Tuesday, November 13, 2007

The Hazards of the Rush to be Green

The public and policy makers are responding to the daily drumbeat of events reported as consequences of global warming. Every especially-warm day, picture of a melting glacier, drought report, etc. adds to the enthusiasm to contain greenhouse gas (GHG) emissions, especially carbon dioxide emissions. The loudest call is for regulation of offending activities and subsidy of non-offending activity.

From an economist's perspective, this thrust is a virtual recipe for failure. It is highly likely that, not only will we not meet goals of reduced GHG emission, but we will in the process of trying, actually make GHG emissions worse than they otherwise would have been.

How can this be? Read on.

The Political Economy of Regulations

Regulation is based on the notion of "market failures", i.e., that the private market mishandles certain resource allocation activity, requiring government to intervene manually and properly redirect resource allocation. In reality, of course, the failure is not of private markets, but rather the failure of government to support even the existence of certain markets.

The economy needs government to provide the supporting legal framework in order for private markets to function. Government has neglected to support markets in air, water, noise and most other resources that constitute the natural environment. Indeed, the Environmental Protection Act actually forbids consideration of benefits versus cost in environmental analyses such as environmental impact studies (EIS). In so doing, the Environmental Protection Act effectively denies the relevance of markets. Again, not a market failure but a governmental failure.

Viewed from this perspective, calling in government to act in lieu of private markets is a bit like asking the guy who was supposed to build the safety nets to run the circus high-wire act. Without any market values or benefits and costs to balance, regulation in the environmental arena can only be arbitrary and capricious. Obviously, this is the perfect setup for a regulation to, in the end, do more harm than good.

Subsidies: The Three-Card Monty of Environmental Policy

The other, general approach to steering the economy to a green future is the subsidy. Hybrid vehicle purchases enjoy tax subsidies, as do solar panel installations, biofuel manufacturing, wind power farms, compact fluorescent light bulbs, etc. Like the sidewalk con of Three-Card Monty, these policies create the illusion that some costs disappear when, in fact, they do not.

Subsidizing a product that would otherwise not be deemed cost-effective by the marketplace risks making the economy less efficient--not only in productivity terms, but also in GHG accounting terms. A solar panel based on solid crystalline silicon cells, for example, likely uses more energy to manufacture, transport, install and operate than it will ever save over its lifetime. Subsidizing such a product and, thereby increasing its use, therefore actually increases, rather than decreases, the amount of conventional energy used in the economy. If conventional energy sources emit GHGs (which they do), then GHG emissions go up, rather than down, through the effect of such subsidies.

Proponents will argue that public subsidies are needed temporarily in order to transform the market and increase penetration of the product. In other words, market participants are too stupid to recognize a good thing without prescient government lighting the way. In fact, of course, private markets make huge investments and take huge risks on unproven technologies every day. The cell phone, Apple computers, Microsoft software,iPods, medicines, the video recorder, jet skis, the automobile, the skyscraper, and a million other products arose primarily from risk-taking capital sources. The notion that there is a silver-bullet energy technology out there that is languishing because of lack of risk-taking capitalists is simply foolish.

Subsidies, by their very nature, bias the economy toward the production of goods that waste resources at the expense of the production of goods that use them more sparingly.

Cap and Trade, Carbon Offsets and other Quasi-Market Schemes

The green frenzy is not without its attempts to mimic real markets through trading schemes. So-called cap-and-trade schemes cap the carbon emissions of a group of producers. As long as some producers caps are not binding, they can sell their excess rights to emit CO2 to another producer whose cap is binding its behavior.

There is, indeed, a market created in cap-and-trade schemes. However, the caps are arbitrary regulatory constructs, the stringency of which is determined in a political economic context. Most cap-and-trade schemes have loose caps that reflect the relative political influence of the capped entities.

Carbon offsets are another method intended to stimulate carbon-sparing activities, such as planting carbon-sequestering trees. Al Gore and Land Rover users can then obtain absolution for their carbon emitting activities by buying carbon offsets. Unfortunately, it is virtually impossible to determine the validity of the carbon-offset arithmetic, or even whether the firm selling the carbon offsets is doing anything different than it would have done in absence of the offset program. Would the tree farmer have planted the trees anyway? Would the landfill have controlled its GHG emissions anyway?

The Market is Working Where it is Allowed to Do So

As long as an input to a production process costs money, businesses have an incentive to be sparing in its use. Indeed, the energy-intensity of the US economy (BTU per dollar of GDP) has been declining steadily for as long as we have data available. Higher energy prices may accelerate this trend, but only if the energy-sparing technologies available to the firm are, themselves, not energy intensive. If they are, then there may be no cost advantage to adopting the new technology.

Ironically, the best way to move quickly toward energy-saving technologies is for a firm, individual or country to be wealthy enough that they can afford to abandon still-useful old technologies in favor of the new. If GHG policies have the effect of impairing personal or corporate wealth, therefore, the turnover of technology wil slow. Those who say that we are just going to have to live more simply, etc., forget this important fact.

Recent trends in energy consumption confirm this notion. Those who embraced the Kyoto Protocols in 1997 such as European Union members, have energy use that is growing more rapidly than US energy use on a per capita basis. While Europe was imposing regulatory constraints on its industry and subsidizing massive solar panel farms (especially in Germany), the US was turning over its capital stock.

Maybe that is why a recent article in Nature declared Kyoto a failure:

The Kyoto Protocol is a symbolically important expression of governments' concern about climate change. But as an instrument for achieving emissions reductions, it has failed1. It has produced no demonstrable reductions in emissions or even in anticipated emissions growth.

In a future post, I will discuss some things that actually might be worth doing.