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Wednesday, June 04, 2008

Someone on the Internet is Wrong...

Tyler Cowen defends Robert Samuelson:

Cap and trade vs. carbon tax, by Tyler Cowen: Robert Samuelson writes:

Unless we find cost-effective ways of reducing the role of fossil fuels, a cap-and-trade system will ultimately break down. It wouldn’t permit satisfactory economic growth. But if we’re going to try to stimulate new technologies through price, let’s do it honestly. A straightforward tax on carbon would favor alternative fuels and conservation just as much as cap-and-trade but without the rigid emission limits. A tax is more visible and understandable. If environmentalists still prefer an allowance system, let’s call it by its proper name: cap-and-tax.

Mark Thoma gets upset at this passage, here is Ryan Avent, Brad DeLong and Matt Yglesias, all upset. Avent was the fount of the opposition:

Yowza. As any economist worth his or her salt will tell you, a cap and trade plan with auctioned permits is essentially identical to a carbon tax. That also happens to be exactly what Barack Obama is proposing. So, another way for Samuelson to have written this column would have been to title it, “Barack Obama has a good plan to reduce carbon emissions."

But Samuelson is correct here and Avent is misleading. When there is uncertainty about the location of the social optimum, and uncertainty about elasticities, a carbon tax and cap-and-trade are by no means equivalent. If you see very high costs from setting the binding cap too low and choking off growth -- as Samuelson mentions -- you should prefer the carbon tax. The price of carbon is more certain and you bear less risk from uncertainty about how fast solar power and other technologies will develop. Alternatively, you might say that risk is transformed into price risk rather than "you can't exceed this cap no matter what" risk.

Of course the postulated uncertainties are realistic in this context and you don't have to invoke uncertainty about the science of global warming.

If there is very high environmental risk to having emissions above a certain level, and we are unsure about the relevant elasticities (again, uncertainty about the pace of technological development can drive this), that militates in favor of cap and trade. It is then easier to ensure that emissions do not exceed a particular level.

You can see that we are comparing the "growth threshold problem" to the "environment threshold problem." Samuelson is apparently more worried about the former than the latter. Maybe he shouldn't be so sure he is focusing on the right problem, but on the economics he is on the mark in the criticized passage.

Addendum: Here is Mark Thoma with more on the topic, here is Megan McArdle on same.

I'll let Ryan respond to the parts directed at him (update - see here). My main objection wasn't the passage above, it was Samuelson's claim that environmentalists are deceiving the public, i.e. my objection was to Samuelson's attempt to "bash environmentalists for proposing a cap-and-trade system" when "there's no foundation" to his arguments. For example, Samuelson says:

[C]ontrolling greenhouse gas emissions ... promises to be hard and perhaps futile, but there are good and bad ways of attempting it. One of the bad ways is cap-and-trade. Unfortunately, it's the darling of environmental groups and their political allies.

The chief political virtue of cap-and-trade ... is its complexity. This allows its environmental supporters to shape public perceptions in essentially deceptive ways. ... It would regulate economic activity, but it's promoted as a "free market" mechanism. ...

Samuelson is the one who is being deceiving here. Cap-and-trade is promoted by environmentalists as market based regulation, the term is meant to distinguish it from command and control type regulation. Samuelson seems to think cap-and-trade is command and control type regulation, but the whole point of market-based regulation is to move away from older style command and control policy regimes since market based regulation has better incentive properties. This is one of the reasons I didn't think he fully comprehended the economics underlying these proposals.

Here's more of Samuelson trying to make the case the environmentalists are deceiving the public by claiming that regulation will be painless:

Carbon-based fuels (oil, coal, natural gas) provide about 85 percent of U.S. energy and generate most greenhouse gases. So, the simplest way to stop these emissions is to regulate them out of existence. Naturally, that's what cap-and-trade does. ...

Even better, their disappearance would allegedly be painless. Reviewing five economic models, the Environmental Defense Fund asserts that the cuts can be achieved "without significant adverse consequences to the economy." Fuel prices would rise, but because people would use less energy, the impact on household budgets would be modest. ...

Here's what the EDF actually says:

How would Americans be affected by a carbon cap?

  • Total job loss would be minimal;
  • The new carbon market would create new jobs;
  • The manufacturing sector is projected to see some job losses, but the models show that losses due to an emissions cap would be minimal.
  • The effect on household consumption is expected to be one percent or less.
  • American households will be most affected by energy costs, but even here the increases would be modest. Overall costs would be small enough to allow us to expand programs to offset the burden for low-income households.

They do tend to minimize the costs in the language used in the write-up, but they don't say there is no cost at all, and the studies they rely upon in their meta analysis are well documented. And it's not exactly clear why the criticism Samuelson is making is specific to a cap-and-trade proposal, which is the case he is trying to make (he's saying that  environmentalists are hiding behind cap-and-trade rather than being honest and proposing a carbon tax). That is, if the EDF provided cost estimates for a carbon tax, how different would the cost estimates be? Probably not very different since most of the same incentives to substitute toward alternatives would still exist, or, according to Samuelson, be even larger. So this point has little to do with using a cap-and-trade proposal to (supposedly) deceive the public.

One reason Samuelson thinks the analysis is misleading is that he objects to the assumption that consumers would substitute away as they face higher prices:

The idea that higher fuel prices will be offset mostly by lower consumption is, at best, optimistic. The Congressional Budget Office has estimated that a 15 percent cut of emissions would raise average household energy costs by almost $1,300 a year.

If environmentalists hide all the costs of cap-and-trade like he claims, what motivates the higher prices and substitution in the study? Anyway, he's really contesting the ability of consumers to substitute, the direct costs aren't hidden, they are out in the open as he implicitly acknowledges with his statement about higher prices (and it's technology too, not just cutting back).

And, in any case, the estimates of little change in energy bills that Samuelson ridicules are not without foundation. As the paper says:

To illustrate the fundamental difference between energy prices and energy bills, we can take a look back at actual household spending patterns. The average American household's monthly electricity bill was virtually the same in 1990 as in 2005 (after adjusting for inflation) -- even though the average residential electricity price was 24% higher in 1990 than in 2005. In other words, even though electricity rates were substantially higher fifteen years ago, the average American family spent no more on electricity than they do today.[14] In the same way, looking forward in time, a given percentage rise in energy prices will lead to a much smaller change in energy bills. This principle is evident in the EIA's projections of future household energy expenditures. The EIA projects electricity prices in the year 2020 to be 9% higher than business as usual under the Lieberman-McCain legislation.

Thus, the EDF estimates are evidence based.

As for lower GDP growth, one of Samuelson's worries, I think his discussion misses this:

And this brings me to a final point that is often overlooked by both sides: the economic indicators that we currently use do not measure societal welfare. When many conservatives point out the lost GDP from a cap-and-trade system or a carbon tax, they typically ignore the fact that GDP does not include the lost welfare from environmental damage done by production. And while figures quoting the lost GDP from imposing a cap-and-trade system are useful, they rarely mention, even in passing, the environmental gain. Any first-year student of macro 101 is taught this difficulty when introduced to national income accounting... The purpose of the income earned from GDP itself is to increase consumption and ultimately utility, but GDP does not measure everything that affects one's well-being.

If there was a government policy instituted for 3 months that said every person must work at least 16 hours per day in that time period, GDP would temporarily increase dramatically. But leisure would be essentially non-existent, and actual societal well-being would fall dramatically. The same can be said for the environment. Due to the tragedy of the commons, lower output (as measured by GDP) could actually improve societal well-being because, after all, the tragedy is a result of overproduction from the perspective of society's welfare as a whole.

On the other side of the aisle, we often hear talk of the number of "green jobs" that would be created by such a policy. Such talk is ridiculous too. The purpose of environmental regulation is not to create jobs. It's to improve societal well-being by reducing emissions. Of course, any time a tax (or its equivalence) on one item is imposed, it will alter behavior. (It's nice to see some liberals finally acknowledge that.) But in the short-to-medium-run the number of green jobs added from cap-and-trade would likely be lower than the number of total jobs lost due to the fact that production overall will fall (which as pointed out isn't necessarily bad), although sector-specific changes would depend upon production functions.

So my doubts about the column remain.

Update: Brad DeLong says "I think that Tyler Cowen has misread Robert Samuelson."

Update: Ryan Avent replies.

    Posted by on Wednesday, June 4, 2008 at 03:24 AM in Economics, Environment, Market Failure, Policy | Permalink  TrackBack (0)  Comments (49)


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