Skeptonomics

If there were any doubt that old fashioned Tory moralism is alive and well in (temporarily) Labor England, this crazy idea should dispel it. It plays on the “personal responsibility” trope at the expense of any hope of getting the job done fairly and efficiently. To wit:

1. If you have a national cap, you have a national cap. Enforce it and people’s carbon emissions have to fall in line according the laws of arithmetic.

2. How on earth are you going to put carbon prices on each and every personal decision, especially if you take life-cycle and indirect effects into account? After all those years of Maggie channeling Hayek you’d think the basic lessons of the socialist calculation debate would have rubbed off.

3. The more upstream the cap, the more flexible and efficient the system will be. Capping each individual’s consumption is as downstream as you can go. Upstream capping means that the advantages of shifting the economy across sectors, technologies and the like would be transparent and seamless: if the higher cost of carbon results in an investment in rail transport being more productive than one in highways, you can transfer the resources and adjust in a lower-cost way to the cap. If you have separate caps for separate activities this visibility and flexibility is lost.

4. And the whole scheme is based on the misperception that an economy-wide carbon tax—or even better, an economy-wide cap—bleeds households. Yes, of course, taking money from households would do this, and the tax/cap would function much like a regressive sales tax. But wait: the money has to go somewhere. The simple solution is to give it back on an equal per capita basis. This reimburses the public and turns a regressive transfer into a highly progressive one. Much more sensible, I would say, than moralism run amok.

Why am I not surprised that the newly announced Milton Friedman Institute will be located in the former Chicago Theological Seminary?

Or so the sign says in Uncle Sam’s Petroleum Saloon, a.k.a. the US Energy Information Agency. Take a look at the monthly forecasts from February to May—the price of oil is always supposed to go down, wherever it is. I’d love to look at the model that generates this serial silliness.

(Thanks to Kevin Drum.)

McCain gave a major policy speech on climate change yesterday. Politically, we might consider this a lower bound on potential federal action next year, so here is a rough assessment of its hits and misses.

1. Sizing up the problem: McCain is forthright on much of the science of climate change. He recognizes it is happening now and is likely to intensify, that human alterations of the carbon cycle are responsible, and that it is imperative to reverse this trend. To put it mildly, this constitutes a big shift away from the doctrine that currently rules Washington. He can be faulted, however, for failing to draw attention to the very real threat of catastrophic climate change Weitzman, among others, has been calling attention to.

2. Mitigation: Many of the consequences of climate change, like sea level rise and disruptive changes in precipitation patterns, are already in the pipeline. McCain recognizes this and accepts a federal role for helping communities defend and cope. I give him credit for this.

3. Instituting a carbon cap: McCain, as he has for several years, endorses a nationwide carbon cap. He is a bit vague on how far upstream he would impose it. This is a rather wonkish topic for a campaign speech, but it has a lot of practical importance: the further upstream the cap, the less scope there is for playing politics with coverage.

4. Emissions target: McCain wants a 60% reduction by 2050. Mainstream opinion, reflected in the Clinton and Obama proposals, targets an 80% reduction, and even this may not be enough in light of the evolving understanding of positive feedback mechanisms in global carbon cycling. In my opinion, however, this is the least significant shortcoming of McCain, since the cap mechanism would readily enable progressive tightening as the political will materializes.

5. Offsets: This is a big problem. McCain headlines his enthusiasm for offsets, suggesting that 40% of the emissions target can be reached simply by trading off for carbon sequestration in domestic farmland. Despite his assurances, it is highly unlikely that offsets will achieve true additionality, not to mention the still uncertain state of our understanding of long run carbon cycling in forests, farms and soils. In my opinion, one should deduct the amount of offsetting allowed to estimate the true cap. If McCain will accept offsets up to, say, 50% of his cap, he is guaranteeing a reduction of no more than 30% by 2050. Obama and Clinton, by contrast, eschew offsets. And offsetting is a political nightmare, dangling billions of dollars in manufactured profits in front of business interests and creating the biggest rent-seeking operation in human history.

6. Allocation: This is another big problem. McCain will simply give away all the permits at the beginning, and in his speech he offers only the vaguest of promises that some portion will be auctioned in the future. Every citizen should know that a cap will causes consumer prices to rise for carbon-intensive products, and if producers get the permits for free they keep the difference. Giving out permits is giving out profits. Every permit should be auctioned from the get-go, and Clinton and Obama are both in accord with this principle.

7. Recycling: If some of the permits are eventually auctioned, McCain would have the government keep the revenue and use it to make infrastructure and other investments. It is easy to see the rationale for this approach, but it is nevertheless a mistake. As much of the revenue as possible should be recycled to households. There are three reasons for this. First, the price increases resulting from the cap will take the form of a highly regressive sales tax, hitting low-income families the hardest. This effect needs to be countered by progressive recycling. Second, the price increase, like any tax, will have a depressive effect on the economy. In theory, if the government could spend the money as fast as it takes it in there would be no problem, but experience shows this is difficult to achieve. It is better to reinject it back into households. Finally, we are talking about a concentrated effort that will have to continue for over 40 years—at least two generations, without so much as a pause. To make the political support for a rigorous climate policy bulletproof, household incomes have to be protected. The climate plan of the future has to be like Social Security, so financially beneficial for so many people that its most rabid ideological opponents will not be able to dent it.

8. Border adjustment: McCain explicitly supports a carbon adjustment tax to prevent leakage via international trade. This is a necessary and important feature.

9. Nuclear energy: A lot of environmentalists are going to focus their ire specifically on McCain’s enthusiastic support for the nuclear option. At the risk of alienating all of my green friends, and the green half of my own brain, in light of the extraordinary risks of catastrophic climate change I think nuclear power has to be given an unbiased look. On the other hand, if it is to have a future, it must be one that does not depend on artificial subsidies, such as the Price-Anderson cap on liability and the failure to safely close the fuel cycle.

10. Regulation and public investment. McCain talks as though, once we’ve set the right price signals via a carbon cap, the magic of the marketplace will take care of the rest. Would that it were so. For better or worse, however, a nationwide cap will require complementary policies at all levels to make adjustment smoother and more manageable. Fuel, appliance, and construction standards will all have to be raised. Government will have to make large investments in research and development. Above all, we need a crash program in new, energy-saving infrastructure in our electrical grid and especially mass transit. These policies are not alternatives to a cap: they make it possible to meet the goals of the cap without bringing the economy to a standstill. Because the investment portion of this program will not begin to pay off for several years after it begins, there is a strong case for starting it before the cap goes live.

So here is my overall assessment: McCain’s approach represents a real improvement in some respects, but it falls far short in others. I’m not worried about the weak target; we can fix that as the need becomes clearer. The permit giveaway and the offsets are much worse, because they will create powerful constituencies determined to keep the spigot open and flowing. Failure to recycle will poison the political climate, creating the impression that to be for a responsible climate policy is to be against the living standards of working class America. And we can’t afford further delay on the wide range of regulations and investments we need to make a carbon cap succeed.

Since the commentary is continuing on the apparent political damage that the Wright affair has had on the Obama campaign, let me add my own view. Obama’s appeal to whites is based on his presentation as completely “safe” and unaggressive, the opposite of the feared “black militant” that still haunts white America’s imagination. He overflows with nice in order to neutralize racial paranoia. And this is why his association with Rev. Wright has been so costly: it reignites subterranean white fears that Obama’s political style takes such great pains to allay. Context is everything. (And the lack of a corresponding context is what makes McCain’s association with frothing right wing ministers politically irrelevant.)

This has nothing to do with what you may think about the good reverend’s jeremiads, some of which I think are right on target and others bizarre. It’s about a battle of racial subtexts.

It also poses another problem for Obama down the road. Quite a few voters think he’s a Muslim, and the web rumor mill will crank this up to a fever pitch as the election approaches. The simplest rebuttal would be to emphasize his church-going, but this will remind people once more of Wright. Forget about the flag pin; Obama needs to wear a giant neon cross.

You just can’t keep a bad idea down. The New York Times, reporting on Europe’s economic angst here and here, wallows in money illusion. Let’s survey the scene of the crime and speculate on the motives.

The way I teach it in introductory macro, there are two types of money illusion. In Type I you are aware of wage increases but not price increases; you think you have more purchasing power than you really do. In Type II you are aware of price increases but not wage increases; you think that if only prices would stop going up you would have more purchasing power than you do. Both are fallacies, since wages are prices, or to put it differently, the money you spend for the things you buy all ends up as someone’s income. It is a logical impossibility for Europeans as a whole to suffer loss of real income as a result of inflation. (And, just to provide context, recall that the rate of price increases over there is in the 3-4% range, not good but certainly sub-ferocious.)

So what are the real problems? The biggest one is income distribution, which is becoming more unequal across the continent as moderating institutions are eroded under the pressure of global competitiveness. This has the most immediate effect on workers who produce goods and services for export or which compete with imports, and it spills over into other labor markets as the wages of the most vulnerable workers slip backward. Firms are also adjusting their organizational strategies to the new world of global competition, relying progressively less on long-term relationships with employees shielded from market forces.

Another possibility, hinted at in these articles, is an adverse shift in the terms of trade, as oil and gas imports become more expensive relative to manufactured exports. Food is less clear, however, since Europe exports vigorously (and controversially) in agricultural products, which leads one to wonder where are the farmers, and those who sell to them, in these tales of Euro-woe.

By blaming the deterioration in living standards on the wrong culprit, these stories detract attention from the true causes. The ECB can crank its rates as high as it wants in order to snuff out inflation, but this won’t restore real income to the average European—quite the contrary, actually, since high rates will produce more unemployment while further elevating the already too-high euro. Wrong diagnosis, wrong treatment.

The question that comes to my mind is why this nonsense about inflation lowering real incomes still has traction after all these years. The disproof is no more complex than the old, familiar circular flow diagram. My suspicion is that it can be attributed to the fundamental political economy fact about inflation: that unanticipated increases in inflation reduce the wealth of net creditors, who map more or less perfectly on the rich as a whole. There will always be a need to find a reason to make inflation the scapegoat for whatever ails the general public, and simple logical error will not constitute a disqualification.