Center for Business and Public Policy
at the University of Illinois, Urbana-Champaign

I would never ever want to be a macroeconomist charged with making economic predictions.  In fact, I’m sorry that anybody makes macroeconomic predictions, because they can’t always be right, and the fact that they turn out wrong gives all economists a bad name!   Yet I particularly like it when some non-economist friend of mine asks  “Do you think the economy is going to improve, or worsen?”  That just gives me a chance to respond, “YES!  That is, yes, I think the economy will improve or worsen.”

So I’m particularly reluctant to write any blog about the poor state of the macro-economy, what should be done about it, and when we are likely to see any turnaround.   But today’s article in the Washington Post is about macroeconomics and environmental policy!  It is called “Obama laments job losses, announces tax credits for clean energy”.   How are those connected to each other?   Only through rhetoric.

Basically, all of the points are valid, as presented by the article and even by the Obama Administration spokespersons.   The economy is bad, and we don’t know when it will improve.  We don’t even know what is the effect of last year’s stimulus bill, because we’ll never know what would have happened without the stimulus bill!  And it’s also true that we might need more stimulus.  And it is furthermore true (even if unrelated) that it might be a good idea to spend more money on green investments, to aid the transition away from burning fossil fuels that worsen global warming, and towards energy efficiency and alternative sources of energy such as solar power.

More specifically, the Washington Post article says:

“The unemployment rate was unchanged at 10 percent, the Labor Department said. Forecasters had expected zero net change in the number of jobs on U.S. payrolls, and some had had expected job growth to return. Those expectations were dashed by a report that — while not without bright spots — suggested that the long slog toward an improved labor market continued in December.”

That paragraph seems unrelated to the prior one:

“As part of an effort to ‘close the clean-energy gap,’ he announced the awarding of $2.3 billion in tax credits to American manufacturers of technologies such as wind turbines, solar panels and cutting-edge batteries. The credits — destined for 180 projects in 40 states — will generate 17,000 jobs and help leverage $5 billion in private-sector investment that would create tens of thousands of additional jobs, while doubling the amount of renewable power over the next three years, Obama said.  …  Since there are far more qualified applicants for the credits than the federal funding will cover, he said, he is calling for investment of an additional $5 billion in the program.”

Yet the Administration might as well link the two, at least to appear to be doing something, and to make headway on another important agenda item.  Just as stated by Obama’s Chief of Staff, Rahm Emanuel, “You never want a serious crisis to go to waste — and what I mean by that is an opportunity to do things that you think you could not do before”.  You can even listen to it on You-Tube, if you click here!

Speaking of “unrelated”, I have another link to suggest.  If you are interested in hearing about progress in Copenhagen toward international agreements on climate change, in the style of Dr. Seuss, click here!

Recently, somebody hacked into servers at the Climate Research Unit at East Anglia University, and they posted stolen emails on the internet.  From these emails, climate change skeptics claim to have proof that anthropogenic (i.e. man-made) climate change is not occurring.  With the climate summit in Copenhagen underway, some say that this  “climategate” scandal could derail the process.  Instead, I believe this situation allows us a moment to remember the facts regarding climate change.

To be clear, however, I am not writing to judge the contents of those emails sent between a small set of researchers using one method of analysis.

First, the Earth always has had a natural greenhouse effect that depends on CO2 and other “greenhouse gases”.  Without this natural process, the Earth would be unable to trap solar radiation and warm the surface.  Fortunately, so far, the Earth has had a stable carbon cycle that regulates the concentration of greenhouse gases in the atmosphere.  In contrast to Earth, Venus has a runaway greenhouse effect due to its lack of carbon cycle, resulting in a mean planet temperature of 461 degrees Celsius.

Second, the CO2 concentration in the Earth’s atmosphere is increasing.  Over the last 150 years, CO2 concentrations have risen from 280 to nearly 380 parts per million (ppm), and the concentrations are still increasing.  While the exact concentration is an empirical matter, the trend is clear.

Third, humans have been burning fossil fuels in large quantities since the industrial revolution.  Carbon dioxide is emitted by the burning of these fuels (coal, oil, wood, and natural gas).

Those three facts are not in dispute.

The only potential room for debate is the causal connections between human activities including those emissions, and the observed rise in CO2 concentrations.  Since climate scientists cannot perform an experiment to test the causal link, the conclusion that humans are causing climate change can never be proven in the same way as results in other branches of science.

However, many scientists using many different methods conclude that enough evidence exists to prove beyond a reasonable doubt that humans are causing climate change.   Moreover, this climate change is very dangerous and damaging.  It is predicted to disrupt agriculture around the world, change ecosystems in ways that endanger biodiversity, increase extreme weather events like hurricanes and droughts, and raise sea levels enough to cover several island nations, much of Florida, other U.S. coastal cities, and about half of the nation of Bangladesh.

Therefore, it is our responsibility to devise a reasonable strategy to limit the effects of climate change.  I don’t mean that the U.S. should or could do it all alone!  Perhaps a small step by the U.S. might encourage other nations to get on board.  The meeting in Copenhagen this month is another, hopefully productive, step in developing a global plan.

The situation in East Anglia should not distract from the facts.  We need to keep our eye on the prize.

A very Happy Thanksgiving to all of our readers out there!

In a recently completed article titled “The Allocation of Permits in U.S. Climate Change Legislation”, Daniel Karney and I analyze the allocation of permits for a cap-and-trade plan recently enacted by the U.S. House of Representatives.  (For an explanation of cap-and-trade, please see my previous post.)  We argue that freely allocating permits to firms on the basis of historic emission rates is unnecessary.  Instead, permit allocation should be focused on other goals, such as helping to cushion the financial impact of higher electricity prices on low-income households.

The figure below shows the percent of household expenditures on electricity for seven different income groups for two regions (Midwest and South).  The figure demonstrates two interesting trends.  First, low-income households spend a higher fraction of their income on electricity compared to high-income households.  Indeed, low-income households spend relatively more on almost all energy-intensive goods and services.  Second, Southern states spend a higher percentage on electricity at every income level (due to air-conditioning use in the summer).

Fossil fuels are used to generate most of the electricity in the United States; the cap-and-trade policy would raise the cost of carbon emissions and therefore would raise the price of electricity.  Thus, low-income households face a higher burden, regardless of region.

Electricity production in the Midwest mainly comes from coal-fired power plants, the heaviest emitters of CO2 pollution. In contrast, Southern states have a large portfolio of hydroelectric dams (see Tennessee Valley Authority) that emit no CO2 , and they have natural gas-fired power plants with low CO2 emissions.  A quick calculation reveals that in 2005, Midwest electricity generation uses twice the carbon dioxide per capita.

Thus, some argue that Southern states would not be affected by cap-and-trade as much as Midwestern states.  They further argue that the use of permit allocation or permit revenue to help low-income individuals should be directed to Midwestern states.  After all, households in that region would see a larger percentage increase in electricity prices.  Yet, because the logic of this allocation is based on historic emission rates, it is a form of grandfathering.  The proponents of such a policy are not taking into account an important technological change that alters the analysis.

The same legislation that enacts a cap-and-trade policy also funds the construction of a “smart” electricity grid.  With lower transmission barriers, electricity prices will converge across regions.  In turn, this means the carbon price impact in Midwestern states will spread to Southern states.  If permit allocations to help low-income families are based on historic emission rates, then Southern households are in much worse shape, because they spend approximately 1-2% more per year of household expenditures on electricity compared to Midwestern states.

In other words, grandfathering permits is generally a bad idea, and this example is just one example of what can go wrong.