In “The Challenges of Climate for Energy Markets” RFF Senior Fellow Timothy J. Brennan examines the economics underpinning climate policy design and their impact on the electricity sector. With a background in the economics of industrial organization, Brennan says he “can take advantage of outsider status to challenge some of the often-implicit presumptions in the climate and energy efficiency policy conversation.” The following quiz is taken from “The Challenges of Climate for Energy Markets” and was published in the January 1, 2010 issue of Managing Power Magazine:
Aspects of how climate and conservation issues are presented that seem completely natural to the environmental and energy policy community can look peculiar from the perspective of an economist who studies markets and market failure more generally. I can illustrate this with a four-question quiz.
A Quiz
Question 1: A common saying among energy conservation advocates is, “The cheapest power plant is the one you don’t build.” Would you similarly infer that …
a) The cheapest school is the one you don’t build?
b) The cheapest vaccine is the one you don’t administer?
c) The cheapest regulatory conference is the one you don’t hold?
Answer: No, I trust. Any reasonable assessment of a school, vaccine, conference, or power plant would factor in the benefits as well as the costs. To infer policy merit from this sort of claim requires an assumption that the benefits of the electricity generated by the power plant are nonexistent.
Many in the energy policy community who are not economists appear to believe that power plants have only costs rather than benefits as well. The reasons seem to be that consumers’ preferences for electricity use or against conservation technologies lack standing, or that they would use less electricity if only they had the information and wisdom of the experts.
Economic tests, such as cost-benefit analyses, that base policy on revealed consumer preferences, typically reject both of these reasons.
Question 2: Suppose someone goes to see An Inconvenient Truth, the movie that former U.S. presidential candidate and vice president Al Gore made to increase public awareness of the potential harm from climate change. After seeing the movie, out of concern that she does her part to save the planet, she goes out and changes all the light bulbs and appliances in her house to devices that use less electricity and reduce her carbon footprint. In energy policy circles, what do we call this selfless, concerned individual?
Answer: A “free rider”! Yes, someone willing to make sacrifices to reduce her carbon footprint—or, for that matter, someone who makes the effort to calculate that she’d be better off financially in the long run by using compact fluorescent lighting or installing a high-efficiency air conditioner—is lumped together with those who take advantage of others by refusing to chip in to supply a public good.
The reason is that these actions are assessed purely on the basis of the effects of utility companies’ energy efficiency subsidy programs. If someone, such as the person in the question, had switched technologies absent the subsidy program, she would get the benefit of reduced prices even without a utility energy efficiency subsidy. Thus, in industry parlance, she is a “free rider” on the subsidy. If you don’t want to be thought a free rider by utilities, be either selfish or lazy.
Question 3: Suppose we have policies directed toward the goal of reducing greenhouse gas emissions. Two examples discussed in the U.S. and Australia are marketable emissions permits and (usually tradable) requirements that a statutorily designated percentage of energy be generated by renewable fuels such as wind, biomass, passive solar, or sometimes water. What would you call these policies?
Answer: “Complementary”—or at least you would call them that if you were part of the U.S. climate discussion. But when two activities generate the same outcome, the more one has of the first, the less one needs of the second. In economics, these are substitutes. Were the more accurate term employed, it would illuminate the idea that legislating is to choose among alternatives.
Leaving political realities aside, the economic choice is simple—figure out how to get prices to incorporate the external harms of climate change, and let producers and consumers adapt by choosing the technological and conservation options that best meet their needs, taking the cost of climate effects into account. Legislators, though, gain not by making choices but by maximizing the spread of benefits, which the misleading designation “complementary” facilitates. Employing multiple options ensures that the widest possible array of potential political backers will benefit from legislation, likely at the expense of consumers and the economy at large.
Question 4: While we’re on the subject of political support, what does one call structuring climate change legislation to provide benefits to industries on the basis of claims that they would be harmed if they had to pay, directly or indirectly, to pollute?
Answer: “Competitiveness.” The (likely) possibility that one or more countries fail to adopt climate policies, and thus can export products at prices below the true marginal cost of production, may warrant adaptive pricing or trade policies in countries that undertake significant climate policies. These trade policies are justified only to reduce distortions, not to keep firms whole. Paul Krugman said in 1993, “If we can teach undergrads to wince when they hear someone talk about ‘competitiveness,’ we will have done our nation a great service.” That lesson continues to be true.
