Two Handed Economists' Views of Cap and Trade

by Richard “Chip” Peterson, Economics PhD, (Finance) Professor Emeritus, Texas Tech University

  Presented Dec. 7, 2009 at Texas Tech Finance Association Forum on Cap and Trade

            President Harry Truman, in exasperation, once said that he wanted to meet a one-handed economist. He was perturbed because every economist he knew said, “Then, on the other hand,” instead of giving him definitive forecasts or policy prescriptions.

             Economists don't do this just because they are notoriously poor at forecasting future events (they are almost as bad as weather forecasters who try to forecast too far ahead). They also do it because they are constantly analyzing supply versus demand conditions, and costs versus benefits of policies. Thus, to say , “on the other hand” implies that every policy can be looked at from another viewpoint—from the viewpoint of the buyer versus the viewpoint of the seller or vice versa.

            When I pursued my PhD in Economics, I once came home during a break and my mother asked what I was learning. I told her that as an undergraduate I had learned how the economy worked. However, in graduate school I had learned that what I had learned as an undergraduate was not necessarily so. In fact, the outcomes that you would expect to get from any economic policy all depended upon the assumptions you made and the appropriateness of the theories you used.

            Given my background, I have used my training as an economist when evaluating cap and trade evidence and proposed policies and I have relied heavily upon the views of other PhD economists when forming my opinions. This is what leads me to make the following comments.

            First, I have noted that most politicians tend to give a very one-sided view of the issue—a view that is used to justify immediate draconian regulatory intervention in world economies. The  press seems to go along—possibly to curry favor with politicians. One thing that made me suspicious of the objectivity of press reports was that the press gave great play to a study that said that poison ivy was growing faster because of increased carbon dioxide in the atmosphere—so carbon dioxide buildups should be capped lest we get more of this noxious weed.  However, upon reflection, it seemed to me that if poison ivy grew faster, so should corn, cotton, and all kinds of other useful crops. So I asked Bob Reed, a horticulture professor emeritus who brought viniculture to the south Plains and was one of the founders of Llano Estacado winery. Bob answered that, of course, all crops would grow better with more carbon dioxide in the atmosphere. CARBON DIOXIDE IS PLANT FOOD. Basically, all plants need to grow is water, sunlight, and carbon dioxide. Carbon Dioxide is not a pollutant, it is one of the essential chemicals that makes plant development of food and fibre possible.

            This made me think more.  All the claims about the dangers of carbon dioxide suggest that it will cause global warming that is bad for the planet—and could threaten its very survival. However, as I thought about it, carbon dioxide levels on earth must have certainly been higher in eons past. There are untold tons of calcium carbonate embodied in caliche, limestone, and marble all around the earth—and that calcium carbonate initially came from the bones and shells of sea creatures that ate plants that contained carbon originally captured from the atmosphere. The carbon the sea creatures ate had been converted into bones and shells that had settled to the bottom of the seas and had been compressed into caliche, limestone, and marble as eons passed. There also is substantial carbon embodied in all the oil, gas, coal, and shale that is buried deep in the earth and was originally formed from the decaying plants and animals of eons past. Those plants and animals, in turn, had used carbon based chemical processes to live and the carbon they used probably had almost overwhelmingly been captured by plants that extracted carbon from the atmosphere. Thus, it is clear that carbon dioxide levels on earth had been much higher in the past and the earth had survived.

            I also noted that the press and publicity made claims that cute little  polar bears would lose their arctic home if the ice flows melted at the North Pole. While that may be true, it is not clear that polar bears cannot live on land as well as ice flows, and it is not clear that their population has declined. Meanwhile, it is clear that if the arctic ice should melt, we will finally have the long sought “Northwest Passage” that will save considerable on shipping costs around the world. We also will have greater access to the vast quantities of useful hydrocarbons that lie below the arctic ocean.

            The fact that there are vast quantities of oil and gas on the North Slope of Alaska and under the Arctic Sea suggests that plant life was abundant there in the past. In fact, scientists have recently found dinosaur skeletons in Alaska and have calculated that Alaska had a much more temperate climate at that time, thus plants could grow and massive dinosaurs could thrive. This suggests that if the earth warmed up, much of Alaska and other formerly inhospitably cold locations could become arable, while some more southerly areas would have longer growing seasons that could support greater plant growth and double cropping. With higher levels of agricultural output, greater levels of life, including humans,  could be supported on earth.

            Thus, from the viewpoint of a two-handed economist, there can be good things as well as bad things that result from carbon dioxide buildup in the atmosphere. However, you never see possible positive effects cited by politicians or reported by the press.

            Second, practically my entire professional career consisted of either doing research, supervising doctoral students who did research, or teaching doctoral students how to do research. Thus, I know that when someone advances a theory about how the world works, it should be supportable with reliable empirical evidence. We accept Einstein's Theory of Relativity in many areas because it has made reliable predictions about phenomena that we can observe. Atomic bombs based upon his theory actually do convert matter into energy. The gravitational pull of the sun actually does bend light waves from distant stars as they pass by the sun. Einstein's theory does not explain all physical phenomena, however, so physicists are still at work trying to develop a grand unified field theory to explain all physical events, not just those predicted by Einstein's theory. However, if a theory cannot correct accurately for the phenomena it seeks to explain, we must doubt its validity.

            The relevence of this methodological argument is that the global warming alarmists use atmospheric theories (as an aside , those theories were developed by people who cannot tell you with any degree of certainty that it will rain next weekend—to be fair,  Economists cannot tell you with any degree of certainty what the Dow Jones average will be one week hence). Those theories predict  that the earth will experience exponential increases in temperature in future decades as carbon dioxide accumulates in the atmosphere. However, one of my friends—a PhD in Microbiology who is such a committed environmentalist that he lives on an island in Puget Sound and grows or hunts or fishes for his own food—sent me a summary of a speech given by a professor who holds an endowed chair in atmospheric science at MIT. In that talk, Professor Lindzen noted that the predictions of the atmospheric science global warming models have not been fully validated. They predict that warming should be most pronounced in the tropical troposphere, and that is not the case. Consequently, the theory behind the global warming alarmist models may be incomplete or flawed.

            In contrast with Einstein's theory, that has been totally validated in all tests so far, and thus is generally accepted, the global warming theories have to be suspect because their predictions are not fully validated. This suggests that we should take care before we use predictions based upon flawed theories to make major changes in our economy.

            Third, given the two-sided effects (some good-some bad) of global warming and the imprecision of the theory upon which the alarmist predictions are based, the question arises as to why the politicians and the press almost uniformly advocate draconian measures to control carbon dioxide emissions—even if such measures would hamstring our economy. One exception to the  rule of political uniformity is Vaclav Klaus, the President of the Czech Republic. Not coincidentally, President Klaus happens to be a PhD economist. He has written a book that reviews  scientific evidence supporting global warming and finds, in contrast to what one reads in the press, that scientists have mixed views about the phenomena of global warming and about the appropriateness of the theories that suggest it is a threat. He also has has given talks and speeches that address the issue.

            Klaus is disturbed because he sees the motivation of many politicians as similar to the motivations of many of the Communist Commissars that formerly dominated his home country. The politicians want power over other people as an end in itself. The issue is not global warming per se, but the ability of the politicians to gather power to themselves if the public becomes alarmed about possible adverse consequences of global warming. Thus, power seeking politicians, seek to enhance their power over other peoples' lives by scaring people into accepting draconian controls over their lives in the guise of fighting global warming.

            Other people may also have vested interests in scaring people into accepting draconian global warming justified restrictions upon their lives. For instance, major investment banks such as Goldman Sachs, a major contributor to politicians' campaigns, have a substantial vested interest in promoting cap and trade policies. Goldman Sachs, along with other major wall street firms owns an exchange that has been set up to trade “caps,” or carbon dioxide emission permits among various parties. People estimate that trading on the exchange might ultimately exceed all trading on all other, highly profitable, commodity exchanges. Thus, cap and trade regulations could provide these wall street firms with substantial profits and justify the large amounts they have donated to politicians.

            Politicians can also gain in other ways. Ultimately, they can sell the “carbon cap” permits for a fee or grant them more abundantly to “friends” who have supported the politicians' political campaigns or provided other valuable consideration. This would allow politicians to gain large revenues, either for the nation as a whole or for themselves, without having to “raise taxes on the middle class.” Instead the middle class would have to pay higher utility and gasoline fees and would blame the utility companies and the oil and gas companies for gouging them The public would blame the utilities and companies who raised prices instead of the politicians who required that those entities pay high fees to buy the  “carbon cap permits” they needed to operate. Thus, politicians and governments can gain revenues without taking any blame. Unfortunately, this process has proven so profitable for politicians under the cap and trade scheme established in Europe, that they issued so many “permits,” that carbon emissions in Europe failed to decline after cap and trade plans were introduced there.

            Other people can also gain from scaring people about global warming. Al Gore has earned revenues from a movie and his books and has received a Nobel Peace Prize. In addition, he has invested substantially in green companies that stand to benefit from political requirements that alternative energy sources be subsidized. Atmospheric scientists can obtain research grants from governments, especially if they propose to do research that validates the global warming threat that politicians want to justify. UN bureaucrats can enhance their prestige and power if they can convince the public that global warming is a threat that needs UN intervention to solve on a global scale.

            The American Institute for Economic Research (AIER) recently sponsored a conference that looked at the global warming issue from many perspectives. Among other things, participants at the AIER conference noted that the UN global warming report summary was created and edited by politically appointed functionaries, who might have had their own political interests to pursue, rather than by the scientists who had produced the underlying research. Another participant at the conference  who was an expert on hurricanes noted that in contrast with what the press reported, the increase in hurricanes in 2005 was not necessarily the result of global warming, since it was within the range of ordinary annual variation. Similarly, the expert on ocean levels noted that many of the “scientists” quoted by the press about ocean level rises were not specialists in that area. However, because of the greater publicity and possible research grants given to people who gave credence to global warming concerns, many people had an incentive to exaggerate the threat.

            Finally, many other countries can  gain from global cap and trade legislation if they can convince the US to adopt draconian cap and trade restrictions. To the extent that cap and trade costs increase energy and power costs in the US, costs of production in the US will increase and this will give a competitive advantage in international trade to countries like China and India who can produce more cheaply, in part, because they are exempt from cap and trade and other global warming restrictions. In addition, many lesser developed countries hope to profit from selling “carbon dioxide cap” permits to companies in more developed countries that need to obtain caps so they can emit carbon dioxide in their production processes. Such countries have been able to sell such caps under the European cap and trade system by letting companies in the more advanced economies obtain carbon credits by planting trees or forests in the lesser developed areas, or by engaging in other conservation measures. If the United States companies also had to buy such permits, the lesser developed countries could look forward to an attractive new source of income—which may be why so many of them castigate the US for not adopting cap and trade measures.

            Fourth, there are probably more efficient ways to obtain similar objectives without  using cap and trade permits. Because the permits are potentially subject to political allocation and may breed incentives for corruption, it makes more sense to use the price mechanism more effectively. The Copenhagen Consensus is a project run by Bjorn Lomborg in Copenhagen. It tries to use the intellect of numerous Noble Prize winning economists and others to identity the most important global problems facing the world and the most cost-efficient ways to resolve them. They recognize that global warming can be a threat in the long run and that carbon dioxide buildup may contribute to the threat. However, they believe that the threat is not necessarily imminent so there is time to take a more reasoned approach to solving it. In particular, they believe that the most efficient use of public resources would be to fund research into ways that carbon emissions can be reduced by the more efficient production, storage, and utilization of energy.

            Furthermore, they believe that wasteful utilization of carbon can be achieved not with cap and trade policies but with a carbon tax that not only would generate revenues to fund the needed research, but also, by raising the price of carbon, would discourage people from frivolously producing or wasting carbon resources. While this was not a proposal of the Copenhagen group, one way that the US could impose such a tax would be to impose it upon hydrocarbon based imports—which would raise the cost of all US hydrocarbons due to our large dependence upon imported hydrocarbons and would have the added benefit of reducing US dependence upon hydrocarbon imports and make our economy more self-sufficient by encouraging domestic energy use and production. By raising costs of hydrocarbons, people would have an incentive to use energy more efficiently and invest in energy saving devices. It also would save  the extensive overhead costs required by direct government regulation and exchange trading of cap and trade permits.

            The Copenhagen Consensus Group also believes that a carbon tax is preferable to cap and trade policies because of its flexibility. If further research or further climatic warming shows that global warming is an increasing threat, such a tax could be easily increased. However, if the threat should dissipate—possibly due to the (often periodic) cooling of the sun or an increase in atmospheric aerosols, it could be reduced. In addition, a tax is less likely to have the potential for inducing political allocations and corruption of the political process as an explicit cap and trade system. Because the price mechanism is more efficient than political decisions for ensuring that people economize on resources whose price has been increased, the economists of the Copenhagen Consensus Group favor carbon taxes over direct regulation as a way to potentially reduce global carbon dioxide emissions, and they also favor research to ensure that energy is produced, stored, and utilized more efficiently. That, in short, is the consensus opinion of a number of distinguished two-handed economists.

REFERENCES

American Institute for Economic Research, Proceedings of a Conference Sponsored by the American Institute for Economic Research, Nov.2-3,2007, Economic Education Bulletin, American Institute for Economic Research,  P.O.  Box 1000, Great Barrington, Massachusetts,01230.182 pp.(available for $5)

“Copenhagen Consensus on Climate: Findings of the Expert Panel,” Copenhagen Consensus Center, the Panel consists of the following economists: Jagdish Bhagwati, Columbia University; Finn Kydland, University of California Santa Barbara (Nobel Laureate); Thomas Schelling, University of Maryland (Nobel Laureate); Vernon Smith, Chapman University (Nobel Laureate); and Nancy Stokey, University of Chicago, their findings are available over the internet.

Klaus, Vaclav, Blue Planet in Green Shackles:What is Endangered: Climate or Freedom, 

Easton, Susan, “Klaus Against the Greens'” Human Events interview subsequent to  Klaus's speech to the Mont Pelerin Society (an international economics organization) available at http:www.humanevents.com/article.php?id=28542, 9/16/09.

Email Chip with any questions., Chippete@aol.com

Richard Peterson Campaign, Richard Peterson treasurer