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My last article on Obama's energy policy (Cap
and trade would sink the US economy and permanently change the political
landscape) certainly provoked an angry
response from the green energy brigade. Now experience has taught me the
futility of trying to reason with those who dogmatically cling to ill-informed
opinions. Nevertheless, considering the extreme importance of this issue it
is pretty clear that the nonsense that is being dished up in defense of
Obama's energy policy needs to be refuted. I don't imagine for one moment
that my critics are open to a closely reasoned argument. Hence this response
is for those who prefer facts and reason to green dogma.
The first thing I noted is that all of the criticism was
completely void of economic reasoning. It seems that for these people
economics really doesn't matter, particularly if its conclusions run counter
to green dogma. Secondly, I was left wondering in some cases whether the
critic had actually read the article. My third observation was the tendency
of some critics to rely entirely on logical fallacies.
One line of attack is that mine is an old and tired argument
that was discredited by the clean air acts. According to this line of
thinking, as these acts did not hurt American industry then neither will
Obama's energy policy. This is a non sequitur. It does not follow that
because these acts allegedly had no detrimental effect on industry and
therefore living standards Obama's energy policy will not damage the US
economy. Moreover, it simply is not true that stringent environmental
controls did not affect the economy. Like it or not, these regulations are
not costless.
In 1979 the economist Murray Weidenbaum calculated that
pollution controls were costing industry $100 billion per annum. (About $262
billion in today's money). This expenditure was at the expense of investment
that would have raised the productivity of labour and hence real wages.
Harvard economist Robert Leone showed that water pollution controls slashed
the number of metal finishing factories from 70,000 to 5,000. Further
investigations also showed that these regulations had the same effect on
tissue-paper manufacturers. The results were predictable: large firms
survived while their smaller competitors were bankrupted. Needless to say,
these large concerns favoured the regulations1.
I find it very hard to believe that the pollution from metal
finishing factories was so great that 93 per cent of them needed to be
bankrupted. But this is simply the result of the "Pigouvian" policy
of taxing negative externalities so as to bring private costs into line with
social costs. Unfortunately Pigou's tax solution is deeply flawed. His
erroneous view of the problem led the British economist Ronald. H. Coase to
develop what became known as the Coase theorem, which basically argues that
optimum outcomes are achieved if property owners are allowed to negotiate
between themselves. (This is a highly stripped down description of the
theorem). In other words, the problem here is not market failure but
institutional failure.2
It is generally recognised among economists that the Coase
approach is superior to the Pigouvian remedy, though I believe it does
contain a serious flaw with respect to its particular use of prices. Now if
the Coase approach had been applied to the water-pollution problem would
65,000 metal-finishing factories -- not to mention a large number of
paper-tissue manufacturers -- have been forced to wall? I doubt it.
A Pigouvian policy results in a bureaucratic strait-jacket, a
one-size fits all irrespective of individual circumstances. Moreover, it is
open to corruption and political abuse. For instance, what is to stop green
fanatics in the Environmental Protection Agency from using it to try and
destroy an industry -- coal mining, perhaps -- that they don't like?
Pollution controls are not costless. This is not to imply that
they are not necessary, only that we need to be made aware of the fact that
there are always trade offs. I was raised in the Midlands, sometimes called
the industrial heart of Britain, and I still vividly remember the unbelievable
density of the smog -- which was also a killer -- and its frequent
recurrences. Thanks to the clean air acts (there was no pollution tax) smog
quickly disappeared from the British environment. But This only happened
because economic growth had created the wealth and the means to eliminate
smog with very little cost to the economy.
One critic declared that "connecting a cap and trade tax to
capital was dishonest". This amounts to saying that a land tax would not
affect the price of land, or that changes in demand cannot affect the prices
of capital goods. In other words, only a complete economic illiterate could
make such a ridiculous assertion. Fortunately there exists a recent example
that neatly exemplifies my point. Australia's National Generators Forum
estimated that the Rudd Government's carbon tax would impose $10 billion in
capital losses on coal-fired power plants. (ETS 'may bankrupt power
stations', Lenore Taylor, The Australian, 1 May 2009). So much for
the air-headed notion that carbon taxes cannot affect the prices of capital
goods and therefore the capital structure.
In order to deal with the remaining criticism I must once again
return to capital theory. For the sake of simplicity I shall use the orthodox
approach and assume capital is homogeneous, with the proviso that capital
goods are also discrete. This means that we can now measure the actual amount
of capital. Let us number the capital stock at 100. Of this amount 10 units
are used to provide electricity for the whole economy. We also assume that
all the firms have factor combinations that minimise their average costs of
production.
Everything is going swimmingly until a group persuade the
government that unless the current method of using centralised generating
plants to produce electricity is abandoned in favour of wind and solar power
there will be a colossal environmental disaster. The government now mandates
that the plants must be phased out and alternative energy used instead.
But because energy density for solar and wind is pathetically
weak and hellishly unreliable they will require vastly more capital and
labour to produce the same amount of electricity as a centralised generating
plant3. Now let us say it has been estimated that alternative energy
production is three times more expensive then the usual method. Does this
mean that the economy would now need 30 units of capital to produce its
electricity? Bad as this would be, the actual situation would be far worse.
As centralised power plants are closed down more and more
labour, land and capital is directed to the production of the same unit of
electricity. In plain English, productivity will dive and prices will
"skyrocket", a fact that Obama admitted and which his supporters
ignore. The price of electricity rises, not because it costs more (prices
determine costs, that's why imputation exists) but because there is less of
it. Because electricity prices are rising firms now find that their factor
combinations no longer minimise their average costs of production. These
combinations will start to disintegrate as firms move to more labour
intensive techniques that employ less energy and capital goods will be
abandoned4. Productivity falls, forcing down real wage rates and hence living
standards. If this process continued uninterrupted the economy would come to
rest at a point where living standards and the consumption of electricity
have reached an abject level.
Critics could once again scream that this approach is too simplistic
to apply to the US economy. On the contrary. In the real world capital goods
are heterogeneous: this is a fancy way of saying that they are not perfect
substitutes for each other. In such a world there is a great deal of
specificity, meaning that changes in costs and demand can completely destroy
the value of specific capital goods. This is one of the reason's Obama's
energy policy would be particularly devastating.
Two further points: I thought it was clear from my last article
that the idea that revenue from a carbon tax could offset its destructive
effects was ludicrous5. Judging from some of the emails I got I was wrong.
However, it should now be abundantly clear why it is impossible for tax cuts
to offset the income effects of a carbon tax let alone stabilise energy
prices and stimulate the economy.
This now brings us Co2 and the Orwellian dishonesty of the
greens and their media allies. Co2 is not a pollutant: it is a nutrient and
the building block of life. Secondly, it is not true that human activity
correlates with the amount of Co2. The green argument that human activity
correlates with global temperatures is another lie. (The Carbon Sense Coalition).
A final note: Not a single critic
commented on the quotes from leading greens in which they admitted that
alternative energy sources are to be promoted because they are expensive. Now
why was that, I wonder?
1. The role that the big meat packers played in regulating their
industry during the Teddy Roosevelt administration was detailed by Gabriel
Kolko. (The Triumph of Conservatism, Free Press, 1977. pp. 98-108).
2. With respect to market failure, one obviously exasperated
critic wrote, "OK smarty pants, whats your brilliant theory to explain
the financial and banking crisis?" What is it with these people? I have
written numerous articles on the causes of the trade cycle and the financial
crisis and this bloke wants to know what my theory is. It is not my theory,
it is the Austrian school theory, the roots of which can be traced back to
some of the early classical economists. Seeing as this character is too lazy
to do a Google search I'll give him a hand. Try Prime Minister Rudd's misbegotten assault
on the market goes unchallenged.
3. In my last article I emphasised the fact that even if these
alternatives were 100 per cent efficient technically they would still be
horribly inefficient economically and that there is absolutely nothing that
can be done about this situation. This why I said you cannot get a gallon out
of a pint pot. Nevertheless, critics still mindlessly asserted that all we
needed is "greater efficiency". Imagine that two techniques, A and
B, produce p. A requires one unit of labour and nine units of capital while B
requires one unit of labour but only 3 units of capital. It is obvious that B
is the more efficient technique. However, in the greens' world we would be
forced to adopt A. And this is eactly what is happening with respect to
energy.
4. Some could argue that because the capital goods are perfect
substitutes they would simply be recombined with labour and land but with a
lower level of productivity. My argument is that capital goods are by
definition complementary. This means that because of the supply of
electricity had been drastically curtailed there would not be enough energy
to now employ the entire capital stock.
5. The Sydney-based Centre for Independent Studies has also been
promoting this rubbish.
Gerard Jackson
Brookesnews.com
Also
by Gerard Jackson
Gerard Jackson is Brookesnews Economics
Editor
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