How Much Should Congress Leave to the Regulators?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Feb 11, 2011

The very existence of the Environmental Protection Agency (EPA) has long been a point of contention between the two political parties.  What is, and what ought to be the role of the EPA with regard to policy making?  Congress cannot possibly enact laws that contain every detail about subsequent implementation, monitoring, and enforcement.  And they should not put everything in the law anyway, in order to allow enough flexibility to deal with future contingencies.  Besides, those in Congress don’t have the science background necessary to decide all of the details of some technological aspects of pollution prevention.

The law does not say that every electric power plant must reduce emissions of each pollutant to no more than some number, like 37 micrograms per cubic meter.  Instead, the law from Congress just says that EPA should protect human health to an adequate margin of safety.

Yet some would prefer that the EPA disappear, along with every agency having any regulatory power.  This agency, which was conceived in 1970 under Richard Nixon, has analyzed and supported some of the most important pieces of legislation of the last forty years, ranging from the Endangered Species Act to – more recently – the new emissions standards going into effect this year. 

In 2007, the United States Supreme Court ruled in a 5-4 decision called “Massachusetts vs. EPA”, that the EPA could in fact regulate greenhouse gases under the Clean Air Act, on the grounds that such emissions do affect human health.  When combined with the new Republican-dominated Congress, we have set the stage for yet another ideological battle. 

Throughout the past decade, much of the discussion about controlling carbon dioxide emissions has largely centered around the idea of Cap and Trade.  That system would effectively put a price on each unit of pollution emissions.  It would create a market where the need for emissions and the cost of emissions are balanced in a way that can achieve economic efficiency.  However, the most viable attempt at this in recent years, the Waxman-Markey bill of 2009 (H.R.5454), passed the House and not the Senate.  It would not even get past the House in this term.  

The question then becomes, what exactly are the cards that the EPA retains in their deck? 

A recent article is titled “Greenhouse Gas Regulation Under the Clean Air Act” by researchers at Resources for the Future (RFF, by Burtraw, Fraas, and Richardson).  It seeks to explore the options available to the EPA, in-depth.  What they find is that the EPA can implement measures that will reduce greenhouse gas emissions significantly in a measured and cost-effective manner.  For this to happen, however, they argue that the EPA must become bold and decisive in their actions. 

Bold action may be taken as an example of government overreach, and so the EPA must be careful.

Republicans are currently in discussion to introduce the Energy Tax Prevention Act of 2011 .  They recognize that the EPA holds some powerful cards after the Supreme Court ruling in 2007, and they want to take that power away.  This Act would shift the EPA’s ability to regulate from the Agency to the legislative branch.  Yet such an action could take any decision-making ability from the scientists and put it in the hands of the politicians.  As EPA leader Lisa Jackson said, “Politicians overruling scientists on a scientific question – that would become part of this committee’s legacy.’”  Herein lies a problem with democracy.  The people in charge of making the decisions that affect us all, often have little knowledge of the actual issues at hand.  After all, Republicans from oil-rich states like Oklahoma still claim global warming is nothing but a hoax.

Uncertainty About Climate Change (Part II)

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Jul 30, 2010

In my last blog, I pointed out the inherent nature of uncertainties in climate projections, and the long list of reasons for particular uncertainties about the effects of anthropogenic greenhouse gas emissions on the change in future temperature levels, droughts, severe storms, sea level rise, and about measures of economic damages from any such event.  The range of possible outcomes is enormous, but I argued that the uncertainties are not a reason to wait and do more research before enacting legislation to reduce those emissions.  Indeed, the huge range of probability outcomes is a big reason to act now to reduce the possibility of such costly events.

In this blog, I want to expand that point to talk about the various kinds of uncertainties and what to do about them.  I just read an interesting blog by Keith Kloor that lists five kinds of reactions to uncertainty.  I will describe HIS five points, but what they bring to mind for me are the FIVE STAGES OF GRIEF (when a loved one dies, for example).  I’m sure you’ve heard these before:

1-Denial

2-Anger

3-Bargaining

4-Depression

5-Acceptance

Well, those approximately label his five reactions to uncertainty about climate change.  First, one could DENY the uncertainty, which might be done to try to further some political agenda.  Those who want environmental protection might say we KNOW that anthropogenic greenhouse gas emissions will cause significant global warming, and therefore we must act to prevent it.  That’s just wrong; we don’t KNOW that global warming will be significant and highly costly.

In fact, “uncertainty deniers” have done a great disservice to their own cause.  The claim that global warming is certain just gives the other side the opportunity to point out correctly that it’s NOT certain!  But that whole argument is irrelevant!  The relevant problem is that global warming MIGHT be significant and highly costly!

Second, one could react by trying to REDUCE the uncertainty, such as through herculean research efforts to make better predictions.  Research might well be worthwhile, and it might help reduce some of the uncertainties, but it will not reduce all of them, and it might introduce new uncertainties that we’ve not yet considered!

Third, one could try to SIMPLIFY the uncertainties, such as to explain in simple terms the complex scientific reasons for the inherent uncertainties listed in my previous blog.  It’s not wrong to try to explain complex uncertainties, and even to fit them into a finite set of categories, but the danger is that such simplification be taken as a replacement for consideration of all the complexities.   The problem is that simplification may in effect minimize those uncertainties.  Anyway, this kind of reaction is somewhat like bargaining: “maybe if we make up simple categories for these complex uncertainties then they might not seem so daunting.”

Actually, Kloor’s fourth reaction sounds even more like bargaining, when he says “Uncertainty detectives – well all scientists should work hard to understand, represent, and reason about uncertainty (. . .). The conflict is when political opponents seize on this uncertainty as an excuse for inaction.”  Now that is a cause for depression!

Anyway, of course, the fifth and final reaction to uncertainty is ACCEPTANCE: “include uncertainty information in rational decision support systems and policies.”  We need to know what is known, and what is unknown, to be able to make rational decisions as a society to adopt policies that can insure us against the worst possible outcomes.  We at least need to make the right tradeoffs between the costs of that insurance and the benefits of reducing those risks.  We need to undertake any available low cost measures to reduce fossil-fuel-fired electricity generation, to increase energy efficiency of vehicles and appliances, to increase alternative fuel use, to build water storage that can help deal with a possible increase in the number of droughts, and to build levees that can help deal with a possible increase in the number of severe storms.

Accepting the fact of uncertainty means giving up the idea of building in those protections because we know things will get worse.  Instead, it means building in those protections because things might get worse, and they might get a lot worse.

Uncertainty is not a reason to wait, but MORE reason to act!

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Jul 25, 2010

Nobody has any doubt that climate forecasts are uncertain.  They are uncertain with or without anthropogenic (human caused) effects of greenhouse gas emissions.  Then, when trying to gauge the effects of humans, we have to take the difference between the uncertain climate forecast with extra emissions and the uncertain forecast without extra emissions.  That only compounds the uncertainty!

Suppose for example that without our extra carbon dioxide and other greenhouse gas emissions, the temperature in 2050 is predicted to average 50°F plus or minus 5°.  And suppose the temperature with our current rate of emissions is predicted to average 52°F plus or minus 5°F.  Then the difference (the effect of emissions) is not just 52-50 = 2°F.  Rather, it could be anywhere between 57-45 = 12°F, at the high end, or 47-55 = -8°F, at the low end.  We just don’t know.

That simplified example is overstated.  But look at the figure from the IPCC Fourth Assessment Report’s “Summary for Policymakers”.  It shows a set of model simulations with a range of results anywhere from no global warming to about 4°C (which is about 7°F).   That is a lot of uncertainty, but that figure does not reflect all possible uncertainties.  Those include (but are not limited to): uncertainties about the amount of GHG emissions in the future, about the effect of those GHG emissions on ambient atmospheric concentrations, about the effect of ambient atmospheric concentrations on air temperature, about the effects of air temperature on ocean water temperature at different depths, about the feedback effects of ocean water temperature back on air temperature, the effects of all those changes on polar ice caps, the effects of polar ice caps on sea level rise, the effects of sea level rise on millions of miles of coastline around the world, and the effect of all those changes on economic damages.

ipcc-ar42

Many have taken this inherent uncertainty as a reason not to act now, but instead to wait, to undertake more research, and to try to reduce that uncertainty.

That may be a natural initial reaction, but it is not a good one.  It assumes that uncertainty reduces the need to act, when in fact increases in uncertainty only increase the need to act!  That is not to say research is unwarranted, or that we have nothing more to learn. We can and should try to find out more and try to reduce uncertainties.  But a lot of that research may raise additional considerations and uncertainties!  Uncertainty is inherent to the problem and will never disappear, so waiting for resolution of the uncertainty means waiting forever and doing nothing forever.

Uncertainty itself is a problem we need to face, as it raises additional costs we can reduce.  A single hot summer or drought is a problem with which we have learned to cope.  But now we don’t even know whether we are facing that same level of heat and drought, or perhaps much more heat, reduced rainfall, extreme storms, huge loss of landmass, etc., etc., etc.  It is the unknown possibility of such loss that ought to make us act now to protect ourselves.

To the extent that anthropogenic GHG emissions raise uncertainties about future climate, the more we need policies that are resilient to those uncertainties: policies that increase our abilities to deal with drought, to make it possible to increase crop production with less rainfall, and to protect ourselves against the possibility of storms worse than Katrina.

Which brings us to the key distinction between adaptation and mitigation.  One way to protect ourselves is to adapt to droughts and storms, as just mentioned.  But another way to protect ourselves against those adverse possibilities is to start now to mitigate climate change by reducing GHG emissions.

Why Low-Carbon Technology Innovation is Not Enough

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Mar 19, 2010

Nobody likes new taxes.   When policy wonks like me talk about addressing the problem of global warming by introducing a carbon tax, nobody listens (even though all of the tax revenue could be returned by cutting OTHER distorting taxes on labor or on investment!).  Instead, policymakers like to use the Manhattan Project analogy, essentially saying that we can solve the whole global warming problem just by research and development (R&D), innovation and diffusion of new technology.  We’ll just throw money at the scientists, and they will solve the problem for us.  Policymakers want to subsidize or require wind power, solar power, and other low-carbon technologies.

Here is why that idea will not work, for reasons based on some new research in a book called “Accelerating Innovation in Energy: Insights from Multiple Sectors”, edited by Rebecca Henderson and Richard G. Newell.     To see what might work for energy, they look at technology innovation in all the other sectors where R&D has been successful (the internet, chemicals, agriculture, and semiconductors).  They find that three elements were key in ALL of those success stories: “(1) the substantial, differentiated, end-user demand that enables private firms commercializing the technology to anticipate healthy returns; (2) the sustained funding and effective management of fundamental research; and (3) the development of an institutional environment that includes robust mechanisms to promote the widespread diffusion of both knowledge and technology and that favors vigorous private-sector competition.”

My point is all about #1: there has to be demand in the market for the technology.  No matter how much money Congress throws at the problem of research into new energy technologies, the program will not be successful unless people want to USE those new technologies.  And people will not particularly want to use those new low-carbon technologies, unless they face a carbon tax!  The researchers and developers of new low-carbon technologies might have great ideas, but those ideas will not come to fruition unless people are chomping at the bit to get those new technologies and use them to increase their profits or reduce their carbon tax burden.

My own thinking about this problem relates to the fundamental reasoning for any government policy intervention: the private market works fine unless you can point to a fundamental market failure.  One market failure is the pollution externality from carbon emissions, and that can be addressed by a carbon tax.  A different market failure is that any private firm might not have sufficient incentive to undertake R&D if they don’t capture all the benefits from it.  Patents only last for 17 years, not all ideas can be patented, other firms can see those ideas, and other firms can get similar patents for similar technologies.  These “knowledge spillovers” are a possible justification for government intervention to subsidize basic research, the kind of research that private firms would not undertake sufficiently.

But we still have two different market failures!  Two different market failures require two different policies to address them.  Subsidies for research might help address the knowledge spillover problem, but we still need a carbon tax to get people to want to use those technologies.

That is why we can’t solve the global warming problem by just throwing money into research.

Europe vs. America (Travelogue vs. Travelblog?)

Filed Under (Environmental Policy) by Don Fullerton on Feb 22, 2010

This week, I’ve been travelling in Paris, to make a presentation at an OECD meeting on “encouraging low-carbon vehicle technologies”.  Now I’ve moved on to Barcelona, and in a few days fly to Istanbul.  I’ve been sightseeing “old Europe”, with very narrow city streets that are really just alleys at best, where walkers share the space with intermittent bicycles and mopeds.  The occasional delivery van is the only four wheeled vehicle that must venture down some of these alleys, just to reach the shops where they have to deliver their goods.

It is all very quaint, and picturesque.  Anybody who really needs to get somewhere just rides the metro.  Perhaps the dense grid of subway stops is not surprising in a city the size of Paris, but Barcelona has a similar number of stops on many routes, all around the city.  The population is about 3 million.  I don’t think that any city of 3 million in the United States has dug so many subway lines for convenient public transportation.

The narrow streets and convenient subways reflect the culture and history of the place.  Given the topic of my presentation, however, I have to wonder if it reflects the current policies in place.   Has the high tax on gasoline (“petrol”) encouraged these citizens to buy mopeds instead of cars, and to vote more funding for public transportation?  Or has the number of mopeds and subways induced the people to vote for high taxes on petrol?

I don’t know, and it would be very difficult to sort out the direction of causation.  But I do know that “old” Europe is a long way ahead of the U.S. in terms of low carbon footprint.  We in the U.S. see congested highways as an indication that we need to spend more money on highways!  That kind of reaction will never get any of us out of our cars and into public transportation.  For that we need infrastructure, which requires exactly the wording I used above: “culture and history”.  It cannot be built overnight.  The existing trajectory for building of highway infrastructure will put us on the path to future emissions, which sow the seeds of future global warming.

I’m easily as patriotic as the next American.  Last night I cheered when Bode Miller won the gold metal in the men’s “super combined event” at the Vancouver Olympics.  But I really have to wonder if the rest of the world is right that the United States has already caused more than its share of what will be a huge global warming problem, and we’re just not doing enough about it.  It’s not much warmer yet, but CO2 concentrations have already increased enough to guarantee another 5 degrees warmer climate.  If we don’t change our culture of driving, our way of life could be history.

Unemployment and the Environment?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Jan 9, 2010

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!

Does a Carbon Tax need a “Border Tax Adjustment”?

Filed Under (Environmental Policy) by Kathy Baylis on Dec 4, 2009

When our colleague Don Fullerton was in Brussels this week speaking at a conference on climate change, he voiced support for border adjustments for carbon policies. This idea was promptly rebuffed with cries of ‘protectionism’, particularly from the business participants. Now, a border adjustment is just a friendly way of saying ‘an import tariff,’ so it’s understandable that people might see them as a harbinger of protectionism. Like most trade economists, I’ve seen many examples of trade policies that were reputedly intended to ‘level the playing field’, e.g. countervailing duties and anti-dumping tariffs, promptly get co-opted and used as a means to protect the loudest domestic industries, so I am sympathetic to this concern. That said, I think there are a number of compelling arguments for introducing some border controls along with a stringent domestic carbon policy.

Think of a carbon tax or cap-and trade system like a Value-Added Tax (or VAT), where border-adjustments are common. Most countries that tax the value-added in production of each good also tax imported goods at the same rate. They do this to ensure that imported goods aren’t given an unfair advantage over the taxed goods produced domestically. The same logic applies to a carbon tax, or a cap-and-trade system on emissions. The idea is that we would like to tax imports at an equivalent rate as domestic production. Thus, we would impose a tax based on the average carbon content of the equivalent domestic product. This approach conforms with the WTO rule of equivalence – that a country doesn’t favor its own producers over producers in another country.

Is designing a border adjustment going to be harder to do for carbon than for a VAT? Definitely, because carbon content is harder to measure than value-added, which is just a price. It also means using domestic carbon content as a proxy for the carbon content in imported goods, which is not going to be accurate. The problem is that the alternative is trying to estimate specific carbon content for all imports, which is not only impossible, but also generates the potential for problems with the WTO.

Now you might well be thinking, you’re suggesting imposing an imperfect, potentially arbitrary tariff on billions of dollars of imports. How can this be a good thing? Let me walk through a few arguments.

1) If you don’t have a border adjustment, other countries have an incentive not to sign on to an international carbon agreement. By imposing a carbon policy domestically, we are raising the marginal cost of production inside the United States, so it gives firms the incentive to move to a lower-cost location as long as they continue to have access to the US domestic market. From the perspective of, say, Indonesia, a US carbon policy might make the US look quite tempting as a potential market. And the last thing they want to do is to get rid of this advantage by imposing a carbon policy themselves.

2) In contrast, a border adjustment means that a country like the US or Europe does not have to wait for an international climate agreement before implementing a carbon policy. In short, because it neutralizes the potential negative trade effects of a carbon policy, it becomes easier for a country to ‘go it alone’ and not have to wait for other developed and developing countries to sign on to a Kyoto-like agreement.

3) Similarly, if you do have a border adjustment, it can be used as an incentive to get other nations to implement a carbon policy, particularly developing countries with a large export base. Only those countries without a carbon policy would be subject to a border adjustment, and the revenue from the border adjustment accrues to the importing country. So an exporting country faces the choice of letting their firms pay the tariff to someone else, or collecting that revenue themselves in the form of a carbon tax or (auctioned) cap and trade permits. So even if the border adjustment is imperfect, one can hope it’s temporary.

I can see my trade colleagues wincing at their computer screens while they read this. Yes, we have had loads of trade measures that were supposed to be temporary that ended up becoming enshrined by the interests that they benefit. So my last argument is for them.

4) Without a border adjustment, import-competing industries will demand special treatment in the form of free permits, or, of more concern, outright exemptions from the carbon policy. Why do I claim this? We’ve seen it in Europe. Under the European Trading System for carbon, each country was allowed to exempt certain industries from the cap-and-trade system, and they particularly targeted those firms in ‘trade-sensitive’ industries. Along with generating concerns about environmental efficiency, such exemptions generate potentially large economic inefficiencies domestically and are incredibly arbitrary. Thus we tend to see the most politically-sensitive industries often identified as the most ‘trade-sensitive’. At least a border adjustment could be designed to be neutral across domestic industries, reducing the potential gains for firms in politically-powerful positions. As an aside, note that industry-specific subsidies could include exemptions to costly general environmental regulations and are subject to countervailing duties (CVD). Thus, I wonder if we might see such exemptions generating a cascade of CVD cases.

OK, I always find it frustrating when people from other disciplines pretend to be economists, so let me be clear that I’m not in any way a trade lawyer, so I can’t speak convincingly on the trade legality of these ideas. That said, we know that border adjustments for VATs are allowed under the WTO. You might also be concerned, however, that any border adjustment policy might spark a trade war, which our anemic global economy certainly does not need. In response, let me note that when the Uruguay round of the GATT was concluded, countries signed on to a ‘peace clause,’ where they agreed not to take trade actions against their fellow countries on agricultural subsidies as long as those subsidies conformed to the Agreement on Agriculture. To facilitate carbon policy, I wonder if there might be the potential to negotiate a similar peace clause for environmental subsidies and/or border adjustments as long as those border adjustments conform to some internationally-agreed upon rules. For example, these rules might try to ensure that countries treat importers no differently than they treat their domestic industries, and that the border adjustments be transparent and apply equally across industries.

In conclusion, border adjustments might help make domestic carbon policy both more palatable and more efficient, and could, in fact, be less harmful to free trade than allowing one-off industry exemptions.

Geoengineering: A Reasonable Solution to Climate Change?

Filed Under (Environmental Policy) by Don Fullerton on Nov 13, 2009

In SuperFreakonomics, the new book by Steven Levitt and Steven Dubner, the authors suggest geoengineering as a possible solution to climate change.  Their assertion has been so controversial that they devoted a long blog entry to its defense.  What is geoengineering, and how should economists think about it?

The National Academy of Sciences defines geoengineering as “options that would involve large-scale engineering of our environment in order to combat or counteract the effects of changes in atmospheric chemistry.”  The specific geoengineering that Levitt and Dubner analyze calls for injecting sulfate aerosols into the stratosphere.  The idea is that the aerosols form a shield to reflect sunlight, thus lowering global temperature.  A similar cooling effect occurs naturally after large volcanic eruptions.  Paul Crutzen, the Nobel Prize winning chemist, estimates that $25-50 billion could be enough to construct a sulfate aerosol shield to counteract a doubling in the current atmospheric concentration of greenhouse gases (see “Albedo Enhancement by Stratospheric Sulfur Injections: A Contribution to Resolve a Policy Dilemma”, Climate Change 77: 211-200).

The traditional solution to climate change calls for limiting greenhouse gas (GHG) emissions that cause global warming.  In a “meta-analysis” discussed in the Stern Review (p.242),  a 50% reduction in worldwide greenhouse gas emissions could cost 2% of world GDP or more.  Let’s see,  world GDP is about $70 trillion, so a 2% reduction in GDP costs $1.4 trillion.   While the comparison here is not exactly apples-to-apples, the point is that these mitigation cost estimates are significantly higher than geoengineering cost estimates ($25-50 billion).  Thus, it superficially appears that geoengineering is the “correct” economic solution to climate change.

However, geoengineering is an ex post solution, where society waits for the symptoms of climate change to become so severe that geoengineering is the only remedy to treat the symptoms.  In contrast, GHG mitigation tries to prevent the symptoms from ever occurring by trying to correct the root cause.

Many present the geoengineering solution as an insurance policy against the disaster of runaway climate change.   Shall we rely on the theory that temperatures can be reduced later, while we continue unlimited burning of carbon?  What if that insurance doesn’t work.  What if geoengineering doesn’t cool the planet as theorized?  What if the sulfates cause other environmental problems?  In addition, geoengineering cannot necessarily counteract the economic effects of severe climate change.  Imagine that society waits for “proof” of climate change, such as waiting for large sections of Arctic ice sheets to break off and raise sea level by a few feet.  At that point the economic damage is irreversible – regardless of the geoengineering temperature correction – with millions of people displaced from low-lying areas, billions (if not trillions) of physical capital submerged, and severe disruption to economic activity.  Then would GHG mitigation look like the bargain solution?

Betting on American Innovation over EPA Mandates

Filed Under (Environmental Policy) by Don Fullerton on Nov 7, 2009

In 2007, the Supreme Court ruled that the Environmental Protection Agency (EPA) has the authority to regulate greenhouse gas (GHG) emissions under the Clean Air Act (link).  This fall the EPA announced its plan to regulate GHG emissions, including carbon-dioxide, by requiring large emitters to adopt state-of-the-art, best-practice pollution abatement technologies (link).  Yet the EPA’s new regulatory plan may rely upon costly methods of reducing GHG pollution.

Under the Clean Air Act, the EPA can only promulgate rules or “mandates” to control pollution.  Requiring every emitter to adopt best-practice pollution abatement technology is an example of a mandate, where the regulator dictates how the emitter must reduce its pollution.

In contrast, economists have long advocated market based approaches to pollution abatement – either a carbon tax or a cap-and-trade system.  Indeed, it is a cap-and-trade policy that passed the House during the summer and is currently being debated in the Senate.

The “cap” sets a hard limit on total pollution, and it then gets tighter and tighter over time, reducing emissions gradually.  Meanwhile, the “trade” part of the policy allows private markets to allocate pollution rights (permits) efficiently among thousands of emission sources.  Capping emissions causes pollution rights to become scarce, and thus the ability to pollute has economic value.  This value is the price at which permits are bought and sold.  If a company holds permits and can reduce GHG emissions more cheaply than the prevailing price, then it sells permits and makes money on the difference; otherwise it may buy permits.  This allows for companies with only expensive pollution abatement options to buy the right to emit at a price lower than they would otherwise incur, thus reducing the cost to society.

In addition, the explicit price on pollution induces profit-maximizing firms to research and implement new and cheaper ways of reducing GHG emissions.  This is a key difference when comparing cap-and-trade vs. mandates.  The price signal of the market based approach induces innovation.  Individual entities acting in their own self-interest will have the incentive to find new and cheaper forms of pollution abatement.  Those future innovations cannot be foreseen, and thus the cost projections of current legislative proposals cannot take them into account.  The costs of reducing GHG emissions are real, but under a cap-and-trade system, U.S. ingenuity and innovation will lower the cost of compliance relatively to current projections.  Why am I confident?  It has happened before.  The cap-and-trade policy to reduce sulfur dioxide pollution from coal-fired power plants cost one-fourth of the project price tag precisely due to unanticipated adaption and innovation by U.S. businesses (link).

Recognizing the Costs and Benefits of Climate Change Policy

Filed Under (Environmental Policy, Uncategorized) by Jeffrey Brown on Nov 4, 2009

I am posting a day later than usual this week because I spent a good part of yesterday participating in a fascinating discussion about U.S. policy towards climate changes sponsored by the Center for Business and Public Policy, the Institute for Government and Public Affairs, and the Environmental Change Institute (all at the University of Illinois).  Three highly accomplished experts on climate change (Charlie Kolstad, Don Fullerton, and Nat Keohane) discussed the various approaches to tackling this global policy priority.  The conversation was refreshing for its analytical clarity, its recognition of both the benefits and costs of alternative policies, and for the fact that it was good economics set against a backdrop of political realism.  It left me wishing that more of our policymakers in Washington would have such high quality conversations when making their decisions.   

 

In preparing my own thoughts for this event, I read through some of the material from two of the many “sides” in the debate over climate policy legislation – the views of the U.S. Chamber of Commerce and the views of the Obama Administration.  Doing so brought back memories of my own days in the White House (in 2001-02 under President Bush).  Specifically, it made me remember the constant struggle between the economists and policy wonks who want to have honest and nuanced discussions about complex issues, and the “spin masters” whose job it is to effectively communicate to the public in a simple way.  I understand the value of simplicity for communication, but all-too-often, the truth gets “simplified away.”

 

Economics is fundamentally about trade-offs.  Perhaps no phrase is more famous for capturing this idea than “there’s no such thing as a free lunch.”  But to listen to the opponents and proponents of climate change legislation – at least after they have been filtered through the communications shops – one could be forgiven for thinking that our policy makers do not understand this.    

 

Let me give two examples – one from each side.

 

The U.S. Chamber of Commerce has an official position on climate policy that states:

 

“Our position is simple: There should be a comprehensive legislative solution that does not harm the economy, …”

 

What is remarkable about this statement is that they do not say that the legislative solution should be one in which “the benefits clearly outweigh the costs.”  Rather, they are imposing a truly impossible standard – that the solution “does not harm the economy.”  The most straightforward interpretation of this is that they are unwilling to accept any cost or slowdown in economic growth in order to reduce emissions.  Unless you believe that there are no costs to climate change and/or no benefit to any solution, this cannot possibly be an optimal – or even rational – policy.  

 

Proponents of climate change often make equally vacuous statements.  To hear many in the Obama Administration speak of climate change, you would think that environmental regulation is good for the economy rather than a cost.  They focus their attention on the number of “green jobs” that will be created, while largely ignoring the large number of jobs in other industries that will be destroyed.  I’ve yet to see a single study showing that environmental regulation is a NET positive for economic growth or job creation in the U.S. 

 

What we need – on this and so many other issues – is a “grown-up conversation” about the costs and benefits.  Of course we know that reducing emissions levels will be costly.  Of course we know that it will require changes in the way we consume and produce energy.  The question is not whether climate policy can be done at no harm to the economy or can even benefit the economy – the question is whether the benefits of reducing emissions is worth the cost. 

 

Fortunately, even if the “talking heads” are not having these discussions, serious thought leaders like those at our forum yesterday are.  Let’s just hope that policymakers listen.