CAP AND TRADE: BEYOND ECONOMICS 101

            Let me say at the outset what a great privilege it is for me to be associated with the Blair County Tea Party and how appreciative I am of the opportunity to contribute to its education efforts.  I am, however, a little daunted by item #11 of the BCTP speaker standards. It says succinctly "we refrain from vulgarities."  So I'm supposed to talk about Congress, the President, and totalitarian legislation without resorting vulgarities?  Talk about mixed messages. 

            When I first set about preparing this talk, I billed it as Cap and Trade: bad policy or the worst policy ever. Well, I think Jim Woomer has made it clear that there is worse policy than capping and trading energy—capping our health care and trading our freedom is a whole lot worse.  Luckily, for the time being, cap and trade legislation is on hold, but it can be illuminating to review the policy to get a sense of how government intervention affects our economy.

            Let me apologize at the outset if this turns out to be a little dry.  It occurs to me there are a lot of people in the world who don't know economics 101 and that's bad; but there are probably more people who ONLY know economics 101 and that's worse.  My aim tonight is to take us beyond economics 101 and cap and trade is a perfect topic for that learning objective.

            Tonight, we will address three questions: First) What's right with cap and trade? Second) What's wrong with cap and trade? and Third) What's really, really, wrong with cap and trade?

            Cap and trade is legislation whose purpose is to address market failure, so let's first understand what market failure is.  Voluntary trades between two people will always leave each party better off and will likely have positive impacts on others who are not party to the trade.  For example, when I buy food from a grocer, the grocer (preferring my money to his food) is better off and I (preferring his food to my money) am also better off.  But the benefits don't end with the grocer and me.  A profitable grocer is able to provide more food in more varieties for additional people; and a well-fed John McGinnis (and if you look very closely you'll notice I am indeed well-fed) is able to lead a productive life beneficial to others. Positive benefits produced for third parties is the typical outcome with free trade.

            Nonetheless, occasionally trade produces harmful effects on others.  Suppose the grocer mentioned earlier is getting his food from farmers who are polluting the watershed of a given area.  Then the grocer, his customers, and the farmer are getting benefits at the expense of people whose water supply is being polluted.  When free exchange produces these undesirable effects on third parties we have what is called market failure. 

            Air pollution is another example of market failure. A factory that pollutes the air will impose costs on the people and property in the area near the factory.  Since the factory owner and his customers do not bear the full costs of their actions, they are likely to engage in too much trade from a global perspective.

            Let us suppose for the moment that the carbon dioxide being produced by American manufacturers using fossil fuels is a pollutant. (That's the same carbon dioxide you and I produce when we do frivolous things like breathe.)  If so, there is a market failure because manufacturers are not bearing the full costs of their actions. Economics 101 teaches two things: 1) if a business does not bear the full costs of its actions, market failure will occur as it will produce more goods and services than are socially desirable; 2) government should address market failure through regulation, taxes, or legislation to ensure that all costs are accounted for by business.

            So this is what's right about Cap and trade: It seeks to address market failure, where many bear large and dispersed costs for the narrow and concentrated benefits of a few.

            The problem with economics 101, however, is the belief that market failure can be and should be corrected by government action.  This is what I call the GSD—Grand Socialist Delusion--the belief that government can be trusted as a force for good.  The fact is that whereas market failure sometimes happens, that is the exception, not the rule, in the private sector; but imposing costs on the many for the benefit of the few (which is the very definition of special-interest politics), that is the rule in the public sector, not the exception.

            But even without special-interest politics, there are problems with government solutions to market failure.  Again, continue to assume that carbon dioxide is a pollutant.  The government means to deal with this market failure are regulation, taxes, and legislation such as cap and trade.

            Regulation works by the government imposing production limits on polluters.  "You may produce this much and no more" is the dictum faced by manufacturers.  The EPA recently announced it will pursue this totalitarian approach and that doesn't surprise in the era of czars and czarinas.  This solution will work if government can correctly evaluate all the costs and benefits of market activity and also knows the best way of dealing with pollution in the production process.  Regulation also assumes that somebody, without any reward, will continue to look for ways to reduce pollution.  So effective regulation only requires an all-knowing, perfectly motivated, and incorruptible government.  In other words, all that we need for regulation to work correctly is three separate and simultaneous miracles. 

            An improvement on government regulation would be something economists call a Pigouvian tax, named after the economist, AC Pigou (no relation to Altoona's own AC Stickel).  The Pigouvian tax works by government placing a direct tax on the pollution being emitted by manufacturers.  The idea is to get the polluters to internalize the cost of their pollution.

            A Pigouvian tax is clearly an improvement over regulation because it requires economic actors to evaluate all the costs of their actions and it motivates manufacturers to look for ways to reduce their pollution.  However, it still requires a government that knows enough to identify and measure pollutants and their effects, while eschewing special interest politics.  So Pigouvian taxes require only two miracles to work rather than three.  An improvement to be sure over direct regulation, but policies mandating miracles is the worst kind of wishful thinking.

            The third government approach to pollution is cap and trade legislation.  In cap and trade, government sets the total allowable pollution per year and issues permits to those manufacturers who wish to pollute.  There are some obvious advantages to this approach: It provides incentives for manufacturers to reduce their pollution and limits the damage from the pollution.  Again, however, it requires government to know the amount of pollution that maximizes net benefits for society.  This also requires elected government officials to remain neutral in their dealings with potential campaign contributors.  In other words, cap and trade requires one and half miracles to work.

            An old joke sums up the analysis.  A Mexican bandito in the 1800s robbed a Texas bank of its gold and escaped to Mexico with the Texas Rangers in hot pursuit.  The bandito buried the gold and hid out in a Mexican town, but soon the Rangers captured him and they wanted the gold back. The bandito spoke only spanish and the Rangers spoke only English, so the Rangers hired a local translator to assist them in their interrogation. "Ask him where's the gold?" the Rangers told the translator, who dutifully asked the bandito the question in spanish.  The bandito replied in spanish, "I am not saying." and the translator so informed the Rangers. They then drew their pistols, cocked the hammers, and pointed their guns at the bandito's head and said, "Tell us where you hid the gold or we kill you right now!"  The bandito became fearful and started to shake uncontrollably as the translator interpreted the ultimatum of the Rangers.  He told the translator, "I buried the gold by the oak tree near the river."  And the translator said to the Rangers, "He says, he is not afraid to die and you are all a bunch of American pigs."

            The moral of the story is that assuming people will be honest with you when you cannot verify their honesty might turn out not as you wished.  We have to understand that government officials are as self-interested as that translator. And they'll use their positions of power for their own advantage.  The Grand Socialist Delusion is that government has levers to operate that can improve our lives and we should PAY NO ATTENTION TO THE MAN BEHIND THE CURTAIN.  But we need to think beyond economics 101:  There is a man behind the curtain, following his own interests, while operating levers that complicate our lives unnecessarily and make market failures worse, not better.    

            And this brings us to what's really, really, wrong with cap and trade.  Government programs are the grist for the mill of special interest politics.  Politicians like to focus benefits on special interests, while dispersing costs on the general public.  To put it another way, politicians are in the business of producing economic failure.  Cap and trade would impact utilities, petroleum interests, manufacturers, trucking companies, airlines and automakers, and we can expect to see those costs passed through to us, the general public. 

            Here are just some of the things in the cap and trade bill passed by the House this summer and now pending in the senate.  85% of the permits will be given away, no doubt to favored corporate campaign donors.  For polluters that may mean less production, but it will also mean more profit.  The reason they'll make more profit is that with reduced production, they'll be able to charge higher prices.  Cap and trade will bring about higher prices for consumers and less availability of product—exactly what a tax does, but it won't be called a tax.  

            Farmers will be able to get in on the fun too. If the government is currently paying you NOT to grow crops you can claim that as a carbon offset and receive an additional subsidy. Further, if you plant some trees on the land that the government is paying you not to grow crops on, then you are in line for bonus payments for "afforestation of marginal farmlands."  No-till planting, where farmers plant seeds directly into the ground rather than by plowing, is considered a green-house reducing action by the government even though it does not reduce CO2 emissions, but it does increase atmospheric amounts of nitrous oxide, a much more powerful greenhouse gas.

            The farm offsets are just one case of the legislation contradicting itself.  There are numerous offsets for other industries, so many that much of the reduction in pollution from cap and trade will be undone by these political favors.  If there's one consistent element to cap and trade, it will be on filling up the campaign coffers of elected officials. No caps there.

            Another very politically connected industry is so-called renewable energy.  Wind and solar energy (which have never been able to stand on their own feet economically) will receive increased support through subsidies and mandates.  Utilities will be required in the next 10 years to get 20% of their energy from "renewables".  Given their current 2% contribution, there are only two ways this mandate is going to be reached: Either utilities will dramatically reduce their production of cheap energy or they'll increase dramatically the production of very expensive energy.  Whichever choice is made, or a combination of the two, our standard of living is going to take a significant hit.

            There are also giveaways in the House's cap and trade bill for community organizations like Acorn and La Raza, (but, surprise, not for Tea Parties).  I can't go into them or I definitely will run afoul of our No Vulgarity standard.

            Beyond the supply-side components of the bill, there are specific and intrusive requirements that will affect all of us, including provisions that affect our clothes washers, dishwashers, showerheads, faucets, televisions, light bulbs, lamps, outdoor luminaires, and even portable light fixtures. The EPA will set environmental mandates for every home and commercial building in America.  (I wouldn't be surprised if at some point, someone will make the argument that energy is a public resource and Christmas displays will have to go.) 

            I could go on and on with how this 2,000 pages of legislation will impact our lives, but given our time constraint, I'll just mention one more: To make U.S. manufacturers competitive internationally, tariffs will be placed on foreign goods.  Foreign nations will no doubt respond by placing even larger tariffs on American goods.  The result will be a further reduction in America's economic success and influence in the world. But even if foreign governments don't impose retaliatory tariffs, our own tariffs will still mean higher costs across the board for the American consumer.  But it's not a tax.

            And all this cost for what?

            Some scientists assure us that the science is settled and that man-made CO2 is causing the earth to heat up.  They and the politicians (and it is getting harder and harder to tell them apart) implore us to change our lives and reverse our economic progress.

            But allow me to point out a few scientific, economic, and political realities.  Climate science is a new field with very limited data.  There have been satellite measurements for less than 40 years and these aren't perfect and the land instruments that have been around a little more than 100 years are even less reliable.  Our data is so limited and questionable, in fact, that scientists have resorted to studying tree rings and glacier probes to produce worldwide temperature records for the past 10 thousand years.  Anybody who thinks this is compelling evidence is suffering from RCIS (rectal cranial inversion syndrome). (I hope that last sentence passes Standard 13 scruitiny.)

            Is climate changing? Yes, it can hardly do otherwise. Is the earth warming? Maybe.  Is that a bad thing? Probably not.  Is man contributing to the warming? Perhaps, but the plain fact is we do NOT know what the net effects are of mankind on climate.  We have a hard enough task worrying about climate's effects on mankind. 

            The global warming hysterics assure us that man is unequivocally heating the planet through CO2 emissions, but that's not clear at all.  Of all the green house gases, CO2 makes up just 3% of the total.  Of that 3%, only about 3% are generated by man.  Of that amount, less than 20% is produced by Americans.  Of that amount, half will be reduced if cap and trade works perfectly.  If green house gases were a stack of bricks, cap and trade's impact amounts to removing all of 1 brick from a stack of 10,000.  Do we really want to impoverish our nation and the world for a reduction in CO2 of .01%, which may or may not be affecting warming, which may or may not be a bad thing? 

            We do know one thing for certain: Most of the costs of cap and trade are up front and the benefits, if they happen at all, will occur in the distant future.  The hysterics assure us that we're going to have a real problem—in 100 years!  And, to be fair, many of them have toned down their dire predictions to say simply this is an insurance program to prevent a worst case scenario.  But as an economist, I can assure you that human beings are unrelenting in adapting to changes in our environment when free to do so.  It strikes me as a silly idea for the world today to collectively sacrifice for the world 100 years hence.  Would it really have made sense for people 100 years ago, in a world with much worse poverty, much worse pollution, and much shorter lives—would it really have made sense for them to sacrifice for us who are alive today with dramatically more wealth, longer lives, and expanded opportunity? 

            And it's not just trend analysis that matters. Bjorn Lomborg, an eminent environmentalist, has pointed out in more than a dozen op-eds in the Wall Street Journal that government mandated reductions in carbon emissions, the kind being considered in Copenhagen and which our President is pushing, will directly make more difficult the lives of those who are poor today.  Tens of millions will die.

            Let me conclude on a note of skepticism: We should be skeptical of climate science, not only because of the obvious nexus of some scientists and politicians interested in advancing a socialistic agenda, but because skepticism is the default setting for sound science.  And to the extent that markets fail and produce more costs than benefits, we should be extremely skeptical of the Grand Socialist Delusion that government can and will make things better.  There is a reason for the Bill of Rights, especially the 5th and 10th Amendments, and it's not because our Founding Fathers trusted government to run our lives.  When it came to the Grand Socialist Delusion, they were deniers.

Friday Mornings

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