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What Economists Believe About the Economic Tools We Can Use to Respond to Climate Change

This is where economists are really the only experts. Economists believe that economic tools can help reduce consumption, divert investment to creating alternative energy systems, and reduce energy demand.

This is not surprising: economists believe that prices affect people. That is probably the central insight in economcs. A surprising amount of the relevant economic theory is summed up in the simple graph of a downward-sloping demand curve. That image is just a way of presenting the general principle that when the price of something rises people generally buy less of it.

As a result, all economists believe that putting a price on carbon will reduce consumption of fossil fuels. If you don’t believe this, you don’t believe the most basic observations in economics and you aren’t an economist.

Corrective taxes
If prices affect how much people buy, then it is possible for prices to encourage people to buy too much or too little. Make machine guns free and there will be too many machine guns in school yards. Make milk expensive and children may grow up with weak bones.

But what is the right price for fossil fuels? It is easier to talk about what the wrong price is. When we burn any fossil fuel we dump CO2 into the atmosphere. Another way to say this is that we are getting garbage removal for free. Whenever price charged by fossil fuel companies leaves out important costs like garbage removal, climate change, pollution and nasty health effects, consumers are not paying the full price of using fossil fuels.  The price is too low, so they burn more than they should.

When important prices are too low, markets simply cannot be efficient. They are broken. Economists call the results “market failure.”

With fossil fuels the scale of the inefficiency is actually startling. Burning one ton of coal with a carbon content of 78 percent and a heating value of 14,000 Btu per pound to produce electricity adds a roughly 2.25 tons of CO2 to the atmosphere.  A common estimate of the appropriate carbon tax is about $70 per ton, which means the carbon tax on a ton of coal should be in the range of $167. One pound of coal produces roughly one Kilowatt hour of electricity so a ton of coal produces roughly 2000 kWh which, at the higher of Ontario’s residential rates, has a retail value of about $200.   This suggests that electricity from coal should cost almost twice as much as electricity currently costs in Ontario. Households are paying only half the economic price for electricity generated form coal plants.  At that rate they consume vastly more electricity than they should.

A similar calculation tells us that we should be adding a carbon tax of $23 for each barrel of oil (and at least $27 for oil from Alberta’s bitumen mines)

A. C. Pigou, showed that when prices are wrong the public can correct them using taxes or subsidies. These “corrective taxes”  or Pigovian taxes” actually make the economy more efficient. Most economists believe that the fossil fuel industries should be subject to corrective taxation. To be more specific, most economists believe that a carbon tax would promote economic efficiency. This conclusion is a necessary result from basic economic theory.

Economists who support a carbon tax
Conservative American economist Greg Mankiw, author of one of the most popular introductory economics texts, and chairman of the economics department at Harvard University,  has listed members of what he calls the Pigou Club, “an elite group of economists and pundits with the good sense to have publicly advocated higher Pigovian taxes, such as gasoline taxes or carbon taxes.” Included in the list are

  1.    Greg Mankiw (Fortune 5/24/99, WSJ 1/3/06, 5/31/06)
  2.    Bill Nordhaus (Foreign Policy in Focus 3/27/06)
  3.    Martin Feldstein (WSJ 6/4/92)
  4.    Gary Becker (Businessweek 5/27/02)
  5.    Robert Frank (NY Times 2/16/06, 6/8/06)
  6.    Andrew Samwick (his blog)
  7.    Ted Gayer (Regulation)
  8.    Mike Moffatt (about.com)
  9.    Ken Rogoff (Project Syndicate)
  10.    Paul Krugman (Slate 4/18/97)
  11.    Greg Easterbrook (NY Times 5/25/04)
  12.    John Tierney (NY Times 10/4/05, 5/23/06)
  13.    Jonathan Rauch (National Journal 2/9/02)
  14.    Thomas Friedman (NY Times 9/21/05, 2/8/06, 6/16/06)
  15.    Joe Klein (Time 5/7/06)
  16.    Andrew Sullivan (Time 4/11/04)
  17.    Jane Galt (her blog)
  18.    Christopher Farrell (Businessweek 8/19/05)
  19.    William Baldwin (Forbes 6/19/06)
  20.     Clive Crook (National Journal 6/2/06)
  21.     Al Gore (Charlie Rose Show 6/19/06 at 42:45)
  22.     Alan Greenspan
  23.     George Schultz,
  24.     Tony Lake,
  25.      Nicholas Stern,
  26.     Hal Varian,
  27.     Larry Summers,
  28.      Richard Posner,
  29.      Nouriel Roubini,
  30.      Joe Stiglitz,
  31.      Brink Lindsey,
  32.      Tim Harford,
  33.       Rob Stavins,
  34.       Ray Magliozzi,
  35.       Robert Samuelson,
  36.       Dan McFadden,
  37.       Charles Krauthammer,
  38.       Paul Mulshine,
  39.       Kevin Hassett, Jason Furman,
  40.       Anne Applebaum,
  41.       Paul Volcker,
  42.       Bill Frenzel,
  43.       Isabel V. Sawhill,
  44.       Charles Stenholm,
  45.       William Hoagland,
  46.       Robert Shapiro,
  47.       David Leonhardt,
  48.       Morton Kondracke,
  49.       Gilbert Metcalf,
  50.       Fred Foldvary,
  51.       Arthur Laffer,
  52.       and a majority of economists.

Nobel Prize winners are in bold type. This list is not complete, and it does not include the Canadian and other non-American economists that support a carbon tax. In fact, most economists around the world believe that a carbon tax is needed  and a carbon tax is the best tool available. Period. Support for a carbon tax is actually a reasonable test of how well trained an economist is. If someone says they don’t support an carbon tax it generally means they are not an economist, and if the person has some credentials as an economist, it means they are not a very well trained economist. It might be possible for someone with a training in economics to argue that carbon taxes would not promote a more efficient economy, but it would be an intellectual strain, like a physicist arguing the earth is flat.

Most economists recognize the obvious fact that carbon taxes can raise stable revenues: existing carbon-related taxes, like gas taxes, have been raising sizeable revenues for years. Raising them significantly would therefore both achieve environmental improvements and allow other taxes to be lower. This isn’t just theory, by the way: British Columbia has shown that a carbon tax does reduce the use of carbon and raises revenue. British Columbia has shown that  governments can use carbon revenues to lower taxes.  Many economist argue for a carbon tax because it allows other taxes to be reduced.

Economists believe that a carbon tax will be resisted because people see all taxes as directly reducing their purchasing power and do not fully recognize the benefits generated by those taxes.

Many economists believe, however, that the public can be won round to green fiscal reform.

A number of polls show majority public support in Britain for a green tax shift, and support  increases when people are persuaded that the green taxes will be used to reduce other taxes .See the UK Green Fiscal Commission Report a thttp://www.greenfiscalcommission.org.uk/images/uploads/GFC_FinalReport.pdf) The existence of the  Canadian Ecofiscal Commission} headed by Dr. Chris Ragan demonstrates the confidence of at least a significant group of Canadian Economists in the political feasibility of carbon taxation. The Environmental Commissioner for Ontario notes that Research has shown that public support for a carbon tax hinges on how the revenue is used. In one American poll, he notes, the public supported a carbon tax most when the revenues would be used to fund renewable energy.

Cap and Trade and Carbon Offsets
Most  economists believe that  in theory cap and trade could work as well as carbon taxes. We like clever theories. Many of us like the idea of creating a market to solve a problem.

Some economists believe that cap and trade will actually work in practice. A few believe it has worked in Europe.

Most economists understand that cap and trade is a bureaucratic approach that requires measurement, reporting, and verification to be effective.   It does create a market, and  is technically a `market-based’ approach,’ but it requires the creation of an agent or collection of agents to issue rights and monitor compliance. It require a government decision about the amount of emission permits.

Most economists believe that Cap and Trade might be easier to implement politically than a carbon tax because the economic incentives are positive for the companies involved while the costs are hidden for consumers:  with Cap and Trade you buy off companies with additional property rights and hide the cost of the implicit subsidy from consumers.

Most  economists recognize that  Cap and Trade is a form of privatization — the rights to emit are transferred to private corporations.

Cap and Trade schemes are usually associated with a system of carbon offsets. You can pay someone to plant a tree to offset the carbon released when you fly to the Bahamas. Economists recognize that under the Clean Development Mechanism of the Kyoto  Protocol, carbon offsets tend to transfer income to less developed countries, as they were intended to do. Some economists approve of the transfer, others don’t. (Prime Minister Harper, who has an MA in economics, called it a form of socialism when he worked for  the self-styled Canadian Tax Foundation.) Some think it is an effective mechanism, others don’t.  Carbon offsets  create a market for sequestration that most economists probably  think could work in principle. that has worked to some extent but is prone to fraud,  hard to verify, and complex. The offset market is market trading an asset that only exists if a public agency says it does.

I think all economists understand that a carbon tax will favour consumers  and that Cap and Trade favours existing producers by giving them an additional property right. I think that most economist would think it obvious that  for carbon taxes to be fair, however, low-income households would need to be protected from energy price rises while their homes were being made energy efficient. The Britich eco-fiscal commission suggeested that a massive  programme to improve the energy efficiency of existing homes for social as well as environmental reasons would be necessary. Such a program would provide an economic stimulus according the the economic theories most economists believe. It would probably pay for itself according to most energy accountants.

Most economists don’t believe that  Canada is doing a good job of getting ready for the new economy because of commitments to the energy industry.

Subsidies
Economists believe that, in general, subsidies are a bad idea and that reducing subsidies is a good idea.  Subsidies for fuel consumption or for producing fossil fuels encourage the production of more carbon dioxide.

Most economists believe that petroleum  and tar sands  production in Canada is heavily subsidized – and some, like the analysts at the International Monetary Fund in ENERGY SUBSIDY REFORM: LESSONS AND IMPLICATIONS  (Available at (http://www.imf.org/external/np/pp/eng/2013/012813.pdf), argue the effective subsidy is in excess of  of 30% of the price ( If there is a technical word for encouraging people to do bad things, it is “stupid.”  We do have some very stupid policies in Canada.  The paper warns that “These estimates are likely to underestimate energy subsidies and should be interpreted with caution.”).

Using Regulations
No economists believe that regulation is an efficient tool  in general, although most believe that regulations can help cut carbon in specific ways, and most believe regulation will be necessary. Mandating fuel efficiency for automobiles in California, for example, forced technological developments that did reduce emissions. The reason it worked is that California was such a large market that automakers couldn’t afford to be excluded. Once that tooled up to produce cars for California, it was cheaper to produce the same cars for the rest of the USA.

Regulations generally require oversight, enforcement, prosecution and penalties, all of which involve costs. When observing behaviour is imperfect, regulation will usually be incomplete as well as costly.

Reducing Carbon Intensity
The Canadian government’s preference for regulating carbon intensity is a non-market approach that does not provide a direct incentive for reducing emissions. It seems attractive because it encourages emitters to reduce emissions per unit of output. It also seems to be good for economic growth because it does not influence output. This is in fact a misunderstanding of the economics involved.

Total Carbon emissions from any sector can be represented as a box. The width is the amount of output and the height is the intensity. Reducing Carbon Intensity reduces the height but allows the width to increase. In Alberta’s bitumen deposits, for example, even though producers emit less carbon dioxide per barrel, they are producing so many more barrels that emission have risen and will continue to rise.

A carbon tax encourages people to reduce both height and width. Here is where a deeper understanding of economics helps. If you just look at one market, the carbon tax seems to reduce production, and this seems to mean it reduces growth. Looking at one market this way is called `partial equilibrium analysis.”

A carbon tax doesn’t reduce total growth in the whole economy, however. Instead it encourages  growth to move to sectors that use less carbon. Studying how the effect of a policy spreads to other markets is called ``general equilibrium analysis.” Economists developed general equilibrium analysis because it is more accurate that partial equilibrium analysis.

Adding it up
To summarize, most economists would accept the conclusion of the UK green Fiscal commission in 2009:

  1. Carbon taxes work
  2.  Carbon t axes are efficient
  3.  Carbon taxes can raise stable revenues
  4.  The public can be won round to carbon taxes
  5.  Carbon taxes would stimulate investment in the low-carbon industries of the future
  6.  Carbon taxes can mitigate the impact of high world energy prices
  7.  The impacts of Carbon taxes on competitiveness can be mitigated

In other words, most economists would assent to the view that carbon taxation will help get Canada on a low-carbon trajectory, help develop  new industries, provide competitive advantage, and contribute to fiscal stability.

Cutting Fossil Fuel Consumption Does NOT Mean Cutting our Standard of Living.

You have been told that limiting fossil fuels will reduce our standard of living. That is the basic economic argument put forward by Republicans in the USA, many climate change deniers, Vic Fedeli, who wants to be Conservative leader in Ontario, and economists who see themselves as realists. It isn’t a lie, just an error.

Or rather it is a collection of errors. It is involves errors about energy intensity, energy supply, and a deep confusion about what “standard of living means”. Lets take these in order.

The pessimists assume that we can’t reduce energy intensity very much. Producing a hammer in 2020 will take as much energy as it did in 2014. This is absolutly absurd. Virtualy every product  we buy is being re-engineered to reduce the energy required to produce it. Just think about lighting. Do you remember incandescents? Fluorescents? Compact fluorescents? LEDs?  In an amazingly  short time we have moved through a series of technologies that reduce energy intensity. And have  you noticed that computers, phones and cars are getting smaller lighter and better? Declining energy intensity happening before your eyes. Cell phones don’t require coppper wires to connect them: less energy required.  Fibre optics? more signal, less energy to produce or operate. The rule is that energy intensity will fall. And in every case the quality of your life improved!

And do remember that  the federal government has based its whole policy for restraining Canadian emissions of CO2 on reducing energy intensity in the tar sands. Those conservatives believe it is easy to cut energy intensity! It really is too bad that they didin’t introduce a carbon tax. that would have speeded up the process quite a lot.

Reducing energy intensity alone is not enough to sharpy reduce fossil fuel use, especially with rising world population, but it helps.

The pessimists also assume that we can’t find alternate sources of energy. This has proven wrong – Solar is getting cheaper, wind is getting cheapers, storage technology is blossoming. Denmark, for example, with one of the highest standards of living in the world, honestly plans to be completely off domestic use of fossil fuels. Despite rapidly rising standards of living for a huge population, China has promised to start reducing emissions  by 2050. That is the equivalant of turning the Titanic aroud in half an hour. Pessimists think the Chinese are lying. They are ignoring the fact that the Chinese need to cut fossil fuels for health and political reasons,  and they are ignoring the fact that the Chinese  seem to be are on track to succeed.

The pessimists also assume that energy-dense stuff is the secret ingredient in a happy life. Philosophers have beens saying for centuries this is not true, but now science is showing that a smile from a friend does more for most people  than a new hat or a bag of chips. If you look at what people are spending money on, you discover that they are spending more and more on phoning friends, playing video games, listening to music, watching movies and TV. All  of these activities are information goods. Information goods are not like hammers. Once the first copy has been produced, it can be copied virually for free. In other words, consumption is expanding, quality of life improving and the energy needed to imporve the quality of life  is minimal.

Put it together and what have you got?  (that is a line from a song, by the way) You have NO convincing reason to think that cutting fossil fuels will reduce the qualtiy of your life. NO reason at all to be afraid of acting on climate chamge!

In fact, you should be expecting  a kind of hurricane of energy-reducing innovations that make your life better. It is those pessimists who are holding us back!

Part 2: What Most Economists Believe About the Financial Aspects of Climate Change

In a previous post I listed some numbers that convince most economists that burning all the proven carbon resources – coal, oil and natural gas owned by energy companies- is  very dangerous. Scientists have calculated that it might be safe to burn up to 20% of the known carbon stock . Economists as professionals accept the scientific view that to burn all the fossil fuels that energy companies have on their books will result in atmospheric carbon dioxide level far above the levels thought to be reasonably safe.

The fossil fuel stocks still in the ground currently count as wealth. A large part of this wealth appears as the value of shares of companies on the world stock markets. The value of many stock portfolios therefore depends on right to burn the known stocks and to add 2,795 gigatons of carbon to the atmosphere. John Fullerton is a former managing director at JP Morgan who now runs the Capital Institute. He calculates that at today’s market value, the carbon resources are worth about $27 trillion.

But carbon stocks are not  not wealth if they cannot be burned. If the fossil fuel companies were forced to leave 80 percent of their carbon underground, they would have to write off  $20 trillion in assets. Economists who have considered the question realize that, if carbon emissions are sharply reduced, energy companies will suffer huge write-downs, stock values will fall, and companies and pension funds that own carbon stocks will take a serious hit.
A possible outcome of a sharp reduction in paper wealth like this is a world-wide recession. A stock market crash contributed to the Great Depression. A massive writedown of the value of the American housing stock precipitated the worst financial crisis since 1929, and brought on a world wide recession. Most economists certainly believe that that a write-down of carbon assets on this scale could cause a financial crisis.

On the other hand there is no way to say whether most economists believe that a write-down really would cause a financial crisis. Even if it did, only some economists believe that financial crises cause depressions and recessions. The link between financial markets and the “real” economy is not very tight. The stock market often goes down when employment increases, for example. Employment can increase when the stock market is falling.

Whether or not the write-down causes a depression, it would certainly shift the distribution of wealth. Carbon stocks are owned disproportionately by the wealthy. The wealthy will take a much larger hit than those living hand-to-mouth. They only suffer when the wealthy force governments to pay them for their losses, or when investment slows down and employment drops. Neither has to happen.
Most economists don’t believe that the owners of the carbon stocks will take their losses lying down. They will not accept a reduction in their wealth just to save the planet.  This follows from the way economist think about people.   We think economic incentives have  a much stronger effect than moral views in most cases. We don’t believe strongly in `”corporate social responsibility,” Very few  economists believe that carbon companies will energetically promote carbon reduction.

In fact, most economists assume that companies hire CEOs to maximize share value.  Energy companies pay CEOs millions to sell that carbon. Because economic theory says people tend to do what is in their economic interest, most economists can be easily convinced that these CEOs will spend a small amount of to reduce their losses. It seems likely that most economists believe a small amount of $20 trillion  is a lot of money. I  think it is fair to say most economists would predict that a lot of money will be spent on on pro-carbon propaganda.

This prediction is easy to check. Watch for oil companies like Enbridge buying expensive TV ads to convince Canadians that they are very nice people doing good things, and that therefore Canadians should help them keep selling carbon to China and the USA. If you don’t see any propaganda from oil companies, and if you don’t see oil billionaires in the USA supporting climate deniers, then perhaps economists don’t understand human nature.

If you do see this kind of  propaganda,  perhaps it is because there is $20 trillion at stake, and the war to save it has begun.

November 11, 2014

What Economists Think About Climate Change, Part 1

It is always a risky to talk about what other people think, but economics is a profession in which certain kinds of facts are accepted and certain ideas have been carefully worked out. It is fair to say they are accepted by the vast majority of people in the field. You don’t need to take a poll to say what an economist, as economist, believes about many issues. You need to know what economics tells them to believe.

I am a respectable economist trained in two of Canada’s best schools and with 30 years experience teaching and doing research. I have paid a lot of attention to what economists have to say about climate change. This essay is a summary for non-economists.

There is quite a lot to say, so I will be posting a series, starting with what we believe about climate change itself, then going on in later blogs to
– What Most Economists Believe About the Financial Aspects of Climate Change,
– What Economists Believe about the Costs and Benefits of Climate Change,
– What Economists Believe About What We Can Do About Climate Change, and
– What Economists Believe About the Economic Tools We Can Use to Respond to Climate Change.

WHAT ECONOMISTS BELIEVE ABOUT THE CLIMATE

To start with, most economists believe that climate change is real. In fact I am sure most economists believe anthopogenic climate change is real.

How can I say most economists believe in anthropogeneic warming? Because economists are professionals and they have learned to trust other professionals. Economists don’t take out each other’s tonsils, and they don’t look to other economists to learn about the effect of methane release in the Arctic Ocean. Economists have some scientific training and are willing to trust the vast majority of climate and atmospheric scientists on this issue.

Economists understand the limitations of their own training. They know that an economist talking about climate change has no special expertise about climate change itself, how it works, how fast it is happening, or what it will do to the earth. Their specialization is in how economies work and how people respond to economic incentives.

Economists are not alone in respecting the scientific consensus. The CIA, in its 1014 Quadrennial Defence Review writes “Climate change poses another significant challenge for the United States and the world at large. As greenhouse gas emissions increase, sea level sare rising, average global temperatures are increasing, and severe weather patterns are accelerating.”

The business press, which relies heavily on economists, treats anthropogenic climate change as established fact as well. The highly respected Economist Magazine, for example, in September 20th 2014 ran a piece titled “Curbing climate change: The deepest cuts: Our guide to the actions that have done the most to slow global warming.” In Canada the Globe and Mail and the Globe’s Report of Business take for granted the role of human carbon emissions in causing dangerous warming. It is worth noting that the business press is quite distinct from the economics profession, although and has a much wider influence on people interested in economic affairs. In general business and the CIA) look to economists, not for facts about climate change but insight into how climate change will affect the economy and how economic policies can reduce the danger from climate change.

DO WE BELIEVE IN THE CLIMATE CLIFF?
Most economists believe the climate scientists when they say that there is a level of warming – probably around 2 degrees centigrade – after which the risks to ecosystems, species, food supply, and human populations probably increase a lot. This is also not economics, so economists as a rule defer to The experts, As a result, most economists believe that we can’t keep burning carbon at the rate we have been without endangering major ecological systems.

More specifically, most economists believe that we will not be able to burn all the carbon that the carbon companies have listed as assets on their books. Economists tend to be convinced by clear quantitative explanations based on easily verified facts. One of the most convincing and accessible versions is in Bill McKibben’s July 2012 Rolling Stone article, Global Warming’s Terrifying New Math. McKibbon summed up the matter with three numbers that most economists would find convincing.

1. The First Number: 2 Celsius, from the Copenhagen climate conference in 2009 

The 2009 Copenhagen accord formally recognized ”the scientific view that the increase in global temperature should be below two

degrees Celsius.” And in the very next paragraph, it declared that ”we agree that deep cuts in global emissions are required… so
as to hold the increase in global temperature below two degrees Celsius.” (NASA scientist James Hansen, the planet’s most prominent climatologist, thinks this number is too large: ”The target that has been talked about in international negotiations for two degrees of warming is actually a prescription for long-term disaster.”)

2. The Second Number: 565 Gigatons

Scientists have calculated that humans can pour roughly 565 more gigatons of carbon dioxide into the atmosphere by midcentury and still have some reasonable hope of staying below two degrees. At the 2012 emission rate of 34.5 billion tonnes per year we’ll have used up the 565-gigaton allowance by 2030.

3. The Third Number: 2,795 Gigatons

The number describes the amount of carbon already contained in the proven coal and oil and gas reserves of the fossil-fuel companies, and the countries. In short, it’s the fossil fuel we’re currently planning to burn. And the key point is that this new number 2,795 is higher than 565. Five times higher.

Economists like to use what we call “back-of-the-envelope” calculations to check whether the answer to a question is a clear ‘yes,’ a clear ‘no,’ or close to the line. What these numbers show is that there really is a huge oversupply of carbon. The numbers tell us clearly that
– No we can’t burn it all.
– Yes that means some of the carbon will have to stay in the ground.
– No, the carbon companies will not like that conclusion. Nor will shareholders, who will discover that part of the wealth they hold in energy companies is actually imaginary.

This has financial implications for the global economy. I will talk about them in the next post.