The economic theory: the state intervenes in the economy in order to prevent free-riding – in order to internalize externalities – in order to better ensure that all private parties pay the full marginal costs of their activities, and that all private parties reap the full marginal benefits of their activities – in order to promote competition – in order to protect the weak from the strong.
The political reality: the state intervenes in the economy in order to promote free-riding – in order to externalize costs and benefits that the market has reasonably internalized – in order to better ensure that politically powerful private parties escape the full marginal costs of their activities, and that politically disfavored groups be stripped of much of the marginal benefits of their activities – in order to promote monopoly – in order to render some people weak who are then pillaged by the strong.
Don Boudreaux, “Economists’ Normative Case for Government Intervention is a Very Poor Positive Theory of that Intervention”, Café Hayek, 2016-09-26.
August 15, 2018
QotD: State economic intervention in theory and practice
March 13, 2018
The economic argument for carbon taxes
Tim Worstall explains what a carbon tax is supposed to do, as opposed to what many environmental activists want it to do:
The essential economic analysis is that carbon emissions are an “externality.” There are costs to third parties of the freely chosen activities of consenting adults. If there aren’t such third party costs then the adults get to consent – as long as your bedroom contains only those freely consenting adults then what goes on there is up to you. But if there are those third party costs – say, the noise from the enjoyments causes lost sleep among the neighbours – then some societal power to force an adjustment seems reasonable enough.
Again, economics analyses here by suggesting that we’ll get too much, or too many, of those third party costs if people aren’t paying for them. If we’ve not got to pay to soundproof the orgy then we’ll have more orgies than if we do. It’s fair that we insist upon such soundproofing perhaps. But sometimes we cannot insist upon such direct actions – then we’ve got to try and change the price system. Which is what the carbon tax does.
There are benefits to using fossil fuels – transport, heat, cooking and so on. Given current technological levels immediate banning would mean billions die – commonly thought to be a Bad Thing. But there are those costs imposed upon others as well in the climate change the emissions cause. The answer is that we look to that greatest good of the greatest number, the utilitarian answer. Where emissions produce more value than the damage they cause – including over time – then we want them to continue. Where they don’t then we want them to stop. That way we get the maximum possible value being created and thus all humans – over time – are as rich as we can be given current technologies.
Calculating what this number is, this tax rate, is also known as determining the social cost of carbon emissions. The Stern Review may or may not have exactly the right number but it’s a good enough starting point, $80 per tonne CO2. Say 50 cents or so per gallon of gas. Slap that tax on and we’ve corrected the price system. People who use gas are now paying the environmental costs of their use. So, anything they use it for must create greater value than the damage being caused. We’re copacetic at this point, we’ve the optimal level of emissions.
Note that this logic still works whatever you think of the rate. 1 cent or $100 a gallon, the logic is still the same, we’re only arguing over what is that social cost of carbon. Stick a tax on of whatever it is and we’re done.
Even if climate change isn’t a problem, or isn’t happening, we do still need some tax revenues somewhere. It’s also better to tax consumption than incomes or capital, better to tax things inelastic in demand with respect to price than those elastic. Fossil fuel consumption taxation is a consumption tax and the demand for fossil fuels is, in the short to medium term at least, inelastic. We’re fine with fuel taxation therefore.
For a quick backgrounder on the concept of externalities, MR University did a video on this a few years back. For reasons to worry that your government might not be quite as revenue-neutral in imposing a Pigouvian tax, Warren Meyer also has doubts.
October 15, 2017
David Suzuki’s (incomplete) economic understanding
Several years ago in the Literary Review of Canada, Joseph Heath explained how he tried “being green” and in the process discovered that Canada’s secular environmental saint David Suzuki literally didn’t have a clue about economics:
David Suzuki’s most recent, The Legacy: An Elder’s Vision for Our Sustainable Future, is billed as an attempt by “one of the planet’s preeminent elders” to “sum up in one last lecture all that he has learned over his lifetime.” Suzuki is, of course, one of the most influential public intellectuals in this country. Like most Canadians of my generation, I grew up watching The Nature of Things, and so tend to think of Suzuki as a constant in the universe.
Suzuki was also an environmentalist long before it was cool to be an environmentalist. Perhaps because of this passionate commitment to the cause, it is startling to discover that Suzuki is oblivious to the logic of collective action. What’s worse, he does not even know what an externality is, and seems unwilling to learn. In The Legacy, he repeats the same incorrect definition that he has been using for years (he equates externalities with anything that is not part of, and hence external to, an economic model, and then claims, on that basis, that economists ignore them). Elsewhere, he even provides a detailed account of where the misunderstanding arose. It was apparently based upon something that the instructor said to him, on the first day of an economics class, which he evidently misinterpreted and never bothered to double check.
It is worth pausing for a moment to reflect upon this. It means that Suzuki does not know the first thing about environmental economics. It means that in 38 years as a university professor, public intellectual and environmental activist, he did not once take the time to find out what social scientists have to say about the problem of global warming. It means that he has never even glanced at the Wikipedia page on environmental economics.
Because of this, Suzuki winds up committing the core fallacy of environmental activism. He thinks that if people only understood the consequences that their actions were having on the environment, they would each be motivated to change their behaviour. And so, to the extent that we are not changing our behaviour, it must be because we do not understand, or that we have not been telling ourselves the right “story.” Yet this is manifestly not the case. My wife understands the science of global warming perfectly well. But she also does not like dandelions growing by the side of the road. And when push comes to shove, the desire to kill dandelions wins over environmental peccadilloes. It is not particularly mysterious. It is called free riding; people do it all the time.
Thus when Suzuki writes “we say we are intelligent, but what intelligent creature, knowing that water is a sacred, life-giving element, would use water as a toxic dump?” he seems genuinely not to know. The answer is easy: we are intelligent creatures who care just slightly more about ourselves than we do about other people. For example, like most residents of Toronto I do not use the water on my land as a toxic dump; I use Lake Ontario for that purpose. Saying that “we are water, and whatever we do to water, we do to ourselves” sounds very nice, but all the “we” talk actually encourages a very serious confusion. What I do to water, I primarily do to other people, not to myself, which is why I care about it just ever-so-slightly less.
In the end, and somewhat contrary to all expectations, Suzuki winds up coming off as a science chauvinist. There are basically two bodies of knowledge that he respects. There is physical science — genetics, biology, the stuff that he studies — and there is what he calls “traditional knowledge” — by which he means the wisdom of aboriginal and indigenous peoples. Conspicuously absent is any interest in what social scientists might have to say about how human beings work, about the political process, about the economy and about how societies mobilize to address collective action problems. As a result, he knows a lot more about the nature of things than he does about the nature of people.
H/T to Andrew Potter, via Stephen Gordon for the link.
June 22, 2017
Words & Numbers: The Population Boom Could Save the World
Published on 21 Jun 2017
In 1798, 95 percent of the world lived in poverty. Today, less than 10 percent do, in spite of the world’s population growing by 700 percent in that same time.
The common thought among young people is that this 700 percent population growth is going to overpopulate the earth. But given the number of people in poverty, it looks like population growth is actually good for poverty – more people means more brains, which means more ideas, inventions, and innovations.
This week on Words and Numbers, Antony Davies and James R. Harrigan talk about how and why the world is improving despite widespread negativity towards the idea of a growing world population, and why that negativity persists regardless of the prosperity we see every day.
May 16, 2017
How service companies might respond to a mandated increase in the minimum wage
At Coyote Blog, Warren Meyer discusses how real world service companies that employ a lot of minimum wage workers are likely to respond when the minimum wage is raised:
When I discuss this with folks, they will say that the increase could still come out of profitability — a 5% margin could be reduced to 3% say. When I get comments like this, it makes me realize that people don’t understand the basic economics of a service firm, so a concrete example should help. Imagine a service business that relies mainly on minimum wage employees in which wages and other labor related costs (payroll taxes, workers compensation, etc) constitute about 50% of the company’s revenues. Imagine another 45% of company revenues going towards covering fixed costs, leaving 5% of revenues as profit. This is a very typical cost breakdown, and in fact is close to that of my own business. The 5% profit margin is likely the minimum required to support capital spending and to keep the owners of the company interested in retaining their investment in this business.
Now, imagine that the required minimum wage rises from $10 to $15 (exactly the increase we are in the middle of in California). This will, all things equal, increase our example company’s total wage bill by 50%. With the higher minimum wage, the company will be paying not 50% but 75% of its revenues to wages. Fixed costs will still be 45% of revenues, so now profits have shifted from 5% of revenues to a loss of 20% of revenues. This is why I tell folks the math of absorbing the wage increase in profits is often not even close. Even if the company were to choose to become a non-profit charity outfit and work for no profit, barely a fifth of this minimum wage increase in this case could be absorbed. Something else has to give — it is simply math.
The absolute best case scenario for the business is that it can raise its prices 25% without any loss in volume. With this price increase, it will return to the same, minimum acceptable profit it was making before the regulation changed (profit in this case in absolute dollars — the actual profit margin will be lowered to 4%). But note that this is a huge price increase. It is likely that some customers will stop buying, or buy less, at the new higher prices. If we assume the company loses 1% of unit volume for every 2% price increase, we find that the company now will have to raise prices 36% to stay even both of the minimum wage increase and lost volume. Under this scenario, the company would lose 18% of its unit sales and is assumed to reduce employee hours by the same amount. In the short term, just for the company to survive, this minimum wage increase leads to a substantial price increase and a layoff of nearly 20% of the workers. Of course, in real life there are other choices. For example, rather than raise prices this much, companies may execute stealth price increases by laying off workers and reducing service levels for the same price (e.g. cleaning the bathroom less frequently in a restaurant). In the long-term, a 50% increase in wage rates will suddenly make a lot of labor-saving capital investments more viable, and companies will likely substitute capital for labor, reducing employment even further but keeping prices more stable for consumers.
As you can see, in our example we don’t need to know anything about bargaining power and the fairness of wages. Simple math tells us that the typical low-margin service business that employs low-skill workers is going to have to respond with a combination of price increases and job reductions.
March 5, 2017
The political Trojan Horse of “Pigouvian taxes”
Warren Meyer used to be quite positive about the introduction of Pigouvian taxes, but recently his opinion has changed:
Here is the Wikipedia definition of a Pigovian tax:
A Pigovian tax (also spelled Pigouvian tax) is a tax levied on any market activity that generates negative externalities (costs not internalized in the market price). The tax is intended to correct an inefficient market outcome, and does so by being set equal to the social cost of the negative externalities. In the presence of negative externalities, the social cost of a market activity is not covered by the private cost of the activity. In such a case, the market outcome is not efficient and may lead to over-consumption of the product. An often-cited example of such an externality is environmental pollution.
The Left often tries to justify new taxes based on their being Pigovian taxes. The classic example is a carbon tax — it is claimed there is a social cost to carbon-based fuel combustion (e.g. CO2 production and resulting global warming) that is not taken into account by market prices. By adding the tax, these other costs can be taken into account, likely raising the price of these fuels and thus both reducing their use and providing a higher price umbrella for alternatives.
For years, I accepted these arguments at face value. I might argue with them (for example, I think that the Left has tended to spot 10 of the last 2 true negative externalities), but I accepted that they really believed in the logic of the Pigovian tax. I am now becoming convinced that I was wrong, that the Left’s support of Pigovian taxes is frequently a front, a way of putting a more palatable face on what is really a naked grab for more taxpayer money by public officials.
Soon after discovering the concept of Pigouvian taxes, I suspected that — even if the economics were sound — no human government was going to implement such a tax in the pure form: there would always be “good reasons” to make the new tax non-revenue-neutral, because once a revenue stream has been established, it’s unlikely the government will actually shut it down afterwards. I have yet to be disappointed in this expectation.
October 7, 2015
A Deeper Look at Tradeable Allowances
Published on 18 Mar 2015
Since the passage of the Clean Air Act, SO2 emissions have decreased by 35%. Part of this is due to tradable allowances, which created a market solution to the external costs of SO2 emissions. In this video, we look at the lessons of tradable allowances for SO2 and see if a similar market-based solution could work to decrease other pollutants, such as CO2.
September 30, 2015
The Coase Theorem
Published on 18 Mar 2015
In this video, we show how bees and pollination demonstrate the Coase Theorem in action: when transaction costs are low and property rights are clearly defined, private arrangements ensure that the market works even when there are externalities. Under these conditions, the market properly manages externalities.
September 16, 2015
External Benefits
Published on 18 Mar 2015
What can the flu teach us about economics and externalities? In this video, we go over how vaccines produce positive externalities that help people stay healthy. When someone receive the vaccine, they pass along the positive benefits of the vaccine to others, generating positive externalities. However, when someone gets a vaccine, they bear all of the costs and only reap some of the benefits of the vaccine. The social value is larger than the private value, resulting in an an undersupply of flu shots. One solution to this problem is a Pigouvian subsidy — a subsidy on a good with external benefits.
September 14, 2015
An Introduction to Externalities
Published on 18 Mar 2015
What are externalities and what are the different kinds of costs? And what does this have to do with the rise of “superbugs”? This video is an introduction to externalities, including the concepts of private cost, external cost, and social cost. Using the example of antibiotics and viruses, we take a look at how costs are passed along to different members of society beyond the producer and consumer. We’ll use a chart to illustrate how to calculate the effects of a Pigouvian tax, and we provide definitions for the other key terms that will be used throughout this video series.
August 5, 2015
A report on phasing out nuclear power in Sweden
It may make politicians and activists feel empowered and righteous, but it has negative aspects that don’t seem to get the same level of attention as the “feel good” rhetoric does:
Nuclear power faces an uncertain future in Sweden. Major political parties, including the Green party of the coalition-government have recently strongly advocated for a policy to decommission the Swedish nuclear fleet prematurely. Here we examine the environmental, health and (to a lesser extent) economic impacts of implementing such a plan. The process has already been started through the early shutdown of the Barsebäck plant. We estimate that the political decision to shut down Barsebäck has resulted in ~2400 avoidable energy-production-related deaths and an increase in global CO2 emissions of 95 million tonnes to date (October 2014). The Swedish reactor fleet as a whole has reached just past its halfway point of production, and has a remaining potential production of up to 2100 TWh. The reactors have the potential of preventing 1.9–2.1 gigatonnes of future CO2-emissions if allowed to operate their full lifespans. The potential for future prevention of energy-related-deaths is 50,000–60,000. We estimate an 800 billion SEK (120 billion USD) lower-bound estimate for the lost tax revenue from an early phase-out policy. In sum, the evidence shows that implementing a ‘nuclear-free’ policy for Sweden (or countries in a similar situation) would constitute a highly retrograde step for climate, health and economic protection.
June 1, 2015
It’s time to end the US federal porn subsidy!
At Real Clear Science, Alex B. Berezow issues a clarion call to stop the US government’s (hidden) subsidy to pornography producers:
You might be asking, What federal porn subsidy? Fair question. Technically, there isn’t a federal porn subsidy. However, if we borrow some of the logic commonly used by politically driven economists, we can redefine the word subsidy to mean whatever we want.
Pornography is enjoyed by many people, but it comes with a very real social cost: it can break up families and perhaps even become an addiction, which are profound losses of productivity. Economists refer to these as negative externalities — i.e., bad side effects that affect people other than the person making the decision. One way to deal with such decisions is to tax them. This should, in theory, reduce the negative side effects, while simultaneously forcing the decisionmaker to bear the “true cost” of his actions. Clearly, if anyone should have to pay for this societal cost, it should be porn watchers, in the form of a porn tax. If they don’t pay such a tax, they are getting an indirect subsidy.
As it turns out, we don’t have a federal porn tax. Thus, we could say that the American government has issued a federal porn subsidy.
Obviously, that reasoning is absurd. Not only does it dubiously redefine the word subsidy, but it unconvincingly claims to be able to accurately place a price tag on every conceivable externality created by watching porn. Accepting that argument would require a nearly complete suspension of disbelief.
Yet, that is essentially the argument that a group of economists at the International Monetary Fund (IMF) just made about fossil fuel subsidies. (See PDF.)
[…]
The Guardian, which penned the most influential coverage, began its article with an eye-popping statistic:
“Fossil fuel companies are benefitting from global subsidies of $5.3tn (£3.4tn) a year, equivalent to $10m a minute every day…”
Wow. $5.3 trillion in fossil fuel subsidies? That sounds insane. But, how do they arrive at that number? The Guardian goes on to explain:
“The vast sum is largely due to polluters not paying the costs imposed on governments by the burning of coal, oil and gas. These include the harm caused to local populations by air pollution as well as to people across the globe affected by the floods, droughts and storms being driven by climate change.”
Ah, okay. The subsidy isn’t a direct financial calculation, but is instead based on a bunch of externalities whose costs are nearly impossible to derive with any sense of believability. To give you an idea of just how much fudging exists in these kinds of calculations, a similar report issued in 2013 (PDF) concluded that the fossil fuel subsidy was $1.9 trillion. A discrepancy of $3.4 trillion should raise red flags in regard to methodology.
February 22, 2015
Obamacare’s externalities
Megan McArdle on just what externalities are and why we pay attention to them:
For those who might not know the term, “externality” is economist-speak, and it means about what it sounds like: an effect that your action has on others. An externality can be positive or negative, and obviously, we as a society would like to have as many as possible of the former and as few as possible of the latter. In other words, “Your right to swing your fist stops at the end of my nose.”
I’m a libertarian, and libertarians love talking about externalities. They give us a (relatively) clear way to define what are and are not legitimate scopes of public action. Whatever you’re doing in the privacy of your own bedroom with another consenting adult is really none of my business, even if I think you oughtn’t to be doing it. On the other hand, if you’re breeding rats and cockroaches in there, and they’re coming through the shared wall of our respective row houses, then I have the right to get the law involved.
Framing things as “externalities” is therefore a good way to get a libertarian, or someone who leans that way, on your side. And such frames have come up over and over in the debate over Obamacare, which has been variously justified by the cost to the state of emergency room care; the cost to society of free-riding young folks who don’t buy insurance until they get sick; the public health cost of people who don’t go to the doctor and get really, expensively sick; an unhealthy workforce that is less productive; and the cost to friends and relatives who have to chip in to cover uninsured medical expenses.
I didn’t find any of those arguments particularly convincing. The third can just be dispensed with on the grounds of accuracy: In general, preventive medicine does not save money. Oh, it may save money in the particular case of someone whose diabetes or cancer went long undiagnosed. The problem is, you can’t just look at the cost of sick folks who would have been a lot cheaper to treat if their conditions had been caught earlier. You also have to include the cost of all the healthy people you had to screen in order to catch that one case of disease. And with limited exceptions, the cost of screening the healthy generally outweighs the cost of treating the chronically ill. Now, you can certainly argue for preventive care on other grounds — for example, that it makes people healthier (though even then you have to add the cost of unnecessary medical procedures, such as biopsies following a false positive on a blood test, which is why we do not, say, give annual mammograms to every American woman). But it’s not generally a money saver, so this particular externality doesn’t exist.
The rest of the arguments have some weight, but in the end, I don’t think they’re weighty enough. Let me explain.
October 22, 2014
What would Milton Friedman do?
David Friedman, who we can safely assume has a better sense of the late Milton Friedman’s thoughts and beliefs than most people, disagrees with a recent Forbes article asking WWMFD:
A recent Forbes article is headlined “What Would Milton Friedman Do About Climate Change? Tax Carbon.” It reports on a forum at the University of Chicago at which several economists, including Michael Greenstone, described as the “Milton Friedman Professor of Economics at the University of Chicago,” argued that Friedman would have supported a carbon tax. The evidence for that claim was a 1979 clip from the Phil Donahue show where Milton Friedman argued that if the government is going to do something about emissions, they should use an effluent tax rather than direct regulation. He does not actually say that government should do something about emissions, only that there is a case for doing so and, if it is done, the best way to do it is by a tax on emissions.
To get from there to the conclusion that he would have favored a carbon tax requires at least one further step, a reason to think that he would have believed that global warming due to CO2 emissions produced net negative externalities large enough to justify doing something about them. The problem with that claim is that warming can be expected to produce both negative externalities such as sea level rise and hotter summers and positive ones such as longer growing seasons and milder winters. The effects will be spread out over a long and uncertain future, making their size difficult to estimate. My own conclusion, defended in past posts here (one example), is that the uncertainties are large enough so that one cannot sign the sum, cannot say whether the net effect will be positive or negative.
I do not know if my father would have agreed but I have at least a little evidence on the subject, more than offered in the Forbes article. The same issue arose in the earlier controversy over population. Just as it is now routinely assumed that warming is bad, it was then routinely assumed that population increase was bad. Forty years ago I wrote a piece on the subject for the Population Council in which I attempted to estimate the externalities associated with population. I concluded that they were too uncertain for me to tell whether the net effect was good or bad. My father read the piece and commented on it. If he had disagreed he would have said so, and he did not. It is possible that he would have felt differently in the case of climate change, but I can see no reason to expect it.
December 18, 2013
Should the government subsidize silly walks?
Prof. Art Carden has developed some silly walks and is seeking payment for his work. Since he cannot find anyone to pay him voluntarily, perhaps he should apply for a government subsidy for producing silly walks. But while silly walks may benefit society, the fact that people will not pay for their development voluntarily indicates that people do not value silly walks as much as other things people would pay Prof. Carden to do. Are some subsidies valid, though? What about for food? Or for education? How about subsidies for clean energy? Is government assistance definitely better for society? What do you think?
