Center for Business & Public Policy
Collaborative blog exploring the relationship between market forces and public policy.

Bloomberg recently published a series of articles criticizing the United States crop insurance program. Given my own interest in insurance generally and crop insurance specifically, I wanted to address some of the claims made by the articles.

There is no doubt that the federal crop insurance program is very flawed, with the largest flaw, by far, being the insane premium subsidies. Farmers currently pay less than half of their premiums, on average, with the rest being covered by the government. Moreover, between 1990 and 2009, Congress has routinely passed additional legislation giving special payments to farmers who suffered crop losses due to disasters.

However, there two features of crop insurance that Bloomberg portrayed as negatives but that are actually positive. First, one article quotes an “uneasy” beneficiary as saying, “I like to think of myself as an independent who’s willing to take risk. [...] With insurance, it takes the risk out of it.” This is actually a good thing from society’s point of view. No one goes around saying, “Man, things are just not fun anymore now that I have health insurance. If I fall down and break my leg, I no longer have to spend thousands of dollars.” The notion that farming should remain risky is simply misguided (of course, farmers are free to forgo insurance if they wish).

Second, the fact that “more than seven in 10 policies guarantee income rather than yield” is actually a good thing from an insurance point of view. Farmers care about their income rather than just about how much corn they have. They face both the risk that their yields will be low and the risk that prices will be low. Considering the two in combination rather than focusing on yields alone is preferable from the point of view of risk reduction.

So the real problem with crop insurance is not that it takes the risk out of farming, but that it is heavily subsidized by the government and supplemented with extra disaster payments. The subsidies have previously been justified by the adverse selection that would result if premiums were not subsidized. However, a much cheaper way to deal with adverse selection is to mandate that every farmer buy insurance. There are probably better things to do with taxpayer money (for example, see this recent National Review article).

Recent debate at the state and national level has focused on whether to enact a climate policy to control greenhouse gas emissions such as carbon dioxide.  The fact is, however, that we already have policies that affect such emissions, whether we like it or not.  Such policies can be coordinated and rational, or they can be piecemeal, inconsistent, and counter-productive.  Almost any policy designed to improve energy security, for example, would likely affect oil prices and energy efficiency, just as any policy to encourage alternative fuels would also affect energy security, electricity prices, consumer welfare, and health!  Here is a guide for thinking about how some of these policies work, and which combinations might work better than others.

The most obvious existing policy that affects carbon dioxide emissions is the gasoline tax that applies both at state and federal levels.  If that tax encourages less driving and more fuel-efficient cars, then it also impacts urban smog and global warming as well as protecting us from the whims of oil-rich nations with unstable governments.   In fact, with respect to the price at the pump, a tax on emissions would look a lot like a tax on gasoline, and vice versa.  Averaged over all state and federal taxes, the U.S. gasoline tax is about $0.39 per gallon, far less than around the rest of the world.  Most countries in the OECD have a tax over $2/gallon.

For the most part, the U.S. has chosen to avoid tax approaches to energy and environmental policy and instead uses various mandates, standards, and subsidies.   Cars sold in the U.S. are required to meet emission-per-mile standards for most local and regional pollutants like fine particles, sulfur dioxide (SO₂), nitrous oxides (NO_X), and volatile organic compounds (VOC) that contribute to ozone smog.  Those rules make cars more expensive but have successfully cleaned the air in major cities and around the country.  They also have the side effect of reducing greenhouse gases.  Another mandate is the “Corporate Average Fuel Economy” (CAFE) standards that require each auto manufacturing company to meet a minimum for the average miles-per-gallon of their fleet of cars sold each year.  For each big gas-guzzler they sell, the company needs to sell more small fuel-efficient cars to bring the average back down.  To meet this standard, every car company must raise the price of their gas guzzlers (to sell fewer of them) and reduce the price of their small fuel-efficient cars (to sell more of them).  The effect is the same as having a tax on big cars and subsidy on small cars.

These energy and environmental policies are also intricately related to other tax policies, as well as government spending!  For any chosen size of government and overall tax bite, any dollar not collected in gasoline tax is another dollar that must instead be collected from payroll taxes, income taxes, corporate profits tax, or state and local sales tax.  When looked at through that lens, gasoline taxes may not be that bad – or at least not as bad as some of those other taxes we must pay instead. 

Every state and local government is also worried about the pricing of electricity by huge electric companies that might naturally have monopoly power over their customers.  Production efficiency requires a large plant, so a small remote town might be served only by one power company (with no competition from neighbors far away, since too much power is lost during transmission).  So the public utility wants to regulate electricity prices, perhaps with block pricing that helps ensure adequate provision to low-income families.   Yet the pricing of electricity inevitably affects electricity use, which affects coal use, urban smog, and greenhouse gas emissions.  These policies are intricately related.

And these policies are related to government spending, since they affect car and gasoline purchases and therefore required spending on roads and highways as well as train tracks and mass transit in cities.  These environmental and energy policies affect human health, and therefore health spending by government – as necessary to pay for additional illness caused by emissions from cars, power plants, and heat from burning fossil fuel. 

We have no way to avoid these inter-connections.  You are a consumer who wants lower gas taxes and electricity prices, but you also own part of the power company and auto manufacturers through your mutual fund or pension plan.  You pay other taxes on income and purchases, and you breathe the air, so you are affected by emissions and need health care.  We might as well think holistically and act for the good of everybody, because we are everybody!

The recent weather extremes over much of the US have created a flood of articles about the link between these heat waves and climate change. Here is one example. For other examples, just go to Google news and search for “heat wave climate change”. Or you can just keep reading this blog post.

Are these recent events being caused by climate change? The answer is “maybe”. Certainly, climate change is predicted to increase the number of heat waves. But attributing a particular event to climate change is very difficult, even when the event is as extreme as the heat waves of the last two weeks. Of course, if such events are more likely under the “climate change” scenario than under the “no climate change” scenario, we should reasonably think that climate change is more likely than not. But because such heat waves are possible during the “no climate change” scenario as well, we cannot rule out that these temperatures would have occurred even if climate change were not a possibility. So all we can do is make statements like, “There’s an 80% chance that the heat wave was due to climate change, and a 20% chance that it was part of natural fluctuations.” (like this guy).

What should we do in light of this uncertainty? Pay attention to the science and the scientists rather than the weather fluctuations. 97% of scientists agree that climate change is real and caused by humans (see this paper for details). Given the high degree of consensus and the time it takes to for carbon dioxide to dissipate in the atmosphere, we shouldn’t wait until we’re sure that we’re experiencing the predicted effects of climate change firsthand. As evidenced by the deaths and misery in the past weeks (see this article for more), extreme weather still has the power to kill, even in developed nations. Trying to figure out a cost-effective way to address climate change is what we should focus our efforts on (more on that in a later post).

In 2010, U.S. researchers conducted experiments on 1,134,693 animals – including 71,317 nonhuman primates – according to U.S. Department of Agriculture data collected in compliance with the Animal Welfare Act (source).  Almost 100,000 of those animals were subjected to experiments in which researchers intentionally inflicted pain and did not administer pain relief.  These data exclude experiments conducted on birds, mice, and rats because they do not fall under the definition of “animal” used in the AWA (source), and thus the real number of animals under experimentation in the U.S. could be in the tens of millions per year.

What, if anything, does society gain from these experiments on animals?  The statistics say not much.

Many argue that animal experimentation is most useful in pharmaceutical research and vital to new drug development.  However, a Food and Drug Administration (FDA) study found that “92 out of every 100 drugs that successfully pass animal trials and go into human clinical testing fail during the human clinical trial phase (source/source).”   That is a lot of animal suffering for less than a 10% success rate on humans.

Question: What about the drugs that do not pass the animal testing and thus “save” humans from harm?  Answer: With such a dismal record of prediction in one direction (success on animals to success on humans), what makes us confident of our predictive powers in the other direction (failure on animals to failure on humans)?  Of course, we do not have statistics on this counterfactual and thus will never know.  Indeed, it is possible that the miracle cure for cancer in humans failed trials with mice and thus was not tested on humans.

It seems clear that pharmaceutical companies and the FDA are reluctant to drop animal testing for one important reason: liability.  They want to be able to say ‘look, we tried it on animals’ if something goes wrong in the human testing phase.  However, even after all that testing on animal, and then on humans, the FDA still has to recall from market hundreds and sometimes thousands of drugs per year (source).  Stop experimenting on animals now, it only causes suffering for them and humans do not see much benefit – if any at all.

Environmental Policy Update:  Many contributors on this blog have written about climate change policy.  With the Supreme Court’s health care ruling yesterday, I thought this piece of news might fall under the radar.  On Tuesday, a federal appeals court rejected multiple challenges to new U.S. Environmental Protection Agency (EPA) rules that would reduce greenhouse gas emissions at large sources, such as power plants and large factories.  Michael Gerrard, director of the Center for Climate Change Law at Columbia University, said the decision was exceeded in importance only by the Supreme Court ruling five years ago that greenhouse gases could be controlled as air pollutants (source).

In a previous post, I examined a United Nations report urging reductions in the consumption of animal-based foods in order to mitigate climate change and avoid world hunger (here).  The report states, “Unlike fossil fuels, it is difficult to look for alternatives: people have to eat. A substantial reduction of impacts [from agriculture] would only be possible with a substantial worldwide diet change, away from animal products.”  Luckily, the concern with finding “alternatives” to eating animals now is no longer a major issue, thanks to a new, plant-based meat alternative developed here in the United States.

Beyond Meat is a Maryland based company that invented a plant-based chicken alternative called Veggie Chicken Strips.  In taste tests, “people either don’t notice the difference [from animal-based chicken], or love it and request it again (source).”  The Strips are relatively healthy with 19 grams of protein, 3 grams of fiber, 25% of recommended daily iron, and only 1.5 grams of non-saturated fat per 100 calorie serving (about 3 ounces).  The secret for this close-to-perfect substitute is a patented processing technique that combines soy and pea protein into the plant-based chicken.  Plans are in the works for beef and pork alternatives too.

The plant-based meat revolution has already begun in Europe.  The extraordinary growth of a Dutch company called The Vegetarian Butcher lead The Independent to ask “Is this the end of meat?”  Opened in 2010, The Vegetarian Butcher’s products now sell in 180 Netherlands outlets, with 500 more outlets coming this Summer and plans for international distribution soon.  Again, their vast array of plant-based meat fools the traditional animal eater.  In a taste test outside one of the Butcher’s shops, not one person guessed the smoke “mackerel” was not fish.

So the “alternative” to eating animals does exist.  The taste and texture of these plant-based meats are the same as the animal-based meats, but without the animal cruelty or environmental degradation.

Putting aside animal rights and the environment, the development of plant-based meat substitutes can help the average household as well.  Prices in the United States for animal-based meat will likely keep increasing as world-wide demand continues to rise (source), and Americans are already feeling the pinch as per capita animal consumption has fallen for 4 consecutive years, a trend expected to continue in 2012 (source). Meanwhile prices for these new, plant-based meats will fall as production increases and techniques are mastered.  These economic trends will lead to increases in plant-based meat consumption by non-vegetarians, but don’t worry, it’s a perfect substitute!

My own research area is environmental and natural resource economics, which others often call “sustainability”.  That’s actually embarrassing, because I don’t know what it means.  For a renewable resource like timber, it seems pretty easy:  you just plant trees, let them grow, cut them down, and then plant trees again.  For a nonrenewable resource like oil, it’s impossible: once a barrel of oil is consumed, it’s gone forever.  The only way to make oil “sustainable” is not to use it, which does not make any sense, because oil has no value at all if it can’t be used.

So, sustainability is either obvious or impossible.  The concept seems to be of no use whatever.  So I turn to people smarter than me, to get some answers.  By “smarter than me”, in this case, I mean (1.) Nobel-Prize winning economist Robert Solow, and (2.) whoever writes for Wikipedia.

Way back in 1991, Robert Solow wrote “Sustainability: An Economist’s Perspective”, in which he says:  “It is very hard to be against sustainability. In fact, the less you know about it, the better it sounds.”   He says he has seen various definitions, but they all turn out to be vague.  So his essay is an attempt to make it more precise.  “Pretty clearly the notion of sustainability is about … a moral obligation that we are supposed to have for future generations.”   But you can’t be morally obligated to do something that is not feasible!  He notes UNESCO’s definition:  “… every generation should leave water, air, and soil resources as pure and unpolluted as when it came on earth.”   But taken literally, that injunction “would mean to make no use of mineral resources; it would mean to do no permanent construction, … build no roads, build no dams, build no piers.”  That is neither feasible nor desirable!

Instead, he suggests that sustainability might be both feasible and desirable if it is defined as “an obligation to conduct ourselves so that we leave to the future the option or the capacity to be as well off as we are.”   In the final analysis, what that means is that we don’t necessarily have to leave all the oil in the ground, if we leave something else of equal or greater value, some other investment that can be used by future generations to produce and consume as we do, and which they can leave to other generations after them.  It is a holistic concept, both simple and operational.  We only need to add the value of all assets, subtract all liabilities, and make sure that the net wealth we bequeath is not less than we inherited. 

We can use oil, but we should not simultaneously be running huge government budget deficits that reduce the net wealth left to our children and their children.  The measure of “net wealth” should include the value of ecosystems, fresh water supplies, biodiversity, and oil, as well as productive farmland, infrastructure, machinery, and other productive assets.   All those values are extremely difficult to measure, but at least the concept is clear.

Has that message been adopted since 1991?  It certainly does not seem to be part of the thinking of the U.S. Congress and the rest of our political system.   What are they using for guidance?

Wikipedia says  “Sustainability is the capacity to endure. For humans, sustainability is the long-term maintenance of responsibility, which has environmental, economic, and social dimensions, and encompasses the concept of stewardship, the responsible management of resource use.”  Okay, well, that’s still pretty vague, by Solow’s standards.  Let’s see if they make it more specific: “In ecology, sustainability describes how biological systems remain diverse and productive over time, a necessary precondition for the well-being of humans and other organisms. Long-lived and healthy wetlands and forests are examples of sustainable biological systems.”

I’m sorry, that kind of specificity does not make it more operational.   They haven’t read Solow.  In fact, the whole entry seems to read like it is intended to maximize the number of times it can link to other Wikipedia entries!

“Moving towards sustainability is also a social challenge that entails, among other factors, international and national law, urban planning and transport, local and individual lifestyles and ethical consumerism. Ways of living more sustainably can take many forms from controlling living conditions (e.g., ecovillages, eco-municipalities and sustainable cities), to reappraising work practices (e.g., using permaculture, green building, sustainable agriculture), or developing new technologies that reduce the consumption of resources.”

Actually, the only phrase in the whole entry that really struck me was “more sustainably.”  Now, I REALLY do not know that THAT means.  Our current trajectory is either sustainable, or it’s not!  If future generations can live forever, how can they live longer than that?  And if not, well, …

What is that, a gastrointestinal disorder?   No, it’s the title of one of my recent research papers  (joint with Dan Karney and Kathy Baylis) about unilateral efforts to reduce emissions of greenhouse gases (GHG).   When worldwide agreement is not possible, then the question is whether GHG abatement policy might be implemented by only one country, or bloc of countries (or region or sector).   The fear of any one country or bloc is that they would only raise their own cost of production, make themselves less competitive, and lose business to firms in other countries that may increase production and emissions.  When only one country limits their emissions, any positive effect on emissions elsewhere is called “leakage”.

Yes, that’s a word in economics, see http://en.wikipedia.org/wiki/Leakage .

In efforts to “abate” or to reduce GHG emissions, the fear of lost business has pretty much deterred any attempt at unilateral climate policy.  That positive leakage might be called a “terms of trade effect” (TTE), because unilateral policy raises the price of exports and reduces the price of imports.   But our recent research paper points out a major effect that could offset part of that positive leakage.  The “negative leakage” term in the equation might be called an “abatement resource effect” (ARE).   That is, one additional thing happening is that the domestic firms face higher costs of their emissions, and so they want to substitute away from GHG emissions and instead use other resources for abatement – such as windmills, solar cells, energy efficient machinery, hybrids, electric cars, and even “carbon capture and sequestration” (CCS).  Thus they have at least SOME incentive to draw resources AWAY from other sectors or other countries.  If that effect is large, the result might shrink those other sectors’ operations overall, and thus possibly SHRINK emissions elsewhere.

I don’t mean to oversell this idea, because it probably does not completely offset the usual  positive “terms of trade effect”.  But in some circumstances it COULD be large, and it COULD result in net negative leakage.  The best example is probably to think about a tax or permit price for carbon emissions only in the electricity generating sector, within one country.  For simplicity, suppose there’s no trade with any other countries, so the only choice for consumers in this country is how much to spend on “electricity” and how much to spend on “all other goods”.   Demand for electricity is usually thought to be inelastic, which means consumers buy almost the same amount even as the price rises.  If firms need to produce almost as much electricity, while substantially reducing their GHG emissions, they must invest a lot of labor AND capital into windmills, solar panels, and CCS.  With any given total number of workers and investment dollars in the economy, then fewer resources are used to produce “all other goods”.

The ability of consumers to substitute between the two goods (electricity vs “all other”) is called the “elasticity of substitution in utility.”  The ability of firms to substitute between GHG emissions and those OTHER inputs is called the “elasticity of substitution in production”.  If the former is bigger than the latter, then net leakage is positive.  If the latter is bigger than the former, then net leakage can be negative.

Okay, too technical.  But the point is that other researchers have missed this “abatement resource effect” and overstated the likely positive effect on leakage.  And that omission has led to overstated fears about the bad effects of unilateral carbon policy.  What we show is that those fears are overstated, in some cases, where leakage may not be that bad.  With some concentration on those favorable cases, one country might be able to undertake some good for the world without fear that they just lose business to other sectors.

Many advocates of small government have many ideas for how to move activities out of the public sector and into the private sector.  Social Security can be privatized, using fully-funded private retirement investment accounts.  Education can be privatized, with vouchers that can be used by parents to choose the best private school or charter school.  All could save money for the federal budget, by taking advantage of the more efficient operations of the private sector.

In this blog, I’ll describe my new idea for privatization.  Why not privatize the military!  Many rich Republicans want more military spending, and I can imagine that they might well be willing to pay for it.   Why not let them?  Now, they are probably not willing to simply donate money to the federal government, with no recognition, nor any private return on their investment.  But, we could provide the same kind of naming rights as many private operations: FedEx Field is the home of the Washington Redskins, because FedEx paid for the naming rights and they get PR advantages of doing so.  The name of the business school at the University of Texas is the “McCombs School of business”, because Red McCombs paid for the naming rights, and he gets PR advantages of doing so.  The J. Paul Getty Museum is the name of a major art museum in Los Angeles, presumably because somebody in the Getty family or foundation paid for the naming rights and gets PR advantages of doing so.

So, the idea is to write the name of any major donor on any piece of military equipment for which that donor covers at least half the cost.  Pay for half a tank, and it will be the “Your Name Here” Army Battle Tank, with the name engraved on the equipment.  You can even visit it, at certain times of year under certain conditions, and have your picture taken with it.  If you are willing to pay a little more, half the cost of a cruise missile, you can have your name on that instead.

Now I’m not suggesting that the donor ought to be allowed to decide when to push the button.  Nor even make any decisions at all.  The payment is just to help out the U.S. Federal Budget deficit, with recognition for doing so.  I’d bet that a good number of millionaires would really be willing to pay, for that kind of prestige.  It might even be greater recognition if the missile were actually used!  The well-heeled U.S. businessman might even get more U.S. business activity, after the newspaper announces that the “Your Name Here” cruise missile was launched at Tehran, killing 137 innocent civilians, but successfully deterring the Iranian government from pursuing a nuclear weapon that might kill even more.

Politicians like to say they want the U.S. to produce at least as much energy as it consumes – “energy independence”.  And they certainly want to reassure consumers that they are doing something about the high price of gasoline.  But the two goals are inconsistent.  You can’t have both.  Indeed, the current high price of oil is exactly what is now REDUCING our dependence on foreign oil!

We all know the price of gasoline has been increasing lately, now well over $4 per gallon in some locations.  Five-dollar gas is predicted by Summer.  In addition, the New York Times just reported that our dependence on foreign oil is falling.  “In 2011, the country imported just 45 percent of the liquid fuels it used, down from a record high of 60 percent in 2005.”  The article points out that this strong new trend is based BOTH on the increase of U.S. production of oil AND on the decreased U.S. consumption of it.  And both of those factors are based on the recent increases in oil and gasoline prices.  Those higher prices are enough to induce producers to revisit old oil wells and to use new more-expensive technology to extract more oil from those same wells.  The higher prices also are enough to induce consumers to conserve.  Purchases of large cars and SUVs are down.  Many people are driving less, even in their existing cars.  A different article on the same day’s New York Times, on the same front page, also reports that “many young consumers today just do not care that much about cars.”

Decreased dependence on foreign oil does sound like good news.   Actually, it is good for a number of reasons. (1)  It is good for business in oil-producing states, helping raise them out of the current economic slow-growth period.  (2) It is good for national energy security, not to have to depend on unstable governments around the rest of the world.  (3)  It reduces the overall U.S. trade deficit, of which the net import of oil was a big component.  And (4) the reduced consumption of gasoline is good for the environment. 

On the other hand, the increased U.S. production of oil is not good for the environment, as discussed in the same newspaper article just mentioned.   As an aside, I would prefer to do more to decrease U.S. consumption of oil – not only from increased fuel efficiency but also by the use of alternative non-fossil fuels – and perhaps less from increased U.S. production of oil from dirty sources such as shale or tar sands.  But that’s not the point for the moment.

The point for the moment is just that maybe the higher price of gasoline is a GOOD thing!  We can’t take even small steps toward decreasing U.S. dependence on foreign oil UNLESS oil and gas prices rise.  Any politician who tells you otherwise is pandering for your vote.  It is the high price of oil that is both increasing U.S. production and decreasing U.S. Consumption.

A recent NY Times has an article about SOL Austin, an acronym for Solutions Oriented Living.  This housing development is interesting for at least two reasons.  First, the designs and materials are intended to be “sustainable” (whatever that means), but also “net zero” (which I gather means that it will produce all the energy consumed).  The houses have solar panels and geothermal wells.

Second, however, it is interesting because it is in east Austin, the low-income part of town.  In fact, a 1928 “city plan” decided that east Austin would be “designated African-American”.  The 1962 construction of Interstate I-35 further divided east from west.  The relatively flat east side of Austin had all the industrial blight, pollution, and low-income housing.  In fact, it was quite cheap!  The hilly west side of Austin had the fancy new upscale houses with views of the Hill Country.

One would think that the intellectual-academic, left-leaning, high-income households of west Austin might be more interested in sustainable housing that could go “off the grid.”  Why then are these developers building super-energy-efficient houses in east Austin?

Well, for one thing, the 2010 census showed a 40% increase in east Austin’s white population and a drop in minority population.  In correlated fashion, land prices in east Austin have risen considerably.  In fact, a different article in the NY Times tells about a study based on the 2010 census finding that all residential segregation in U.S. cities has fallen significantly.  Cities are more racially integrated than at any time since 1910.  It finds that all-white enclaves “are effectively extinct”.  Black urban ghettos are shrinking. “An influx of immigrants and the gentrification of black neighborhoods contributed to the change, the study said, but suburbanization by blacks was even more instrumental.”

Since I’m visiting here in Austin, Texas, it is easy enough to go see the new development.  As you can see in the snapshot below, the houses have a modern box-like style.  They range from 1,000 to 1,800 square feet.  That explains the article’s reference to “matchbox” houses.    But the roofs are sloped enough to hold photovoltaic arrays and to channel rainwater into barrels.  

The developers said they wanted to “examine sustainability on a more holistic level, that would not just look at green buildings, but in our interest in affordability, in the economic and social components of sustainability as well.”  As stated in the NY Times article, the developers “hammered out a plan with … the nonprofit Guadalupe Neighborhood Development Corporation, to sell 16 of the 40 homes to the organization.  The group, in turn, sold eight of the houses at a subsidized rate to low-income buyers (who typically were able to buy a house valued at more than $200,000 for half price).”  Each of those 16 subsidized homes has a photovoltaic array on the roof, though not necessarily large enough to produce all of the needed power for the house.

Of the “market-rate” houses, all sold at prices in the low $200,000’s.  Eleven have been sold, and thirteen have yet to be built.  Because of the financial and housing crisis, however, the “holistic” development ideas have not worked perfectly.  Homeowners got rebates from Austin Energy and tax credits from the federal government. So far, however, only four market-rate house owners paid the extra $24,000 for photovoltaic arrays substantial enough to fully power a house.  Only one is also heated and cooled by a geothermal well.  But they all have thermally efficient windows, foam insulation, and Energy Star appliances.

So far, only one couple paid to install the geothermal well and the extra energy monitoring system:  a systems engineer and a microbiologist.  So, “sustainability” in low-income neighborhoods might still require some gentrification.