Expensive apples

Greg Mankiw passes along an interesting agricultural anecdote (which doubles as an economics parable):

Economics textbooks, including Chapter 14 of my favorite one, explain how firms shut down production when the price of output falls below average variable cost. Here is an example:

NY apple growers leaving more fruit on trees

New York's apple orchards are being carpeted with red as unpicked apples drop to the ground.

With the best of the crop off to market, growers say this year it's cheaper to leave leftovers on the trees than to pick and sell them for juice....

One reason is an abundant crop, not only in New York but in neighboring Pennsylvania and nearby Michigan, which has produced more second-tier fruit than juice and applesauce makers need and driven down market prices.

When labor and transportation costs are factored in, selling anything but the cream of the crop for the supermarket can become a losing proposition.

"In some cases it's not worth the bother of picking them off the tree," said Peter Gregg, spokesman for the New York Apple Association.

The difference in prices is the biggest one-year swing some have ever seen. Last year, growers hurt by severe hailstorms were getting an above-average 12-18 cents per pound for processing apples, those sold for sauce and slices. The price is about 5-8 cents this year.

So not only are New York apples bad for the earth's climate, the economics don't always work even without internalizing the negative environmental externalities!

More to life than blogging

Greg Mankiw gives some very legitimate reasons why he won’t be blogging any more than he already does.

Sorry to disappoint, but more frequent blogging is not in my future. I have a full life: classes to teach, students to advise, articles to write, textbooks to revise, kids to raise, and a wife who still enjoys spending time with me (within limits).

I will continue use this site to pass along links for articles of interest, weigh in when I have something to get off my chest, and flog my favorite textbook. But I am too busy with other things to produce the voluminous output of some of my more energetic colleagues in the blogosphere.

Disappointing for those of us who very much enjoy access to his thoughts, but completely understandable.

Update: Chris Blattman gives some good reasons why he will continue his excellent blog - great news for the rest of us!!

Stavins on cap-and-trade vs. carbon tax

The distinguished Robert Stavins (who is >> Mankiw on cap-and-trade, and probably >>>> Rex Tillerson) takes on the cap-and-trade vs. carbon tax debate.

After first demonstrating the need for a market-based mechanism, he then strongly defends cap-and-trade (and not on the grounds of political pragmatism, which is perhaps the argument most oftenly advanced).

While there are tradeoffs between these two principal market-based instruments targeting CO2 emissions — a cap-and-trade system and a carbon tax – the best (and most likely) approach for the short to medium term in the United States is a cap-and-trade system. I say this based on three criteria: environmental effectiveness, cost effectiveness, and distributional equity. So, my position is not capitulation to politics. On the other hand, sound assessments of environmental effectiveness, cost effectiveness, and distributional equity should surely be made in the real-world political context.

Here is his more detailed argument:

Having said this, there are some real differences between taxes and cap-and-trade that need to be recognized. First, environmental effectiveness: a tax does not guarantee achievement of an emissions target, but it does provides greater certainty regarding costs. This is a fundamental tradeoff. Taxes provide automatic temporal flexibility, which needs to be built into a cap-and-trade system through provision for banking, borrowing, and possibly a cost-containment mechanism. On the other hand, political economy forces strongly point to less severe targets if carbon taxes are used, rather than cap-and-trade – this is not a tradeoff, and this is why environmental NGOs are opposed to the carbon-tax approach.

In principle, both carbon taxes and cap-and-trade can achieve cost-effective reductions, and – depending upon design — the distributional consequences of the two approaches can be the same. But the key difference is that political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table. But political pressures on a cap-and-trade system lead to different allocations of allowances, which affect distribution, but not environmental effectives, and not cost-effectiveness.

Proponents of carbon taxes worry about the propensity of political processes under a cap-and-trade system to compensate sectors through free allowance allocations, but a carbon tax is sensitive to the same political pressures, and may be expected to succumb in ways that are ultimately more harmful: reducing environmental achievement and driving up costs.

In summary, there is a true trade-off between certainty on emissions reduction and certainty on cost, but in a realistic political environment, the carbon tax is vulnerable to both looser targets, and less efficiency in meeting them. The "picking favorites" criticism directed against legislation such as Waxman-Markey holds equally against a carbon tax, and the political outcomes would be in all likelihood worse from an environmental standpoint.

Update: Environmental Economics highlights a different (but also excellent) passage from Stavins:

The Hamilton Project staff concluded in an overview paper (which I highly recommend) that a well-designed carbon tax and a well-designed cap-and-trade system would have similar economic effects. Hence, they said, the two primary questions to use in deciding between them should be: which is more politically feasible; and which is more likely to be well-designed?

The answer to the first question is obvious; and I have argued here that given real-world political forces, the answer to the second question also favors cap-and-trade. In other words, it is important to identify and design policy that will be “optimal in Washington,” not just from the perspective of Cambridge, New Haven, or Berkeley.

In “policy heaven,” the optimal instrument to address climate-change emissions may well be a carbon tax (largely because of its simplicity), but in the real world in which policy is developed and implemented, cap-and-trade is the best approach if one is serious about addressing the threat of climate change with meaningful, effective, and cost-effective policies.

Carbon tax in France

Greg Mankiw is pleased that France has proposed a revenue-neutral carbon tax. Tyler Cowen is less sanguine:

In reality, France’s carbon tax is basically just a gasoline tax—and a tiny one at that. The electricity sector, overwhelmingly powered by emissions-free nuclear power, isn’t part of the plan [TC: Duh!], Prime Minister Francois Fillon told Le Figaro. The tax will basically fall on liquid fuels—raising pump prices 3 euro cents a liter (that’s roughly 15 U.S. cents a gallon).

In theory it will be revenue-neutral but most French voters are nonetheless opposed to the measure.

Incidentally, one argument that carbon tax proponents make against cap-and-trade is that a carbon tax is less subject to loopholes and political manipulation. That argument has always been silly; now it is more demonstrably so:

Large CO2 emitters, such as oil refiners and steel makers, will be exempted from paying the new tax. The government will propose special compensations for fishermen, farmers and truckers...

P.S. Not the first backdoor gasoline tax we have seen proposed this year.

Barney Frank on economists

Via Greg Mankiw:

Not for the first time, as an elected official, I envy economists. Economists have available to them, in an analytical approach, the counterfactual. Economists can explain that a given decision was the best one that could be made, because they can show what would have happened in the counterfactual situation. They can contrast what happened to what would have happened. No one has ever gotten reelected where the bumper sticker said, "It would have been worse without me." You probably can get tenure with that. But you can't win office.

So true... and you'd better believe that the associated frictions help generate sub-optimal political outcomes.

Outsourced responses to cap-and-trade originator

Greg Mankiw and Environmental Capital both pointed quickly to an article in the WSJ citing one of the originators of the cap-and-trade idea, Thomas Crocker, who is now in favor of a carbon tax. But Felix Salmon (my favorite finance blogger, mind you) shows his versatility by turning Crocker's arguments on their head:

Let’s take Crocker’s arguments one by one, with the proviso that they’re coming second-hand, via the WSJ, rather than directly from Crocker himself.

First, Crocker says that a carbon tax “would be easier to enforce” than a cap-and-trade system. But it’s hard to see why that should be the case: both of them involve measuring the same carbon emissions. It’s certainly easier to enforce when you measure upstream rather than downstream, but that applies equally to carbon taxes and to cap-and-trade.

Crocker then gets into the meat of his argument:

Mr. Crocker sees two modern-day problems in using a cap-and-trade system to address the global greenhouse-gas issue. The first is that carbon emissions are a global problem with myriad sources. Cap-and-trade, he says, is better suited for discrete, local pollution problems. “It is not clear to me how you would enforce a permit system internationally,” he says. “There are no institutions right now that have that power.”

Yes, cap-and-trade is better suited for local pollution problems than it is for global pollution problems. But that doesn’t mean that a carbon tax is better for global pollution problems than cap-and-trade is. Indeed, the opposite is true. In theory, once a number of jurisdictions implement a cap-and-trade system, carbon traders will start arbitraging the various different carbon permits, and we will end up with something approaching a global system. Carbon taxes, by contrast, are ever and always local. Crocker is right that a US cap-and-trade system wouldn’t necessarily slow global carbon emissions if China and India refuse to play ball. On the other hand, neither would a carbon tax. But at least a cap-and-trade system has the ability to scale into China and India.

But moving on:

The other problem, Mr. Crocker says, is that quantifying the economic damage of climate change — from floods to failing crops — is fraught with uncertainty. One estimate puts it at anywhere between 5% and 20% of global gross domestic product. Without knowing how costly climate change is, nobody knows how tight a grip to put on emissions.

In this case, he says Washington needs to come up with an approach that will be flexible and easy to adjust over a long stretch of time as more becomes known about damages from greenhouse-gas emissions.

Agreed, 100% — which is exactly why we need a flexible cap-and-trade system rather than an inflexible carbon tax. A cap-and-trade system can be tweaked much more easily than a carbon tax, both in terms of the level of the cap and in terms of the proportion of the permits which is auctioned off rather than given away. Crocker says it’s hard to adjust a cap once it’s in place — but he neglects to mention that it’s harder still to adjust a tax once it’s in place.

John Whitehead at Environmental Economics arrives at the same conclusions, noting sagely that:

Unfortunately, there is no good solution to the global nature of the problem. Protectionism, voluntary agreements and war are three ways to enforce international "policy."

... and the interesting factoid that

Crocker, a 2008 AERE Fellow, won the 2001 AERE Publication of Enduring Quality Award for his work on cap-and-trade.

The versatility of cap-and-trade is such that it's hard to come up with arguments against it that don't apply to a carbon tax as well - other recent failures include admin costs and the distortionary effect of taxes.

Dear Greg, Why Waxman-Markey is minimally distortionary

Greg Mankiw, whose style and wonkiness I love, posts a simple model of how he sees a cap-and-trade bill or carbon tax functioning.

The trick is how to fix the second distortion [inefficiently high carbon intensity of consumption baskets] without making the first one [work/consumption decision distortions via taxes] worse.

This is a fair way of framing the problem.

The basic problem is that a new tax on carbon-intensive products C1 is also an additional tax on consumption C, unless there is some other offsetting tax change.

This is where the Rorschach test comes in. A carbon tax without a compensating income tax cut makes one problem better and one worse. The question then is which problem is bigger.

Stop there - what I think the crucial point he is missing is that Waxman-Markey will effectively function as an income tax cut for the most part. Let's review the Waxman-Markey allowance allocations and split them into those which will effectively function as consumer rebates, and those which will not.

- 46% to electricity generators and local natural gas distribution companies, "which they must use to protect consumers from price increases" (REBATE)
- 15% to low- and moderate-income households to "protect them from other energy cost increases" (REBATE, although implicitly redistributionary)
- 17% to domestic energy-intensive, trade-exposed industries and refining (REBATE unless there is some collusion in pricing to increase prices beyond the cost increase)
- 11-16% to energy efficiency and clean energy technology (NOT A REBATE)
- ~10% to other public purposes like avoiding deforestation, adaptation and international clean tech transfer (NOT A REBATE)

So almost 80% of the "giveaway permits" are effectively consumer rebates, and the remaining ones, which will be largely purchased by oil refiners, amount to a gasoline tax whose proceeds will be used for energy efficiency, clean tech and other public purposes.

So in addition to Robert Stavins' conclusion that “the appropriate characterization of the Waxman-Markey allocation is that more than 80% of the value of allowances go to consumers and public purposes, and less than 20% to private industry,” I would add that ~80% are effectively rebated to the consumers, mitigating the majority of the distortion which Mankiw laments in his post. Waxman-Markey is in fact, for the most part, a carbon tax with a compensating income tax cut.

Exemplary intellectual discourse

I've gotta hand it to Greg Mankiw - while he is wrong on cap-and-trade, there is so much to be commended in his modus operandi. He links to pieces disagreeing with his premise; he links to pieces disagreeing with his conclusions; he posts wonky follow-ups to explain his thoughts in more precise technical terms; and his air throughout is inquisitive, unegoistic (is that a word?), respectful, and without a whiff of personal attack. There is much to learn from him (not to mention Jon Stewart)...

Mankiw still confused on cap-and-trade

Greg Mankiw, whose blog is among my favorites, has an op ed in the NYT lamenting "a missed opportunity on climate change":

The problem occurred as this sensible idea made the trip from the campaign trail through the legislative process. Rather than auctioning the carbon allowances, the bill that recently passed the House would give most of them away to powerful special interests.

... The problem arises in how the climate policy interacts with the overall tax system. As the president pointed out, a cap-and-trade system is like a carbon tax. The price of carbon allowances will eventually be passed on to consumers in the form of higher prices for carbon-intensive products. But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes and offset that price increase. The result is an increase in the effective tax rates facing most Americans, leading to lower real take-home wages, reduced work incentives and depressed economic activity.

Once again, Mankiw does not seem to understand that the majority of the "giveaway" permits are allocated such that they will effectively be rebated to consumers (the 30% to regulated power companies, for example). The big exception is for refined petroleum products like gasoline, which will experience a de facto tax increase - but isn't that what Mankiw wants?

The ad hominem index

Richard Evans uses the "ad hominem index" to draw a glaring contrast between Greg Mankiw and Paul Krugman. Krugman's arguments are often loaded with personal attacks, whereas Mankiw's are admirably respectful and self-restrained. Although I don't always agree with Mankiw's conclusions, I heartily agree with Evans' conclusion: "Thanks to Milton and Greg for teaching by example."

Michael Roberts of Greed, Green and Grains notes the same argumentative style in Krugman's recent editorial on the treasonous planet-betrayers.

Stavins >> Mankiw on cap-and-trade

I generally like Greg Mankiw's blog - he is very smart, curious, intellectually honest, respectful, and concise - but he gets it wrong here, where he laments the "missed opportunity" of not being able to use cap-and-trade revenues for non-environmental purposes (deficit reduction, healthcare, tax cuts, etc.). The problem with this argument is that, even if permits were auctioned, revenues were going to go toward some combination of consumer rebates and renewables/efficiency research anyway. A cap-and-trade bill that immediately raised prices for consumers wasn't politically realistic - even as is (close to budget neutral for most consumers) it barely made it out of the house.

Another Harvard economist, Robert Stavins, is much closer to the issue. He's pleased with the bill's positioning on international competition, and while he frets about protectionism and the compromise on ag offsets, overall he is sanguine:

The Waxman‑Markey bill has its share of flaws, but it represents a reasonable starting point for Senate deliberation on what can become a national climate policy that will place the United States where it ought to be - in a position of international leadership to help develop a global climate agreement that is scientifically sound, economically rational, and politically acceptable to the key nations of the world.