How to thrash an economist

While the rest of us are ringing in the new, some folks would like to ring out old-fashioned environmental economics.

First, some background. Power plants burn fossil fuels, emitting carbon dioxide into the air that raises global temperatures and vexes the climate.  How can we cut carbon emissions that cause global warming? 

Economists recommend two policies. One is to issue a fixed supply of permits to pollute, which firms could buy and sell among themselves. Firms that could avoid polluting cheaply would sell their permits at profit to firms that couldn’t.  This would ensure that we cut pollution by the desired amount as cheaply as possible. For example, power plants with the latest technology for injecting carbon into the ground would sell their pollution permits and opt for injection. The permits would be bought by utilities without this technology – plants that could cut emissions only at great cost; for example, by burning expensive natural gas rather than cheap coal. The idea is that if, as a practical matter, we have to have a little pollution, then we might as well get it from firms that would have found it prohibitively costly to clean up. This will save jobs.  (And this, by the way, is of moment to Kazakhstan, which not only exports oil but burns coal for its own electricity.)  

The second tool is a tax on each ton of carbon released into the atmosphere. If the government believes that carbon is damaging, then it will set the tax high. This will compel emitters to take into account the environmental costs of their pollution. The end result is much the same as the one for permits: Power plants that can inject carbon into the ground cheaply will do so rather than pay a tax of, say, $50 per carbon ton. Once again, we get cleanup at a bargain-basement price.

But a prominent American journalist, Justin Gillis, is skeptical of the carbon tax. “...A carbon price is no magic bullet,” he writes. “One of the biggest climate problems is poorly constructed buildings that waste energy. A carbon price will not solve that problem, for the elementary reason that the people who put up the buildings, and have an economic motive to skimp on insulation and windows, are not the people who wind up paying the energy bills.”

Actually, they are. Occupants of the energy-wasting building must pay a hefty carbon tax, so they will pay little to rent this building rather than an efficient one. The fall in rent will come out of the pockets of the developer (who presumably owns the land) and the builders.

The power parable

For example, suppose that the utility providing electricity to the inefficient building WasteCity pays a monthly carbon tax of $100 because it burns coal.  The utility will pass on this tax to the occupant of WasteCity.  She will move to the solar-powered building WasteNot unless the owner and builder of WasteCity cuts her monthly rent by $100.   

But carbon taxes do pose a problem.  Evidence is rapidly piling up that we have underestimated the costs of global warming. Since the tax rate is based on past estimates of the environmental cost, polluters may face too low of a tax and thus emit too much. So we should ditch carbon-price schemes, no?

No. We can use the permit rather than the tax. If we think that environmental costs will keep rising at an unexpected rate, then we can limit the amount of pollution by printing only a few permits. Yes, we could have raised the carbon tax instead; but given all the uncertainty about the consequences of global warming, it is hard to anticipate the tax rate that would give us the right amount of cleanup. If we set a $100 tax, we don’t know how many carbon tons we will get; but we do know if we print permits for only a thousand tons. As a safety measure, nothing beats a cap on permits. –Leon Taylor tayloralmaty@gmail.com

Good reading

William Baumol and Wallace Oates. The theory of environmental policy. Second edition. Cambridge University. 1988.

Justin Gillis. Forget the carbon tax for now.  The New York Times. December 27, 2018.   

       

Belyanin on why nations fail

https://notes-from-the-golden-horde.blogspot.com/2018/12/a-review-of-why-nations-fail-origins-of.html.

Getting it right

United States President Donald Trump is not the only purveyor of confusion. The editorial page editor of the Washington Post, Fred Hiatt, writes: “How does the United States counter [China’s record of development]? One comparative advantage, historically, has been the depth and quality of America’s alliances. A visiting American once chided a Chinese leader for his country’s liaisons with unsavory regimes. ‘What do you expect?’ the leader replied. ‘You’ve taken all the good ones.’”

Hiatt is in the wrong ballpark. “Comparative advantage” is the economist’s term for the value of trading the good that you can produce most cheaply, in exchange for goods that you would find more costly to make.

A ridiculous example may help. Suppose that a worker in the US could produce either six cars or two barrels of oil in one day. In Kazakhstan, which has fewer machines than does America, a worker can provide either one barrel or one car in a day. Who should produce what?

One is tempted to say that the US should provide both cars and oil for itself, since its labor force is so much more productive than Kazakhstan’s in both industries. But there are times when one should resist temptation. In reality, the US would gain from trade.

Check out the table below. Suppose that the US extracts a barrel of oil for itself. Then it will have to give up three cars, since its worker could have manufactured them in the time that it took her to produce a barrel of oil instead.  The US would do better to make two cars and sell them to Kazakhstan in exchange for one barrel of oil. The cost to America of trading for the barrel is only two cars; had it produced the oil for itself, it would have had to give up three cars.

	US	Kazakhstan
Cars	6	1
Oil barrels	2	1

Table: Output per labor day in two countries

But is Kazakhstan willing to trade? Consider its situation. If it produces two cars for itself, it will have to forego two barrels of oil. So it would be willing to sell one barrel to the US in exchange for two cars: Losing one barrel is better than losing two.

In short, the US should produce cars and Kazakhstan oil; each should then trade for the other good. The reason is that the US can produce a car more cheaply than Kazakhstan can: the cost for the US is a third of a barrel of oil, whereas it’s a whole barrel for Kazakhstan. The US has a comparative advantage in cars. Similarly, Kazakhstan has a comparative advantage in oil: One barrel costs it only one car but costs the US three cars.

It’s not clear what Hiatt means by “comparative advantage.” He seems to say that a nation should ally with the US rather than with China because the former has a record of forming better alliances than the latter has. This may be closer to what Michael Porter calls a “competitive advantage.” 

-- Leon Taylor tayloralmaty@gmail.com

Reference

Fred Hiatt. Trump’s unilateral disarmament. Washington Post. December 3, 2018.