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October 07, 2005

Incentives for the Environment

John Quiggin notes that John Tierney advocates taxes on energy use. However, it somehow slips Tierney's mind to praise Al Gore, who was the driving force behind the Clinton administration's attempt to raise energy taxes back in 1993.

Funny, that.

Anyway, here's John Quiggin:

Hard Cash and Climate change Posted by John Quiggin: Tim Worstall gets us past that pesky NYT paywall to link approvingly to a John Tierney column arguing that the way to encourage energy conservation in the US is not to fiddle with standards but to raise prices. Broadly speaking I agree. At a minimum, getting prices right is a necessary condition for an adjustment to sustainable levels of energy use. Nevertheless, the rate of adjustment and the smoothness with which adjustment takes place can be greatly enhanced by the adoption of consistent pro-conservation policies, or retarded by the adoption of inconsistent and incoherent policies.

This is as good a time as any to restate the point that, given a gradual adjustment, very large reductions in energy use and CO2 emissions can be achieved at very modest cost. Rather than argue from welfare economics this time, I've looked at the kind of adjustments that would be needed to cut CO2 emissions from motor vehicle use (one of the least responsive) and argued that price increases would bring this about over time, without significant pain.... With the price of gasoline in the US passing $3/gallon and most of the remaining sceptics now conceding the reality of human-caused climate change, it seems like a good idea to re-examine some fundamental assumptions in the debate over climate change. Rather than focus on the short-run arguments about the Kyoto protocol, it seems more useful to focus on the question of whether anything can really be done to stop climate change.

A common estimate is that to stabilise the global climate, we would need to reduce emissions of carbon dioxide by 60 per cent, and proposals to achieve this by 2050 have been put forward. Assuming only a limited role for alternative energy sources, it seems reasonably to look at a 50 per cent reduction in primary energy use. It's a widely-held view that the kinds of changes required to stabilise the global climate must imply a fairly radical reduction in our material standard of living. This view is shared by radical environmentalists, who see such a reduction as a good thing, and by opponents of such changes most of whom, at least in developed countries are on the free-market right. The fact that radical environmentalists view the modern economy as critically dependent on unsustainable patterns of energy use is not surprising. On the other hand, supporters of the free-market generally praise the flexibility of dynamism. Currently, energy use accounts for about 6 per cent of GDP. The suggestion that reducing this proportion to, say, 3 per cent, is beyond our capacity seems to represent a very pessimistic view of our economic potential.

There's a standard economic technique for giving a rough estimate of the economic cost of such a shift. Begin with the assumption that in the long run, the demand for energy is sufficiently flexible that a 10 per cent increase in costs will eventually produce a 10 per cent reduction is usage, relative to the underlying trend. Although energy use responds slowly to price changes in the short run this is a fairly conservative estimate of price responsiveness over periods of a decade or more. Given this assumption, halving energy use would require a 100 per cent increase in prices.... A standard economic calculation suggests that the reduction in economic welfare associated with such a tax would be somewhere between 50 and 100 per cent of the revenue raised, or between 1.5 per cent and 3 per cent of GDP..... Remember that this estimate is not for the modest first steps required under Kyoto, but for a reduction in emissions on the scale required to stabilise climate.

Is such a broad-brush estimate reasonable? One way to check is to look in detail at the kinds of changes that would be needed to achieve such a reduction in the most sensitive single category of energy use, that of private motor vehicles.... [A] significant reduction could be achieved simply by improvements in the technical efficiency of fuel use. The motor vehicle industry, although technologically mature, still exhibits steady improvements in the efficiency of engines and other aspects of vehicle design. When fuel prices are low, much of the effort is allocated to improving performance. When fuel prices are high, and policy is oriented towards reducing energy use, innovations that improve fuel economy are favoured.... [T]he mix of vehicles in the fleet would change over time.... A small further saving, say 5 per cent, could be achieved through discretionary decisions on which vehicle to use for a given trip....

Now consider some changes in travel patterns... raising occupancy to 1.65 persons would reduce fuel use by 10 per cent for a given number of person-km travelled.... Adding all of these modest changes together would yield a reduction in fuel use of more than 50 per cent Some of these changes would be imperceptible, others would require marginal adjustments over a couple of decades. Taken all together, they would be barely noticeable relative to the changes in lifestyle that most people experience over such a period.

You might think that adding together a whole lot of small changes in the same direction is stacking the deck in some sense. But this is the way markets work. An increase in the effective cost of some commodity generates adjustments on many different margins, all in the direction of economising on that commodity. It is also the way coherent public policy works. If a goal of reducing energy use or CO2 emissions is properly embedded in public policy, it will be reflected in modest shifts in many different dimensions of policy, producing a significant aggregate impact...

Posted by DeLong at October 7, 2005 01:11 PM