Dubious Cap-and-Trade Skepticism

In a Washington Post op-ed, Bjorn "the Skeptical Environmentalist" Lomborg argues that more government funding for research is a better way to reduce carbon emissions than a cap-and-trade system, as in the Lieberman-Warner bill (recently fillibustered by Senate Republicans). He writes:

Politicians favor the cap-and-trade system because it is an indirect tax that disguises the true costs of reducing carbon emissions. It also gives lawmakers an opportunity to control the number and distribution of emissions allowances, and the flow of billions of dollars of subsidies and sweeteners.

Many people believe that everyone has a moral obligation to ask how we can best combat climate change. Attempts to curb carbon emissions along the lines of the bill now pending are a poor answer compared with other options.

Consider that today, solar panels are one-tenth as efficient as the cheapest fossil fuels. Only the very wealthy can afford them. Many "green" approaches do little more than make rich people feel they are helping the planet. We can't avoid climate change by forcing a few more inefficient solar panels onto rooftops.

The answer is to dramatically increase research and development so that solar panels become cheaper than fossil fuels sooner rather than later. Imagine if solar panels became cheaper than fossil fuels by 2050: We would have solved the problem of global warming, because switching to the environmentally friendly option wouldn't be the preserve of rich Westerners.

Lomborg seems to miss the point of a cap-and-trade: by making it more costly to emit carbon, the system would create incentives to develop energy alternatives and increase efficiency (a carbon tax would do the same thing). By changing relative prices, cap-and-trade will create opportunities for firms, entrepreneurs and inventors in the private sector to profit from developing less carbon-intensive methods of producing energy and products that use less energy. It would also give everyone an incentive to be less wasteful by bringing the price of carbon emissions in line with the true cost (i.e. reflecting the private as well as social costs).

Though government research grants might be helpful (as an academic, I can't argue against throwing more money at universities...) using market forces to mobilize the private sector is likely to be a more effective, lower-cost way of getting us to those cheap solar panels.

That logic is standard intermediate microeconomics, but Lomborg - who has a PhD in political science - doesn't appear to get it.

Whose Main Street?

If I had been born a decade earlier, I might have grown up to be a Kremlinologist (probably for the best that I wasn't!). Perhaps the most comparable job today is that of Fed-watcher (or maybe NY Mets front office-watcher).

Today, Washington Post FOMC-ologist Nell Irwin sees evidence of division in the marble temple:

In contrast to the consensus that characterized the Fed for most of the past 20 years, there are now divisions over some of the most fundamental challenges that Fed Chairman Ben S. Bernanke is facing: how to combat the financial crisis, the slumping economy and high inflation.

These divisions are rooted in the structure of the Fed -- which includes 12 regional banks with independent boards of directors, and a central board of governors in Washington chaired by Bernanke -- but have come to the fore only because of the twin problems of weak growth and inflation.

Presidents of the regional banks are appointed by bankers and businesspeople in their communities and, like them, tend to put a premium on keeping inflation in check. The Board of Governors, along with the New York regional bank, has been more attuned to the troubles roiling financial markets, such as those for complicated debt securities and the spillover into the wider economy.

"The presidents bring a wealth of knowledge acquired from their regional contacts," Bernanke said in a speech dedicating the new headquarters of the Kansas City Fed earlier this month.

"Thus, in making policy, we are able to view the economy not just from a Washington perspective or a Wall Street perspective but also from a Main Street perspective."

As Irwin explains, the regional Fed presidents tend to be more "hawkish" (i.e. inclined to favor higher interest rates). However, this doesn't mean that they represent "Main Street," or at least not all of it. The regional Feds are owned by the member banks, which elect most of the board members, and the board chooses the bank presidents. So, it would probably be more accurate to say that the regional Fed presidents represent the interests of Main Street banks, but I would think many that other "Main Street" businesses - a car dealership or real estate agency, for example - would prefer lower rates, even at the risk of higher inflation (I'm not sure about the establishments on Bob Seger's "Main Street"; their business might be counter-cyclical).

Tom Wolfe, Schumpeterian

A year ago, just before the credit market crisis began, Tom Wolfe visited the New York Stock Exchange and declared: "we may be watching the end of capitalism as we know it." The Times' Andrew Ross Sorkin has an interesting follow up:

When I asked Mr. Wolfe about his comment on the floor of the stock exchange, he said, “I didn’t realize anyone would take me seriously.” He says he has since made up an explanation of why he thought it could be the end of capitalism.

Citing Joseph A. Schumpeter, the economist, Mr. Wolfe said, “Stocks and bonds are what he called evaporated property. People completely lose touch of the underlying assets. It’s all paper — these esoteric devices. So it has become evaporated property squared. I call it evaporated property cubed.”

Then he cautioned, “Of course, I’m not an economist.” Maybe that’s why he’s gotten it so right.

So, does this mean the 1980's are over for real this time?

GPM = 1/MPG

One might think of the "fuel economy" of a car as the amount of gas needed to travel a given distance - the number of gallons per mile - which is the reciprocal of the common miles per gallon measure. Discussing fuel economy in terms of miles per gallon is therefore somewhat deceptive - e.g., the improvement in efficiency of going from 25 to 43 MPG is about the same as going from 10 to 12 MPG (in both cases 0.0167 GPM). The Guardian reports on a study by two Duke management professors explaining exactly that.

The Candidates get a Fiscal Exam

The Tax Policy Center has made a preliminary analysis (with slight revisions) of McCain and Obama's tax plans. Under current law, most of the tax cuts passed in 2001 and 2003 are scheduled to expire after 2010 - i.e., if nothing is done, there will be a significant tax increase in 2011 (returning us to the higher tax rates we had back in the Clinton years, when the economy was growing faster, unemployment was lower, and the federal budget was in surplus...). Relative to this, both candidate's plans would reduce revenue - McCain by $3.6 trillion and Obama by $2.7 trillion over 10 years (or, compared to keeping the current tax code in place, Obama would raise revenue by $262 billion while McCain would reduce it by $615 billion). Federal tax revenue was 18.8% of GDP in 2007 - under McCain's plan it is projected to be 17.9% of GDP over 2009-2018, versus 18.4% under Obama's.

Both candidates' proposals are multifaceted; highlights include:

McCain would extend almost all of the 2001-03 tax cuts (except that a 15% tax would remain in place on estates over $5 million), increase the tax exemption for dependents and reduce the maximum corporate tax rate from 35% to 25%.

Obama would extend the portions of the tax cuts affecting lower- and middle- income households, but allow the top tax rates to revert to their 2000 levels (e.g. the top income tax rate would return to 39.6% from its current 35%) and raise capital gains and dividend taxes. Lower and middle-income families would also be the beneficiaries of more tax credits: he would add a $500 "Making Work Pay" tax credit, expand the Earned Income Tax Credit (EITC) and the child and dependent care tax credits.

The distributional effects of the two plans are very different: Obama's plan would raise the average federal tax rate in 2009 for the highest-income quintile (i.e. the top 20%), and lower it for the remaining 80%. The cut would be 5.3 percentage points for the bottom quintile and 2 pts for the middle quintile, while the top 20% would see a 1.5 pt increase (and the top 1% would see their tax rate increase by 6.1 pts). Under McCain's plan, the average federal tax rate for all groups, but the decrease for the bottom quintile (0.2 pts) and middle (0.6 pts) are small compared to the change at the top (2.2 pts for the top quintile).

The study has a number of caveats. The center had to make some assumptions because proposals are vague - the report says "no one - not even inside the campaigns - knows exactly what the proposals are. Stump speeches and campaign white papers are often short on the technical details needed to analyze the proposals fully." Also, the analysis did not tackle the candidates' plans regarding health care, which will also affect the tax code (the TPC promises a separate study on this).

EconomistMom examined the distributional consequences; here's her answer to the Telly Savalas question ("who loves ya, baby"):

So in aggregate, at least in terms of tax cuts, McCain loves taxpayers (even) more than Bush loves taxpayers, and Bush loves taxpayers more than Obama loves taxpayers. All of them are not so fond of our children and grandchildren though, because they’re all willing to have our children and grandchildren (aka future taxpayers) pay for all that love they’re willing to give to us current taxpayers.

But how much the candidates love you, in particular, depends a great deal on how “rich”, or not, you are. With his tax cuts, Senator Obama loves those who are not so rich a lot more than he loves those who are. Senator McCain, on the other hand, really loves the really rich. In fact, with his tax cuts, Senator McCain loves the really rich even more than President Bush has loved them.

And Paul Krugman says:

The key point, again: because of all those middle-class tax cuts in the Obama plan, he collects only 0.4% of GDP more in taxes than McCain. The tax collection comes from different people: lower and middle-income Americans would be substantially better off under the Obama plan. But where is the money for health care reform?

Krugman also wrote a column on the subject (his numbers are slightly different because they are prior to the TPC's revision of its estimates), and Clive Crook did too.

The TPC's analysis does not include Obama's proposal - which is still lacking specifics (maybe we should call it a "gambit" for now) - to apply the social security payroll tax to higher-income owners (currently, income above $102,000 is not subject to social security contributions). Back in November, this came up in a debate between Clinton and Obama (see this post for a discussion). Obama says that the tax would kick back in for incomes above $250,ooo (i.e. there would be a 'donut hole'). While the problems of social security are often exaggerated, this would make the tax code more progressive (and the top marginal rate would be getting pretty high, for those who worry about such things) and reduce the amount the government needs to borrow from the "public" (or, really, China), because the social security trust fund would buy some of the Treasury bonds that would otherwise have to be sold to finance the deficit. That should be a plus for investment (less "crowding out") and the current account. The TPC says:

Senator Obama not been clear about what rate would apply, when the tax would take effect, or even what the tax base would be. (See our follow-up blog post.) Assuming that the proposal would apply the full 6.2 percent OASDI (old age survivors and disability insurance) tax, paid by both employers and employees, to earnings above the threshold, TPC estimates that the proposal would raise $629 billion, or about 0.4 percent of GDP, over the ten-year budget period.

For a good analysis of the donut, see this post from EconomistMom.

Update (6/19): The Times' David Leonhardt has three questions for McCain.

Obama, Breaker of (Nontariff) Barriers

One man's environmental or health regulation is another's non-tariff barrier (i.e. a trade restriction in disguise). Barack Obama apparently sees alot of them, according to this useful NY Times examination:

“You can’t get beef into Japan and Korea, even though, obviously, we have the highest safety standards of anybody, but they don’t want to have that competition from U.S. producers,” Mr. Obama said last month in a speech to farmers in South Dakota. Last week, near Detroit, he asserted that “if South Korea is selling hundreds of thousands of cars to the United States and we can only sell less than 5,000 in South Korea, something is wrong.”

Yes, "highest safety standards of anybody" - I guess he hasn't been reading Paul Krugman (see the post immediately below). As for the cars, the article explains that while Korea's auto imports have dramatically risen, the US share has fallen:

One reason for the decline may be a longstanding engine displacement tax levied on automobiles by motor size, which appears to have benefited Japanese and European carmakers like Honda, BMW and Volvo. The United States considers the tax an unfair trade barrier and has sought to have it and other requirements “streamlined,” but defenders describe it as part of a Korean government strategy to reduce consumption of ever-more-costly imported gasoline and related carbon emissions.

“You can say that people in Korea don’t like American cars, but then you have to say why in nearby places people do seem to like them,” Mr. Goolsbee [Obama's economic advisor] said. He added, “The Koreans have designed a system that will prevent competition from a segment of the market that is different from what they produce, and that is a nontariff barrier.”

Pretty weak stuff - I don't think that argument would win a WTO case. This cheesy populism isn't exactly inspiring, but at least he hasn't (yet) suited up as a hockey goalie in a TV ad (as Bob Kerrey infamously did in 1992).

Update (6/18): At How the World Works, Andrew Leonard defends Obama against the charge of "protectionism."

The EU is Watching Out for You

Paul Krugman sees deregulatory ideology run amok as the culprit in food safety crises that have tomatoes being pulled off the shelves and Koreans protesting importation of US beef. He writes:

[H]ard-core opponents of regulation were once part of the political fringe, but with the rise of modern movement conservatism they moved into the corridors of power. They never had enough votes to abolish the F.D.A. or eliminate meat inspections, but they could and did set about making the agencies charged with ensuring food safety ineffective.

They did this in part by simply denying these agencies enough resources to do the job. For example, the work of the F.D.A. has become vastly more complex over time thanks to the combination of scientific advances and globalization. Yet the agency has a substantially smaller work force now than it did in 1994, the year Republicans took over Congress.

Perhaps even more important, however, was the systematic appointment of foxes to guard henhouses.

Thus, when mad cow disease was detected in the U.S. in 2003, the Department of Agriculture was headed by Ann M. Veneman, a former food-industry lobbyist. And the department’s response to the crisis — which amounted to consistently downplaying the threat and rejecting calls for more extensive testing — seemed driven by the industry’s agenda.

The primary market failure at work here is one of imperfect information - it is prohibitively costly for consumers to obtain detailed information about how every available food ingredient was produced (and, really, would you want to?) in order to make a judgment about the associated risks. In such cases, basic microeconomics tells us that the free market outcome is not optimal and government intervention - possibly through regulation (which is only effective if credibly enforced) - can be welfare-improving. That is, the "free market" view does not represent sound economics.

The same logic applies to the chemicals in everyday products. In the absence of effective government intervention, consumers may be taking greater than optimal levels of risk (i.e. we are taking chances we wouldn't if we had complete knowledge of what's in all that stuff we buy). The uncertainty could also have the effect of deterring consumers from buying products that are indeed perfectly safe (this is why credible regulation is good for producers).

While Washington may be asleep at the switch, the Brussels isn't, and one pleasant side-effect of globalization is that tougher EU regulation may benefit US consumers, or so suggests this fascinating Washington Post story:

Europe this month rolled out new restrictions on makers of chemicals linked to cancer and other health problems, changes that are forcing U.S. industries to find new ways to produce a wide range of everyday products.

The new laws in the European Union require companies to demonstrate that a chemical is safe before it enters commerce -- the opposite of policies in the United States, where regulators must prove that a chemical is harmful before it can be restricted or removed from the market...

Adamantly opposed by the U.S. chemical industry and the Bush administration, the E.U. laws will be phased in over the next decade. It is difficult to know exactly how the changes will affect products sold in the United States. But American manufacturers are already searching for safer alternatives to chemicals used to make thousands of consumer goods, from bike helmets to shower curtains.

The European Union's tough stance on chemical regulation is the latest area in which the Europeans are reshaping business practices with demands that American companies either comply or lose access to a market of 27 countries and nearly 500 million people.

From its crackdown on antitrust practices in the computer industry to its rigorous protection of consumer privacy, the European Union has adopted a regulatory philosophy that emphasizes the consumer. Its approach to managing chemical risks, which started with a trickle of individual bans and has swelled into a wave, is part of a European focus on caution when it comes to health and the environment.

Regulation in the US is weaker than you might think:

The EPA has banned only five chemicals since 1976. The hurdles are so high for the agency that it has been unable to ban asbestos, which is widely acknowledged as a likely carcinogen and is barred in more than 30 countries. Instead, the EPA relies on industry to voluntarily cease production of suspect chemicals.

"If you ask people whether they think the drain cleaner they use in their homes has been tested for safety, they think, 'Of course, the government would have never allowed a product on the market without knowing it's safe,' " said Richard Denison, senior scientist at the Environmental Defense Fund. "When you tell them that's not the case, they can't believe it."

Eep. Because the EU is a large market, it may make sense for producers to conform to their stronger regulations and therefore the same products sold here will live up to European standards. The bad news is that logic only applies insofar as the products are the same, which will depend on the marginal costs associated with producing up to EU standards (the fixed costs of developing products that can be sold there will likely worth bearing for multinationals) relative to the economies of scale gained from producing the same product for both markets.

There would be more incentive for producers to conform to European regulations if US consumers start to look for the CE mark which is used to label products that meet European standards.

Now, if only we could find a way to get the EU involved with our domestic food supply... (that is, Americans would feel much more confident eating Brussels sprouts if they are Brussels-certified).

Unemployment = 5.5%

Since I'm on the road, I haven't dug into the (bad) unemployment news, but Andrew Samwick has (he notes that a big part of the rise is due to increased labor force participation).

Transport Costs

I'm traveling (hence light blogging) and incurring transport costs - which won't deter my vacation, but may reduce world trade. This is an interesting topic of discussion amongst Menzie Chinn, Paul Krugman and Free Exchange.