Plague of economists continues

Martin Feldstein uses Washington Post op-ed page for cap-and-trade scare-mongering 13

Martin Feldstein is a conservative economist—a long-time advocate of supply-side, trickle-down economic policy and a leading advocate for Social Security privatization—so it’s no great surprise that he has taken to the pages of the Washington Post to characterize the Waxman-Markey climate and energy bill as “All Cost, No Benefit.”

Feldstein has one good point: that it’s scandalous how many of the pollution permits are being given away instead of auctioned. And he has one argument so disingenuous I have a hard time believing it is made in good faith: that since a global agreement will be necessary to achieve the necessary reductions in CO2 emissions, we should wait until such an agreement is in place before passing a domestic law. (Since other nations insist that America demonstrate its commitment to climate action before they’ll sign on to a new international accord, Feldstein’s strategy would make an international bill impossible, so advocating for it is tantamount to arguing that the problem isn’t worth solving.)

But I want to focus on another point.  Feldstein cites a CBO analysis showing that cap-and-trade (to reduce emissions by 15 percent by 2020) would cost the average American family $1,600. And he says that cost will rise as the cap on carbon declines.

A number of things could be said about the CBO’s work on climate, but the main point here is that Feldstein is using it in a highly deceptive way.

The $1,600 number is simply a calculation of how much prices would rise if current businesses are charged for carbon emissions. It leaves out three crucially important factors:

1. Revenue

As current cap-and-trade systems are constructed, government collects carbon charges from businesses and redistributes the revenue. It does not, contrary to what you might think from reading conservative economists,  light the money on fire. Under Waxman-Markey, the money is not returned directly to consumers, as Feldstein prefers. However, a huge chunk of the permit value finds its way to consumers, via regulated local electric distribution companies (LDCs), assistance to low-income consumers, money to keep trade-exposed industries from moving to China, and money to states to accelerate RD&D for clean energy technology. All that money eventually benefits consumers—that is to say, it all reduces that $1,600 figure.

2. Complementary policies

The CBO analysis looks purely at cap-and-trade. It doesn’t figure in the effect on consumers of the other provisions in the Waxman-Markey bill, which address clean energy, energy efficiency,  the electric grid, green jobs, and more. All these complementary policies would accelerate and lower the cost of the transition from dirty to clean energy—that is to say, they would all reduce that $1,600 figure.

3. Innovation

The costs that a carbon price will impose on consumers are determined by, in dork-speak, “elasticity of demand.” The question is, how easy is it for consumers to shift from increasingly costly carbon-intensive products and services? How easily available are alternatives? If it’s trivially easy to switch from product A to product B, which costs about the same, then the costs will be little-to-negligible. If there are no alternatives available (for example, no low-carbon electricity), then consumes have no choice but to pay the rising price, and costs will be high.

Conservative think tanks like the Heritage Foundation tell us that climate legislation will raise consumer prices by an average of a kabajillion dollars per defenseless elderly lady, but those claims assume zero elasticity of demand; their projections are based on the (bizarre) notion that when prices rise on a class of products and services, consumers will just ... wince and pay, no matter how high the price goes.

It’s not just the conservatoids, either. It’s the nature of the econometric modeling beast.  Most economic analyses are run based on current technology, current products and services. At best prices of alternatives decline along a gentle curve.

But think about it: why would that be true? If U.S. history shows anything, it’s that when the market is challenged it is capable of extraordinary innovation. That’s why the costs of regulation always end up being lower than economists predict—entrepreneurs develop new products and services and make them cost-effective. This kind of innovation can’t be predicted, so perhaps it’s legitimate the economists don’t incorporate it into models, but as a result their models are horrible predictors, as history has shown again and again.

Anyone with faith in the smarts and guts of American entrepreneurs (hello conservatives!) should believe that the same forces will be unleashed when it comes to carbon: Challenged by new regulations, entrepreneurs will find cost-effective ways of reducing energy demand and generating low-cost renewable energy. That will increase elasticity of demand and lower prices for consumers—that is to say, it will lower $1,600 figure.

So Feldstein’s use of the $1,600 figure in relation to Waxman-Markey is accurate (and honest) only insofar as he ignores the revenue used for consumer benefit, the complementary policies, and the capacity of markets for innovation. All these will lower the price for consumers.

I don’t mind if conservatives hate regulation. But it’s really deplorable how easily they resort to distortions and scare tactics. I would say that the WaPo editorial board should know better, but I guess that ship sailed long ago.

David Roberts is staff writer for Grist. You can follow his Twitter feed at twitter.com/drgrist.

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  1. Ken Johnson's avatar

    Ken Johnson Posted 4:09 pm
    01 Jun 2009

    "As current cap-and-trade systems are constructed, government collects carbon charges from businesses and redistributes the revenue." - only to the extent that international offsets are not employed. By reducing trading prices, international offsets do not necessarily reduce costs, because they provide no revenue to redistribute."All these complementary policies would accelerate and lower the cost of the transition from dirty to clean energy" This would appear to undermine a fundamental tenet of cap-and-trade, that market-based instruments (trading) can achieve emission reduction more cheaply than direct regulation."...the costs of regulation always end up being lower than economists predict ... This kind of innovation can’t be predicted ..." That's precisely why some people favor tax-type instruments. If your policy is based on willingness-to-pay, then direct regulatory control of emission prices will be more effective than emission targets that are based on over-inflated expectations of what emission prices might be.

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  2. hapa's avatar

    hapa Posted 6:05 pm
    01 Jun 2009

    feldstein is painting a picture of "arms race" -- "if i put down my economic advantage, those ****ers will shoot me" -- which is fascinating because the last time i checked, having all your banks implode is a serious economic handicap, and martin isn't a fan of bank regulation.ah, well, anything for the cause.ok so,"All these complementary policies would accelerate and lower the cost of the transition from dirty to clean energy" This would appear to undermine a fundamental tenet of cap-and-trade, that market-based instruments (trading) can achieve emission reduction more cheaply than direct regulationyesssssss... isn't it funny how often and how easily economic efficiency fails to deliver the goods to ordinary households.…

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  3. enviroperk Posted 8:32 pm
    01 Jun 2009

    The version of the bill I have reviewed, the House version here  does not provide a any specifics on how much will flow to the consumer. Frankly, there appears to be no specific requirement that funds received are committed in any pro proportion to anything specific. I see a big grant to large utilities, and even bigger grant if they use bio fuels.Mr. Roberts, am I missing a section or interpretation of the bill you have seen to reach your conclusions on this?Mr. Feldstien is not poorly educated, was a mentor to Larry Summers, and though widely considered Conservative, he clashed with Reagan and now serves on President Obama's Economic Recovery Advisory Board. I am sure your insight is superior, but he may know a thing or two about the bill and have something useful to add to the debate here.I do not automatically think every conservative person is ignorant or  wants to run the country into the ground. Granted, his AIG Director position is a bad omen. However, the issue of privatization of Social Security is not something to be discarded. Right now there are no funds sitting in any one's Social Security account. Just an IOU from the Federal Government saying we spent the money but we got you covered. Given the deficient this year, I wish my Social Security  fund was in stocks, as weak as they may be.     

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    1. hapa's avatar

      hapa Posted 9:50 pm
      01 Jun 2009

      woah. social security is solvent for 40 years. don't freak out.
      unless you WANT to freak out. in which case: there's no money sitting in your bank account, either! just an IOU!
      money. weird stuff.

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      1. enviroperk Posted 10:11 pm
        01 Jun 2009

        Actually, Social Security's solvency varies every fiscal quarter based on receipts by the Social Security Tax system, and changes in benefit levels legislated. In April, the receipts dropped by 25% +, on an annual basis this reduces the solvency by maybe 3-4 years. Changes in benefits are inflation adjusted which further reduces the levels. If you are 30 and plan to live to 85 ... well you research the math.Further, a new government in say, 2025, could declare that we can no longer fund Social Security at the expense of the working class, so all benefits backed by the special class of debt ( it is not t-bills, it is a unque class on its own that can be voided separately from T-bill) backing SS could be declared null and void. It would be a bit more difficult to declare all stock investments as null and void.Even in 2009 when GM means Government Motors and the national debt in one year is... well , suffice to say this is not a far fetched idea. By 2020 or 2025, the youth of America could demand it. Otherwise, without immigrant populations, they will be pay SS taxes alone that are double what we pay now .. just to fund our( those born in the 1960s and 1970s) retirement.If you also count retiring our current debt, I dare say the income tax rate will be much higher. Math on that anyone?   

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      2. hapa's avatar

        hapa Posted 11:00 pm
        01 Jun 2009

        so what you're saying is one day the government might steal everybody's money and keep it.
        and you're thinking, the way to stop them would be to move social security to the honest people who run the stock markets, because that one thing will ensure that in the future the country doesn't elect the scum of the earth.
        do you think it might be possible that the honest people running the markets might... be... the ones trying to take that money?
        considering what just happened. to the stock market. and private retirement accounts. and people's home equity. and stuff.

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      3. Green Granny's avatar

        Green Granny Posted 9:31 am
        02 Jun 2009

        I'm with HAPA.

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  4. Clifford Wells's avatar

    Clifford Wells Posted 11:09 pm
    01 Jun 2009

    Well we can all feel good about this, that somehow, our consumer costs will go up somehow, no telling by how much, but industries will be glad to pass along any costs of doing business to the consumer.  But so what?  Maybe we could use some inflation around here instead of this nasty deflation or "stagflation." And I agree, doing an analysis on the back of a grocery sack without considering all the options and inputs is not-so-good.  On the other hand, you have to admit that the Old Conservative Bloke was right that the current bill as marked up doesn't do very much, and by giving away allocations really defeats its own purpose - 85% of the credit will be given away!But consider this, everyone seems to think that if CO2 control costs money, and money can be returned to the consumer, it's a Zero-Sum Deal. Wrong-o!  There is a fundamental disconnect between charging people more money and giving them a rebate of the same amount - let's say $1,600 just to be real cute and funny.  You fail to recognize the element of human nature, which is more ruled by game theory and human passion.  Let's take a silly example, something I excel at.  First, your local stinky power company charges you an extra $1,600 a year because of CO2 mandates of some kind.  The government sends you a Treasury Check for $1,600 a year later.  Now I'm supposed to zero-out that?  Hah-hah-hah.  You must be shafting me! Why didn't you just tell the electric company to comply with the reductions and save the expense of writing me a stupid check?  There again, $1,600 is almost enough money to visit the Bahamas for a few days, what the heck.  That's human nature.So it's another Ponzi scheme.  Those reductions of a few percent a year are permanent, supposedly lasting forever ... next year, the year after, and so forth.  Yet you are adding more reductions, generating credits, and presumably some major cash.  The sales or rebates are one-time, one-year reappropriations.  It's game theory I'm telling you, and I can see right through it - wasn't that an episode on that Gilligan's Island TV show or something?It get's worse, David.  Lets say your "reappropriation money" is worth "x" many tons of COx values at "y" amount of dollars, or you decided to buy some CO2 credits when you were slightly tipsey after a lunch with beer.  What do you have in your hand? Absolutely nothing.  In fact, is has a negative mass, worse than a derivative or default credit swap note.  You might be hiding $1,600 in negative CO2 in your hands.  It's reduced, man!  You can't cash it in more more CO2, that's for sure, good luck there.  It has no intrinsic value other than some governmental agency or industry gave you some "consumer carbon credits."  What's next, buying credits so I won't buy my wife a diamond ring, because that would be "African blood money"?  No ring then, for $1,600?  Aiyeeeee, I want to go to the Bahamas instead.Game theory is a strange thing, and economists are starting to use it.  You know I was being light-hearted in what I wrote above, and please. & & &I am seriously thinking that a voluntary, risk-based system that awards grant and subsidies might be the better wat to go.  That economic model works, and there is some major competition for the best grants awarded in proportion to emound reduced due to (1) new technology and (2) increased efficiency. This is the carrot instead of the stick, really.  It's better than giving out free government allowances for 85 percent of the baseline emissions.  If you can generate distributed and powerplant power in a cleaner way, big stuff like 125 megawatts in the distributed system or a central facility, and do it cleaner, then you should be rewarded.  Overall reductions have to occur so as to get any money. So this isn't "cap-and-trade" as much as locking in systemwide emissions by region and type, establishing a cap, and creating incentives to reduce the carbon footprint.  Personally, I think such a program should be started and that it will become more popular in our economy that is trying to recover from a major recession.  If you have 125 MW of baseload power and can prove you're reducing emissions though new technology (or even caulking up old houses) that you can have done in 2 years, I say it's worth a deal. It's game theory, you know.  Then people want everything to work, instead of fail.

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  5. Max8806's avatar

    Max8806 Posted 3:47 am
    02 Jun 2009

    David, The allowances allocated to electricity LDC's will raise costs for consumers (that $1600 figure would go up not down) because by mitigating price increases in electricity, prices must rise in other sectors to ration the carbon that is not saved as rising electricity prices spur changes (not just lower demand - elasticity of supply is a major player as well) in that sector. And since the electricity sector has the low-hanging fruit, those price increases in other sectors will have to be harsher, because we won't let the easy stuff work its way out.This has been written about on grist before, and I thought I'd seen you acknowledge it as well, not to mention its common knowledge among economists. Why pretend it away now just to tow the company line?

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    1. David Roberts's avatar

      David Roberts Posted 1:07 pm
      02 Jun 2009

      I wish I had a nickel for a) every piece of highly contentious speculation that is "common knowledge to economists," and b) every time I've ben accused of either blindly following the Dem line or blindly following the enviro line or blindly following the Grist line or blah blah. I can't see how the insult adds anything to your point.Anyway, I'm going to do a post on this, so I won't get too far into it, but the idea is that the price signal is preserved because the per-kwh cost goes up -- the lump sum rebate is unconnected to use and included in the fixed-price portion of the electrical bill. Maybe, as Gar alleges, that gets consumer psychology wrong and use will be unaffected. Maybe not. I expect anybody who claims to know for certain is full of it. Anyway, I tend to think consumer decisions aren't the prime mover here. I care more about utility-run energy efficiency programs and power plant investments. The "making consumers suffer until they change" model is neither good politics nore the end-all be-all of energy policy.

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      1. Max8806's avatar

        Max8806 Posted 10:44 am
        03 Jun 2009

        David, I look forward to your post, but you have overlooked something very important here. There's no mandate that allowance value be used to provide rebates at all, meaning no mandate that the price signal be preserved, and in reality it likely never will. Sec 783 (3) (C) "Limitation" says that "to the extent an [LDC] uses [allowance value] to provide rebates, it shall, to the maximum extent practicable, provide such rebates with regard to the fixed portion of ratepayers' bills." Nowhere is a rebate mandated, only that (in 783(A)) allowance value be used for ratepayer benefit. The "to the extent" part quoted above makes explicit that rebates are not mandatory.And why use allowance value for price-signal-preserving rebates? From the PUC's perspective it just complicates things. The simplest way to comply with 783 is to just rule that all allowances purchased by the utility are passed along as fuel costs to ratepayers. That way, allocated allowances clearly benefit ratepayers by detracting from the costs for purchased allowances that are eventually passed through. Plus it has the legal precedent that this is how SO2 allowances have been treated by most (all?) PUC's.So again, why rebate? That would mean a utility would have to1) get allowances allocated2) sell all those allowances, put money in bank account X3) buy that many allowances back, and then more4) raise prices significantly5) Empty bank account x in lump sum rebates to ratepayers Clearly that's a lot of waste on administrative costs and transaction fees for selling allowances and then buying them back. The obvious and efficient thing for each PUC to do will just be to allow allocated allowances to detract from passed through "fuel" (purchased allowance) costs, except when everyone does that we all lose, because of the argument I initially laid out in the first comment. Honestly, this is a pretty clear case where if the politicians listened to the economists, auctioned all permits and returned the revenue itself to consumers, we'd be far better off.

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  6. LogicRules Posted 9:30 pm
    02 Jun 2009

    A U.S. Cap and Trade bill is an effort in self destruction, nothing more.  Unless your intent is to destroy the economy and drive industry out of the country, it will be a failure.  The biggest issue with Cap and Trade is that most of the world will have no incentive or ability to reduce their emissions, they have coal, and it is cheap.  I suggest reading a paper by Peter Huber available at http://www.city-journal.org/printable.php?id=4377 for a discussion of the issues.  

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    1. enviroperk Posted 11:38 am
      03 Jun 2009

      Thank you for that article by Huber.But Ouch! I feel the hurt of an unkind truth. I hope he is not correct but fear he is spot-on.Really, how much CO2 reduction will we need, by what date, to stop, and then reverse global warming?Possibly, we cannot stop or reverse it and all of our resources may best be spent learning how to survive it?

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