Climate change policy

Bjorn Lomborg seems to be causing a stir again with his new book, ‘Cool It’. I haven’t read the book but the essence of it seems to be that the dangers of climate change are over-rated. Lomborg also proposes that trying to cut emissions might be part of a good policy response to climate change, but it shouldn’t be the entire response. He says in an interview with Bill Maher,

Right now, we talk a lot, and we say, let’s do the Kyoto Protocol, which costs a lot of money; we actually don’t implement [it], and then even if we did, [it] would do very little good… Instead, we should focus on cutting the cost of cutting emissions. That is, invest in research and development on non-carbon-emitting energy technologies.

Whether Lomborg’s right about the numbers or not, it raises an interesting point: in our haste to talk about ways of cutting emissions have we lost sight of the basic economics principles which should guide us? Lomborg points out that good things can come from global warming too, such as the opening of the Northern Passage. If we can no longer prevent it happening, wouldn’t it be worthwhile to invest in making it productive? Essentially, his point is that many of the responses to climate change have a higher marginal cost than marginal benefit and a re-allocation of resources would be beneficial to everyone.

On a broader lever, does there come a point where we have to acknowledge that, given the lack of action so far, many of the predicted consequences are unavoidable? At that point, would it be more beneficial to invest in technology that will take advantage of a different global climate than continue to aim for an unachievable first-best outcome of preventing climate change? I don’t pretend to know much about the issue but books such as Lomborg’s that address such questions in a reasonable fashion are vital to the construction of effective policy. Climate change is simply too important to let a knee-jerk reaction dictate the future of our planet.

Check out comments by people who’ve read the book at MR.

Carbon taxes again…

It looks like Matt’s not the only brilliant economist campaigning for Pigovian taxation of carbon emissions. Now Greg Mankiw’s weighed in on the side of taxation. To those who claim a carbon tax is regressive because poor people are forced to live in the suburbs and drive more than the wealthy, Mankiw says

Gilbert Metcalf, a professor of economics at Tufts, has shown how revenue from a carbon tax could be used to reduce payroll taxes in a way that would leave the distribution of total tax burden approximately unchanged.

In addition, the Economist points out that

…it’s possible that a carbon tax might sharply reduce carbon output without any fall in oil consumption, so long as consumers of other fuels affected by the tax reduce their use of such pollutants and their consequent emissions,

although this seems like a bit of a long shot.
In NZ, the government has preferred a cap-and-trade system to carbon taxes. Mankiw mentions that this is equivalent to a carbon tax only if the permits are auctioned off. If they are allocated for free based on previous emissions, as I believe the case will be in NZ (please correct me here if I’m completely mistaken), then “…the prices of energy products would rise as they would under a carbon tax, but the government would collect no revenue to reduce other taxes and compensate consumers.” In other words, a cap-and-trade with grandfathered permits IS regressive and it’s expensive to redress the burden on the poor.

Is nuclear power generation the way for New Zealand?

Over the weekend, Australian Prime Minister John Howard said that countries who supported reducing GHG emissions must support nuclear energy. Of course the one does not presuppose the other (non-sequitur), and New Zealand politicians came back saying that it was not for New Zealand. In reaction, I note a number of ‘straw-polls’ on websites such as Stuff and NZHerald, where more than half of self-selecting participants said that they wanted nuclear power in New Zealand.

I am not against nuclear power in New Zealand if a robust economic case can be supported for its use, relative to other generation sources. This case would, of course, have to internalise the probability of a nuclear disaster multiplied by the expected costs of such a disaster, and also the real difficulties of disposing of nuclear waste. On 26 April 1986 in Chernobyl there was a nuclear power plant explosion, that is one thing that I worry would happen here. But is Chernobyl safe now? From research I read that they got rid of the topsoil and put new soil down, except they were not able to do that around the trees. So if you stay on the paths it has very little radiation. On the other hand, the emissions of alternatives (such as coal thermal generation) would need to be internalised as a negative for them in comparison to nuclear.

I support analysis that works to such a framework as being a crude but generally good way to rank alternative generation sources, taking into account all of the many pros and cons of each. Unfortunately, most New Zealanders seem to think that because the only raw materials used in generating power from nuclear is a plant and a bit of Uranium, it must be cheap in comparison to a wind farm or photovoltaic (solar) generation, let alone coal or other thermal generation sources – which in New Zealand just is not true. This was best exemplified by a column by Michael Laws in yesterdays Sunday Star Times. Besides describing George W Bush as a very smart man, it suggested that nuclear was more cost effective than wind power and geothermal power (among others), and that an oil price of $2million a barrel was needed to justify the costs of marine energy (plain wrong) and that solar is not an opportunity for future generation (actually, solar is currently non-viable, but not anywhere near as what Mr Laws suggests. In 10-15 years it will probably be a goer).

Let us get some perspective here. With current nuclear technology, the cost of nuclear generation is around twice the current cost of generation in NZ. Wind is actually much more efficient than nuclear, does not emit, generate nuclear waste, or risk catastrophe. There is some visual impairment. But the cost of this is much less than that of storing nuclear waste, or the risks of nuclear disaster. Indeed, marine would at the very least appear to be roughly as economic as nuclear for NZ (and in terms of scale is much more economic), without counting the risk of catastrophe and the costs and risks of nuclear waste disposal.

I am not against nuclear power for NZ per se, but the debate needs to be grounded in economic facts. New generation nuclear technology, probably emerging in 10-15 years may be more suitable for New Zealand than current technology. We should keep an open mind when this comes, but also not just jump on it as an easy fix and a solution to all of our problems – there are a lot of things to think about and internalise when comparing different generation options, and this should be done with care. Knee jerk opinions such as Mr Laws’, based on nothing but perception, do not represent good economic analysis.

Cost of carbon

No right turn has a good point about what the market price of carbon will be versus what the government is pricing it at.

As of May, the government is financing based on a carbon price of $13.21 per carbon ton (update CO2). This is ridiculous, when we see other New Zealand prices set between $33.75 and $70. In European market pricing carbon dioxide futures at over 20 euros.

Update: As carbon dioxide is only 27% carbon (thankyou wikipedia), in carbon terms the European futures price is approximately 74 euros per ton. However, I suspect that the govt. and market prices are for CO2 as well, implying that the price per carbon ton is $49 in Treasury estimates.

Whether you agree with the Kyoto protocol or not, we have to pay our Kyoto liability. What good is lying to ourselves about what the size of it will be. Hopefully government environmental policy uses the world price for carbon to make policy, instead of the Treasury price.

Emission trading: Fairness and efficiency

An article by Adolf Stroombergen (from Infometrics) discusses how NZ is going to meet its obligations under the Kyoto protocol.  First Adolf discusses the merits of a Pigovian tax as a way to cover our obligations.  One line I particularly enjoyed was:

“However, even if a tax has no effect on emissions, it is still fairer to put the cost of emissions on those who cause them than to put the cost on taxpayers generally.”

So damn true!  Having established what the government should do, he then goes on to discuss what they actually will do, an emissions trading system.  While a emissions trading system could, in theory, be as efficient as a tax, governments around the world have taken the strange measure of given out emissions permits for free, instead of auctioning them and using the money gained to pay off the Kyoto obligation.  The reason given for this in the article is that it is fair to compensate industries where investment has occurred only on the basis that producing carbon was free.

However, I think I see it a little differently.  If an established firm can only stay in business when carbon emissions are free, then they are socially inefficient.  So the only way the firm can stay in business is if it makes society bear some of the cost of their production decision.  That seems unfair to me.  As a result, I think that emissions permits should be auctioned by the government in almost all cases.  The only time I see scope for them to be given away for free is when we have an infant-industry, one which would be able to pay for the full cost of their production activity in the medium term.

There is no such thing as a free lunch

A column in the Sunday Star Times actually discussed an interesting issue this weekend; how the biofuel revolution will lead to higher food prices. They are exactly right, you increase the demand for corn, and the price of corn will increase. Now corn is a substitute for other foods, so the demand for other foods rises, increasing their price. Furthermore, corn is an input in the production process of milk, beef, chicken etc – so you shift the supply curve left, and the price goes up. Anyway you think about it, biofuels will push up the price of food.

Furthermore, when the government enforces regulation, what happens? The government makes petrol stations sell biofuels. As they aren’t already, they must be uneconomical, implying that they will be more expensive than normal fuel. As the government is saying that petrol companies have to sell a minimum amount of biofuel, they will have to cross-subsidise the price of biofuels with petrol, leading to an increase in petrol. Now, biofuels should reduce world demand for fuel, so the world price of petrol must fall, however I’m not sure which factor will be dominant when the price of fuel is determined.

It might be annoying that the price of food (and maybe fuel) will rise. We know that the most heavily affected will be the poor. Third world countries will face highly escalating prices for agricultural products, now even though some third world countries are food exporters, many of the poor in these countries have to pay the world price for food (in the same way we pay the world price of milk). As a result, rising food prices will make life even more difficult for the very poor in the age of biofuels.

Given this, it is difficult to know what would be optimal for the global community. The US is subsidising biofuels in order to provide a substitute for/reduce dependence on foriegn fuel. As oil is a non-renewable resource, we should be interested in finding substitutes. However, food is a necessity. Rising prices for food will affect outcomes, especially for the very poor.

The reason the price of food is rising, is that their is a limited supply, and governments are trying to use it as both food and fuel. Now you may argue that the supply of food will rise, and the price will again. This is a fair argument, however it is important to realise that the price of agricultural goods will be set such that the MC=MB for the least efficient plot of land. If the marginal cost of production on new land is significantly higher than on currently used land, we can expect prices to be a lot higher.

Ultimately, we have to realise that there is some tradeoff between these, and accept the consequences of the choice we make.