Going it alone on climate legislation

Filed Under (Environmental Policy) by Kathy Baylis on Sep 20, 2010

On November 2, California will vote on proposition 23 that postpones the move to a cap and trade system for greenhouse gas emissions until four consecutive quarters of an unemployment rate of 5.5, a condition that, according to a recent NYT article  has only been met 3 times over the past 40 years.  This proposition would essentially kill the 2006 California legislation that mandated the state to reduce emissions to 1990 levels by 2020. 

Opponents to the legislation argue that the legislation raises costs for California businesses, potentially driving firms across the state line while  California will not be able to capture much of the benefit of greenhouse gas reduction.  In economics terms, we might well be concerned about so- called leakage, where environmental regulation in one area just pushes the polluting activity next door.  An energy producer required to pay for carbon-dioxide generated from a power plant within California might just transfer some of that production capacity to plants outside of the state, both reducing jobs in California while having no effect on emissions.  Add to this the fact that because climate change is a global problem, most of the environmental benefits of any hard-fought-for emissions reductions will go to regions outside of California, raising the question as to why a jurisdiction would ever want to go it alone to reduce greenhouse gases.

So why go it alone?  Green jobs.  The opponents to proposition 23 note that the burgeoning green energy sector in  California is a source of jobs, with good potential for future employment growth as other jurisdictions move toward regulating emissions and import ready-made green technology from California providers.  In an op-ed article George Shultz, Reagan’s secretary of state compares California’s move on climate change legislation to the state’s earlier first mover experiments on clean air. “In the four years since California’s clean air standards were passed, clean energy investment has tripled. About three of every five venture capital dollars nationwide has been invested in California companies, with about $2.1 billion worth of clean energy investments in 2009 alone. “ Tom Friedman in the New York Times Sunday noted that China is making great strides in terms of encouraging green technology, at least in part as a jobs creation strategy. 

Demonstration Effect.  The real reason to make the first move is the hope that one can bring other jurisdictions on board by example.  If California can demonstrate that greenhouse gases can be reduced without large-scale job losses, it may make climate change legislation more appealing at the federal level.  Arguably, California’s tighter vehicle emissions helped the federal government impose stricter emissions regulations after auto manufacturers had already developed the technology and shown that it was possible to meet these higher emissions standard.  The Western Climate initiative is evidence that this demonstration effect may well be working.

What about leakage?  In a recent talk at the University of British Columbia, Stanford Economist Larry Goulder notes that policy options exist to mitigate against the leakage effect. The state could impose a form of border tax, or force utilities selling electricity to account for the emissions produced in the generation of that electricity regardless of where the generation occurs.  If these approaches ran up afoul of Interstate Commerce rules, California could tie the allocation of future permits to output of the good itself or the use of a input, implicitly subsidizing production.  Granting permits on the basis of using an input that substitutes for pollution in the production process may give firms an extra incentive to adopt pollution-reducing technologies.

Last, California is not really going it alone.  Along with multiple initiatives across U.S. states, two jurisdictions in Canada have bucked the tax cut trend and gone to the length of imposing an explicit carbon tax.  Quebec was the first North American jurisdiction to impose a carbon tax in 2007.  The tax itself is small (around $1.16 per ton of CO2) and limited to the use of hydrocarbons (petroleum, natural gas and coal).  A year later, British Columbia imposed a larger and broader-based carbon tax of around US$7.80 per ton of CO2, which is to increase to $23.50 by 2012.  Thus, despite the hold-up of legislation at the national level, other regions are pushing ahead with climate change legislation

One of the biggest arguments against national level climate change legislation has been that the United States or Canada needs to wait for a multilateral agreement before moving ahead. In short, that there is no advantage to unilateral action against this global environmental problem.  Other jurisdictions have argued with their feet that waiting for joint action is not the only solution.

Adverse Selection — California Style

Filed Under (Health Care) by Nolan Miller on Feb 9, 2010

News from the West Coast today that Anthem Blue Cross, one of the largest private insurers in California, is raising the prices for the 800,000 or so people it sells individual health insurance policies by up to 39%.  The Obama administration is not happy, to say the least.  HHS Secretary Kathleen Sebelius fired off an angry letter to Anthem and its parent company, WellPoint, demanding an explanation.  Of course, this also comes at a time when the Obama administration is struggling to make the case that health insurance reform is urgently needed, so this also provides a perfect example for them.  The letter is kind of cool, since I have never seen an angry letter from a Cabinet Secretary before.  The text is here.

What I find more interesting as an economist, however, is WellPoint’s response.  They haven’t replied formally to the letter yet, but in a statement WellPoint’s spokesman said the following:

“As medical costs increase across our member population, premium increases to the entire membership pool result. Unfortunately, in the weak economy many people who do not have health conditions are foregoing buying insurance. This leaves fewer people, often with significantly greater medical needs, in the insured pool. We regret the impact this has on our members.”

So, where’s the economics lesson here?  In a competitive market, health insurance prices are driven by the cost of caring for the average person in the insurance pool.  That means that healthy people usually pay more than their actual cost of care and sick people pay less.  Although healthy people pay more than their average health expenditures in any year, they’re still willing to buy insurance because it provides them with, well, insurance.  In the event that they have a car accident or other unexpected, large expenditure on health care, they’re protected against the financial consequences.  This works fine as long as the premium (driven by the average cost of care) doesn’t get too high above what the healthy people are willing to pay for insurance against relatively rare events.

Now, enter the recession.  People are losing their jobs, wages for the employed are stagnating, and people are losing money on housing and financial investments.  In light of these challenges, some healthy people are looking at their health insurance premiums, their income, and the likely cost of going without insurance, and deciding not to buy health insurance.

This is a perfectly rational response to increasing premiums and decreasing incomes.  However, it results in the remaining people in the insurance people being, on average, sicker.  This means that the average cost of caring for the insurance pool will be higher, which will necessitate higher premiums.

Unfortunately (and interestingly if you study this stuff), this leads to the potential for what is known as an “adverse selection death spiral.”  The idea is that once premiums rise, the healthiest people who are still buying insurance may decide to drop out of the pool.  Since the remaining pool is even less healthy on average, premiums will once again need to rise to cover their higher medical needs.  And then the cycle starts over again.  In extreme cases, the premium just keeps going up until nobody is willing to buy insurance.

So, what next?  Well, the adverse selection story holds in competitive markets.  But, you can already see Secretary Sebelius telegraphing the administration’s punches.  They will argue that the price increases are not due to competitive pressure and an increasingly unhealthy insurance pool but rather a greedy, for-profit insurer trying to take advantage of people when they’re down.  For their part, WellPoint/Anthem will argue that this just shows why health reform is needed, but health reform of a fundamentally different sort than Obama has proposed.

My prediction is that we’re headed for a highly charged series of Congressional hearings that boil down to an attempt to drive home to voters that something needs to be done.  Really went out on a limb, there, didn’t I?