear you.

Meanwhile, at a panel discussion with Rich Lowry of National Review, I heard the latest argument against the Employee Free Choice Act: now would be a really bad time to make union organizing easier, because it would hurt business confidence in a recession.

Recession, recovery, whatever: it’s always proof that the Bush years should continue forever.

"Uncertainty, Climate Change, and the Global Economy"

This research concludes that "global warming will be a major problem even under very optimistic circumstances":

Uncertainty, climate change, and the global economy, by Torsten Persson and David von Below, VoxEU.org: What will the climate be like in a hundred years’ time? The answer to this question is highly uncertain, and will depend on a number of socio-economic as well as natural processes, which describe the links between human activity, emissions of greenhouse gases, and warming of the atmosphere. The existing policy discussion in important forums, such as the IPCC and Stern reports (see this Vox column), is largely based on the uncertainty about the biogeophysical and biogeochemical systems, as are analyses such as that of Wigley and Raper (2001). In a recent paper, we include such uncertainty – but highlight uncertainty about the drivers of climate change in the socioeconomic system. [...continue reading...]

"The Only Politically Feasible Approach"

A call for "a comprehensive, upstream cap-and-trade system" to combat climate change:

Inspiration for climate change, by Robert N. Stavins, Commentary, Boston Globe: ...Will the environment and energy team of President-elect Obama respond effectively to the serious challenges that lie ahead? ... Ultimately, will Obama work with Congress to develop climate strategies that are scientifically sound, economically sensible, and thereby politically pragmatic? Will he take on the difficult task of crafting meaningful climate legislation?

The only politically feasible approach that can make a real dent in the problem is a comprehensive, upstream cap-and-trade system to reduce carbon dioxide emissions 50 to 80 percent below 1990 levels by 2050. The declining cap will increase the cost of polluting, thereby discouraging the use of the most carbon-intensive fossil fuels and providing powerful incentives for energy conservation and technology innovation.

The system could start with a 50-50 split of auctioned and free allowances, gradually moving to 100 percent auction over 25 years. To establish political support in the short term, free allowances should be targeted to sectors that are most burdened by the policy. And the auction revenue which will increase over time can be used to compensate low-income consumers...

The best option may be to make the program revenue-neutral by returning all auction revenue to citizens through direct cash dividends or annual tax credits. This can go a long way toward making the legislation palatable to Republicans and Democrats alike who are reticent to take any actions that even resemble a tax increase.

By making the overall emissions cap gradually become more stringent over time, costs can be greatly reduced by avoiding premature retirement of existing capital stock, reducing vulnerability to siting bottlenecks, and ensuring that long-lived capital investments incorporate appropriate advanced technology.

Still, the costs of meaningful action will be significant, with impacts on gross domestic product eventually reaching up to 1 percent per year. ...

The bottom line is that getting serious about global climate change will not be cheap or easy. Beware of claims to the contrary. But if the current state-of-the-science predictions about the consequences of another few decades of inaction are correct, this defining moment provides an important opportunity for serious and sensible action.

Is a carbon tax out of the question?

Real-Time Wal-Mart Data

Purchases of essentials are increasingly clustering around payday:

Wal-mart: Scenes from the Economic Front Lines, by Paul Kedrosky: Wal-mart is like the Bureau of Economic Analyst of retail: It has all the data you wish you had about what's going on in the economy, plus more -- and it has it all in realtime. With that in mind, here are some alternately choice and concerning nuggets from a speech today by the company's president in Los Angeles:

• Credit is declining as a form of payment at Wal-mart. It will be down double-digits this year, he said.
• Spending spikes around pay periods have become much more pronounced, implying that many Wal-mart shoppers are living check-to-check.
• For the first time the company is seeing a paycheck-related spike in purchases of baby formula, suggesting some real teetering out there.

More here.

"Taleb vs Economists"

Chris Dillow wants help:

Taleb vs economists, by Chris Dillow: Everyone seems to be hailing Nassim Nicholas Taleb as the man who saw the crisis coming. I have a problem with this. It’s not that what Taleb says about risk is wrong. Quite the opposite. It just strikes me as trivially true.

We’ve known for ages that returns are non-Gaussian, that extreme events are more common than a normal distribution predicts, and that risk can’t be quantified simply, if at all. The Black Swan, then, was just an entertaining if a little egocentric way of telling us what we already knew.

So, when I read in it (p43) that bankers “are not conservative at all; just phenomenally skilled at self-deception by burying the possibility of a large, devastating, loss under the rug” I thought: “But surely they’ve learnt from statistics and experience by now. Their risk management can’t be as terrible as Taleb claims. I know bosses are stupid, but they can‘t be this gibberingly, imbecilically, carpet-chewingly, moronically cretinous, can they?” I suspect most economists thought my way.

It looks like we were wrong and Taleb right.

But this isn’t because Taleb had any great insights into the nature of risk. It‘s because he thought banks‘ risk managers were idiots, whilst economists didn’t think so - not even me.

In doing this, however, we were just following economists’ standard procedure - of assuming that agents were if not rational then at least not wholly stupid.

For me, all this is very troubling.  It suggests that what we economists have to learn from Taleb has nothing to do with the nature of risk - we‘ve all known that - but about others’ rationality. We should ditch the assumption - which in a sense is mere courtesy - not only that others are rational but even the weaker assumption that they are nearly so. Perhaps we should indeed regard them merely as “empty suits.”

But this is a vastly greater departure from standard practice than anything Taleb has suggested about the nature of risk.

All of which leaves me genuinely puzzled. Were banks risk managers really that bad? Are bosses an order of magnitude stupider than even I had thought? Or is something else happening? Help me.

Climate Change and Gas Prices

Is it good news or bad news that a carbon tax sufficient to reduce emissions by 10% won't have much impact on gas prices or miles driven?:

Climate change and gas prices: Less impact than you might think, CBO: CBO released a brief today on climate-change policy and CO2 emissions from passenger vehicles (for the PDF, click here).

Discussions about addressing climate change (e.g., through a cap-and-trade program or a carbon tax) often focus on the transportation sector. The brief argues, however, that most of the reduction in CO2 emissions would occur in other sectors (e.g., the electricity sector) and that the effects on vehicle emissions would be modest, especially in the shorter run.

To be sure, a cap-and-trade system or a carbon tax would raise the price of gasoline, encouraging consumers to drive less and to buy more fuel-efficient cars– but the magnitude of these effects would be relatively small. For example, CBO has estimated that a price of $28 per metric ton of CO2 in 2012 would lead to a reduction of about 10 percent in total U.S. emissions compared with a no-action scenario. Vehicle emissions, though, would remain relatively constant in the short run, and even over time they would decline only by around 2.5 percent — much less than the 10 percent reduction in overall emissions.

Several factors account for the relatively small influence that a price on CO2 emissions would have on passenger vehicles and driving behavior. First, a CO2 price of $28 per metric ton would raise gas prices by about 25 cents per gallon, far less of an increase than consumers have recently born with little behavioral result. (Between 2003 and 2007, gas prices increased from $1.50 to more than $3.00 per gallon. Vehicle miles driven, driving speeds, and the purchase of larger vehicles have all responded only modestly despite the dramatic increase in prices.) An increase in gas prices of 25 cents or so per gallon is unlikely to generate massive changes in driving behavior.

In addition, recent changes to corporate average fuel economy (CAFE) standards will require substantial gains in fuel economy over the next dozen years. Especially over the longer term, gas price increases are not likely to have a large effect beyond what CAFE standards will require.

Finally, cultural, historic, and geographic considerations drive the extent to which Americans have become dependent on automobile travel, and their choices tend towards larger and more powerful (and less fuel efficient) automobiles. While dramatic increases in gasoline prices (or shifts in cultural norms) might eventually influence these considerations, the magnitude of gas price increases under most legislation under consideration would likely have little effect.

Another Bursting Bubble?

Ted Nordhaus and Michael Shellenbergers say Democrats "must break once and for all from green orthodoxy":

The green bubble bursts, by Ted Nordhaus and Michael Shellenberger, Commentary, LA Times: ...Democrats and their environmental allies face a political challenge they could hardly have imagined just a few months ago. America's growing dependence on fossil fuels, once viewed as a Democratic trump card held alongside the Iraq war and the deflating economy, has become a lodestone instead. Republicans stole the energy issue from Democrats by proposing expanded drilling ... to bring down gasoline prices. ...

Democrats and greens ended up in this predicament because they believed their own press clippings -- or, perhaps more accurately, Al Gore's. After the release of ... "An Inconvenient Truth," greens convinced themselves that U.S. public opinion on climate change had shifted dramatically, despite having no empirical evidence that was the case. In fact, public concern about global warming was about the same before the movie..., hovering near the bottom of the Pew Center for People and the Press' top 20 priorities.

By contrast, public concern about gasoline and energy prices has shifted dramatically..., gas prices became the second-highest concern after the economy, according to Gallup.

This summer, elite opinion ran headlong into American popular opinion. The train wreck ... went by the name of the Climate Security Act. That bill to cap U.S. greenhouse gas emissions would have, by all accounts..., increased gasoline and energy prices. ...Democrats brought the bill to the Senate floor in June when gas prices were well over $4 a gallon in most of the country. Republicans were all too happy to join that fight.

Indeed, they ... relished the opportunity to accuse Democrats of raising gasoline prices in the midst of an energy crisis... Democratic leaders finally killed the debate to avert an embarrassing defeat... Republicans have been bludgeoning Democrats with it ever since. ...

In following greens, Democrats allowed McCain and Republicans to cast them as the party out of touch with the pocketbook concerns of middle-class Americans and captive to special interests that prioritize remote wilderness over economic prosperity. ...

The most influential environmental groups in Washington -- the Natural Resources Defense Council and the Environmental Defense Fund -- are continuing to bet the farm on ... making fossil fuels more expensive in order to encourage conservation, efficiency and renewable energy. But with an economic recession likely, and energy prices sure to remain high for years to come..., any strategy predicated centrally on making fossil fuels more expensive is doomed to failure.

A better approach is to make clean energy cheap through technology innovation funded directly by the federal government. In contrast to raising energy prices, investing somewhere between $30 billion and $50 billion annually in technology R&D, infrastructure and transmission lines to bring power from windy and sunny places to cities is overwhelmingly popular with voters. Instead of embracing this big investment, greens and Democrats push instead for tiny tax credits for renewable energy -- nothing approaching the national commitment that's needed.

With just six weeks before the election, the bursting of the green bubble is a wake-up call for Democrats. Environmental groups, perpetually certain that a new ecological age is about to dawn in America, have serially overestimated their strength and misread public opinion. Democrats must break once and for all from green orthodoxy that focuses primarily on making dirty energy more expensive and instead embrace a strategy to make clean energy cheap. ...

Arctic Ice Loss

[via: Fasted recorded August rate of Arctic ice loss]

FRBSF: Regional Variation in the Potential Economic Effects of Climate Change

How much variation will there be in the effects of global warming across regions within the US? This summarizes research on expected geographic variation in agriculture and health effects, and then looks in more detail at how ski areas will be affected by global warming of 2 degrees (C):

Regional Variation in the Potential Economic Effects of Climate Change, by Van Butsic, Ellen Hanak, and Rob Valletta, FRBSF Economic Letter: Extensive scientific evidence suggests that the worldwide climate has been warming in recent decades and is likely to continue doing so (IPCC 2007). The possible contribution of human activity has produced considerable debate about appropriate responses by governments, businesses, and individuals to "mitigate" (limit) the extent of global warming by reducing greenhouse gas emissions, a primary source of which is fossil fuels. A key element in this debate is the magnitude of the net economic costs associated with potential climate change.

One area of considerable uncertainty in regard to the economic effects of climate change is the likely differential impact of global warming across geographic regions. In this Economic Letter, we provide a partial overview of recent research that examines such geographic variation in the economic impact of climate warming in North America. Not surprisingly, this research suggests that the adverse effects will be greatest in locations where the existing climate is warm, although some regions and sectors may benefit from a warmer climate.

"Are Malthus's Predicted Food Shortages Coming True?"

Jeff Sachs asks, "Have we beaten Malthus?":

Are Malthus's Predicted 1798 Food Shortages Coming True?, by Jeffrey D. Sachs, Scientific American: In 1798 Thomas Robert Malthus famously predicted that short-term gains in living standards would inevitably be undermined as human population growth outstripped food production, and thereby drive living standards back toward subsistence. We were, he argued, condemned by the tendency of population to grow geometrically while food production would increase only arithmetically.

For 200 years, economists have contended that Malthus overlooked technological advancement, which would allow human beings to keep ahead of the population curve. ...

Another factor undermining Malthus’s argument, it would seem, is ... demographic transition... Malthus did not reckon with the advance of public health, family planning, and modern contraception, which together with urbanization and other trends, would result in a dramatic decline in fertility rates to low levels... Perhaps the human population would avoid the tendency towards geometric growth altogether.

These critiques of Malthusian pessimism have long seemed irresistible. Indeed, when I trained in economics, Malthusian reasoning was a target of mockery, held up by my professors as an example of a naïve forecast gone wildly wrong. ...

Yet the Malthusian specter is not truly banished—indeed far from it. Our increase in know-how has not only been about getting more outputs for the same inputs, but also about our ability to mine the Earth for more inputs. The first Industrial Revolution began with the use of fossil fuel, specifically coal... Humanity harnessed geological deposits of ... coal, oil, and gas... We learned to dig deeper for minerals, fish the oceans with larger nets, divert rivers with greater dams and canals,... and cut down forests with more powerful land-clearing equipment. ... Much of what we call “income,” in the true sense of adding value from economic activity, is actually depletion instead, or the running down of natural capital.

And although family planning and contraception have indeed secured a low fertility rate in most parts of the world, the overall fertility rate remains at 2.6, far above replacement. ... According to the medium-fertility forecast of the United Nations Population Division we are on course for 9.2 billion people by mid-century.

If we indeed run out of inexpensive oil and fall short of food, deplete our fossil groundwater and destroy remaining rainforests, and gut the oceans and fill the atmosphere with greenhouse gases that tip the earth’s climate into a runaway hothouse with rising ocean levels, we might yet confirm the Malthusian curse. Yet none of this is inevitable...

In the coming decades we will have to convert to solar power and safe nuclear power... Know-how will have to be applied to long-mileage automobiles, water-efficient farming, and green buildings... We will need to re-think modern diets and urban design to achieve healthier lifestyles that also cut down on energy-intensive consumption patterns. And we will have to help Africa and other regions to speed the demographic transition to replacement fertility levels, in order to stabilize the global population at around 8 billion.

There is nothing in such a sustainable scenario that violates the Earth’s resource constraints or energy availability. Yet we are definitely not yet on such a sustainable trajectory... We will need new policies to push markets in a sustainable manner (for example, taxes on carbon to reduce greenhouse gas emissions) and to promote technological advances in resource saving rather than resource mining. ...

Have we beaten Malthus? After two centuries, we still do not really know.

Robert Pindyck on Energy Policy

Robert Pindyck is interviewed on the candidate's energy proposals:

A Q&A with MIT Professor Robert Pindyck, by Stephanie Schorow, News Office: This is the first in an occasional series in which MIT experts weigh in on the presidential candidates, their policy ideas and aspects of the campaign.

As jittery consumers contemplate the price at the pump, energy issues have become a major factor in the U.S. presidential race. Have the two major-party candidates forthrightly addressed the hard issues about the country's energy needs? ...

"Distributional Effects of Environmental and Energy Policy: An Introduction"

Is it true that many of the effects of environmental policy are likely regressive? According to this, the answer is yes, but rebates to low-income households can offset the regressive effects. "This makes it important to use emissions taxes or the auction of permits, to raise revenue enough to cover the cost of those rebates":

Distributional Effects of Environmental and Energy Policy: An Introduction, by Don Fullerton, NBER Working Paper No. 14241 August 2008: Public economics has well developed tools for analyzing the incidence and distributional effects of ... taxes. ... Yet most pollution policy does not involve taxation at all. Instead, it employs permits or command and control (CAC) regulations such as technology standards, quotas, and other quantity constraints. ...

CAC environmental restrictions do impose costs, and an important question is who bears those costs. Moreover, those restrictions provide benefits of environmental protection, and another important question is who gets those benefits. Thus, full analysis of environmental policy could address all the same questions as in the tax incidence literature. ...

This introduction discusses some initial literature on distributional effects of environmental and energy policy. ... To identify the major effects around which this introduction is organized, consider a simple requirement that electric generating companies cut a particular pollutant to less than some maximum quota. This type of mandate is a common policy choice, and it has at least the following six distributional effects.

"Fuel Subsidies Drag Down a Nation"

Why lump-sum transfers are better than fuel subsidies:

How Fuel Subsidies Drag Down a Nation, by Robert H. Frank, Ecponomic View, NY Times: ...[M]any emerging economies employ subsidies that keep domestic fuel prices far below the world price. As a result, these countries consume far more fuel than they would otherwise.

By one estimate, countries with fuel subsidies accounted for virtually the entire increase in worldwide oil consumption last year. Without this artificial demand stimulus, world oil prices would have been significantly lower. ...

It would surely be unrealistic to expect other governments to abandon subsidies just so Americans who drive S.U.V.’s and live in big houses could benefit from lower world energy prices. But those governments might want to reconsider their policy in the light of overwhelming economic evidence that the subsidies create net losses even for their ostensible beneficiaries. ...

The problem is that when the price of a good is below its cost, people use it wastefully. In the case of a gallon of gasoline, the cost ... includes not just the price of buying the gallon in the world market — say, $4 — but also external costs, like dirtier air and increased congestion. The external costs are ... substantial. With reasonable estimates factored in for them, the true cost of using a gallon is clearly greater than $4. By contrast, the price of gasoline to users is simply the amount they pay at the pump. With a $2-a-gallon subsidy in effect, gasoline bought in the world market at $4 would sell for $2...

Consider how this difference might affect a trucker’s decision about whether to accept a hauling job. ... Suppose the job... requires 1,000 gallons of fuel, available at the subsidized price of $2 a gallon, for a total fuel outlay of $2,000. If the cost of the trucker’s time and equipment are, say, $1,000 for the trip, his narrow interests dictate accepting the job if the shipper is willing to pay at least $3,000. Suppose the shipper is willing to pay that amount but not more.

The problem is that if the trucker accepts the job at that price, the country as a whole will be worse off by more than $2,000. Although the $3,000 fee would cover his own costs, the government would end up paying $2,000 in additional subsidies for the 1,000 gallons consumed. On top of that, the trip would generate additional pollution and congestion costs. So the fact that the subsidy encouraged him to accept the job means that its net effect is equivalent to throwing more than $2,000 onto a bonfire.

Waste is always bad. ... Subsidy proponents cite the firestorm of political protest that would erupt if fuel were to sell at the international market price. That fuel subsidies are wasteful, however, implies that there must be less costly ways to keep the peace.

Consider again our trucker... Instead of paying $2,000 to subsidize his fuel, the government could give him a tax cut of, say, $1,000, and use the remaining $1,000 to help pay for public services. Because the trucker’s earnings from the hauling job were only enough to cover his costs at the subsidized fuel price, he would be $1,000 better off with the tax cut alone than with the fuel subsidy. The additional support for public services would augment this benefit. In short, a tax cut is always a better way to keep political protest at bay because ... it does not encourage shipments whose costs exceed their benefits.

If a United States president urged developing economies to eliminate fuel subsidies because they result in higher energy prices for Americans, the conversation would probably end very quickly. But this conversation might be reframed.

A good place to start would be to heed the same advice we’d like others to follow. Emerging economies are not the only ones in which prices at the pump substantially understate the true social cost of fuel. ... Adopting some variant of a tax on carbon ... would help eliminate this discrepancy.

That would set the stage for our next president to explain to other leaders why eliminating fuel subsidies would make the overall economic pie larger. Because the resulting efficiency gains can be redistributed so that everyone gets a bigger slice than before, the idea should be fairly easy to sell.

Paul Krugman: Can This Planet Be Saved?

John McCain's flip-flop on drilling shows he's not very serious about environmental issues:

Can This Planet Be Saved?, by Paul Krugman, Commentary, NY Times: Recently the Web site The Politico asked Nancy Pelosi, the speaker of the House, why she was blocking attempts to tack offshore drilling amendments onto appropriations bills. “I’m trying to save the planet; I’m trying to save the planet,” she replied.

I’m glad to hear it. But I’m still worried about the planet’s prospects. ...

Most criticism of John McCain’s decision to follow the Bush administration’s lead and embrace offshore drilling as the answer to high gas prices has focused on the accusation that it’s junk economics — which it is.

A McCain campaign ad says that gas prices are high ... because “some in Washington are still saying no to drilling....” That’s just plain dishonest: the U.S. government’s own Energy Information Administration says that removing restrictions ... wouldn’t lead to any additional ... production until 2017, and that even at its peak ... would have an “insignificant” impact on oil prices.

What’s even more important than Mr. McCain’s bad economics, however, is what his reversal on this issue — he was against offshore drilling before he was for it — says about his priorities.

Back when he was cultivating a maverick image, Mr. McCain portrayed himself as more environmentally aware than the rest of his party. He even co-sponsored a bill calling for a cap-and-trade system... But the lure of ... political gain ... was all it took to transform him back into a standard drill-and-burn Republican.

And the planet can’t afford that kind of cynicism. ...[T]he skirmish over drilling is the opening stage of a much bigger fight over environmental policy. What’s at stake..., above all, is ... whether we’ll take action against climate change before it’s utterly too late.

It’s true that scientists don’t know exactly how much world temperatures will rise if we persist with business as usual. But that uncertainty is actually what makes action so urgent. While there’s a chance that we’ll act against global warming only to find that the danger was overstated, ... Martin Weitzman, a Harvard economist..., offers some sobering numbers. Surveying a wide range of climate models, he argues ... they suggest about a 5 percent chance that world temperatures will eventually rise by more than ... 18 degrees Fahrenheit..., enough to “effectively destroy planet Earth as we know it.” It’s sheer irresponsibility not to do whatever we can to eliminate that threat.

Now for the bad news: sheer irresponsibility may be a winning political strategy.

Mr. McCain’s claim that opponents of offshore drilling are responsible for high gas prices is ridiculous — and to their credit, major news organizations have pointed this out. Yet Mr. McCain’s gambit seems nonetheless to be working: public support for ending restrictions on drilling has risen sharply, with roughly half of voters saying that increased offshore drilling would reduce gas prices within a year.

Hence my concern: if a completely bogus claim that environmental protection is raising energy prices can get this much political traction, what are the chances of getting serious action against global warming? After all, a cap-and-trade system ... really would raise energy prices.

The only way we’re going to get action, I’d suggest, is if those who stand in the way ... come to be perceived as not just wrong but immoral. Incidentally, that’s why I was disappointed with Barack Obama’s response to Mr. McCain’s energy posturing — that it was “the same old politics.” Mr. Obama was dismissive when he should have been outraged.

So ... I’m very glad to know that Nancy Pelosi is trying to save the planet. I just wish I had more confidence that she’s going to succeed.

A Solar Power Revolution?

Instead of all the drivel about offshore drilling from Republicans, this is what we need - technological solutions as described below. We aren't going to solve our energy problems, or even make a noticeable dent in them, by allowing offshore drilling. That's a ruse to capture votes. The solution lies in alternatives and conservation, and if the claims made below are correct, this looks like a big step in the development of solar power:

'Major discovery' from MIT primed to unleash solar revolution, Anne Trafton, News Office: In a revolutionary leap that could transform solar power from a marginal, boutique alternative into a mainstream energy source, MIT researchers have overcome a major barrier to large-scale solar power: storing energy for use when the sun doesn't shine.

Until now, solar power has been a daytime-only energy source, because storing extra solar energy for later use is prohibitively expensive and grossly inefficient. With today's announcement, MIT researchers have hit upon a simple, inexpensive, highly efficient process for storing solar energy.

Requiring nothing but abundant, non-toxic natural materials, this discovery could unlock the most potent, carbon-free energy source of all: the sun. "This is the nirvana of what we've been talking about for years," said MIT's Daniel Nocera ... senior author of a paper describing the work in the July 31 issue of Science. "Solar power has always been a limited, far-off solution. Now we can seriously think about solar power as unlimited and soon."

Inspired by the photosynthesis performed by plants, Nocera and Matthew Kanan, a postdoctoral fellow in Nocera's lab, have developed an unprecedented process that will allow the sun's energy to be used to split water into hydrogen and oxygen gases. Later, the oxygen and hydrogen may be recombined inside a fuel cell, creating carbon-free electricity to power your house or your electric car, day or night.

Trash Talk: Pay-As-You-Throw Systems

Should communities adopt "pay-as-you-throw systems" for garbage collection to reduce the amount of garbage flowing into landfills or incinerators?:

Kicking the Cans, by Robert Tomsho, WSJ: Plymouth, Mass. -- In this historic community ... garbage has become ... a touchy subject...

During months of debate, Mr. Quintal, chairman of the town's governing board of selectmen, argued that people who throw out more trash should pay higher disposal bills. "I got emails from people saying they thought I was right," he says. "But there were just as many from those who thought I was an idiot."

Like Plymouth, more and more communities are grappling with whether to abandon traditional garbage service and adopt so-called pay-as-you-throw systems. With PAYT, residents are charged based on how much garbage they generate, often by being required to buy special bags, tags or cans for their trash. Separated recyclables like glass and cardboard are usually hauled away free or at minimal cost. ...

PAYT represents an effort to curb garbage's impact on the ecosystem by pressuring consumers to create less of it. But the effort to make people change their habits has often stirred tension...

While Americans are accustomed to paying for utilities like water and electric based on use, that's not true about garbage in most places. ...

Tampering with that notion can be tricky in communities that switch to PAYT. Illegal dumping has cropped up in about 20% of such communities, according to a 2006 U.S. Environmental Protection Agency report. Local officials also complain about variations of the so-called Seattle stomp (named after one of the first PAYT cities), where homeowners try to beat the system by compacting huge amounts of trash into a single can or bag.

There has also been a recent backlash in some locales over costs and inconvenience...

Supporters of PAYT say it gives residents a direct economic incentive to recycle. Skumatz Economic Research Associates, a waste-consulting concern in Superior, Colo., estimates that PAYT programs lead to a 17% reduction in the flow of residential waste to incinerators and landfills... "Every analysis shows that this is a very cost-effective thing to do," says Lisa Skumatz, the firm's principal.

I should stop here and comment, every analysis doesn't show that, but we'll come back to the cost-effectiveness in a moment. Continuing:

The Value of a Statistical Life is Not the Value of Life

This article by Seth Borenstein of the AP generated quite a bit of subsequent commentary:

An American life worth less today, by Seth Borenstein, AP: It's not just the American dollar that's losing value. A government agency has decided that an American life isn't worth what it used to be.

The "value of a statistical life" is $6.9 million in today's dollars, the Environmental Protection Agency reckoned in May — a drop of nearly $1 million from just five years ago. ...

Some environmentalists accuse the Bush administration of changing the value to avoid tougher rules — a charge the EPA denies. ...

Agency officials say they were just following what the science told them. ... EPA officials say the adjustment was ... based on better economic studies. ...

As noted below, the rest of the AP article does a decent job of explaining the reasons for the change in the value of a statistical life, but the headline "an American Life Worth Less Today," and the opening paragraph supporting that claim is what most people heard about in the follow-up coverage.

For example, the Colbert Report weighs in here. Most of the commentary that came after the AP article ran along the lines in the Colbert Report video, i.e. that the Bush administration has devalued life in an attempt to avoid costly regulation. I'm not known as a defender of the Bush administration, but I don't think this characterization is fair. Let me turn the microphone over to a colleague.

Trudy Cameron has been researching these issues for the past six years, has served on the Science Advisory Board for the US EPA for almost a decade (until just last year) -- first on the Environmental Economics Advisory Committee, then on the Advisory Council for Clean Air Compliance Analysis (the committee which monitors the EPA's in-house benefit-cost analysis of the Clean Air Act) and on the Executive Committee. She is also the current President of the Association of Environmental and Resource Economists (AERE), the main professional organization in the US for environmental economists, with about 800 members. Thus, she can speak with some authority and, after reading Borenstein article, she decided she would like to set the record straight. Here is a shorter, less technical, newspaper version of her response from an op-ed that appeared today:

‘Value of life’ figures help government measure risk, by Trudy Anne Cameron, Commentary, The Register-Guard: On July 11, The Register-Guard ran a front-page Associated Press article the lead paragraph of which trumpeted that, “A government agency has decided that an American life isn’t worth what it used to be.” The story and its headline could easily give readers the impression that government agencies assign monetary values to human life in an arbitrary, perhaps even amoral, fashion. This is not the case. ...

And here is a longer version with a bit more detail:

On July 11, on the front page, the Register-Guard ran an AP article by Seth Borenstein entitled “In the numbers game of life, we’re cheaper than we used to be.” The reporting on this issue was better than the misleading title, but there are a few points which should be clarified.

The “value of a ‘statistical’ life” is not the same thing as the “worth of a life.”

Cash for Clunkers

What do you think about this proposal?:

A Modest Proposal: Eco-Friendly Stimulus, by Alan S. Blinder, Economic View, NY Times: Economists and members of Congress are now on the prowl for new ways to stimulate spending in our dreary economy. Here’s my humble suggestion: “Cash for Clunkers,” the best stimulus idea you’ve never heard of.

Cash for Clunkers is a generic name for a variety of programs under which the government buys up some of the oldest, most polluting vehicles and scraps them. If done successfully, it holds the promise of performing a remarkable public policy trifecta — stimulating the economy, improving the environment and reducing income inequality all at the same time. Here’s how.

Paul Krugman: Rove’s Third Term

Will the Rovian tactics that the McCain campaign has started to employ such as willful misinterpretation and distortion of remarks so as to impugn the patriotism of Democrats work again in this election?:

Rove’s Third Term, by Paul Krugman, Commentary, NY Times: Al Gore never claimed that he invented the Internet. Howard Dean didn’t scream. Hillary Clinton didn’t say she was staying in the race because Barack Obama might be assassinated. And Wesley Clark didn’t impugn John McCain’s military service. ...

Again and again we’ve had media firestorms over supposedly revealing incidents that never actually took place. The latest fake scandal fit the usual pattern as an awkwardly phrased remark, lifted out of context and willfully misinterpreted, exploded across the airwaves.

What General Clark actually said was ... not at all outrageous...  Yet the Clark affair did reveal something important — what a McCain administration would represent: namely, a third term for Karl Rove. ...

Mr. McCain’s run for the White House has always been based on persona rather than policy: he doesn’t have ideas that voters agree with, but he does have an inspiring life story — which, contrary to the myth of the modest maverick, he talks about all the time. The suggestion that this life story isn’t relevant to his quest for office was bound to provoke a violent reaction.

But the McCain campaign went beyond condemning General Clark’s remarks; it went out of its way to distort them. “This backhanded slap against John as not being a worthy warrior because he just got shot down is one of the more surprising insults in my military history,” said retired Col. Bud Day ... in a conference call organized by the campaign. In fact, General Clark had said no such thing.

The irony, not lost on Democrats, is that Col. Day himself has done what he falsely accused Wesley Clark of doing: he appeared in the 2004 Swift boat ads that impugned John Kerry’s wartime service.

The willingness of the McCain campaign to engage in these tactics, employing such tainted spokesmen, tells us that the campaign has decided to go negative — specifically, to apply the strategy Karl Rove used so effectively..., portraying Democrats as unpatriotic. ...

Will Rovian tactics work this year? ...Republicans were so successful ... thanks to a combination of compliant media and cowering Democrats. At first, the Clark affair suggested that nothing has changed. News organizations reported as fact the false assertion that General Clark criticized Mr. McCain’s military service, and the Obama campaign rushed to “reject” his remarks. ...

Since then, however, both the press and the Obama campaign seem to have recovered some of their balance. Opinion pieces have started ... pointing out that General Clark didn’t say what he’s accused of saying. Mr. Obama ... declared that General Clark doesn’t owe Mr. McCain an apology for his “inartful” remarks and denies that his own condemnation ... of those who “devalue” military service was aimed at the general.

In the end, the Clark affair may have strengthened the Obama campaign. Last week, with his cave-in on wiretapping, Mr. Obama was showing disturbing signs of falling into the usual Democratic cringe on national security. This may have been the week he rediscovered the virtues of standing tall.

Furthermore, my sense, though it’s hard to prove, is that the press is feeling a bit ashamed about the way it piled on General Clark. If so, news organizations may think twice before buying into the next fake scandal.

If so, the campaign has just taken a major turn in Mr. Obama’s favor. After all, if this campaign isn’t dominated by faux outrage over fake scandals, it will have to be about things that really did happen, like a failed economic policy and a disastrous war — both of which Mr. McCain promises will continue if he wins.

You Make the Call

[I wrote this last night, then decided against posting it, but the issue is getting more attention than I expected and I don't have much else right now...]

John McCain proposes government intervention - industrial policy - intended to direct private investment into a particular area:

McCain Proposes a $300 Million Prize for a Next-Generation Car Battery By Michael Cooper, NY Times: ...Senator John McCain is suggesting a new national prize: He said here Monday that if elected president he would offer $300 million to anyone who could build a better car battery. ... Mr. McCain ... [also] called for ... big tax credits for nonpolluting cars. ...

John McCain (a) recognizes that markets can work imperfectly, and that government intervention to correct incentives can fix the problem (even though, in this case, the private market probably does provide the correct incentives - so this would be yet another demonstration of poor economic reasoning from the McCain campaign), or (b) whether he gets economics or not, and I'll take his word that he doesn't, he has no real commitment to "core" principles such as his belief in free markets and their ability to provide the optimal level of investment in goods like batteries, and is instead a political opportunist who will propose or agree to whatever is convenient at the moment.

Here's more since I first wrote this (and feel free to add an option (c)). First, we have Cafe Hayek:

John McCain's proposal that Uncle Sam offer a $300 million prize to whoever develops a battery ... is silly -- as explained well by the Denver Post's David Harsanyi. ... Here are Mr. Harsanyi's closing paragraphs:

But when McCain peddles prize money, he also feeds the perception that industry and scientists aren't already working diligently on energy breakthroughs — with batteries and areas unknown — or that the market doesn't incentivize them to do so.

Worse, McCain makes it seem that a cure for oil is just beyond our grasp. Around $300 million away.

In this arms race of goofy ideas between the candidates — windfall taxes and gas-tax holidays, to name two — we're sure to see more poorly thought-out plans in the near future.

Let's hope they are just empty promises. ...

Tom Lee, through Ezra Klein, echoes this theme:

A Better Battery? or a Better Candidate?, by Ezra Klein: I didn't blog about John McCain's $300 million prize for a better car battery yesterday because it seemed too banal. But as Tom Lee points out, it also suggests a basic ignorance of the economic rationale for "prize" proposals:

I should be able to avoid saying anything as dumb as McCain's battery-prize proposal. Not that I don't like batteries, mind you! But if someone were to invent a better one they'd already be poised to make a huge amount of money through its commercialization. Offering prizes for innovation isn't always a terrible idea - for pharmaceuticals with a limited market of potential users it can make sense due to the huge costs associated with developing and testing a new drug. But everyone in the developed world needs better energy storage technology, and they need it right now. And while it's important to make sure your new batteries are safe and robust (e.g. they don't explode too much), that's still much easier and cheaper to do than it is to conduct a set of double-blind human trials. So sweetening the pot is unnecessary. Anyone who has a good idea about how to build a better battery is already working on the problem.

Over the past couple of days, McCain has come out with a couple of these small bore proposals. Today he promised to make the government use more fuel efficient cars. ...A bunch of micropolicies meant to demonstrate attention to the issue without, you know, solving it. ... To the average person, a $300 million prize for a better car battery sounds like a lot of money. But it's a big pot of nothing in the face of climate change.

Paul Krugman: Driller Instinct

Mr. McCain’s energy gambit:

Driller Instinct, by Paul Krugman, Commentary, NY Times: Blaming environmentalists for high energy prices, never mind the evidence, has been a hallmark of the Bush administration.

Thus, in 2001 Dick Cheney attributed the California electricity crisis to environmental regulations that, he claimed, were blocking power-plant construction. He completely missed the real story, which was that energy companies — probably some of the same companies that participated in his secret task force... — were driving up prices by deliberately withholding electricity from the market.

And the administration has spent the last eight years trying to convince Congress that the key to America’s energy security is opening up the Arctic National Wildlife Refuge to oil drilling — even though estimates ... suggest that ... would make very little difference to the energy outlook...

But it still comes as a surprise and a disappointment to see John McCain joining that unfortunate tradition.

I’ve never taken Mr. McCain’s media reputation as a maverick seriously,... on most issues, he’s a thoroughly conventional conservative. On energy policy, however, he has ... seemed to show some independence. Most notably, he voted against the really terrible, special-interest-driven 2005 energy bill, which was backed by the Bush administration — and by Barack Obama.

But that was then.

In his Monday speech on energy, Mr. McCain tried to touch all the bases. He talked about conservation. He denounced the evils of speculation... A weird aspect of the current energy debate, incidentally, is ... that many of the same market-worshipping conservatives who first denied that there was a dot-com bubble, then denied that there was a housing bubble, are utterly convinced that nasty speculators are responsible for high oil prices.

The ... news, however, was Mr. McCain’s call for more offshore drilling... This was a reversal of his previous position, and it went a long way toward aligning his energy policy with that of the Bush administration.

That’s not a good thing.

As many reports have noted, the McCain/Bush policy on offshore drilling doesn’t make sense as a response to $4-a-gallon gas: the White House’s own Energy Information Administration says that ... even at peak production its impact on oil prices would be “insignificant.”

But what I haven’t seen emphasized is the broader picture: Mr. McCain has now aligned himself with an administration that, even aside from its blame-the-environmental-movement tendencies, has established an extensive track record as the gang that couldn’t think straight about energy policy.

Remember, they didn’t just insist that the Iraqis would welcome us as liberators;... administration officials were also adamant that regime change in Iraq would add millions of barrels a day to the world oil supply, driving oil prices way down...

So why would Mr. McCain associate himself with these characters? The answer, presumably, is that it’s a cynical political calculation. I’m reasonably sure that Mr. McCain’s advisers realize that offshore drilling would do nothing for current gas prices. But they may believe that the public can be conned...

And Mr. McCain may also hope to shore up his still fragile relations with the Republican base..., many people on the right ... believe that all our energy problems have been caused by sanctimonious tree-huggers. Mr. McCain has just thrown that constituency some red meat.

But I very much doubt that Mr. McCain’s gambit will work. In fact, it’s almost certainly self-destructive. To have a chance in November, Mr. McCain has to convince voters that he isn’t just Bush, continued. Energy policy is one of the areas where he could best have made that case.

Instead, he has ceded the high ground on energy to Mr. Obama, and linked himself firmly to the most unpopular president on record.

"Sue OPEC"

Should we sue OPEC for anti-trust violations?:

Sue OPEC, by Thomas W. Evans, Commentary, NY Times: The president of the United States has the power to attack, and perhaps destroy, the Organization of the Petroleum Exporting Countries, the illegal cartel that has driven the price of oil over $130 per barrel. ... The president need simply allow the states to seek relief in the Supreme Court under our antitrust laws.

The oil ministers of the OPEC countries meet periodically to set production quotas ... and in the process establish an artificially high price for crude oil. Under our antitrust laws, this is illegal. Two years ago, Amy Myers Jaffe, an energy expert at Rice University, estimated that the real production cost was $15 a barrel, at a time when the price was approaching $60. Recently, an OPEC spokesman said the price could be $70 a barrel — a little more than half the current price — if speculation and manipulation could be eliminated.

Despite this illegal conduct, ... “under the current state of our federal laws the individual member states of OPEC are afforded immunity from suit brought for damage caused by their commercial activities when they act through OPEC.” ...

Fortunately, there is another way to sue OPEC. Even if actions by individual citizens fail, a seldom-used provision of Article III of the Constitution grants original jurisdiction to the Supreme Court over lawsuits brought by states against “foreign states”...

The attorneys general of the various states should sue OPEC as ... a foreign state. (A joint action by the attorneys general is the method the states used to collectively sue tobacco companies, Microsoft and health maintenance organizations.) ... If the states won the case, the court could recover substantial damages based on assets and commercial activities of OPEC member nations in the United States.

Still, even though the states are allowed to sue OPEC in the Supreme Court, they might not prevail. There are significant separation of powers issues. ...

That’s where the president ... comes in. If the Supreme Court decided to defer to the policies of the political branches, the states could ask the president to issue a statement permitting the lawsuit to go forward... This pathway was established in a statute passed by Congress in the wake of Cuba’s expropriation of American sugar interests. ...

Moreover, confronted with the likelihood of huge damages and restraint of its illegal conduct, OPEC, or some of its members, might seek a settlement establishing production goals that would provide a price closer to actual costs. The probable reduction in the price of heating fuel and gas at the pump might exceed the amount of the current federal stimulus package.

If the president allowed the states to sue OPEC, his actions would undoubtedly anger political leaders in the Middle East and create the need for diplomatic initiatives to limit the fallout. But how stable is the Middle East right now? And isn’t starting a lawsuit better than starting a war?

And, from the LA Times, Sue OPEC (same title, but different authors, different editorial pages):

As the national average price of gasoline raced toward $4 a gallon and airlines laid off workers by the thousands because of rising jet fuel costs, the House of Representatives took action: It overwhelmingly passed the Gas Price Relief for Consumers Act of 2008. The bill would have ... permitted the U.S. Justice Department to charge the Organization of the Petroleum Exporting Countries with violating American antitrust laws.

Even before the 324-84 House vote last month, President Bush pledged a veto, saying OPEC might retaliate against U.S. interests overseas or cut oil production further. But he didn't have to make good on that promise. Senate Republicans held the line for him, last week threatening a filibuster... That effectively killed the bill and, for now, any hope that the United States would finally start treating oil the same way it does computer chips, vitamins, rubber and all other products. ...

If monopoly power is distorting these markets, then sure, we should fix that just as we should fix other market failures (e.g. not fully internalizing environmental costs into production decisions). However, it's unlikely that this is the factor behind the run-up in prices. Monopoly power explains the level of prices, i.e. why price is $8 rather than $5, but it doesn't explain the change in prices, i.e. why the price would change from $8 to $12. There are ways to tell this story, e.g. a war or some other event giving a cartel the cover it needs to raise prices and blame it on external factors, but I don't think that's what's going on in oil markets today, at least I don't think this is a significant factor behind the oil price increases.

For these reasons, if we fix the monopoly power problem, it's unlikely that oil prices will suddenly plummet. Even if monopoly power is a factor, it's unlikely it's as important as the growth in world demand. And while I don't put a lot of faith in the speculation story, I'd be more likely to believe speculation was the cause of the price run up than I would monopoly power.

I don't mean to downplay monopoly power, I've been frustrated that we seem to have lost focus on this aspect of markets over the last few decades, and we don't worry enough about market power in public policy. And maybe breaking up OPEC would bring down the price noticeably (for now, world growth will continue to put upward pressure on oil prices). If so, then we should eliminate the monopoly power, there's no reason to pay more than is necessary (though if we impose carbon taxes to correct other problems in these markets, the price will go back up again, the difference will be who gets the extra revenue).

But I'd also hate to see the oil price discussion get diverted by false hopes. Breaking up OPEC might bring prices down some, but it won't bring back the good old days and the longer term problems remain. At some point we have to face that things are changing, that we have to adjust - we can't keep hoping for a return of the low oil prices of the past because those days aren't coming back (no matter how many holes we drill in Alaska or off our coasts). Maybe technology will save us, but that too will require that we face reality and devote the resources and effort needed to fully investigate and develop alternative energy sources.

Stiglitz: Rethink the Sources of Growth

Joseph Stiglitz says we need to change our ways:

The world must rethink the sources of growth, by Joseph E. Stiglitz, Commentary, Project Syndicate: Around the world, protests against soaring food and fuel prices are mounting. The poor – and even the middle classes – are seeing their incomes squeezed... Politicians want to respond..., but do not know what to do. ...

Hillary Clinton and John McCain took the easy way out, and supported a suspension of the gasoline tax... Only Barack Obama stood his ground and rejected the proposal... But if Clinton and McCain were wrong, what should be done? One cannot simply ignore ... those who are suffering. ...

When George Bush was elected, he claimed that tax cuts for the rich would cure all the economy’s ailments. The benefits of tax-cut-fuelled growth would trickle down to all...

Tax cuts were supposed to stimulate savings, but household savings in the US have plummeted to zero. They were supposed to stimulate employment, but labour force participation is lower than in the 1990’s. What growth did occur benefited only the few at the top.

Productivity grew, for a while, but it wasn’t because of Wall Street financial innovations. The financial products being created didn’t manage risk; they enhanced risk. ... Millions of Americans will likely lose their homes and, with them, their life savings.

At the core of America’s success is technology, symbolised by Silicon Valley. The irony is that the scientists making the advances..., and the venture capital firms that finance it were not the ones reaping the biggest rewards in the heyday of the real estate bubble. ...

The world needs to rethink the sources of growth. If the foundations of economic growth lie in advances in science and technology, not in speculation in real estate or financial markets, then tax systems must be realigned.

Why should those who make their income by gambling in Wall Street’s casinos be taxed at a lower rate than those who earn their money in other ways? Capital gains should be taxed at least at as high a rate as ordinary income. ... In addition, there should be a windfall profits tax on oil and gas companies.

Given the huge increase in inequality in most countries, higher taxes for those who have done well – to help those who have lost ground from globalisation and technological change – are in order, and could also ameliorate the strains imposed by soaring food and energy prices. ...

Two factors set off today’s crisis: the Iraq war contributed to the run-up in oil prices..., while bio-fuels have meant that food and energy markets are increasingly integrated. ...

Huge agriculture subsidies ... have weakened agriculture in the developing world... Rich countries must reduce, if not eliminate, distortional agriculture and energy policies, and help those in the poorest countries improve their capacity to produce food.

But this is just a start: we have treated our most precious resources – clean water and air – as if they were free. Only new patterns of consumption and production – a new economic model – can address that most fundamental resource problem.

The list of criticisms and proposals sounds somewhat like a campaign speech. And that makes me wonder, four years from now, what will be different?

Gas Price Elasticities

A meta-analysis of "the price elasticity of petrol":

Message to the Coalition: people respond to incentives, by Andrew Leigh: I was listening the other day to Tony Abbott claiming that the price elasticity of petrol is zero... It was perhaps the first time that I had heard a politician use the word ‘elasticity’... Anyhow, this struck me as the kind of issue that people have probably researched, and sure enough a quick search turned up a nice meta-analysis by Daniel Graham and Stephen Glaister. Here’s the key graph:

As the authors conclude:

There are differences between the short- and long-run elasticities of fuel consumption with respect to price. Typically, short-term elasticities are in the region of -0.3 and long-term between -0.6 and -0.8. Therefore, it may be right to say that ”it won’t make much difference” or ”people will use their cars just the same”, but only in the short run. The evidence is clear - and remarkably consistent over a wide range of studies in many countries - that in the long run there is a significant response, albeit a less than proportionate one.

In other words, a 10% rise in petrol prices reduces petrol demand by 3% in the short-term, and by 6-8% in the long-term. (Although the study isn’t clear on this point, I’m guessing short term is <1 year, and long term is >1 year.) ...