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Further thoughts on a carbon tax
I haven't figured this out yet, but I'm experiencing ongoing worries. Let me try to articulate them, maybe one of you can cure me. One story I hear is that the new, carbon-friendly energy technology will be subject to decreasing costs, or alternatively increasing returns to scale. In other words, there are high start-up costs, but once it is underway it will be pretty cheap and lots of countries will adopt it. So: 1) the U.S. levies a carbon tax, 2) the U.S. incurs the start-up costs and invents or improves the decreasing cost technology, and 3) lots of countries make the switch. Voila!
It was reading about the new $2500 car, from India, that got me worried. Let's say the new technology is more carbon-friendly than what we do now, but still generates some carbon. (That sounds reasonable, no?) The new energy technology is really cheap, so lots more people -- most of all in China and India and Africa -- enter carbon-using sectors of the economy. Even if the new technology is three times as carbon-efficient, if the world as a whole uses three times more energy, carbon emissions do not go down. The basic problem is the combination of low costs and many people standing on the verge of the carbon-using sector of the economy.
Or to put it another way, eventually gasoline costs become a very important part of the total cost of a car. Then say that cars become much more gasoline efficient. Lots more people can afford cars.
Of course if the new technology is solar, and hardly generates carbon at all, this problem goes away. (That said, even cheap solar power might encourage other kinds of carbon-using technologies. Maybe factories and homes can go solar but cars can't. The factories make Africa wealthier, and Africans buy more cars, etc.)
Alternatively, maybe the new induced carbon-friendly technology has increasing costs rather than decreasing costs. It never gets really cheap. We keep on using it only because the tax is high. Most importantly, countries without comparable carbon taxes will never switch to the new technology. I might add that many factories will relocate to those countries, thereby partially thwarting the initial purposes of the tax.
I am not sure if I have spelled out these scenarios correctly. I am not sure which scenario we are supposed to be rooting for.
Posted by Tyler Cowen on February 24, 2008 at 05:11 AM in Economics | Permalink
Comments
If the first scenario the new form of energy is actually cheaper than currently existing energy sources; that's a rather silly assumption. In any case, a world where cheap energy lets billions of people improve their life dramatically would be a much better place than one where they can't; probably even if we do have to worry about GHG emissions.
Posted by: jsalvati at Feb 24, 2008 6:37:07 AM
I feel the same way.
I thought the Millenium Assessment had a good way of considering different scenarios, by classifying two economic and political approaches - globalisation & regionalisation, and two ecosystem approaches - reactive & proactive.
The key to success would be a bilateral agreement between US & India/China, no? How does one go about it?
Posted by: Naadir Jeewa at Feb 24, 2008 6:39:59 AM
Absent some astonishing technological miracle, the world will burn every drop of oil it can raise from the ground for the foreseeable future.
This is a fundamental that's simply not going away. The rest of it is just polite talk.
Posted by: Mike at Feb 24, 2008 8:20:00 AM
I'm actually working for a new energy-conservation (less energy used=less carbon!) startup and looking to hire a director who's well-known in carbon credits.
Can't think of a better source of smart people then Marginal Revolution. Any recommendations, anyone?
Posted by: Steve at Feb 24, 2008 8:52:20 AM
Once the government introduces a carbon tax, it can alter the tax rate as necessary to counter increasing carbon emissions. Total transaction costs can be minimized by taxing carbon content of inputs rather than emissions.
Posted by: Dan Cole at Feb 24, 2008 8:52:48 AM
I think it is important that on both scenarios, the US will end up with less carbon emissions, since it will still have the carbon tax. The US is better off in the first scenario, and probably less carbon-emitting, but both are good from a greenhouse point of view. And non-taxing parts of the world still produce lots od greenhouse gases.
So, how does your story change anything to the standard collective action problem associated with greenhouse gases? If some countries cut carbon exhaust, and others don't, both profit from reduction in global warming. That's a problem, but we already knew that.
Posted by: greatzamfir at Feb 24, 2008 9:34:51 AM
Should not imports also bear carbon taxes, import duties or tarrifs (Im not an economist and dont know which is the proper term)? Would not countries such as China and India reduce carbon emissions to reduce the burden of duties upon their exports to the US? If imports were free of such duties, the US would simply offshore carbon generating industries.
Posted by: Bob at Feb 24, 2008 9:45:04 AM
TC doesn't specify which technologies he is thinking of, but the assumption that these new technologies displace oil is not necessarily a good one--as far as I can tell they will mostly displace coal and natural gas, which won't really make gasoline cheaper, and so not encourage more driving. The carbon-displacing technologies for cars are still way too expensive for the poor. In any case, someone will probably burn all the oil we can get to, keeping the price high, since the production costs of the marginal reserves are high and increasing. The key thing to do is to make coal-burning unattractive.
And yes, if the US imposed a carbon tax, it would make sense to have a carbon content duty of some kind on imports from countries that didn't have a corresponding tax, but it seems to me like it would be very hard to assess fairly. I think it is an excellent idea in principle, but I'd have to see a practical proposal on how to actually do it.
Posted by: matt wilbert at Feb 24, 2008 10:03:22 AM
To date we've seen no advances that fundamentally change Steven Den Beste's analysis:
http://denbeste.nu/cd_log_entries/2004/06/AnewManhattanProject.shtml
And if the wisdom of crowds is to be believed, the current (non government boondoggle) investments in new energy sources implies a long term price of a barrel of oil below 20 of today's dollars. What do the VC's know that we don't? They are certainly not making the multi-billion dollar technology-sector-like wagers that “Peak Oil” is true.
An aside. I'll wager a fine dinner that when the cost of an alternative to oilfield derived energy sources is competitive, it'll be used to create a synthetic fuel that has the energy density, handling, and safety characteristics of today’s gasoline, kerosene and diesel. Meaning if nature hadn't invented oil, by now we would have.
Unfortunately Électricité de France is as opaque and as softly-corrupt as any state-run business (or near-state run, like the Bell company in its prime), else we might have a better sense of what a well engineered nuclear solution would cost. My guess is their sixty plus plants were built at a cost of not more than $100M-US each at the time (irrespective of the numbers they quote in their financial reports). Which they staff with operators from the equivalent of a service academy. Call it a quarter-cent per KWH fully burdened. Note that they charge more than ten cents a kwh today, and export half. Granted, they have 20-30x the employees they need to run their < 100 facilities, including many state employees "retired" to EDF jobs, etc. Not dissimilar to the old AT&T.
If we can get another two orders of magnitude reduction in our costs per KWH (from a best-case 5 cents down to .05 cents), we'll be able to make petrochemicals out of air and water at a cost competitive w/ oil pumped at $10 a barrel (but still not competitive at what would be a competitive price in a non-cartelized, non-OPEC controlled market of $1 a barrel – given that oilfield is a “manufacturing” business that has otherwise seen 50-100x productivity gains over the last two to three decades).
Sensible nuclear regulation and appropriate locating of mega-plants would get the first order of magnitude (could be done today). The second is likely fusion or new physics - perhaps we (more likely the Europeans at Cern, Switzerland) will find the Higgs bosun and then learn how to control it (could make WMDs as we know them look like firecrackers). Maybe in 25-40 years. The third order of magnitude (to compete with $1 per barrel oil) I can’t conceive, so let’s put it out 100 years.
The cost of energy is inversely proportional to the quality of life (historically and there’s no sign that this won’t be true in the future). The more energy costs, the more humans sweat (and the more time is diverted from productive activities).
Posted by: Ari Tai at Feb 24, 2008 10:09:40 AM
What is the alternative on the margin?
It's true that with the carbon tax, a cheap new low-carbon technology might be developed in the U.S. and propagate worldwide.
However, without the carbon tax, a cheap, new high-carbon technology might be developed and propagate worldwide.
I don't see how the carbon tax can make things worse by comparison to the alternative. It will always direct more resources into low- or zero-carbon technology development on the margin, relative to a no-carbon-tax scenario.
As we discussed before, it is impossible for reduced use of carbon to have such large price effects that it leads to increased use of carbon.
Posted by: A student of economics at Feb 24, 2008 10:14:41 AM
Den Beste analysis of various energy alternative cited above as a link.
Posted by: Ari Tai at Feb 24, 2008 10:16:31 AM
In the rich western democracies, higher energy prices, increased GW awareness, and lack of (real or palatable) alternatives all argue for a race to efficiency.
I could see any nation which doesn't join that club facing carbon-trade barriers, sure.
Russia is an interesting case though. Does Europe need Russian energy too much to ask them anything?
Posted by: odograph at Feb 24, 2008 10:49:39 AM
I agree with Dane Cole, but he assumes that we know the damage function. Since there is so much dispute about what it exactly looks like, and we are definitely not sure what it will look like for specific regions this is problematic.
Nevertheless, we seem to know certain thresholds and that we need to reduce emissions massively to not cross them. That alone should be enough to introduce the tax as the most efficient tool and adopt it over the time if cheap low-carbon technology actually increases consumption. In that way, the incentive at the margin for everless carbon using technologies will remain.
I don't see why "it is impossible for reduced use of carbon to have such large price effects that it leads to increased use of carbon." If a new product only has marginally lower carbon use than its predecessors, but its price is much lower and the quality the same, than eventhough use of carbon is reduced the higher demand will increase the total use of carbon. Think about the car market where decisive innovation rarely seems to occur, but everything is about the marginal decreases in gasoline use. If because of some other reason the price drastically drops, we will have increased use of carbon
Posted by: D at Feb 24, 2008 11:04:05 AM
The high level of uncertainty in this situation as well as the associated opportunity costs with the various tax proposals suggest waiting or doing nothing is the optimal path forward. Further, we have high uncertainty regarding the CO2 temperature linkage. The debate appears to be turning on the AGW folks as more data comes forward. The probability that we are entering a period of global cooling is now being actively discussed in the weather circles. If this is true, then CO2 could be of value.
In summary, uncertainty in environmental factors coupled with uncertainty of policy decisions leaves us waiting for more information. This is particularly true given that the costs of waiting are low.
Posted by: bee at Feb 24, 2008 11:47:00 AM
"Maybe factories and homes can go solar but cars can't."
Cars can go solar, they just need a big battery.
Posted by: at Feb 24, 2008 11:48:14 AM
D writes: "If because of some other reason the price drastically drops, we will have increased use of carbon".
Yes, that is true. The point is that policies that raise the price of carbon emissions, and/or reduce their quantity, will not, on the margin lead to increased emissions of carbon. It may happen anyway, but it would be worse without such policies.
(If you are concerned that some fluke new technology happens to get developed because of the carbon tax, then you can add the qualifier "in expectation" to the preceding sentence, since it is more likely that a fluke technology that is carbon intensive will get developed without the carbon tax. The tax changes the focus of innovation toward technologies that use less carbon for a given price/performance level.)
Posted by: A student of economics at Feb 24, 2008 12:28:57 PM
Lots more people are going to be using more energy regardless of the cost of low carbon energy. We're building huge coal plants all around the world.
There's an almost limitless supply of coal. Burning massive amounts of coal will produce an environmental nightmare. The only question is whether there we're going to have alternatives. If we don't internalize the costs of burning coal through a carbon tax, we're much less likely to develop low carbon alternatives.
Posted by: JDM at Feb 24, 2008 12:39:00 PM
Well, first, I give Tyler credit for not using the word elasticity, even though that's the concept he was using. I think he's right to avoid jargon in order to attract a wider range of commentary.
I have someruidemntary thoughts.
A lot of this depends on what you think the "loss" function is based on carbon emissions. Are we talking about some smooth increasing external cost curve that rises with carbon use, or are we talking about a probability of an "Oh my God" Disaster scenario, where the probability of horrific losses rises with carbon use? I think the difference between a continuous and discontinuous loss function really drives the choice of policy instrument. In a world with a discontinuous loss function, we may not like even very small increases in carbon use, even if they accompany very large increases in utility. I do suspect, however, you would need one heck of a horrific discontinuous loss before you start begrudging China and India greater use of cars.
Posted by: Keith at Feb 24, 2008 12:51:15 PM
Following up on JDM's comments on coal, to what extent should we consider an export tax on our coal in order to reduce carbon emissions around the world?
If our coal burns more cleanly than other coal sources, this may be counterproductive.
But surely we could place an export tax on our bituminous coal relative to our anthracite, or something like that.
Are there other coal-exporting developed countries in the world that would sign on to a coal export tax?
Posted by: Keith at Feb 24, 2008 12:54:36 PM
What I believe:
1) There is not enough oil and natural gas left to melt the polar ice caps. So we needn't worry about them.
2) How much coal is left? That ought to be the biggest question in global warming research. Some smart people (e.g. the Energy Watch Group in Germany and David Rutledge at CalTech) believe we are within a couple of decades of reaching Peak Coal. If we are then coal can't melt the polar ice caps either.
3) Energy technologies that displace fossil fuels seem within the realm of possibility. Great car batteries and super cheap photovoltaics combine to have these characteristics.
4) Use of coal is more problematic than use of oil since there's a lot more carbon left in the ground as coal than as oil. So cheaper non-fossil fuels ways to generate electricity will do a better job of slowing CO2 emissions than biomass energy for liquid transport fuels.
5) Increased energy efficiency in the United States and Europe accelerates economic growth and leaves more fossil fuels for Chindia to consume. Increased efficiency really doesn't cut CO2 emissions. But it does raise living standards.
6) The trend toward cheaper devices for consuming energy will continue. Wait till nanoassemblers start building cars. We might reach a point where the first month's cost of gasoline is far higher the cost of the car. The bulk of the money now spent on physical cars that currently holds back demand for fuel will eventually be available for buying the fuel.
6) The big wild card is clathrates. If technologies are developed to efficiently and cheaply extract them then welcome to Water World.
7) All the economic debates and policy discussions about global will not stop or even greatly lower CO2 emissions. Only exhaustion of fossil fuels or development of cheap non-fossil fuels replacement technologies will make a difference.
Posted by: Randall Parker at Feb 24, 2008 1:22:39 PM
I just read Nordhaus' critiques of the Stern Review in Science and the JEL, and what I find remarkable is that 100 years from now, the planet is going to be 2C warmer if we cut back to 1990 levels, and 2.5-3C warmer if we don't. So regarding the "Viola" part, I think the probability that the world is able to cut back anywhere near 1990 levels is right about 0.
Posted by: david at Feb 24, 2008 1:24:46 PM
The high level of uncertainty in this situation as well as the associated opportunity costs with the various tax proposals suggest waiting or doing nothing is the optimal path forward.
A common, but still false, dichotomy.
There are actually a range of responses, with different degrees of severity. Why not match the degree of response with the degree of certainty?
I mean, at the worst we would shave some low cost items off of our CO2 emissions curve, and then discover with new data that we needn't have bothered.
On the other hand, "waiting" and "doing nothing" only forces a more aggressive and painful response, should it later be found necessary.
Posted by: odograph at Feb 24, 2008 1:30:05 PM
Tyler, I don't understand your reasoning. You worry that "Even if the new technology is three times as carbon-efficient, if the world as a whole uses three times more energy, carbon emissions do not go down." However, if there's no carbon tax, then the next "new technology" can be expected to be just as cheap (if not cheaper) while being less carbon efficient. If 3x as many people use it, then carbon emissions go up. Are you assuming that there will be more cost-reducing technology advances with a carbon tax than without one? I don't follow that.
Your example of gas efficient cars is even more confusing. Are you arguing that the cost of cars (including fuel lifecycle costs) will be lower if we constrain ourselves to the set of technologies that minimize gas usage rather than allow an unconstrained choice of technologies?
Posted by: A student of economics at Feb 24, 2008 1:42:53 PM
"The high level of uncertainty in this situation as well as the associated opportunity costs with the various tax proposals suggest waiting or doing nothing is the optimal path forward.
A common, but still false, dichotomy."
Actually, it's worse than that. Higher uncertainty almost surely makes waiting less likely be to optimal. Instead, the value of an "insurance" policy of acting now increases as uncertainty increases. The reason is that the marginal costs (decrease in utility) of climate change are increasing in temperature. Consider two scenarios:
a) A lottery with a 50-50 chance of either no change or a 6 degree increase.
b) A 100% certainty of a 3 degree temperature increase.
The expected costs in the first scenario are greater than the expected costs in the second scenario.
The greater the uncertainty, the greater the expected costs, and thus the greater the expected benefit of acting now instead of waiting. This is why people buy insurance for unlikely, but catastrophic events.
Posted by: A student of economics at Feb 24, 2008 1:54:49 PM
Why can't we just compel other countries to impose a similar carbon tax?
Couldn't we just impose tariffs on imports calibrated to the estimated greenhouse pollution content of each product category from each country. Exporters that can demonstrate that their product (including pollution by suppliers and employees) generates significantly less pollution than the estimate for that product category would face a lower tariff. This would create a local incentive to find ways to be less polluting.
Since countries with a well administered carbon tax regimes would be exempt from the tariff, China and India would find it in their interest to establish carbon taxes covering the entire economy.
Posted by: Michael Bishop at Feb 24, 2008 1:57:24 PM
