Comments Matt Rognlie has made

You miss the point entirely here when you snark: "Government spending cannot compensate for that reduced growth, because governments aren’t as smart as markets."

The question isn't whether given a certain amount of capital $X, the government or the market will do a better job at allocation. That question is irrelevant, because there is no mechanism by which the government can raise capital from the private sector without distorting incentives and incurring a deadweight loss. This is a reality that no one denies, even if there is plenty of quibbling about the size of the loss.

You should read up on the relevant literature, especially this primer on the mythical double dividend and this explicit analysis of the costs of implementing emissions taxes without offsetting income taxes. Essentially, by raising the costs of consumption, a carbon tax acts as an implicit tax on income, albeit one that lacks the anti-savings bent of the income tax. In isolation, this is fine. In fact, it's optimal: if you ignore the presence of existing income taxes, you will find that a carbon tax discourages labor exactly to the extent that maximizes efficiency in the economy. (People may work a little less because it's not worth it to shell out for carbon-intensive goods anymore.) This is one of the nice efficiency results that pops out of Environmental Economics 101. 

We do not, however, live in a world where income taxes are zero, and this significantly complicates the analysis. If a carbon tax effectively decreases the value of income by 2%, but the income tax rate is already 25%, then this "tax interaction effect" moves the effective income tax rate from 25% to 27% rather than from 0% to 2%. This is far more damaging. It can be alleviated by recycling the revenues to lower actual income tax rates, but otherwise the true costs of the emissions-reduction program can go increase by up to several hundred percent, as the analysis linked above estimates.

Dave,

All right -- I hate to distract you from your deadline, and I have plenty of impending work as well (including, suddenly, a broken stove in the kitchen). I'll just respond to a few points in the hope of clarifying my intentions, and not expect any response from you. At this point, presumably no one else is reading this comment thread anyway, so it doesn't matter too much.

I think our problem regarding the oil discussion is that there two distinct arguments being made:

1. When a significant portion of national income is dedicated to oil consumption, oil price shocks may have negative macroeconomic effects that go beyond the private cost of oil to each consumer.

2. Fuels-based energy is much less labor-intensive than alternative energy, or efficiency-oriented infrastructure projects. Most of the money goes to resource

I think #2 is a lot weaker. Admittedly, I can see a situation where shifting expenditures from scarcity rents to wages would be optimal because of the distributional benefits, even if it involved some extra costs. The problem is that at the margin, we import basically all of our oil. Importing this oil causes the dollar to weaken relative to where it would otherwise be; this, in turn, ultimately raises the volume of exports to match the import spending on oil. From our domestic perspective, then, the money we spend on fuel imports cycles back into our exports -- and our exports (especially at the margin) may not be any less labor-intensive than the "green" spending proposed as an alternative. The distributional benefits thus disappear.

Now, it is possible that a carbon tax could provide a boost to some infant alternative energy technology, which will ultimately help the economy. (I cover the quite reasonable economic logic for this position here.) The problem is that a stiff carbon tax causes all sorts of other inefficiencies that aren't at all related to industry development. If our main goal is to encourage the development of new industries that have difficulty achieving economies of scale (or technology) on their own, we have much more efficient means at our disposal to do so. The only justification for specifically implementing a carbon price is the damages from global warming. Again, I think that the damages are large enough that this is a satisfactory justification, but it is essential: if we're interested in the economic benefits from infant industry protection, there are a million far better means (like direct subsidies) to accomplish this. In fact, I think that the optimal policy is some combination of a carbon price, to account for the damages from carbon emissions, and targeted subsidies to technologies like solar energy, to account for the market failures associated with early-stage development of energy technology.

Regarding infrastructure spending,

"First, while a whole massive infrastructure spending program cannot be cast as a short-term stimulus, there is plenty of short-term infrastructure spending queued up -- there are ongoing capital projects in states that are on hold as we speak, and passing some money to them would mean short-term spending."

Fair enough. The procyclical effects of no-deficit state budgets are pretty awful, and I'd be glad to see increased spending in the short term. I'm not sure how relevant this is to the points discussed here, though -- my sense is that we're talking about things like massive new rail projects that take years to plan and construct.

"And second, long-term infrastructure spending is constantly shunted aside by the perceived need for insta-stimulus. It's an irksome dynamic. Every economist I know agrees that infrastructure spending is falling woefully short, and that spending on urban infrastructure and inter-city transit pays itself back richly in economic development benefits."

Well, sure. My whole point was that I thought that the case for public spending should be made on its own long-term merits, not perceived "multiplier" or stimulus effects, which I don't think are very relevant anyway.

On this topic, we probably agree more than it appears. I think that there are probably many benefits from improved public transportation systems in large cities. I'm more skeptical about inter-city transportation -- because I don't think the market failures that justify government involvement are there in such abundance -- but I am perfectly open to the notion that infrastructure investment may have huge payoffs of its own.

The main problem is that the infrastructure discussion is actually pretty tangential to the global warming debate. Yes, I know this is counterintuitive, and I make the case in this post that even an unprecedented expansion of rail is unlikely to lower carbon emissions by more than 1% or so. As I mentioned earlier, a high-ish carbon price of $75 would increase gas prices by 75 cents -- not insignificant, but it won't revolutionize the case for alternative transportation much more than the recent run-up in oil prices has already done. Other sectors of the economy (coal electricity, certain kinds of heavy industry) are far, far more sensitive to carbon prices, and that is where the main effects of anti-climate change policy will be felt. In many ways, the economic benefit of city infrastructure spending is a very different policy question.

As far as the whole debate about economic modeling... frankly, I don't even care much about the details of whatever general equilibrium models are being used. I'm just relying upon the simple and valuable economic intuition that in the absence of market failure, significantly distorting the market damages the economy. Of course, there is a gaping market failure here, the externality from carbon emissions, but that's my entire point: carbon prices should be justified according to the damages from climate change. They should not be justified according to the mishmash of other arguments presented here, which are either (1) tangential to climate change, (2) flawed economically, or (3) partially correct, but actually better suited to justifying a different policy.On Climate policy isn't a pill to swallow, it's a way off a sinking ship posted 1 year, 4 months ago 16 Responses

A misreading of economics

You write:

"It is long past time to stop acceding to the absurd notion that money spent to avoid high fuel prices is just sunk inflationary cost. It's not. It is investment in other things, and those other things will generate economic activity and jobs."

I'm not sure what exactly "sunk inflationary cost" is supposed to mean -- certainly it's not a phase in any wide use among economists. That said, I think that your follow-up perfectly encapsulates the flaw in your reasoning.

Almost anything will "generate economic activity and jobs." If the government decides to spend $1 trillion launching pointless wars in the Middle East, it may increase overall GDP. This is a complicated point, because you have to pit the GDP-lowering distortionary effects of taxation against the GDP-raising income effects of taxation, and any countercyclical stimulus effects from military spending against the destabilizing effects of the resulting war. But let's say, for the sake of argument, that $1 trillion war expenditures would increase total GDP.

This is still not good for the economy in any meaningful way. Sure, overall "output" might rise, but since the output is directed toward something that generally doesn't contribute to the welfare of society (war), Americans in general will be worse off. Yet using your logic,  one could deploy the same generic rhetoric about "economic activity and jobs" to justify this spending. This shows the flaw in your discussion of economic benefit.

Now let's indulge another thought experiment for a minute. Say that the damages from global warming didn't exist, and that we were utterly positive that no harm would come from increased emissions of greenhouse gases. (Obviously, this is ridiculous, but that's why it's a thought experiment!) Every piece of your reasoning here about why fighting climate change is good for the economy would still be valid. With your logic, the economy would be better off if we retooled to fight crises that didn't exist. In fact, your logic justifies any labor-intensive public expenditure as "good for the economy." Under the rubric implicitly laid out in your post, hiring millions of Americans to build towers out of toothpicks would be a good economic decision -- after all, it "keeps money in the economy," is extremely labor-intensive, and has positive multiplier effects!

The fact that your reasoning leads to such absurd conclusions indicates that there is something fundamentally wrong with it. Again, one important flaw becomes clear with the "$1 trillion war" example: what matters isn't the total amount of economic output, but rather how that output is directed to make people's lives better.

There are other instances of economic naivete. "Multiplier effects" are only beneficial when we're in a cyclical downturn and want to lift ourselves out of it with government spending -- otherwise they would be a justification for spending almost anything, at any time. "Keeping money in the economy" is a classic protectionist fallacy. "Generating more jobs" is meaningless: the aggregate rate of employment in a country is determined by large-scale macroeconomic factors and the Federal Reserve, not by individual sectors "adding jobs." Maybe the jobs associated with alternative energy will tend to be higher-paying ("green collar") than other occupations available to low-skill workers, but you have to balance this potential distributional benefit against the fact that higher energy prices disproportionately affect the poor.

Please don't interpret my response the wrong way: I am not saying that we shouldn't take strong measures to stop global warming. In fact, I am in support of a strong carbon tax or cap-and-trade regime, because I think that the possible damages from climate change are enormous. But I think it is dangerous to spread the idea that fighting global warming is somehow costless, because it isn't. Action should be taken because the benefits outweigh the costs, not because of the fantasy that there aren't really costs after all.On Climate policy isn't a pill to swallow, it's a way off a sinking ship posted 1 year, 5 months ago 16 Responses