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Can Pigovian taxes be Coasean bargains? – The case of climate negotiations

July 14th, 2008 1 comment

David Zetland’s libertarian-environmental blog, Aguanomics, has recently been carrying on some excellent discussions on resource and environmental economics, with interlocutors like Bob Murphy, Gene Callahan and others.  In the context of two recent posts on government approaches to climate change, I commented on one thread (An Ounce of Prevention…) that

As for the setting the level of carbon taxes, you and Gene keep assuming that there is a global government that sets taxes in a vacuum. Instead, we have a multi-player game, where any politically sustainably prices are set at levels that the chief emitters are willing to agree to.

This is analogous to ranchers, lobstermen or shrimpers deciding to close a range or fishery. No single one of them is setting a price.

On an earlier thread (Pigouvian Libertarians), I noted to the effect that:

Bob, the standard objections to Pigovian taxes don`t apply to climate change, as there is no single government administering the world. Rather, we are engaged in multi-player negotiations as to how to regulate a commons.  The taxes (or other schemes) that individual governments may impose will ultimately be coordinated, and much more resemble a Coasean trade among nations with respect to a shared resource.

David has kindly made this point the subject of a new post:  How to Set a Carbon Tax.

Allow me to elaborate my point.  A C Pigou, is often trotted out by supporters of government economic regulation, for the proposition that governments should regulate or impose taxes in order to force economic actors to internalize the “external costs” of their actions (costs that are imposed on others outside of that transaction without their consent).  This use of Pigou is a bit unfair, as Pigou himself noted that taxing authorities would always lack the information needed to determine the correct tax, but nevertheless the perception that externalities are ubiquitous has helped to justify a wide range of governmental regulatory interventions.

Other objections to Pigou can of course be raised, as Ronald Coase prominently did when he argued that, when trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial distribution of property rights.  Pigou and those using him did not consider the real world dynamics of self-help among economic actors, and many ignored Pigou’s acknowledgment that governments are seldom positioned to calculate external costs.  Coase noted that because transaction costs are NOT zero, many bargains would not be reachable, so that the initial distribution of property rights would affect ultimate outcomes in resource allocation.  Coase properly turned the focus of the debate over “externalities” towards a focus on the use of bargaining between parties to accommodate differences in personal objectives, and to fruitful discussions of how property rights and bargains are defined and enforced and whether information and transaction costs can be lowered.  Austrians have further criticisms of Pigou and Coase, but those can be set aside for the moment.

In ongoing discussions over at Aguanomics, Bob Murphy and others have trotted out that standard Coasean attacks on the proposals by economists (such as Robert Nordhaus and other members of Gregory Mankiw’s “Pigovian Club”) for carbon taxes, i.e., that government can’t know at what level to set carbon taxes, that such carbon taxes will prevent private transactions among parties that might fully address climate concerns at less costs, etc.

In the context of this discussion, I ask that people step back from the theoretical and observe the pragmatic – that we are in the midst of a multi-decade multinational negotiation of a GLOBAL resource that no one nation controls, in which there are no private property rights or common legal systems and in which transaction costs for private transactions are enormous and swamp individual economic benefits that may be achieved by them, and that in this context, our governments are essentially our negotiating proxies who can more efficiently negotiate for us and come to terms with others than can any private entities or groups.  Given these circumstances, even though our governments are all subject to domestic rent-seeking pressures, because no effective approach to climate change can be reached without the voluntary agreement of all major emitters, is it not the case that the discussions that our governments conduct – including the possibility of coordinated Pigovian taxes at the national level for implementation purposes – ARE efforts at Coasean bargaining?

Any thoughts?

T. Boone Pickens accelerates the tragedy of the Western water commons – by connecting thirsty markets to unowned, common-pool resources

June 16th, 2008 No comments

The latest Business Week magazine sports the headline, “Is Water the New Oil?” and a caricature of T. Boone Pickens.  The cover story -“There Will Be Water: T. Boone Pickens thinks water is the new oil—and he’s betting $100 million that he’s right” – describes Pickens’ plans to ship water to eager consumers in Dallas from his ranch and other water rights holdings in the Texas Panhandle region. 

While I’m all for water markets, there’s one small problem that deserves attention:  essentially Pickens will simply be sticking a huge straw into the unowned Ogallala Aquifer and pumping for all he’s worth.  Pickens will have to cover only his own costs (pumping and transportation), but he has no ownership stake in, or incentive to invest in maintaining or sustainably using, water resource itself.  As he draws down the water table, his neighbors will have to shell out more to dig and pump from deeper wells to maintain their own current draws, and if any of them wants to follow Pickens in shipping water to urban markets, then the race to drain the water commons in the Panhandle and other parts of the Ogallala will ratchet up further (it’s already been underway for many years in other parts of Texas and other states in which the Ogallala Aquifer lies).

Pickens may not be planning to replicate the history of the wasteful, competitive pumping of the East Texas common pool oil resources (also seen in the elimination of the passenger pigeon, the Plains bison, the great whales, and the crashing of ocean fisheries), but his own rational self interest is surely leading in that direction.  I hope Pickens can see where this is headed and take a positive role in heading off a destructive tragedy of the commons, which may be in the cards, but is not inevitable.   As Bruce Yandle has noted:

People can build institutions that take the edge off frantic commons behavior. People have unwritten and written constitutions that help to establish social order. People can and do accumulate wealth. People communicate, invent lines of kinship, and develop customs, traditions, and rules of law that limit anti-social behavior. People define, enforce, and trade property rights. People can and do avoid the tragedy of the commons. Indeed, instead of living with tragedies, people triumph over the commons. But the triumphs are never perfect or complete. There is always another commons to manage. …

At very low levels of income, what might be called stage one, human beings cannot afford to do much about property-rights enforcement and the commons. They live in a world where custom and tradition sustain them. As incomes rise and losses from the commons expand, stage two is entered. Fences go up, and rules are set for protecting the commons. Finally, in stage three, markets evolve along with rules of law that define spheres of private and public action. Private rights replace public control, and the triumph replaces the tragedy of the commons.

Life for mankind began on a commons where tragedies were commonplace and the incentive to improve was powerful. Out of the struggle to survive and accumulate wealth evolved markets, property rights, and the rule of law—a triumph on the commons. …

Human beings can and do avoid the tragedy of the commons. But doing so requires property rights and markets, which must be defended if the triumph is to continue.

Easy pickins?  Easy, Pickens.

h/t David Zetland

[Updated] Bob Murphy heroically nitpicks the CBA model of reluctant carbon tax advocate, William Nordhaus

June 5th, 2008 2 comments

Bob Murphy, an economist at Rob Bradley‘s Institute for Energy Research, has posted on the main Mises Blog a link to a paper that he has submitted to an economic journal, “Rolling the DICE: Nordhaus’ Dubious Case for a Carbon Tax“.

[Update:  Bob thoughtfully copied environmental economist David Zetland on his draft paper, and while he has not returned to comment at his own Mises thread, Bob has made further comments at David’s blog and at his own shared blog.]

IER promotes Murphy’s paper as ambitiously “tackl[ing] the basic premise of pricing carbon … using William Nordhaus’ DICE model as the representative of economic orthodoxy”, but it seems to me that both his objectives and his achievements are far more modest.  Murphy:

(1) fails to attack either the fundamental premises of orthodox cost-benefit analysis as applied to climate change or the basic premises of the DICE model,

(2) focusses chiefly on various uncertainties involved in the parameters in Nordhaus’ model, while ignoring not only that such uncertainties cut in more than one direction, but that other economists have strongly argued that Nordhaus has underestimated or mishandled important damages and uncertainties (e.g., John Quiggin and Sterner & Persson) and has simply misunderstood the usefulness of CBA in the face of important uncertainties that CBA cannot easily handle (e.g., Martin Weitzman, Richard Tol, others),

(3) fails to note the point (made by McKitrick and others) that even if imperfect, carbon taxes, if substituted for income, capital gains and other taxes, will significantly lessen important economic distortions; and

(3) fails to offer much in the way of Austrian approaches to CBA, much less to the property rights and preference issues involved in economic decisions involving significant externalities or open-access common resources, fails to point to possible ways in which government policy may be inefficient, costly, and subject to the skewing effects of rent-seeking, and fails to recommend important policy changes that are needed to facilitate a transition to a lower carbon economy, by promoting economic freedom, competition in energy and power markets, easing corporate tax depreciation rules that slow innovation, and strengthening property rights and common law enforcement mechanisms (Bruce Yandle and Jon Adler have both made concrete suggestions on desirable policy changes; what is holding back people at LvMI?)

In short, what Murphy delivers is flawed and far less than billed.

[Update:  As Ludwig von Mises himself noted (see my blog post Mises on fixing externalities“), private property institutions arose in response to the economic inefficiency of older systems that did not force economic actors to bear the external effects of their actions.  We are intelligent and occasionally rational creatures – why should we not be pro-actively considering what institutions might be desirable and feasible for dealing with the effects of our activities on the atmosphere and  climate (and oceans, ecosystems and unowned species, or how to improve governance in countries that don’t recognize or protect property rights)?]

I copy below (with some typo corrections) the comments that I posted on Bob’s Mises thread; I will try to revisit later to add links and further resources:  

Bob, thanks for posting this

Here are a few quick notes:

– although you note that every step in Nordhaus’ analysis involves uncertainty, you have failed to note Marty Weitzman’s recent work that tells us how strongly uncertainly serves as a factor SUPPORTING early action – an important factor that neither Nordhaus nor you take into account at all. Weitzman states, “the influence on cost-benefit analysis of fat-tailed structural uncertainty about climate change, coupled with great unsureness about high-temperature damages, can outweigh the influence of discounting or anything else.”

– while you indicate that one key area of uncertainty is that future GHG concentrations may be overstated, your observations actually suggest the opposite – that because the oceanic sink is finite, as it becomes saturated atmospheric GHG concentrations are apt to rise even more sharply.

– while you indicate that the temperature increase form a given GHG concentration may be overstated, you ignore the possibility of the opposite – that the long-term temperature impact of a given GHG level may be higher than the number Nordhaus has used. Further, given paleo evidence that Hansen has noted, it appears unlikely that climate sensitivity will be less than 3 degrees C.

– Similarly, while you note that economic damages from a given temperature increase may be overstated, you fail to address the possibility that such damages may be understated – and also fail to note that the Earth is apparently more sensitive to climate changes than has been expected, witness the rapid Arctic/Greenland melting that we are seeing at only a 0.7 C increase, and the rapid expansion of tropical zones.

– it is a distinct possibility that Nordhaus has underestimated nonmarket damages, as John Quiggin and others argue. In any case, Nordhaus does not account for the changing relative prices for various goods and services that the changing composition of the economy and climate change will induce,as Sterner and Persson have noted in a recent paper at RFF:

“future scarcities that will be induced by the changing composition of the economy and climate change should lead to rising relative prices for certain goods and services, raising the estimated damage of climate change and counteracting the effect of discounting. … [C]hanging relative prices … has major implications for a correct valuation of future climate damages. We introduce these results into a slightly modified version of the DICE model (Nordhaus 1994) and find that taking relative prices into account can have as large an effect on economically warranted abatement levels as can a low discount rate.”

– in looking at damages, you tend to focus on the US picture alone, without regard to other nations – largely poorer ones – in which greater net losses are expected to be felt. You also completely fail to address, even in the case of the US, that benefits and impacts will not be uniformly shared, and that those with net benefits presently have no obligation to compensate those shouldering losses.

– while you fairly note that Nordhaus’ analysis can be helpful in comparing the relative net costs and benefits of different proposals, you fail to note that with changed assumptions, even using Nordhaus’ model as is, much higher estimates of “optimal” levels of carbon taxes can be derived.

– You point to Nordhaus’ remarks on how free-riding be various countries will drastically affect the benefits to be derived from any carbon taxes, but argue that this itself is a justification for the US to free ride, rather than for us to work to coordinate compliance by others.

– You also seem to be very worried that a coordinated approach would actually result in heavily distorted worldwide production, when widespread noncompliance by the various Kyoto parties indicates how ready nations are not to unilaterally assume burdens that other nations will not share.

– You also express concern that any coordinated approaches to climate change may be difficult to unwind as information changes, when it is clearly that various nations (and their industries) are acutely aware of comparative advantage and quite ready to react to what others are or are not doing (in the fact of the easy movement of capital).

– Further, you have confused measures like possible geoengineering and carbon sequestration approaches – which would be incentivized by carbon taxes and are a form of “mitigation”, with what is properly considered as “adaptation” to unavoided temperature increases and climate changes.

There are of course many other points that one would like to see Austrians making – such as the benefits of freeing up the economy from burdensome regulations (while strengthening property rights and private litigation remedies), adding greater degrees of freedom and competition to energy markets to drive greater energy efficiency, allowing immediate depreciation of capital investments, and the desirability of avoiding government-directed investments and subsidies – but perhaps these are things you intend to address in another paper spelling out a truly Austrian approach, rather than nitpicking at a single conventional CBA argument?

Sincerely,

TT

(I apologize that this is link-poor, but it seems like the best way to actually have this comment posted.)

Published: June 12, 2008 7:49 AM

 

Bob, allow me to suggest that you (and others) may also wish to consider taking a look at addressing also the recent short pieces by Joe Stiglitz, Tom Schelling and Ken Arrow others in last year`s The Economists’ Voice; they are as relevant as Nordhaus, and much more accessible to the average reader:

Joseph Stiglitz, A New Agenda for Global Warming

Kenneth J. Arrow, Global Climate Change: A Challenge to Policy

Thomas C. Schelling, Climate Change: The Uncertainties, the Certainties and What They Imply About Action

Published: June 12, 2008 9:41 AM