Should we care about future generations?

In The Age on Saturday we got a fairly standard critique of the case for addressing the global warming costs faced by future generations. Instead, it was argued, we should concentrate on the economic needs of current people. According to the author, Mirko Bagaric, future generations are non-existent ‘uncertain’ people whereas current people are ‘certain’ people who deserve greater weight in any moral calculus. More certain too than future generations are the 90,000 potential Australian’s consigned to become a bucket of blood by abortionists. Indeed, the abuses of millions of other sentient beings, such as animals slaughtered for food, deserve greater weight than uncertain future people, according to Bagaric.

These are not foolish or naive arguments at all. There is hypocrisy in much of the claimed altruism that pervades modern environmental debates. While many bleat about the need to account for the needs of future generations there is a measure of stinginess in many citizens when it comes to using tax policy as a redistributive tool or for assisting the disadvantaged.

A celebrated proponent of the view that we should place low weight on the welfare of future generations is the philosopher Derek Parfit in his fascinating Reasons and Persons. Parfit’s view is that the course of history determines who gets born since it affects which potential parents actually meet and have children. In addition the precise timing of conception determines the meeting of specific sperm with specific eggs and hence the precise children who are born. Both history and these timing events depend on the resource use levels of current people. If the current generation are not altruistic towards future generations that will determine a sp[ecific identity for their progeny. Were they conservationist the next generation would have a different identity.

Then future persons have a no right to complain about our resource conservation action since they would not have existed if things had been different. Under these circumstances current people should ‘have a party’ with respect to the earth's resources and use them to maximise their utility without concern for other than the current generation. This will optimize current welfare. Of the future generations we should be concerned with those people who actually exist rather than merely potential people. The people who do actually exist in the future will appreciate the fact that current people enjoyed a feast of resources since they would otherwise not have existed at all. Those potential people who might have existed had we employed a different current usage policy are irrelevant in the Parfit calculus.

Many economists I have spoken to reject Parfit-type arguments on the basis of overlapping generations arguments. Simply put our children do not arrive after we die but while we live our lives. For example if people live to age 80 and reproduce at age 25 then current and subsequent generations will overlap by 55 years. One suggestive strand of thinking that followed the Stern Review determines the implication of this view for the weight we should place on the welfare of future generations in terms of discounting. The claim is that social rates of discount are revealed to be low because of the way we do value our own lives and those of our children. John Quiggin has suggested that setting low discount rates makes sense if we attach plausible values to our own lives and the lives of our children at not too distant periods in the future – discounting at only 3 per cent involves attacking a 50% weighting to lives only 16 years in the future – hence the argument goes we should discount at very low rates in order to prevent such absurd undervaluations. This is a plausible argument and, consistent with the Parfit critique it relies only on observations about actual rather than potential people.

This argument appeals to me and resolves the issue of discounting in an intellectually satisfying way.  Thus one does not need to think vaguely about duties to future anonymous generations as Parfit and Bagaric do. The hypocrisy of displaying foresight toward future lives but disregarding disadvantage among those currently living still surprises me but presumably reflects our selfish genes.  We will incvest huge amounts in ensuring extremely good outcomes for our own children but disregard poverty in our community and around the world. There should be a less selfish balance.

Housing stock not part of wealth?

Willem Buiter has offered the provocative view that the stock of housing should (generally) not be included as part of net wealth. As The Economist remarks:

A shift in the value of housing does not affect household wealth in the aggregate, he says, because on average everyone is a tenant in his own home. A price fall hurts those who are “long” housing assets, ie, those who own more property than they will need over their lifetime (call them landlords). It benefits those who are “short” housing, ie, those who plan to buy a property or to trade up to a bigger one in the future (call them tenants). The average experience is of an owner-occupier who plans to live in his home until he dies. Unless he worries about how much he will leave to his heirs, he is indifferent to the value of his home.

The qualifier 'generally' is needed since Buiter excludes property price changes that stem from speculative bubbles since in the Buiter model:

'should prices fall because of a bubble bursting, then there is a wealth effect. Landlords are worse off because they lose the bubble value—the part that did not reflect fundamentals. But tenants are no better off, because the present cost of future housing services is unchanged'.

Otherwise falls in house prices are transfers of wealth between landlords and potential buyers and will not have deflationary effects. They will simply be redistributions. Thus the standard sorts of wealth multipliers which are between 0.01-0.07 for rich countries (so if wealth rises by $1, spending rises by between one and seven cents) are an exaggeration. There should be no deflationary impact from the current fall in house prices to the extent these reflect a collapse in fundamental valuations.

Of course the empirical relevance of the Buiter argument depends on the extent to which current house prices are falling in response to a deflated bubble. My guess as a non-specialist macroeconomist is that this is in fact a fair part of the current story.

The complete NBER Working Paper can be sought here.

Irreversible destruction of the Murray River's lower lakes

The imminent destruction of the freshwater ecology of the lower lakes of the Murray River on the grounds that upstream freshwater supplies are insufficient to flush them out and that stored water suppliesin the river system must be safeguarded for human consumption might well be justified on triage grounds but it is nevertheless an alarming policy failure. The present government can hardly be held entirely responsible for the current situation - this represents a policy failure by government that goes back decades. The claim by Greg Hunt that Penny Wong is behaving like Saddam Hussein in destroying Ramsar listed wetlands is completely over the top - the catastrophe that is emerging also implies culpability through the successive policy failures of Coalition governments. Of course Wong's claim that there are insufficient water resources should be thoroughly checked out but it seems likely to be an accurate summary of the current situation.

The inability of state and federal governments in Australia to reduce the excessive use of water in irrigation reflects a political failure of the Australian federal system. The only possible benefit from the destruction of these Ramsar-listed wetlands might be the impulse it provides governments in Australia to finally seek to address the environmental catastrophe emerging in the Murray-Darling as a consequence of excessive water use in agriculture. Labor is in power both federally and at state levels - it should now act to buy back excessive water use entitlements to prevent these types of situations recurring with the hope that the seemingly irreversible ecological effects of being forced to flood the lower lakes with saltwater can eventually be reversed.

Stephen King leaves ACCC, goes to Monash

The ACCC's Stephen King has been appointed Dean of the Faculty of Business and Economics at Monash University.  Joshua Gans provides praise for the appointment of his co-author and business partner.

I hope this appointment is a success story for Monash - a university which, in my view, has not quite lived up to its considerable potential in the economics and business areas.   In the late 1970s I visited Monash and came to the view that it would likely become one of the top economics department in Australia.  It then had resources plus a youthful dynamism but the positive outcome didn't happen. Monash has had similar opportunities since then but has suffered under a load of administrative philistinism.

Today Monash has outstanding academics including Professors Yew-Kwang Ng and Peter Dixon.  It needs to be driven in a direction that encourages scholarship and which abandons values of academic entrepreneurship and managerialism.  Stephen King probably has the required values - it remains to see what changes he can make given administrative structures that often promote administrative rather academic values.

If Stephen can achieve success in putting competitive pressures on other universities, the business and economics areas throughout Australia - including my own - will derive benefits.  It is up to the Dean incumbent to be cautious and calculating but not to lose sight of core academic goals - good teaching, good research not administrative empire building.  Overall I am reasonably optimistic that the outcome with Stephen will be an improvement that will advance business and economics education in Australia.

But time will tell.

Update: I learnt today that Professor Gael McDonald has been appointed Dean of the Faculty of Business and Law at Deakin University. Professor McDonald undertook her PhD at the London School of Economics in 1989 on 'cross cultural issues in ethics management'. She has published in 'sports management' and on 'character education in NZ schools' - I could not locate a comprehensive CV online. Professor McDonald is currently Vice-President (Research) at Unitec in New Zealand. She has held a number of senior positions, including Vice-President (International) and, before that, Dean of the Faculty of Business at Unitec. Here are some more of her recent publications.

Tipping Point on climate change?

An outstanding Four Corners show last night dealt with the melting of the summer pack ice in the Arctic as a consequence of global heating.  The reality of a 'north west passage' could become a reality by 2013 as the Arctic becomes ice free during the summer months.  The US, Soviet Union and Canada are engaged in a scramble for oil and other resources that will become accessible as a consequence of this climate change - the use of these resources will of course worsen the problem.  Shipping companies and fishery businesses are likewise scrambling for business in the newly opened up areas.

More seriously, the possibility of positive climatic feedbacks from reduced ice cover - less reflection of heat energy back into space and the possible melting of the northern permafrost - raises the realistic prospect of a climate change catastrophe that might impact on people currently living. This would markedly increase world average temperatures and substantially increase sea levels.

Severe temperature increases in turn might lead to drought in the Amazon and fires there than would release huge amounts of carbon and destroy 15% of the world's carbon absorption capacity.  The Greenland ice sheet and the ice cover in parts of the Antarctic also become vulnerable. It is an apocalytic scenario that would make an enjoyable feature film were it not so plausible and potentially destructive for our children.

The show reinforced views in the Stern Review which is excellent on these same issues and was one of the first policy oriented-documents to account seriously for the prospect of catastrophic change.

The issues raised have immense consequences for dealing urgently with global heating issues. Indeed one view is that we may have already gone too far.  The dates at which the summer pack ice was forecast to disappear has progressively shifted back from 2100 to 2070 to 2050 to 2013 ominously suggesting that the prospect of substantial damage is coming more keenly into focus.

An incidental observation - the photography in this show was superb.

Leadership of Liberals

It is obvious to me that Brendan Nelson will not lead the Liberal Party to the next federal election. His attempt to turn the emissions trading scheme debate into a mean spirited rejection of trading unless developing countries with a fraction of our energy consumption also commit to do so means that he will lose Liberal Party supporters such as myself.

I cannot support this clown because (i) his stance is immoral; (ii) the urgency of climate change issues makes it imperative that we put pressure on other countries to act by not being hypocrites ourselves and (iii) it is unwise to be out of step with the majority of Australians who do support an ETS.

I am unsure whether Peter Costello or Malcolm Turnbull would make a better alternative leader - a leader who would regain power from Labor. Costello has the greater electoral appeal but has the liability of being a strong supporter of labour market reform that went even beyond WorkChoices. These reforms I continue to support. John Howard did too but he always figured they would be electorally unacceptible. The Liberals lost ground here after the election by whimping out like a bunch of beaten dogs when the Labor Party moved towards dismantling policy moves that fostered employment and created a more efficient workforce in Australia.

Its a simple principle. Don't abandon successful policies when opposition to them is backed in the main by a disappearing trade union movement who have zero economic intelligence - witness their stupid insistence on preserving the real wage in the face of food and oil price increases. Believe me - stripping aside party-political allegiances - there is not an economist in Australia who supports this foolish policy in private.

In addition Costello will always be viewed as being a sook because of his unwillingness to take on John Howard for the leadership (in my view, to be fair, he had no choice) and because of his early suggestion he would quit politics after the 2007 loss.

Malcolm Turnbull has lower electoral appeal according to the polls but won the day on retaining a sensible attitude to climate change. He is a mile smarter and much quicker to sense the political winds than Nelson and would make a much better PM than Rudd. He has had lower visibility and less experience than does Costello but that is changing.

Whoever the Liberals do select to replace Nelson they should back this leader through to the next election and ignore the invitation to commit political suicide with continuing leadership debates. The economic downturn and the preospect of a severe contraction of house prices will swing back those 'working families' who believed they could reliably trust the economy to Labor with its trade union debts and fundamental lack of talent.

Whoever wins the current leadership tussle I believe Julie Bishop remains a capable potential Deputy PM with Tony Abbott standing in the wings should Bishop eventually be shifted into a leadership role. Unlike Labor the Liberal Party has plenty of talent to draw on. Brendan Nelson was a 'sacrificial lamb' who probably understands his temporary role - he might be part of a Liberal front bench but not a future PM.

No, global heating did not stop in 1998

I am constantly surprised how wrong arguments are repeatedly trotted out in policy debates. They can be relentlessly refuted but, like the weeds in my front lawn, they consistently reappear. Nowhere is this truer than in the climate change debate.

Andrew Bolt claims that climate change stopped in 1998 so that current policies to address it are a waste of effort and money. These claims are comprehensively refuted here in an article by climatologists Robert Fawcett and David Jones.

‘While 1998 was the world’s warmest year in the surface-based instrumental record up to that point in time, 2005 was equally warm and in some data sets surpassed 1998. A substantial contribution to the record warmth of 1998 came from the very strong El Niño of 1997/98 and, when the annual data are adjusted for this short-term effect (to take out El Niño’s warming influence), the warming trend is even more obvious.

Because of the year-to-year variations in globally-averaged annual mean temperatures, about 10 years are required for an underlying trend to emerge from the “noise” of those year-to-year fluctuations. Hence, the fact that 2006 and 2007 were cooler than 2005, is nowhere near enough data to clearly establish a cooling trend’.

Data from three international time series and one for Australia discredit the wrong claims of Bolt. The Garnaut Review commissioned two econometricians at the ANU to examine the same vclaim of a cessation of warming. They also found that the evidence did not support the claim. So too does this study from the Yale Forum.

Bolt rejects the Garnaut findings although he agrees temperatures did rise after 1998 a bit but they have since stabilised. Hardly a compelling counterexample to the case for a continued warming trend given that he is attempting to draw inferences about the long-term trends in climate from a few year’s observations when longer-term trends, and even the short-term evidence, is inconsistent with his claims. It is interesting that one of the institutes he claims supports his views of sustained cooling says no such thing - in fact they forecast a moderation in rates of warming up to 2020 followed by a rapid resumption of warming after this date.

It is tedious to attempt to continue to have to refute the strong evidence of global warming and the case for addressing this problem now. The reason I post this claim is that the shenanigans in the Liberal Party suggest there is still a rump of climate change denialists determined to thwart action on climate change in Australia.

There is no certainty on this issue of climate change but science does not present its claims as certainties. Given that almost all climate scientists accept the reality of warming and that the counter-arguments provided seem so self-evidently weak it seems reasonable on this occasion for non-science citizens to act on the view that waiting for absolute certainty is riskier and more expensive than controlling the causes of emissions now.

A break from blogging

Apologies to readers for the recent lack of posting. I have been busy lately with preparations for forthcoming teaching and have been travelling. Hopefully things will normalise over the next week or so.

On Friday this week I am presenting a seminar on 'Policies for Reducing the Costs of Cigarette Smoking in Australia' (a much earlier version here) at the University of Queensland from 11-12pm in the Colin Clark Building Room Level 6. I'll be in Brisbane Thursday-Saturday morning and would like to meet blog readers in Queensland. I'll be staying at Hotel Ibis on Turbot Street.

The good news this morning is that the much-maligned Premier Iemma has moved decisively in NSW to ban the public display of cigarettes in stores and to fine the 10% of smokers who insist on smoking while driving when there are young children in the car. This follows similar moves in other states such as South Australia.

Passive smoking is particularly injurious to kids and lurid displays of cigarette products are primarily designed to attract young kids into this disgusting habit (a source of Phillip Morris' disgraceful opposition to this move).

Well done Morris and brickbats to those hideous corporates who continue encouraging our kids into making a premature visit to the morgue.

Update Sunday:  Brisbane was sunny and University of Queensland a pleasant destination.  Saw old friends and had a great few days. Now back in freezing Melbourne.

Oil subsidies in emerging countries

A standard economic proposition is that poorer people generally have more price elastic demands for many goods.  When a good's price rises it is those with constrained purchasing power who cut back their consumption most. Why then have oil demands not fallen in oil importing emerging and middle income countries when we know demands have fallen off markedly in developed countries?

This is partly because in countries accounting for 96% of the increase in demands last year oil prices are subsidised - often massively. Until recently Malaysia devoted 7.5% of its national economic output toward fduel subsidies.

Often provision of these subsidies is an intractable political issue. Sometimes too the subsidies are a second-best way of addressing the environmental problems of deforestation that would worsen were poor people to be charged the fiull price of kerosene.

These subsidies mean that the aggregate quantities of fuel demanded will not adjust in response to higher prices so as to stabilise these prices - they keep prices high in developed countries where oil products are generally taxed rather than subsidised.

Eddi Reader

In terms of contemporary music I have to agree I am out-of-touch.  This is of course a disadvantage but pleasant surprises often present themselves as a consequence. The other night on ABC TV I saw a talented, female singer performing at The Basement in Sydney - Eddi Reader.  She is Scottish and that's about all I know about her. The next day, selecting at random, I bought an early recording of hers - its just called Eddi Reader - and I have been listening to it this evening.   It is distinctive contempory, uncompromising folk-rock (occasionally bluesy) music.

I can't find any poached versions of music from this album of Eddi on the net but there is plenty of other stuff. Try this YouTube for a sample - or this or this or this.  She obviously shines in concert!

Are excises on fuel too high?

This provocative post by Gary Becker argues that the low taxes on US petrol completely internalise the external costs of petrol consumption in terms of the global warming and foreign oil dependence externalities imposed on the US.  On this basis, Australian excises on petrol - much higher than US excises - would seem to be on the high side and to go further than you would want in internalising externalities that hurt Aussies.  Thus the Rudd Government's Green Paper decision to exempt petrol from carbon charges by rebating any carbon cost from current excises would seem justifiable.  At least it is not a priori a foolish argument.

Of course Rudd is concerned with the political costs of taxing petrol further when its cost is currently high.  Maybe this is not a dishonourable position either.

Becker points out a host of benefits of high current fuel prices in internalising congestion and other externalities.  He is right. OPEC and China are jointly doing a better job of managing congestion issues in Melbourne than the Victorian Government with their inane fixation on expensive tunnels and extra freeways.

Climate change adaptation policies for the City of Melbourne

This interests me – a draft plan for adaptation to climate change in the City of Melbourne. As stewards of their local communities, local governments have a role in assessing and addressing the impacts of climate change.  Note I am interested in the fact that such a plan exists for our local community rather than the specific insights of this draft report. 

 

Generally cities are seen by this report as likely to be affected by climate change in three key ways:

• Impacts on resource productivity or changes in market demand for goods and services;
• Performance of physical infrastructure & industries directly affected by changed climate conditions or damaging extreme events;
• Populations affected by extreme weather, scarce resources, health status, changed economic conditions or migration.

By 2030 Melbourne is expected to be significantly affected by warmer temperatures and heatwaves, lower rainfall, intense storm events and flash flooding. An adaptation response comprising four policies sought:

• Loss prevention – actions to reduce vulnerability to climate change;
• Loss sharing – spreading the risk of loss among a wider population (eg insurance);
• Behaviour modification – eliminating the activity or behaviour that causes the hazard;
• Relocation – moving vulnerable population or systems away from hazards induced by climate change.

The City of Melbourne has employed consultants to assess Melbourne’s climate change risks for 2010, 2030 and 2070. The main climatic effects envisaged are:

• Reduced rainfall and drought;
• Extreme heatwave;
• Intense rainfall and wind storm;
• Sea level rise.

Melbourne is expecting unprecedented population growth to become Australia’s largest capital city by

2030 - population within the CoM is expected to double over this period.

 

Two key adaptation measures seen as having high value in this draft report are:

• Stormwater harvesting which can assist in both flash flooding events & insufficient water supply;
• Increasing passive cooling of the city to reduce the heat island effect.

With respect to the latter Melbourne’s CBD can be 7 degrees higher than other Melbourne suburbs on a hot day. This significant difference substantially heightens the vulnerability of people in the city to heat stress, injury or death. Measures to reduce the city temperature both inside buildings and at street level will provide considerable benefits to reducing overall exposure.

 

Feedback on this proposal can be submitted by replying to this email, via the online feedback form. I am interested in collecting information on this type of work and thereby increasing my knowledge of climate adaptation to urban and city areas.

Mr Ali Allawi on Iraq

Former defense and finance minister in Iraq, Mr Ali Allawi, gave a valuable account of the current political situation in Iraq on last night's Lateline.  According to Allawi the majority of parliamentarians - and probably most citizens*  - would quietly back Obama's policy to withdraw troops from Iraq in 18 months.  At the same time the government feels a debt of gratitude to George Bush - if only because many owe their positions to the US intervention. Of course Bush too has noew stated a commitment to withdraw although there is no specific timetable. The reasons for the improved security situation in Iraq - extra oil money driving a more prosperous economy, the decline in the Sunni Arab insurgency,  the defeat of  al-Qaeda and - paradoxically but unquestionably - the success of the recent surge.

Critics of the US effort in Iraq (including Obama's criticism of the ineffectuality of the 'surge') have been proven completely wrong. 

The transcript is short and very worth reading.

* Not the Kurds and some Sunni who, despite their public opposition, fear the consequences of a US withdrawal.

Let's hear it for the 'old' guys

After 3 rounds Greg Norman is leading the field in the British Open at Royal Birkdale. At 53 years of age and without having played a lot of golf in recent years Norman has astonished the golfing world.  Good on him - regardless of what happens in the final round it is an amazing achievement. His marriage to Chris Evert undoubtedly improved his game. Cheers too for Rocco Mediate who came within a whisker of beating Tiger Woods at the recent US open - he shared the lead with Norman in the British Open for a while. The likeable, 45 year old Mediate has demanded a rematch with Tiger! 

I never thought I'd come to backing sports people at least partly because of their age.  I agree it is a bit tragic.  But the conditions at Royal Birkdale - high winds and rain - were about as bad as I have seen at a major tournament.  The old guys had the golf skills and the general savy to do well.  They deserve applause.

Update: Norman crashed in the final round with a 77 while his worthy opponents shone with great rounds of 69. The Shark went down and ran a distant third.  He was leading after 9 holes so - Harrington and Poulter must have put in fantastic performances then.  The criticisms of Norman losing his nerve etc have already started. What a sad lot of critics they are.

Carbon Pollution Reduction Scheme

This is my take on a ponderous, overly-long document. They were notes for a university class so if I’ve missed important points I’d appreciate being told.

According to the Green Paper we will have an emissions trading scheme (ETS) – a Carbon Pollution Reduction Scheme (CPRS) - by 2010 based on cap & trade. The cap will be consistent with the goal of reducing national emissions by 60% below 2000 levels by 2050 – a bound that may be too low but which is a start. The caps & hence the equilibrium carbon prices will be determined in a White Paper in December 2008.

Generally the scheme seems a good start to me. Many of the criticisms of it are at best naive.

There will be a cap on the price businesses would pay for permits from 2010–11 to 2014–15 so a hybrid trading/price system. This enhances the credibility of the scheme by ensuring carbon prices don’t get ‘too high’ and also provides predictability as we move into unchartered territory.

The propaganda arm of government has been quick to point out that more than 99% of all firms in Australia will not be directly involved in the regulation of emissions. Only about 1,000 firms will be directly affected although, as general equilibrium theory makes clear, there will be impacts throughout the community. That is the idea – to change people’s behaviour by making them respond to higher prices. Significant emitters must acquire or be granted permits.

The transport sector will be covered but, for 3 years, charges on petrol will be offset by excise reductions. This seems inevitable to me given rocketing fuel prices. If fuel prices did slump in 3 years the policy could be revised.

An ‘equivalent’ rebate will be applied to businesses in agricultural & fishing industries for 3 years – this was seen as necessary as excise system does not apply to this sector. A bit weird.

Forestry is included on a voluntary ‘opt-in’ basis. Carbon pollution permits additional to the cap would reward the net quantity of CO2 stored in forest. A liability would be imposed for net reductions in stored CO2. Deforestation is not included in the CPRS which I think is a mistake.

Agricultural emissions are not included until at least 2015. Predictable -  but this sector is a major source of emissions – eventually it must be included.

There is limited scope for offset credits on the grounds of the implied administrative complexity - you know ‘what would have happened in the absence of a particular decision’.

Carbon pollution permits could be used in any year from or after their year of issue (unlimited banking) with limited borrowing from future scheme caps is possible. Seems sensible.

The scheme will be designed to link with other schemes overseas to lower the price of carbon pollution permits in Australia. The decision to link would depend on the reliability of the monitoring systems, of another country. Sensible.

Revenue raised will help households & business adjust. It will provide low income households with increases in assistance through the tax & transfer system & all households with some assistance. This is reasonable. The aim is not to levy another tax but to change relative prices. I would cut GST and income taxes and push for greater reliance on ‘double dividend’ yielding green taxes such as those implied by the CPRS.

A Climate Change Action Fund (CCAF) will assist business transition to a cleaner economy. The CCAF will assist in funding capital investment in innovative low emissions processes; industrial energy efficiency projects with long payback periods; dissemination of innovative practice among SMEs. Strongly agree – demand management measures will be insufficient. Also need supply measures and measures to induce appropriate technology switches.

Free permits will be supplied to the most emissions-intensive trade-exposed activities to reduce ‘carbon leakage’. Around 30% of free permits will go to emissions-intensive trade-exposed activities. Strongly agree with the sense of this and disagree with much commentary on this issue. The objective is to charge for emissions associated with Australian carbon consumption not production – to charge on a destination basis. Ideally this would be achieved by taxing our consumption of carbon producing goods that are produced locally and by taxing imports of such goods – via retaliatory tariffs - if other countries are not taxing carbon emissions. Exports would be tax free. This amounts to charging for emissions on a destination basis.

The bureaucratic machinery to work all this out would be nightmarish. Just giving free permits to major exporters is enough. This principle should extend to all carbon intensive exports including those of environmentally friendly natural gas. The grizzles by BHP-Billiton and Woodside Petroleum are fully justified and I hope will lead to a policy change by government.

Assistance to trade exposed industries will be on the basis of industry average activity emission intensities to ensure businesses have an incentive to reduce their emissions leading up to the introduction of the scheme. It would reward those firms that have already taken action to reduce their carbon footprint. The rate of assistance given will be gradually reduced over time at a pre-announced rate to ensure all parts of the economy contribute to the objective of reducing emissions. I am not sure that these points reflect a sound understanding of the principles of destination accounting or not. Again, we should tax our consumption of carbon not our production – that is the point.

The Government proposes to provide a limited amount of direct assistance to existing coal fired electricity generators. To ameliorate the risk of adversely affecting the investment environment, the Limited direct assistance will be provided to existing coal-fired electricity generators via the Electricity Sector Adjustment Scheme (ESAS). I don’t really think this is sensible. These are non-traded goods and the prospect for carbon trading has been anticipated for years. For the most part this will be a cash handout to multinationals that will not have any effects of making them greener. I’d rethink this one.

An independent scheme regulator will be established to conduct reviews of the CPRS every 5 years. The responsibilities will be to monitor and enforce compliance, run auctions for permits, allocate free permits according to specified rules & maintain the national emissions registry. Unfortunately the Government will set and extend scheme caps and gateways, decide the nature and extent of international links, and decide when allocations of free permits to emissions-intensive trade-exposed industries should cease.

On this last point I would have set up an independent authority that had most powers with respect to these issues. There are too many opportunities for backtracking by future Labor and Liberal Governments. There are real credibility issues here. Industry will only undertake the sorts of massive capital investment programs sought if they expect carbon trading to last.

We need to be committed to a program of carbon pricing that will gradually lead to a phasing out of the use of fossil fuels in the economy.

A minimum price for booze

This is a cute microeconomics task.  From an group email sent to me by NCETA's Dr Anne Roche:

‘The National Centre for Education and Training on Addiction (NCETA) has been contracted by the Australian Government Department of Health and Ageing to conduct a feasibility study on setting a floor price for alcohol products. This study is being conducted nationally to determine if state and territory governments, working in conjunction with liquor licensing bodies, can introduce a floor price to control high-risk alcohol consumption.

For the purposes of this study, an alcohol floor price is defined ‘as a minimum fixed price per standard drink applied to all alcohol products in Australia’. Please note that an alcohol floor price is not a synonym for an increased levy or tax on alcohol. It is a distinct and unique strategy’.

The move is presumably an effort to stop heavy boozers from drinking themselves silly on cheap flagon wine. In a sense it is an imperfect surrogate for volumetric pricing. The latter identifies ethyl alcohol content as the prime cause of alcohol’s social costs and advises taxing accordingly in accord with the alcohol content of booze.

A key issue is how a minimum price would compare with a volumetric tax. One obvious effect is that the tax revenue would accrue to the government rather than as revenue to the booze companies.

The effect of a minimum price would be to force a switch towards better quality booze whose price lies at or above the minimum away from booze that is currently priced below the minimum. There would also be a reduction in overall consumption.

The measure would have very regressive impacts and will undoubtedly be criticized by non-thinking social worker types on these grounds. (It’s a dumb argument because regressivity should be assessed from the viewpoint of the total impact of the tax-transfer mix, not the impact of a particular tax).

It might restrain limited income youth from experimenting with booze which might be a good thing.

It would presumably foster the creation of homemade brews which might have some health and other costs.

It might encourage substitution toward non-alcoholic intoxicants via activities such as petrol sniffing and smoking cannabis.

It would reduce problem drinking by those with drinking problems though the precise effects are a matter of evidence. Dependent drinkers might often be income-constrained but their compensated price elasticities are likely to be low in any event. It is an empirical question which of these effects works harder.

NCETA are seeking submissions on this. If we got some good comments and some bright ideas we might send in this blog post as a joint contribution. What are your views on this proposal?

Investing wisely in love

Love is scarce so invest in it wisely. That's the message of this piece by Ben Stein in the New York Times.  I'd be interested in comments.   I guess don't want to just be 'something you invest in' but do you organise your affections on the basis of cost-benefit analysis and the payback principle?

According to Stein the returns in love situations are proportional to time and devotion invested. The amount of love you get from an investment in love is correlated to the amount of yourself you invest in the relationship. If you invest caring, patience and unselfishness, you get those things back.  Of course that is not necessarily true - ask any parent!

It helps if you stay with 'high-quality human beings'. Don't have relationship with someone with many 'serious problems'. The question ios how do you know? I guess inspection procedures go with investment effort.

And do your research. The most appealing exterior can hide the most danger and chance of loss.

Diversification in love, at least beyond a very small number, is impossible Stein claims so be relatively faithful.  Quote:

'In every long-term romantic situation, returns are greater when there is a monopoly. If you have to share your love with others, if you have to compete even after a brief while with others, forget the whole thing. You want to have monopoly bonds with your long-term lover. At least most situations work out better this way'.

I wonder if there isn't a case for optimal diversification - though it depends what you mean by love.

Finally, according to Stein, apply cost-benefit analysis towards your relationships and take a long-term perspective:

'The returns on your investment should at least equal the cost of the investment. If you are getting less back than you put in over a considerable period of time, back off.  Long-term investment pays off. The impatient day player will fare poorly without inside information or market-controlling power. He or she will have a few good days but years of agony in the world of love'.

I wonder - are many of these things not built into our genes. The next thing so mid-west American college will incorporate these ideas into a dubious undergraduate unit 'Personal Finance 3'.

Fannie, Freddie & you

A joke in Washington these days goes like this: "What's the difference between Enron and Fannie Mae? Answer: The guys at Enron have been convicted."

(WSJ as part of a potted history)

The US will intervene to lend to Fannie May and Freddy Mac - by far the biggest home lenders in the US. They may even buy stock in the firms to support their equity price. Their equity prices have fallen by half in a week.

Paul Krugman sets out the background to the Fannie and Freddie problems. These institutions were not involved in the sub-prime crisis - they have just been caught with substantial lending to housebuyers who paid too much for their houses. Many borrowers have negative equity in their houses so that delinquency rates are high. This poses problems basically because these institutions are undercapitalised and the US government have effectively guaranteed their liabilities.

Krugman argues that it is no big deal that taxpayer money will need to rescue these firms - he argues theUS is in a major financial crisis and this ctype of intervention is inevitable. To Krugman Fannie and Freddie can’t be allowed to fail since with the collapse of subprime lending, they’re now more central than ever to the housing market, and the economy as a whole.

Its true that intervention is desirable from the viewpoint of the global financial system - it would be dealt a hefty blow were these firms to fail. These institutions have over $5.3 trillion in liabilities and the problems they face stem from the moral hazard implications of the US government guaranteeing these liabilities. Its ca repeat of the S&L saga. The difficulty here is that the current bailout provides the grounds for worse problems in the future. It is an apparently tough choice but not really a choice at all given that history cannot be rewritten.

Fortune magazine

Fortune is one of those magazines I subscribe to with mixed feelings. On the one hand it caters to some the worst aspects of US consumerism and an almost adolescent worship of wealth. But it also provides a gritty and useful view of the world of business from a business rather than economics perspective. It's latest issue contains the Fortune 500 Global edition which looks at the performance of the world's biggest firms. I generally look at this carefully noting particularly how Australian firms figure and how the emerging giants of China, India and Mexico are making their impact. I always stick my copy of this particular edition on a bookshelf and refer to it over the coming year - it is an invaluable resource and a great teaching aid.

Another feature of Fortune I greatly respect is that much of its material is online.

On the Fortune 500 listing Australia's own BHP-Billiton is 183rd on the Fortune 500 list but 17th in terms of profits. For every three dollars of sales it makes about a dollar profit. For its size it is one of the most profitable firms on the planet. Amazing!

Barney Gimbel's piece The New New World Economic Order in the same edition (unfortunately not online) is about as eloquent a 2 page summary of where the world economy is going as I have seen. The US, and indeed the developed countries as a whole, are no longer the locomotive of global growth - 54 developing countries surveyed will grow by 6.7% this year even though growth in 31 developed countries averages 1.6%. Voracious consumerism has historically come from the US but its source will soon be elsewhere. By 2020 China will have 700 million middle income earners and India 583 million. Gimbel sees the major threat to the world economy as exploding inflation in developing nations.

Despite some mild misgivings Fortune remains one of my favourite weekly reads.

Choose economics as your business specialisation

I have never recommended that any other than the least academically able business students* even consider enrolling in undergraduate degrees such as dedicated marketing and human resource management. The vast bulk of students are far better off studying a discipline like economics or finance provided, again, that the latter provides a solid background in basic economics.

Economics students are better off that this lot because they learn to analyse the world in terms of a solid body of theory that has been developed over the past 200 years. Apart from providing them with an education of intrinsic interest (with quantitative methods, modelling skills, economic history, knowledge of institutions) economics also gives them a good fundamental education that they can apply in various areas. They also earn more money.

• Those who want to employ marketing specialists would be better-off seeking an economics or arts graduate with a good fundamental education followed by practical experience (and perhaps an MBA) rather than an undergraduate who has majored in marketing but doesn't know what a demand curve is. Or who doesn't know any finance or macroeconomics and hence doesn't understand the broad forces that drive business.
• Those who want to employ human resource managers could usefully sample from the same pool. They will certainly do better than employing an undergraduate who has studied some gobbledegook personel management and third rate psychology - but no labour economics, game theory or industrial law - and who, apart from a part-time job working at McDonalds, has never themselves been part of the paid workforce. How can they assist in bargaining with a trade union or employer when they have never studied bargaining?

The fallacy in believing that you do best by choosing a vocational specialisation rather than a solid fundamental education is underlined by a recent Forbes study on graduate salaries in the US. Business isn't fooled even if naive undergraduates fall for the vocational slogans and the managerialism-speak.

In the Forbes study, guess what - economics comes second! in terms of reward. In order of the fields are:

1. Computer Engineering
2. Economics
3. Electrical Engineering
4. Computer Science
5. Mechanical Engineering
6. Finance
7. Mathematics
8. Civil Engineering.

The reason that economics is valued so highly is that it provides strong generic, analytical skills. It is adaptable and is consistent with flexible thinking. Those who seek to analyse marketing and human resource issues without quantitative methods and without the economics that provides a clear understanding of how markets work are like the hapless soldier trying to charge a regiment of tanks with a defective slingshot.

They will almost inevitably lie at the bottom of the managerial ladder both in terms of status and salary and deservedly so.

Firms provide better on-the-job training than universities do. Most of the self-proclaimed practical 'businesspeople' pushing an atheoretical, anti-analytical line in the universities couldn't organise themselves a root in a brothel. Most have no business experience and parade their philistine anti-intellectualism as something to be admired when it is clear to all that they are simply making a virtue of necessity.

For the Forbes survey (not the polemics) a Hat Tip to Greg Mankiw.

* The least able students have other options too. The generic B.Bus when properly constructed with enough quantitative methods, economics and finance is better than any amorphous dedicated vocational degree that, in the main, combines psychobabble with management-speak. They would also be better off doing an Arts degree.

Financial markets & the world

These types of headlines amaze me:

'The Australian dollar has open higher as the US dollar weakened on world political tensions after Iran test-fired 9 missiles overnight'.

Its an obvious point - my obvious point for the day - but we do live in one world.

Nelson nibbles away at a 2010 start on carbon trading

Brendan Nelson seeks to gain appeal by abandoning all principle. He has now reverted to the Howard position of not endorsing controls on carbon emissions before other large polluting countries (China, India, Russia) do so. Nelson warns of economic peril in ‘going ahead of the pack’. Nelson's warning is simply opportunism.

As the Garnaut Review suggested the climate change issue is ‘diabolical’. We don’t need to act on warming problems today - we can apparently delay until tomorrow so there are endless procrastination probabilities. In addition we need international co-operation, there is much uncertainty etc etc. It is just all too hard!

But the bottom line is that the probable costs of not taking action are huge and the costs of taking action are relatively low. The costs of constantly postponing are accumulating and this is making decisive actions more difficult and expensive.

The issue of carbon leakages has probably been exaggerated and leakage effects can be dealt with anyway by applying destination accounting in taxing carbon. This means exempting exported energy intensive outputs and placing tariffs on imports from countries that do not price carbon emissions correctly.

Update 1: It seems Penny Wong, the Australian Worker's Union and Labor's Michael Costa are all backpedalling on Garnaut's proposed 2010 startup date for carbon trading. It is a pathetic display and an indictment of that miserable branch of humanity comprising Australian politicians.

Update 2: Nelson continues to dig himself a deeper hole. He rejects the position of the Shadow Treasurer Malcolm Turnbull that Liberal Policy is for emissions trading to begin unconditionally in 2012.

Garnaut Review preliminaries

I have been reading the enormous Garnaut Climate Change Review (hereafter, Review) rather selectively – mainly in relation to forecast events in the Murray-Darling Basin. I'll report on my investigations later and also comment on what to me are the guts of the Review's work - it's findings on designing an emissions trading scheme which are in the last one third of the Review.

I wonder about the size of this Review. Those without specialist interests in climate change will not read the whole document because the effort is too daunting while those with specialist interests might not read it because there is a huge amount of material in the Review that is non-new – I cannot see much that is new in Chapters 1-5. Chapters 6- 7, 11-13 include much descriptive material already published or which is on meteorological websites. The substance starts after Chapter 14 - that is useful information since it cuts the read by 50%.

I can’t help thinking a much shorter and more focused discussion would have been better. It is unnecessary to engage in yet another literature review – there is already plenty of material out there e.g. the Stern Review. What is of interest are the specific problems Australia faces and this should have been the exclusive emphasis – indeed these problems were the main assigned ‘terms of reference’.

On the other hand the document is well-written and thoughtful. Climate change is a ‘diabolical policy problem’ and is ‘insidious rather than confrontational’. Given the high levels of uncertainty involved there are significant incentives to procrastinate yet the costs of doing this are huge. We need to take action when there is no immediate need to do so and where third-rate politicians eager to grab at any short-term political advantage bedevil attempts to deal comprehensively with the issues. Moreover international cooperation of a type never achieved in history is required. The Review points out the problems but also the advantages Australia has in terms of being a resource supplier to Asia and in terms of its resilient market-driven economy.

The Review does not present specific targets or estimate the costs and benefits of mitigation - these we are told will come later - although it does estimate trajectories of the economy without climate change or mitigation comparing this with estimates with climate change but without mitigation – the difference between these scenarios is one way of measuring the cost of climate change.

The Review is frankly a political document that is designed to encourage politicians to show conviction on the climate change issue and to motivate voters to back those who do. Thus there is a considerable amount of pure fiction in the report. For example the Review forecast in 2008 that output in 2100 (in the absence of climate change) will be 700% higher than at present with per capita output quadrupling. With median estimates of climate change and no global mitigation response GDP would fall from this level by 4.8%. I wonder if any economist in Australia places faith in such numbers. Yet it is these numbers which are being used as reference scenarios through to 2100.

Of course the immediate defence is the imperative 'do better' which I cannot. There is also the inevitable defence that a simple message needs to be told to achieve what those pursuing the Review believe is sensible policy.

I also would have liked much more explicit discussion of the 2007 report by the CSIRO detailing climate change forecasts for Australia – these are very similar to the 2001 forecasts. I would also like to see detailed the Monash Multi Regional Forecasting (MMRF) model which is the main way actual climate changes are forecast to translate into economic changes which is barely discussed at all. The only reference to it is to a qualitative piece by Phillip Adams in 2007. We are told that more details will be provided in the ‘Supplementary Report’ due later this year. In my view this is unsatisfactory and not a detail - these two inputs determine the climate change outcomes of the Garnaut Review.

Update: Colleague Damien Eldridge points to this link to further information on MMRF.

Birthday bash

Friend Jack R, is having his 60th birthday party soon - in Forestville, Sydney. I will be there but it seems the acceptances have been slow. This has got to be the YouTube of the decade.

Fuel price surrogates for congestion pricing

New York politics failed to agree to introduce congestion taxes to deal with traffic congestion. But higher fuel prices are delivering desired outcomes anyway. This is true in New York and, of course, in all major cities along the eastern seaboard of Australia. Fuel tax increases to deal with congestion are generally ill-advised because they lead to drivers being penalised when they take non-congesting trips. But when urban dwellers take fewer private car journeys because of high fuel prices there is no such distortion.

It seems to me there are few downsides on the fuel-priced-induced traffic slowdown. And it does mean that with lower congestion, congestion tolls where they are levied, can be lower than they would otherwise be even if travel costs overall are not reduced. With private operators of facilities such as CityLink and EastLink in Melbourne this will not occur - charging here is based on cost-recovery not on ensuring travel efficiency. This is another reason for leaving the management of tolls in public hands and for redesigning the contracts State governments have with private operators. .

Sting: A bitter post

I have an unfortunate, rather negative approach to rock musicians like Sting. They have no obvious musical talents or intelligence and travel the world in their personal jets telling us all how to be environmentally friendly. It is accurate to describe them as hypocrites.

And look at Sting's taste in women. Look at Rita Sting's charming, unpretentious natural smile and the elegant décolletage. Note the way the cleavage neatly bunches over her high waist band-cum-broach. Was it air-touched?

They deserve each other but, surely, the world does not deserve them.

HT: the Currency Lad.

Last words: Environmental tobacco smoke

'Last twinges of a coffin posting this book where the awning flaps a distant thank-you'. (William S. Burroughs)

The US Surgeon General’s ‘Health Consequences of Involuntary Exposure to Tobacco Smoking’ is a massive 19MB document with a reasonably accessible Executive Summary. The evidence is mainly for the US but many arguments apply to Australia. It is a 2006 report but I have only just had the chance to pour through it with care.

Forget about the lies the tobacco companies (and their allies in the libertarian movement) tell you about the freedom you have to kill yourself and those about you.

Life itself is a somewhat sick joke. We survive for 3 score years (and perhaps ten or twenty) then our bodies and our frantic concerns about income and status turn into dust. But we want to live – or at least I do! That’s the funny bit.

Exposure to environmental tobacco smoke (ETS) has fallen dramatically in the US mainly because of near total restrictions on smoking in the workplace – cotinine concentrations (a metabolite of nicotine) have fallen 75% in 10 years.

Still in 2005 ETS in the US killed more than 3,000 people from lung cancer, approximately 46,000 from heart disease and 430 newborns from SIDs. And still about 60% of non-smokers in the US show exposure to ETS.

The argument that cigarettes mainly cause internalities (market failures due to ignorance, youthful impulsivity) rather than externalities is true. A wonderful paper on internalities by Gruber – that demolishes the ludicrous ‘rational addiction’ model - is here.

Smokers reward non-smokers by paying more in taxes than they recoup in medical benefits simply because they die earlier. Perhaps non-smoking spouses who marry spouses cannot complain of 20-30% higher lung cancer death rates and 20-30% higher risk of heart disease. Perhaps too you can stretch it and say that workers in bars get better salaries that compensate them for higher heath risks. But what do you say about kids who suffer respiratory problems, slower lung development, higher rates of asthma and much higher rates of mid-ear infections because their parents smoke.

There are externalities from ETS and no-one should be forced to experience them.

A tipping point toward global deflation?

The Bank for International Settlements reported yesterday that the current global financial situation - viewed as a bust after a boom - could trigger a global recession on a par with that experienced in the 1930s. The full report is here. Basically it argued that central banks should act as, well, central banks, by restraining excess credit growth by raising interest rates during boom times and puttting aside capital so that cutbacks on lending could be more restrained when times turn bad.

The BIS instruction seems to be to keep current interest rates high even if inflationary expectations do not materialise. On balance however they do see inflation as a threat obviously driven by high oil prices although they see wage increases as a significant threat. According to the credit crunch now being engineered by central banks has the potential to have catastrophic implications for the global economy.

Pornification of girlhood

I was interested in this Quadrant article by Melinda Reist on trends in modern commercial culture towards the sexualisation of girls. Girls are increasingly taught that their bodies are their major asset and the main source of their self-worth. The important thing is to be 'hot'.

Despite the internalisation of many of the ideas in the 'women's movement' many young women seem to me to lack a sense of autonomy. Modern dress styles mirror this. Freedom and fulfillment are endangered by a promoted need to be desired.

Reist's arguments are a bit exaggerated - and a bit worn - but, overall, they are a good read. They came at the same time as this Senate report on the sexualisation of children in the media - policy recommendations are here.

Public policy responses to the sexualisation of children are often inappropriate - they should be directed at restricting offensive advertising. Beyond this promoting realistic sense of self-worth is a matter of education and developing sufficiently discriminatory tastes.

Young children should not marry

In Yemen 8-10 year old female children get married to adult males where they are raped and beaten. The children are married off because the alternative is to be abducted and raped. In addition ‘young virginal brides can be shaped into dutiful wives’. And as tribal elders say, the Prophet Mohammed was married to a 9-year old wife.

At these ages girls are not equipped physically to give birth – Yemen has one of the highest maternal death rates on earth. The children produced from these unions who survive are often 'stunted'.

Most of the girls who get married have no sex 'education'.

Ugly societies, with incredibly ugly and ignorant people with what can be objectively described as barbarous beliefs, who have beautiful, innocent children.

Turnaround for the Coalition?

With its total domination of the Australian political scene are the public becoming cautious about State Labor? Are Australians tiring of Kevin Rudd's hot air politics? The cartoon above (from The Age) is an absolute delight.

In NSW Morris Iemma would be thrashed on the basis of current opinion polls and yesterday’s State Government by-elections in Victoria also look good for the Coalition – the Nationals got a 7% swing to them in Gippsland and there was a 13% swing against Labor in Kororoit – admittedly, in the main, to independent Les Twentyman.

The performance of the Liberals in NSW has been disgraceful for years in the face of a hopeless, corruption-ridden Labor Party but the trend is finally a bit more positive for the Coalition.

Parentonomics

Joshua Gans is auctioning off the first copy of his book Parentonomics on Ebay. Proceeds will go the MS Society so bidding gets you a good (autographed) read and does good. Joshua will match the bid with a contribution of his own.

Update (1): I bid $50 but was soon outbid. Go for it sons and daughters of the idle rich!
Update (2): By Sunday at 6-15pm it was $421. I'll buy it (eventually) but too rich for me at this price!

Andrew Leigh on house prices & the value of a quality public education

Andrew Leigh is an amazingly active economist and does work of real social value. The current Economic Record has a piece by Andrew and his colleague Ian Davidoff where he values public school education in the ACT by looking at the effects of better than average test scores on house prices. A preprint of the whole paper is here.

I have a question for Andrew. If you get an education benefit from locating in a suburb that provides access to better-than-average public schools that means that house prices should rise to internalise that benefit. But doesn't it also mean that house prices should subsequently grow more slowly to account for the non-residential benefit? For example suppose real estate is increasing at 7% per annum on average everywhere. If you get some education benefit from living in a living in a particular location (say it is worth 2% of the value of the house) doesn't arbitrage mean that house prices should grow at the slower rate 7%-2% = 5%.

I wonder about this because I observe house prices in suburbs like Kew and Balwyn in Melbourne. The prices of these houses are high partly because they are very near good public and private schools. My theory suggests rates of capital appreciation should be slower in these suburbs - a prediction at variance with the facts. These suburbs are galloping away in terms of rates of capital accumulation.

Am I confused? I have asked many people about this over the years and remain none the wiser. The best discussion I had on the topic was with Ted Sieper a decade ago - he was adamant that prices in suburbs offering education benefits should grow more slowly than the market as a whole.

How we think

I'll post this review of 7 books on neuroscience because, while I didn't learn a lot that is new - I am sure I would if I read the books - it contains a fascinating collage of titbits and is a good introduction. The comments on the ambiguous benefits of nicotine I have discussed before.

Carbon leakage effects leak away

As is well known the global external costs of greenhouse gas emissions (GGEs) are ignored for Prisoner’s Dilemma reasons. This means that even if all countries would be better off with an agreement to cut their GGEs it makes sense for individual countries top defect from such an agreement. They can then either enjoy the benefits of other countries cutting GGEs without incurring the emission reduction costs themselves or derive benefits from joining other countries in not cutting back.

This provides a hindrance to negotiating an agreement to cutting back global GGEs.

Another claimed obstacle is the existence of carbon leakage effects. These were the source of Australian and US opposition to ratifying the Kyoto Protocol. Simply put the claim is that if Australia enacted strict quotas on carbon emissions or hefty taxes on these emissions then our aluminium smelting (and other) industries would relocate in countries such as China where they would pollute at perhaps even higher levels than when in Australia. Thus the global environmental situation would not have been improved but unemployment would have risen in Australia.

These types of effects mean that unilateral moves to control GGEs won’t work.

One response to such effects is to levy such things as carbon taxes on a destination basis. Thus Australians would be taxed on the aluminium they consumed (whether imported from a country not levying such a carbon tax or produced locally) not the aluminium they produce. Most of our energy exporting firms would then be exempt from carbon taxation though tariffs would be imposed on the import of carbon intensive goods not taxed in their country of origin. This would be a type of retaliatory tariff as more recently advanced by authors such as Joe Stiglitz – I provided a consulting report to Environment Australia urging such tariffs 10 years ago.

Recent studies discussed in The Economist suggest we should not be over-concerned with the leakage phenomenon. The authors of “Leveling the Carbon Playing Field” argue that with respect to carbon leakages:

‘the damage would be small.... Energy makes up less than 1% of the cost of making cars, furniture or computers. Even some energy-intensive industries, such as power generation, should not be much affected. Since they have no foreign competition, they could pass on extra costs to their customers.

Only a few industries—metals, paper, chemicals, cement and the like—are both global and profligate enough to be at risk. These accounted for just over 3% of America's output in 2005 and less than 2% of its jobs. Much the same is true in Europe: those industries, plus refining, account for less than 5% of output and an even smaller share of jobs....

Even those supposedly vulnerable industries do not seem to have wilted in the face of a carbon price....(the authors) cannot even detect any impact on aluminium, which is as energy-intensive and widely traded as any good. ...a shuttered smelter in Germany reopened in 2007, despite the rising cost of emissions.

There are many explanations for this resilience. One is that booming demand for aluminium and other commodities has kept all manufacturers profitable. Product specifications that vary from country to country, meanwhile, help to protect refiners from foreign competition. And Europe has handed out so many free permits to pollute that the costs of meeting its emissions cap have been negligible so far.

But putting a price on carbon may still do some harm in the future.... Europe is planning a tighter cap and fewer free permits. Many blueprints for emissions-trading in America call for no free allocations whatsoever. What is more, the biggest effects may come not in the short term, as factory closures, but later, as lower investment in new plant.

A study sponsored by Resources for the Future, an American think-tank, has tried to describe how American industry would meet a carbon price, albeit one of just $10 a ton—much less than the European price of over €25 ($39). Based on economic modeling, it concludes that industrial output would fall by less than 1%. The hardest-hit industry would be metals, but even that would shrink by only 1.5%. Better yet,
the damage could be offset by granting energy-intensive firms enough free permits to cover just 15% of their emissions.

Another study under way at the Pew Centre on Global Climate Change, another think-tank, sizes up a $15 carbon price using data on the past effects of rising energy prices on industry. It concludes that output would fall by 2% or less in 80% of cases. Paper and glass would face a bigger contraction, of 5%. Still, even the most vulnerable industries would not suffer the Armageddon that lobbying groups are predicting.

That is important, since it suggests that the politicians are over-reacting, and that their remedies may actually make matters worse. A carbon tariff....would be hard to implement. Customs officials would either have to assess the emissions embedded in imports, an impossibly complicated task, or make arbitrary assumptions, a recipe for a trade war. Moreover, it would do nothing to protect exports of energy-intensive goods from cheap competition.

Many studies also point out that carbon caps could bring benefits, in the form of factories making windmills, say, or solar panels. But these are even harder to quantify than the costs—and so they are even easier for the politicians to ignore.’

This last point sounds suspect. Investments incurred to meet the effects of GGEs are a cost not a source of income and are so regarded in such studies as the Stern Review. But the overall argument is sound.

Nibbling away at nature & amenity resources

I don't have strong views on the proposed use of the particular park in Kensington for Sir Ron Eddington's proposed tunnel to connect the eastern freeway with the western suburbs in Melbourne*. Public protests are being organised on this use of the park. However I am concerned at the propensity of governments at all levels to nibble away at public parks and nature reserves in meeting infrastructure and other developments within intensively settled urban areas.

These parks and reserves have significant social value both in terms of their use values (e.g. walking the dog, bicycling, enjoying the open air) and because of the implied amenity externalities that get crystallised into increased local property values. The extent of the use value generated can be measured by the consumer surplus triangle the presence of such areas generate - the triangle is large because the access costs of large numbers of people in urban areas to these resources is so low. (I always set out this idea to my environmental economics students as an application of Harold Hotelling's 'travel cost' method of valuing natural resources).

But every time a new road or development is proposed the prospect of resuming large numbers of private homes and business firms to provide land needed looks far too expensive compared to nibbling a bit of the local park or reserve and, of course, the externalities these resources give rise to get forgotten about. And the argument normally put is that the park is quite large and we are only taking a 'small' proportion of it. Repeated applications of this reasoning lead to death by one thousand cuts, to an impoverished amenity resource and a urban environment.

It is not always the public sector alone that is at fault here. Private developers stage protracted campaigns to get land in reserves rezoned to develop private housing and industry - private nibbling along most of the Yarra Parklands in Melbourne is close to an outrage despite the excellent efforts of Melbourne Water and other groups in restoring this land. Developers pester local governments for decades.

And at the time of each public or private sector 'nibble' the argument is sensible in terms of myopic development costs or of giving private agents the chance to 'enjoy nature'. It is just that the long-term outcome is not at all sensible.

In my view we ideally want far fewer private gardens and much more public land that can be assigned to provide amenity resources and nature conservation. There are economies of scale in providing both types of output. One advantage of private holdings however is that they are less susceptible to development pressures and nibbling. While they are much less efficient they are more resiliant in the face of relentless development pressures and the views of philistine public administrations.

* Of course I am strongly opposed to unending expansions of road and tunnel infrastructure when socially costly urban travel is unpriced. Supply decisions should be made in an environment where costly travel is priced.

Sydney's traffic woes

Correspondent Conrad referred me to this interesting newspaper account of an academic report on Sydney’s traffic woes. The suggestion is that, without congestion pricing, Sydney would need to construct the equivalent of 14 Lane Cove tunnels annually just to stabilise traffic congestion at current levels.

These claims seem a bit exaggerated. Crippling congestion will itself discourage travel. But the essential message is correct. Pricing travel at zero and then trying to accommodate the resulting excess demands with infrastructure investments is dumb policy. I lived in Bangkok for most of the 1980s – believe me, living in a city with hypercongestion imposes huge costs on your everyday life - getting to work, going out to dinner etc.

The moronic comments of Roads Minister Roozendaal are worth noting. He dismissed the findings as "armchair advice from academics in ivory towers". "We need commonsense solutions," he said. How pathetic.

I think what we really need as some politicians with guts and foresight.

Useful background to the report is here. Note the authors endorse a package of policies for Sydney and certainly do not rely on congestion pricing alone.

Urban congestion

My paper, Targeting urban congestion: Equity and second-best issues, has just been published in the Australian Economic Review. Unfortunately the complete paper is firewalled outside the universities. I originally drafted this here on my blog for the Making the Boom Pay Conference in 2006. Comments welcome.

Editorial assistant sought

I am looking for someone to work as an Editorial Assistant for the journal Economic Papers which I now edit. They must be based in Melbourne.

The work involved is 1-2 days per week depending on the volume of work. The work involves proof-reading and dealing with academic journal submissions. It also involves maintaining records for refereeing of journal articles, reminding referees of work due and communicating with authors and the Economic Society of Australia by email and phone.

The work would be part carried out at my university but could also be partly done at home. It is a position that would be casual but would be fairly permanent - probably for several years - if things worked out well. The position would suit someone wanting regular, part-time employment. Remuneration depends on skills.

The main requirement is excellent written English language skills and the ability to communicate easily with authors and referees by telephone. Prior knowledge of economics is useful but not essential.

I can be contacted at harryrclarke@gmail.com.

Closing date: 27 June 2008.

Transport costs, fuel prices & trade

As fuel gets more expensive the transport costs associated with international trade get larger and trade diminishes. By how much? Paul Krugman cites a study (by Nuno Limão and Anthony J. Venables) that deals with transport costs and geography as factors determining trade. It implies that a doubling of fuel costs will contract trade by 45%. Current fuel price hikes if sustained would reduce trade by 17%.

Of course such significant reductions would reduce the demand for fuels and have the general equilibrium effect of reversing the price increases.

Much the same effects apply to reductions in the demand for long distance travel induced as a consequence of higher fuel costs.

It is certain that the direct initial effects of a fuel price increase will dominate offset effects that reduce fuel prices. This means that from the viewpoint of travel and trade the world is getting bigger.

Tiger Woods again & again

After an extra 19 holes of playoff Tiger woods defeated Rocco Mediate to win his third US Open Golf championship. Wood's rounds included 3 spectacular eagles. It was great viewing on FOXTEL - I have watched all but the final playoff holes which I will view this evening.

Woods played with a severe knee problem that left him wincing in pain throughout the tournament. Mediate is a comparatively old guy (45 years) who hasn't achieved a respectable win in 6 years but who severely challenged Woods. At times I found myself barracking for the older guy - yes I know that is tragic - but still the Woods phenomenon amazes me and I was pleased to see him get his victory.

Update: Woods' knee was in fact in very bad shape. He subsequently announced that he would miss the remainder of the 2008 season as he has a total knee reconstruction. The tremendous torque he generates with his golf swing puts huge pressure on his knees. Its a pity.

Conservative governments who run large deficits

When do conservative administrations run big budget deficits? One answer might be that they face almost inevitable electoral defeat and wish to leave the pantry bare to restrict the options of future less conservative administrations. That's Paul Krugman's view of the rationale for the Bush tax cuts and the resulting huge US government deficits. A Machiavellian might apply the same reasoning to John Howard's huge tax cut offers in the face of electoral defeat at the last Federal election.

Of course Howard left Rudd with a huge budget surplus - not a deficit - but forced Rudd to match his tax cut policies in an environment where inflation and interest rates were accelerating and where Howard knew Laborite stupidity towards restricting markets for labour would complement inflationary pressures in driving higher unemployment.

The prospects for a Labor-induced recession might have looked good to Howard with, at best, a short vacation from office for the Coalition. The issue is whether politicians exhibit this foresight?

Update: Gregory Mankiw discusses the same issue in an entertaining 'Starve the Beast' post. there is a long discussion over at Catallaxy.

No need for moral panic over drugs

I have pointed out repeatedly that drug use in Australia is under control. Cigarette, heroin, amphetamine and cannabis consumption are declining and alcohol consumption is roughly stable. It is the reason I don’t support moves to reform drug laws on the grounds that current laws have failed – they have not failed at all.

An article in today’s Age makes the same points about alcohol.
Alcohol consumption has costs and benefits – to an economist this suggests trying to get the balance right in consumption and to persuade consumers not to drink in risky situations – such as prior to driving a car.

Proposals to redefine ‘binge drinking’ (meaning socially excessive drinking) to mean the consumption of half a bottle of wine (3 standard drinks) do not seem wise. All activities involve some level of risk but this risk must be balanced against benefits. Telling people who are not driving that they should not enjoy a half bottle of wine is destroying too much enjoyment and not addressing dangerously high levels of drinking and situations of drinking before driving or operating machinery.

The moral panic that is developing needs to subside a bit and the very real problems of drinking that do exist should continue to be addressed. As usage of dangerous illicit and licit drugs decreases then efforts to further reduce harm will need to become more focused – targeting indigenous Australians makes much sense – but this does not mean further coercion across the whole community.

China & India will end up complying with US demands on greenhouse gas mitigation

The current environmental situation in countries such as China and India is poor – China’s citizens are getting richer but increasingly living in a rubbish dump. But, with respect to climate change and other environmental problems, China is altering its policy view towards being much more environmentally protective. I don’t think it has altered its commitment to mainly pursuing ‘no regrets’ policies – it is just coming to understand that climate change will severely damage its agricultural sector. No regrets options now include contributing towards the global mitigation effort.

To quote The Economist:

‘The vast and sparsely populated Tibetan plateau is the origin of the great river systems of China, South-East and South Asia: the Yangzi and Yellow Rivers, the Brahmaputra, the Indus, the Mekong and the Salween. The Ganges rises on the Indian side of the plateau's Himalayan rim. These rivers, fed by thousands of Himalayan glaciers, are an ecological miracle. They support some 1.3 billion people.

But the glaciers are retreating. Chinese experts predict that by 2050 the icy area on their side of the Himalayas will have shrunk by more than a quarter since 1950. Predictions for the Indian side are gloomier still’.

China sees its agricultural output as declining 5-10% by 2030. In India the figure is estimated to be closer to a catastrophic 30-40%. China now recognises its role as the major contributor to greenhouse gas emissions and is committed to cutting emissions. India is dragging its feet partly because half its population is still not linked to electricity supplies and there are widespread fuel subsidies.

The attitude of India is foolish if understandable: A senior official in the India’s foreign ministry characterises the US line of urging developing countries to cut their emissions as: “Guys with gross obesity telling guys just emerging from emaciation to go on a major diet.”

This is foolish logic because, irrespective of the ‘rights’ of developing countries to damage the global environment to the same extent as the US, they will suffer much greater damages from failing to mitigate. The local benefits from mitigation are much greater in India and China than they are in the US.

Indeed, whatever the moral arguments advanced the US is in the box seat in terms of bargaining options for negotiating a global greenhouse agreement post-Kyoto. It will insist on developing country mitigation efforts and will get them.

Update: Of course the optimism about China must be tempered with some statistical realities - it has just extended its lead as the world's largest CO2 emitter. Last year it provided 2/3 of the worl'd increased CO2 emissions.

To succeed as a terrorist

This early Freakonomics post made a much criticised approach to the issue.

This recent clip makes useful (cutting edge) suggestions.