Original URL: http://www.theregister.co.uk/2008/11/28/climate_bill_cb_analysis/

Climate Bill scores a fail in economics

Parliament near-unanimous for excess self-flagellation

By Tim Worstall

Posted in Science, 28th November 2008 11:45 GMT

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.

Which leads us to the next important question, how high should that tax be? That question bringing us back to a c/b analysis; what are the effects of carbon emissions going to be in cash terms?

Note, please, that by "cash" we do not mean simply money, we are converting economic resources into a number, one which we can then compare with others. "Economic resources" does indeed mean the ability to vaccinate a child, to comfort or cure the sick and the halt. The total capacity of our current technology and the organisation of the society to go and do things, that's what we're trying to measure. More is better here: while it's obviously true that not all the resources are indeed used to vaccinate poor children (and I'm certainly with the idea that more should be so) having more resources does at least potentially allow us to do such things. Similarly, less is worse here for it constrains the choices we can make about what we do go and do.

Here there's a great deal of argument. William Nordhaus thinks that we should start low and raise the tax over the years. Perhaps $5 a tonne CO2 now rising to $200 and more in some decades' time. His thinking is heavily influenced by the capital cycle. We don't want to throw away perfectly good functioning plant that we've got now but we do want to make sure that, over the decades, as we replace plants, build cities with or without suburbs, that the correct new investments are made. Nicholas Stern (and there are many others between the two for various different reasons) in his report said it should be $80 a tonne now, largely based upon his rather apocalyptic view of the damage the climate change will do plus a rather odd view of discount rates (no, don't ask). So there's a difference about the numbers: but all agree that such a carbon tax actually solves our problem. No, it doesn't matter what the money is spent upon, just that that cost of carbon gets encapsulated in market prices. Thus every polluter is paying the cost of their pollution and thus we get the optimal amount of it, just as market pricing gives us the optimal amount of bread or of Pokemon characters.

Fully paid-up already?

Now there will be those who ask whether I've lost my marbles at this point (those who aren't already sure that I have) because of course such a plan would be hugely expensive, wouldn't it? Well, actually, if we're to be honest about this (and this is one of the dirty little secrets about climate change in the UK), no it won't be all that expensive. If we take the Nordhaus numbers then we're already paying vastly more in environmental taxation than a proper carbon tax would require. But even if we took the much higher Stern numbers we're already paying roughly the correct amount: we're just paying it in the wrong places.

Stern told us that the social cost of one tonne of CO2 emitted was $80. Defra uses a costing of £25 a tonne or so (and there are boring technical reasons why these two different numbers are in fact the same). OK, let's use these. Air Passenger Duty thus already covers the CO2 costs of flying. Fuel duty is higher, much higher, than needed to cover carbon costs (a cut of some 13p a litre would be needed to make it accord with Stern's numbers). Look at it another way. Annual emissions in the UK are some 500 million tonnes CO2-e (equivalent, converting methane etc to CO2 so we can count, that apples and oranges thing again). At the Defra costing that's £12.5 billion a year. So that is the required carbon tax and if you add up the various taxes we're already paying, fuel duty (that part of it at least, the rise in the fuel duty escalator since 1993), APD, landfill tax and so on, we're already paying more than that.

And that rather surprising answer is I think the reason that I'm not really all that worried about climate change nor the costs of dealing with it. As the Stern Review insists (and as many other economists do as well) all that is required is that carbon tax, a so called "Pigou Tax". And as we Brits are so heavily taxed already that we are already (with perhaps a little bit of shifting it around) paying the necessary sums, whatever it was that we needed to do to beat climate change we've already done. And all other countries need to do the same is to become more like Britain.

Which is really rather a relief, don't you think? ®

Tim Worstall knows more about rare metals than most might think wise, and writes for himself at timworstall.com, and for The Business and the Adam Smith Institute, among others.