Understanding the Economic Impact of Mitigating CO2 Emissions

It’s time to finish up my thoughts on CO2 emissions. In previous posts, I discussed why I felt taking risk mitigation actions on our CO2 growth made rational sense and why I’m concerned about those that simply assume there is no risk at all without evidence.

However, I think the strongest of the conservative counter arguments has always been fear that we break the economy through what essentially amounts to an overwhelming energy tax. So let’s talk about how economics works and see if we can address this concern.

Let’s start with this quote as a typical of AGW Skeptics:

Few people have any problem with anthropogenic global warming being treated as a tentative theory worthy of further investigation.

Many do, however, have a problem with the idea that a tentative theory that is completely devoid of critical evidence should be used as a justification for permanently dampening the economic prospects of mankind.

Here we meet the claim that current CO2 curbing proposals will permanently the economy for the rest of forever. 

I look at this argument I want to scream? Isn’t this guy supposed to be a conservative? Why such an incredible lack of faith in the markets?

How Markets Work

I’m sure you all know that the free market works by the law of supply and demand. If you have large demand suppliers can charge higher prices and make greater profits. So more suppliers enter the market to take advantage of the increased profits. As more companies supply products and services competition increases. This causes the prices and profit margins on that demand to drop, but it also reduces desire to supply for that demand. In addition, as supply goes up, economies of scale reduces the over all costs.

Of course, if supply grows too large, then the profit just isn’t there. This causes supply to drop and for prices to rise. As prices rise, demand drops.

The net result is that we end up with a sort of equilibrium where the market finds just the right price to give the optimal supply and demand that is worth it to the most customers and companies.

How does this apply to the quote above?

The quote above basically assumes that the free market does not function. It assumes that if we decide to place a so-called “carbon tax” on fossil fuels that demand will not go up for alternative energy sources thus increasing competition and economies of scale on those sources and reducing their comparative price with fossil fuels.

In reality, as the cost of fossil fuels rise, the demand for alternative energy sources will naturally increase and there will be higher profit margins to be made from these sources. Then the market will work it’s magic (over a long period of time perhaps) and eventually a new equilibrium will be reached where alternative energy sources are naturally more competitive with fossil fuels. So, if we believe markets work the way they are supposed to, we don’t have to worry about hindering the human race forever.

What About the Short Run? Why We Need to Avoid Sudden Jolts

While we have nothing to fear in the long run, we need to have great respect for the short run. In the short run, the market won’t be able to respond and the net result will be massive increases to energy costs across the board. (Even non carbon energy will increase at first due to the increase in demand for them caused by the sudden jolt over fossil fuels costing more.)

You do not want sudden jolts to the economy like this, especially anthropogenic jolts. When suddenly millions can’t afford the cost of their energy, you’ll have sudden poverty, unrest, and a lot of bad things. We don’t really know how bad, or for how long. But that lack of knowledge should scare us. It could be very bad and for a very long time.

Nevertheless, the bad period will be temporary. Eventually the market will recover from anything we do to it and will get back to where it was at. So any ‘carbon tax’ we add will only be temporary.

Market Problems

But in saying ‘the market will fix it in the long run’ I’m essentially glossing over just how bad it could be in the short run. The invisible hand of the market is often the blind hand. The way it ‘fixes the problem’ may be by getting rid of the surplus population by letting them starve to death. This reduces demand for fossil fuels, thus reducing the costs, etc. It’s a victory not worth having.

So while I have faith that the market will ‘fix the problem’ I do not have faith that I’d like the fix. As Keynes is famous for saying, the market can stay irrational longer than you can stay solvent.

The Zero Cost Solution

I think we need a clear and present danger in AGW before I’m willing to use a fix like a massive carbon tax. If we get to a point where things are going bad fast, and we know for sure people are going to die either way, then I’d be in favor of a massive carbon tax so that we can quickly save the planet. But not before.

But this raises the question. Can’t we just reduce the “tax” on carbon and take longer to fix the CO2 problem? Yes. That is possible. And not very hard.

But if this is true, then it means it’s also possible, at least in principle, to maybe even eliminate the additional costs via a trade off with how long we take to fix the CO2.

In my next post I’ll explain how emissions trading works and how it can be tweaked to not cause a short term economic impact.

The Time Frame for a Non-Cost Solution

Obviously the time frame on a ‘no impact’ solution would be much much longer than the quicker fix (if you can call it that) supported by democrats. As I mentioned in my previous post, I’m advocating for nothing less than five decades before we actually stop the CO2 growth. Probably longer.

But at least it’s good news that we can both decide to try to act on CO2 growth for risk mitigation reasons and also still reject the current liberal policies that we fear will cause an economic disaster. Curbing CO2 growth does not have to be a trade off between atmospheric and economic disaster.

10 thoughts on “Understanding the Economic Impact of Mitigating CO2 Emissions

  1. Pingback: Tweets that mention » Understanding the Economic Impact of Mitigating CO2 Emissions The Millennial Star -- Topsy.com

  2. Bruce, you’re still not saying exactly what you favor. You mention some vague carbon tax and refer to emissions trading but avoid specifics. So I can’t really comment on your solution because there are no details.

    However, there is good news in this in that I agree in theory with this comment:

    “I think we need a clear and present danger in AGW before I’m willing to use a fix like a massive carbon tax. If we get to a point where things are going bad fast, and we know for sure people are going to die either way, then I’d be in favor of a massive carbon tax so that we can quickly save the planet. But not before.”

    The key issue is what evidence is used to favor “a massive carbon tax.” So far, much of the evidence used for such policies and for cap and trade has been shoddy, exaggerated and manipulated, as we have discussed. Current weather patterns are completely in line with natural weather phenomena over time.

    However, if global temperatures were to shoot up by 5 degrees C in five years, or if the oceans were to really rise by 10 feet (rather than a few inches) and if the Arctic really did disappear during the summer months (which it is not even close to doing), I might be more persuaded that some kind of govt action is necessary.

    So, I can imagine scenarios where some kind of concerted international effort is necessary, but we are far, far away from those scenarios today.

    I will make a “gentlemen’s bet” with you, however: I bet technological advances will happen that will move us away from carbon-based energy long before any of those three conditions I mention above take place.

  3. “I bet technological advances will happen that will move us away from carbon-based energy long before any of those three conditions I mention above take place.”

    I agree.

  4. Geoff,

    At this point, please give me criticism on two main points:

    1. Do you agree or disagree with the idea that even if were to *gulp* implement the liberal cap-and-trade policies that the market will naturally solve the problem of a ‘carbon tax’ on its own through development of alternative energy sources.

    2. Do you agree or disagree that it’s possible to trade off between time and economic impact.

    This second one is particularly important. One poster once said he’d accept any proposal that had a worthwhile ROI. What I’m suggesting with point #2 is that it’s basically always possible to get a good ROI because you can always trade off time and cost until the cost is marginal.

    Now obviously, if you believe the risk is zero (see risk mitigation post for discussion on why that would be an irrational stance) then even a cost of $1 is a bad ROI. I am going to guess this is that poster’s real position. Therefore a claim to accept any good ROI is actually a smokescreen. What he really meant is “I would accept any good ROI, but since I irrationally eliminate all risk there is no possible ROI that I will accept.”

    What I am trying to do is come up with a ‘conservative’ approach to CO2 growth. Instead of sticking my head in the sand over the parts of this debate that are accepted by both sides, I’m taking seriously the idea that there is at least some limited risk (which is rationally the only justifiable position) and therefore we need to find the correct ROI for it. I see a trade off of time and cost as the right way to find that ROI.

    This really is a *very* conservative answer to CO2 growth. Deeply conservative in it’s principles.

    As far as your gentleman’s bet goes, I have never claimed you were wrong. I simply claimed there was no way for you to know that so I’m not prepared to make policy based on a WAG like that.

    Here’s the beauty of a trade off of time for cost. If you are right, then the legislation I’m propose *never comes into effect* because we naturally switch over on our own. But if we are wrong, then it helps us switch over in a timely manner via making the risks of CO2 growth calculated into the markets.

    It’s hard to see how you can criticize this position if you really believe everything you claimed you have. I’m offering a way to address a risk (however slight) that causes minimal or no economic impact and — if you are really sure it’s a non-issue due to natural switch away from carbon based energies — it’s all dormant anyhow. But at least we were good stewards for taking a rational approach to the risk.

  5. Bruce, here is the problem with the liberal cap and trade policies: anytime the government gets involved in a scheme like this, it ends up choosing winners and losers, which encourages corruption and causes perfectly viable businesses to be forced into bankruptcy. In addition, such a scheme necessarily causes higher costs to consumers, which again is an additional unnecessary tax. Such policies also stifle innovation, which is exactly the opposite of the environment we want — we want increased innovation so we can discover new sources of energy.

    Here is something interesting to think about. VP Biden recently said all invention started with government action. This is a ludicrous statement — Edison for example came up with most of his ideas without any government involvement. But he mentioned the railroads in the 19th century. When you actually study the railroads, there was government involvement in some railroad companies. For the most part, these were the railroads that went out of business because of bloated costs. But there were dozens of profitable private railroad companies, which were successful and efficient for decades, really until the last 40 years. Amtrak is a govt-subsidized enterprise that should be allowed to fail so that other, more efficient alternatives could spring up.

    In general, industry succeeds despite the hand of government trying to get in the way, not because of it.

    We have a private VC marketplace that is doing an incredibly efficient job providing seed money to private enterprises. THIS is our savior, this is what will create the next group of companies that will provide carbon energy alternatives. This model succeeds best when government stays out of the way. If you study what is actually happening to the VC marketplace in California, it is being destroyed by government involvement. Higher taxes are causing employees to be forced out of Silicon Valley. Global warming legislation is forcing companies out of California to other states. We are literally killing the goose that laid the golden egg.

    So, my answer to your number 1) is that, yes, markets are the natural order of things so markets will continue but that the cost will be so high and so counter-productive to the private entrepeneurial environment that we want, that we will be destroying entire industries (and causing millions to lose their jobs) and SLOWING the development of alternative energy sources. This is exactly the opposite of what we should be doing.

    Regarding your number 2, we may have a possible area of agreement. I think we both can agree that there are certain triggers (I mention some in number 1) that should cause all of us to be alarmed regarding CO2 and the environment. If you want me to agree that we should pass some legislation JUST IN CASE we hit some of those trigger points, I would probably agree. So, for example, let’s pass legislation that says X, Y and Z happen in case temperatures go up 5 degrees C globally in five years or even 10. The key is, “what are X, Y and Z?” I hope you address that in your next post.

  6. Geoff,

    Good thoughts. I hear you on the fear that government screws things up. Obviously that is always a concern.

    “necessarily causes higher costs to consumers”

    “is that, yes, markets are the natural order of things so markets will continue but that the cost will be so high

    Just to be clear, I am suggesting that if it’s true that a trade off of time for cost is possible — as we are taught be economic theory — then we can take those ‘additional costs’ you fear and either minimize them or possibly even eliminated them all together. (i.e. due to being such a slow switch over to non-carbon fuels.)

    Do you agree that markets are supposed to be able to do such a trade off between time and money? That is certainly basic economic theory. If you agree, then you can’t use the objection that “the cost will be so high” because that’s only true if we force a quick change — which I have stated I am not advocating. Do not make the mistake of assuming my conservative proposal is somehow the liberal proposal.

    I’m also suggesting that if economic theories are correct, that your objection that it “necessarily causes higher costs to consumers” is also not true unless we’re talking about only negligible higher costs.

    For example, by legislating a future additional cost for CO2 — rather than one today — the costs do not raise today by much, but future plans will be made with the additional costs in mind. This will cause the market for alternative sources to start to innovate without effecting current prices. (Well, obviously it might effect them a bit because future plans start to project to be higher. But it’s a much much smaller impact.)

    You can keep the rest of your objections, but I’m saying that if you agree that time and cost can be traded off that these two objections (the most important two) are now eliminated.

    Plus, keep in mind that I was advocating 50 years or longer for a switch over. If you are right that a switch over (to non-carbon fuels) is going to happen on it’s own shortly anyhow, then I’m literally advocating for engineering a switch over that will never take effect because your predicted natural one will happen first. So the impact is now literally zero and you should have no objections at all on the “additional cost” front.

    So once that concern is removed, does that redo the ROI for you?

  7. Discussions of curtailing combustion usually bring to my mind the myth of Prometheus. In Hesiod’s 8th Century B.C. telling of the tale:

    The gods keep livelihood hidden from men.
    Otherwise a day’s labor could bring a man enough
    to last a whole year with no more work.
    Then you could hang your oar over the smoke of your fireplace
    without a thought for the work of oxen and hardy mules.
    But Zeus was angered in his heart and hid the means to life
    because Prometheus with his crooked schemes had cheated him.
    This is why Zeus devised sorrows and troubles for men.
    He hid fire. But Prometheus, noble son of Iapetos,
    stole it back for man’s sake from Zeus, whose counsels are many.
    In the hollow of a fennel stalk he slipped it away,
    unnoticed by Zeus, who delights in thunder.

    [Works and Days, lines 42-53, translation by Apostolos N. Athanassakis]

    Centuries later in Aeschylus’ play Prometheus Bound, more connection was made between fire and civilization:

    Yea, to my friends a woeful sight am I.

    Hast not more boldly in aught else transgressed?

    I took from man expectancy of death.

    What medicine found’st thou for this malady?

    I planted blind hope in the heart of him.

    A mighty boon thou gavest there to man.

    Moreover, I conferred the gift of fire.

    And have frail mortals now the flame-bright fire?

    Yea, and shall master many arts thereby.

    And Zeus with such misfeasance charging thee —

    Torments me with extremity of woe.

    And is no end in prospect of thy pains?

    None; save when he shall choose to make an end.

    [translation by G.M. Cookson]

  8. “I bet technological advances will happen that will move us away from carbon-based energy long before any of those three conditions I mention above take place.”

    Noncarbon technology has to have some prospect of profitability before serious advancements will be made. With carbon so cheap, such prospects do not exist. Nothing will accelerate noncarbon technology faster than a carbon tax that makes noncarbon technology competitive. Once it has a significant share of the market, economies of scale will kick in, reducing the price. Carbon use will decline and the incidence of the tax will fade to relative insignificance.

  9. LL, in the meantime millions will lose jobs and there will be huge disruptions in the economy. A barrel of oil was under $10 in 1984-85. It is now about $80. Carbon is not relatively cheap, it is actually fairly expensive by historical standards.

    If you really care about technological innovation, the best thing you can do is to lower tax rates on “the rich,” decrease capital gains, lower the estate tax and lower dividend taxes. These taxes are direct disincentives to people discovering new technologies because the relative returns on their discoveries become less and less profitable. This means less VC money, which today is the key driver to innovation (I’m sure you know that most of the greatest inventions today get their expansion money from Venture Capital, which is very sensitive to tax rates).

    History has show us that greater taxation means less innovation. This is one of the reason not as many things get discovered in Europe anymore — tax rates are so high that the incentive to take risk is very low. The carbon tax, in addition to putting millions out of work, will be exactly counter-productive to creating the pro-innovation environment we want in the U.S. This will delay new sources of energy, not encourage it.

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