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Climate Bill scores a fail in economics

Parliament near-unanimous for excess self-flagellation

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The stated objective of the Climate Change Bill, recently passed by Parliament, is: "To avoid the impacts of dangerous climate change in an economically sound way." It's an excellent idea, one worth supporting - but possibly not entirely the one that the Government itself is pursuing.

The quote comes from the Government's own Impact Assessment, which presents a cost/benefit analysis of the effects of the Climate Change Bill. That. however, is were it all starts to go wrong:

Total Cost (PV*) £30 to 205 bn
Total Benefit (PV) £82 to 110 bn
* Present Value

As you can see, we've something of a problem here - particularly as the Bill received Royal Assent this very week. The authors of the Impact Assessment have set out to convert costs and benefits into monetary values, and of course they will have faced huge problems in deciding which effects are costs and which benefits, which nice and which nasty. Peter Lilley, one of the few politicians to question the process, notes that they admit that they're not including all the costs nor some of the benefits. But by the standard measures of a c/b analysis the course of action the Climate Change Bill maps out fails.

We've got a possible range of nice to nasty of + 52 to – 95. That's what's known as a fail. We're more likely to be making things worse than we are to be making things better. So by the Government's own calculations we shouldn't be doing whatever it is that is in the Climate Change Bill and should be looking around to come up with something else, a plan B.

But that's not what happened - Parliament wafted it through without even discussing its cost and with only five votes against. Lilley goes on to point out one of the great pieces of political wisdom:

"In my experience, our biggest mistakes are made when Parliament and the media are virtually unanimous and MPs switch off their critical faculties in a spasm of moral self-congratulation. That is what happened with this Bill."

I have been accused around here of being relentlessly negative about things, only willing or able to slag people and ideas off rather than offering anything constructive. So given that we know that we shouldn't be doing what the Government has just passed a Bill insisting that we should do, why not actually lay out what we should more properly be doing about climate change?

Yes, why not. So, here is what the economists are saying should be done about climate change. There are different numbers used, differences of opinion at times, but the general lines of argument are common to all.

Climate change is the result of the externality created by the emission of greenhouse gases to the atmosphere. Those who emit do not have to bear directly the full cost of their actions.

That, from our c/b analysis, is the root of the problem. No, it isn't capitalism, unfettered greed, an absence of omniscient bureaucrats, insufficient love of Gaia, it's that people are not bearing the costs of their actions, that the polluters are not paying.

Market failure, or absence?

Nicholas Stern (he of the report to the Government that led to the current Bill) has said that this is the "biggest market failure ever". Loath as I am to criticise a much better economist than I will ever be, this isn't quite true. Externalities are best thought of not as market failures but as the absence of a market (perhaps, if you prefer, the absence of something from a market). The solution is thus either to create a market or to include them in the current one.

That is exactly what is being proposed in the case of carbon emissions. Outside the loonier Green circles no one is proposing a ban on certain activities, no one is insisting that we all need to hunker down in the caves and subsist on yurt flavoured tofu. No, we either want to get a cap and trade system working (create a new market) or we want to have carbon taxation (include emissions in the current market).

There's a difference between the two approaches. Cap and trade allows you to set the number, the amount, of emissions but you don't know the price that will emerge from the system. A carbon tax allows you to set the price but you don't know how emissions will be affected by that price. To some extent which of these you prefer is purely a matter of personal preference. Either should, if properly implemented, solve the problem. Once we have the externalities properly embedded in the market system then we can stand back and let those markets do their stuff.

Now I do have a preference and it comes from my contempt for politicians and the political process. No, they're not wise and omniscient beings with our best interest at heart: they're frail human beings facing a particular set of incentives, the most important of which is to get re-elected so as to stay on the gravy train. This is the heart of the Nobel Laureate James Buchanan's approach to politics, public choice theory. Politicians do what is good for politicians, not what is good for anyone else. Which is why I prefer the carbon tax route to the cap and trade. Yes, cap and trade involves markets, something which I'm predisposed to prefer, but these markets have too many sticky fingers interfering in them. Just look at what's going on in the European Trading system (ETS) for credits: preferments for certain classes of firm, a refusal to auction all permits rather than hand them out to favoured clients and so on. No, better that we should simply have a straight carbon tax and be done with it.

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