Category Archives: Green Economics

Behaviour economics and welfare/stimulus payments

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Business week has an interesting story on the role of designing policies based on behavioral economics. In short, behavioral economics suggests that people are not rational and that they will make decisions not entirely based on rational cost benefit analysis. Well, who knew.

The “making work pay” program in the US was designed to give people stimulus money in small additional payments to their salary and in theory they would have spent the money. What actually happened was that people did not see the small additional difference and saved the money. That by itself is not a bad consequence just that it does fit with the Keynesian stimulus economics.

What is interesting here is that in Australia it was the other way round. There is clear agreement here that lumpsum money is spent immediately on big ticket items. For example, Kevin Rudd when he was Prime Minister decided to give $900 in stimulus for most people and a lot more for families with children. There were stimulus ads everywhere for people to spend that money. And they spent.

Another example is the baby bonus. In Australia when we have a child the government provides $5000 as a baby bonus to families. What was observed that for some families that created a negative situation in how the money was spent. Now, the bonus is paid over 13 weeks and it seems to work better.

What I am not sure is how did the behavioral economists in the US came to the opposite conclusion for the spending of stimulus money?

Carbon emissions and basic algebra

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When the countries around the world announced emission reductions, cuts, plans the media cheered. However, if we all did some basic algebra it would be different.

For example, the US announced its plans based on 2005 rather than the 1990 conventional numbers used in Kyoto. Why? Because US emissions grew a lot from 1990 to 2005 and reductions from a large base is easier. Australia is using 2000.  China uses 2005 and India another number. So every country is talking a different benchmark. So, we cannot actually compare.

May be we should GDP per capita as a benchmark.

On the second set of numbers.  US announced reduction in carbon emissions and China, India announced carbon intensity reductions. Both are as different as apples to oranges. But the press misses this. For an example check out the Ny Times. Just to clarify, I support the carbon intensity focus of the developing countries. My gripe is with media reporting.

Some good analysis from Matthew Khan,

I am happy to hear that China has pledged to reduce its carbon intensity by 40% by 2020 but does this guarantee a smaller global carbon footprint? Recall that carbon intensity = tons of CO2/GNP. China’s economy has been growing by 8% per year. Make the big assumption that this average growth rate will continue until 2020 and ignore compounding. So, in ten years their economy will be 80% bigger and their carbon intensity will be 40% lower than it is now. So, according to my logic relative to today, China’s total carbon emissions will be .6*80% or 48% higher. From Al Gore’s standpoint, is that progress? At the same time that President Obama is pledging a 20% reducing in CO2 emissions (under these growth assumptions), China’s government is pledging that their emissions will be 48% higher.

Carbon models and economic models

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Don’t count on the economists to have a good “Computable General Equilibrium” model to yield valid estimates of how each nation’s economy will evolve in the presence of a carbon tax. If we introduced uncertainty into our models the confidence intervals would be huge. But today a group of economists are getting rich peddling their “scientific” models as truth in predicting very difficult policy counter-factuals.

The modern economics profession has made great progress estimating partial equilibrium relationships. See almost any NBER applied micro paper to get a taste of this. We have made much less progress on multi-sector dynamic general equilibrium models with endogenous innovation, irreversibilities, learning and uncertainty. Introduce all of these bells and whistles and you have the issue of climate change. Now economists like to be quoted and we are self confident but if we currently do not have good answers to policy questions should we follow the Nobel Laureate Robert Lucas and modestly say; “I don’t know”? If we follow this path, we are well aware that some bozo out there will fill our place offering the politicians an even sillier answer. So, we must pick our poison.

via Environmental and Urban Economics: Copenhagen and International Carbon Politics.

Copenhagen Prediction Market (COPPM)

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Despite the general optimism in the lead-up to the conference, the chances of such deal still look to be at long odds. But if you want to play the climate change market, in the absence of our own ETS, there is a way. The UNSW Centre for Energy and Environmental Markets and legal firm Baker & McKenzie have set up a Copenhagen Predictions Market, in which participants using “experimental dollars” (E$s) can bet on a range of outcomes, such as deadlines for legally binding agreements, aggregate reduction targets, and the long term stabilisation target.

You can bet on an outcome of less than 10 per cent, between 10 and 15 per cent, between 15 per cent and 20 per cent, and so on. UNSW expects the price of these shares to vary as new information about negotiating positions becomes available. You can even bet on individual country reduction targets, including for Australia, and the design of REDD mechanisms (reducing emissions from deforestation and degradation) and the future of the CDM (clean development mechanism) market. There are no fees, and no real money at stake, but the three winners in each category will each get a prize.

via COPENHAGEN CALLING: Rudd’s cool reception – Giles Parkinson – News – Business Spectator.

Do we need to change behaviour at all?

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I have been writing about how Kevin Rudd’s plan to introduce carbon trading included payments to millions of households on the increase in expenses. I suggested that was the wrong thing to do and that we need to change behaviour of consumers to solve this.

What about the other side? What if the emissions reductions are possible through large systemic changes in electricity production, energy efficiency at the business level etc and leave the consumers out of it directly. Consumers will still pay for the increased business costs through increases in product costs however, that is dependent on the market (which is somewhat free in Australia).

In a way the business guys are better at doing this than each individual consumer. Let them sit back and have fun and pay a bit more in product expenses.

What say?

Gaming the CDMs and carbon trading

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Under the CDM, the United Nations awards carbon credits to emissions-reducing projects in the developing world. When credits are sold on to rich countries, the buyers can count them towards their Kyoto emissions targets. Supposed to kill two birds with one stone – reduce emissions and transfer money and technology to the poor – this was, however, never likely to work.

The CDM inherits the UN’s suffocating bureaucracy, so smaller projects struggle to gain approval. But more important than what it keeps out is what it lets in. The criterion of “additionality” is supposed to rule out projects that would not be undertaken without CDM payments. Not only is this counterfactual approach utterly unverifiable; it is also an ideal target for gaming.

The Chinese wind farms are a case in point: Beijing allegedly lowered their subsidies to make them eligible for CDM. The accusation plays right into the hands of the opposition to emissions cuts in the US. Congress threw out Kyoto because China and India were let off without obligations. A US public convinced that poor countries game the system would kill any prospect for a Copenhagen deal.

via FT.com / Comment / Editorial – Anticlimatic policy.

What makes a nation rich?

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From MIT economist Daron Acemoglu:

Full Image – Link

And yet while Sachs and Diamond offer good insight into certain aspects of poverty, they share something in common with Montesquieu and others who followed: They ignore incentives. People need incentives to invest and prosper; they need to know that if they work hard, they can make money and actually keep that money. And the key to ensuring those incentives is sound institutions — the rule of law and security and a governing system that offers opportunities to achieve and innovate. That’s what determines the haves from the have-nots — not geography or weather or technology or disease or ethnicity.

Put simply: Fix incentives and you will fix poverty. And if you wish to fix institutions, you have to fix governments.

How do we know that institutions are so central to the wealth and poverty of nations? Start in Nogales, a city cut in half by the Mexican-American border fence. There is no difference in geography between the two halves of Nogales. The weather is the same. The winds are the same, as are the soils. The types of diseases prevalent in the area given its geography and climate are the same, as is the ethnic, cultural, and linguistic background of the residents. By logic, both sides of the city should be identical economically.

And yet they are far from the same.

(from Greg Mankiw)

Australian ETS = Carbon Tax + Consumer Welfare

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I have been rooting for the ETS for a while now but with better understanding of the legislation (thanks a lot to the commentary on BusinessSpectator.com.au) I have learned that the ETS in its current form is not going to solve Australia’s problems at all. With ability to pacify any group that the government seems fit and the issue of carbon offsets there are not guarantees on how on the scheme will work.

The latest comes from Robert Gottliebsen who explains how the money from the ETS will be used as a welfare card by the labour government to stay in power.

Over the period from 2011 to 2020 the government expects to raise a staggering $114 billion from industry based on a carbon price of above $20 a tonne.

Where will that money go? John Howard retained office via the so called ‘Howard battlers’. Rudd learned from Howard so that’s where the money goes.

About $54 billion, or just under half, goes to lower and middle income people. Around 90 per cent of all low income households – or some 2.6 million households – will receive assistance equal to around 120 per cent of the overall cost increases they face.

Around 50 per cent of middle income households – about 1.7 million – will be fully compensated for overall cost increases flowing from the carbon trading legislation. And it gets better. Once the scheme starts, assistance will continue in perpetuity because these assistance payments are indexed to CPI and upfront assistance will automatically increase in line with the increasing carbon price as it affects household cost.

Think about it, if we provide people with 120% of the increase in costs; so more than what the costs have increased; then there is no hope in changing behaviour which is the goal.

Earlier I quoted Greg Mankiw on the fundamental theorem of the ETS:

Cap-and-trade = Carbon tax + Corporate welfare.

Well Greg, we have changed that in Australia. It should now read,


Cap-and-trade = Carbon tax + Consumer welfare + Corporate welfare.

What will the Australian ETS achieve? or What can a centrally planned carbon economy achieve?

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The goal of any emissions trading scheme is to reduce carbon emissions. The idea is to provide a price on carbon which currently does not have a price so as to create a value for carbon. To achieve this; the government is creating a market out of thin air. It is restricting the use of carbon by limiting its supply. The users of carbon will then need to think and act innovatively to cut down their use of carbon or pay for the use of carbon. The cost of carbon will depend on the supply and demand of carbon on any particular day. There are far more intricacies that I do not understand but basically this is it.

However, the Rudd government is clearly incapable of managing to pass legislation that does not pander to special interest groups. Also, it has shown that politics is more important than economics.

The Australian ETS called the CPRS has put a cap on carbon price of $10 a ton till 2012. By doing this; the CPRS is not creating a market at all, it is creating a centrally planned market economy for carbon. On top of this the government decides which industries are part of the CPRS and which are not; which industries get free carbon credits and how much. In addition, it is allowing overseas carbon credits to be bought in Australia to the tune of 100%. What this means is that carbon reduced in other countries as part of their ETS can be bought by Australian companies and they do not have to innovate to reduce their carbon output.

By putting a cap on the price, by providing free credits as it seems fit, by excluding some industries and providing access to foreign carbon credits the government is acting as a central planner and distorting the idea of a carbon market. Centrally planned economies do not work. A distorted market will not provide the benefits of a free market and in this case it will not lead to reduction in carbon emissions. What else will happen is hard to fathom?

And this is the problem with public policy. It is not always clear what will happen when we distort the market.

With a low carbon price the energy companies may not have enough incentive to innovate? Or they can easily buy from overseas credits and continue business as usual. Foreign competitors who are selling their carbon credits to Australia can become more competitive in than Australian companies.

On the other hand, an Australian ETS implemented before the US or other major countries in the world leaves a small country like Australia in a position where it may be disadvantaged by the policies of the bigger and more powerful countries. This will have an adverse effect on the Australian economy.

So coming back to my original question, the Australian ETS does not seem to be in the direction of achieving its basic goal of reducing carbon emissions but it will surely be creating additional effects that are hard to understand right now and can be detrimental to the country.

As a Buddhist saying goes, “First, do no harm”. That should be the goal of public policy. However, the Australian ETS may be doing harm first. This is dangerous.

The imported book fiasco in Australia

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Time Labor was brought to book | – suhit’s posterous

Given this week’s decision to maintain regulatory protection for Australian publishers from imported books, these politicians may find themselves paying up to 30 per cent more than readers in other countries, but then that’s the price of an economic policy that panders to vocal special interest groups at the expense of the wider community.

The decision – and Cabinet was reportedly deeply divided on the issue – means Australian publishers will retain a 30 day exclusivity period within which, if they decide to publish a specific title, they will not be subject to competition from often cheaper overseas imports.

This is nothing short of a special tax on books, and would appear to fly in the face of the pro-education rhetoric in which the Government so likes to cloak itself. Furthermore, the decision totally rejected recommendations from the Productivity Commission and also knocked back a compromise proposal from Competition Minister Craig Emerson.
[...]

In terms of books, if a title isn’t available here because an Australian publisher hasn’t picked it up or it’s far cheaper overseas, then in the digital age there’s always the likes of Amazon – which doesn’t pay Australian taxes or employ Australian workers. The imported books fiasco is a stark illustration of the fact that when it comes to continuing the process of reforming and modernising the Australian economy that began with the Hawke and Keating governments, and continued through the Howard years, the Rudd Government has to date been found sadly wanting.

via news.com.au

This is most ridiculous. In terms of losses, consumers in Australia will spend about $200 million per year because of this decision. These kinds of decisions by the Rudd government makes you wonder how they can manage the carbon reduction scheme. Their ability to pander to vocal interest groups is scary.

Update: An interesting history of the law in question which was enacted by the Britishers to help British publishers.