Earlier this month, Nathaniel Keohane replaced Harvard’s Joseph E. Aldy at the White House’s National Economic Council. Keohane’s previous post was chief economist for the Environmental Defense Fund. In his new position he will help direct environmental and energy policy, according to the New York Times’ “Green” blog.
Although he is no doubt a technically savvy economist, Keohane is an unabashed advocate for government intervention in energy markets. His video “The Facts of Cap and Trade”—which urged Americans to support Senate passage of the American Clean Energy and Security Act after the House had passed H.R. 2454—shows a remarkably one-sided presentation of the “facts.” Someone viewing this video would think there wasn’t any conceivable downside to unilateral U.S. implementation of federal limits on carbon emissions:
In the interest of balance, here are responses to a few of the statements from the video (with the time-stamp in parentheses after each quotation):
“We’ve been dumping carbon pollution into our atmosphere for decades, warming our planet, and wreaking havoc on the climate.” (0:09)
This is simple hyperbole. Even if the most alarming climate models are correct, and mankind must drastically curb emissions in order to avoid catastrophe, such havoc is in the future—so long as the word “havoc” implies “events that seriously impact human welfare.” The IPCC reports do indeed argue for a strong link between carbon emissions and rising global temperatures, but they do not say that this has caused appreciable damage to humans yet. Keohane talks as if the evidence of harmful, human-caused climate havoc is all before our eyes, when in fact they are projections in models.[i]
“As cap-and-trade kicks in, the demand for clean energy increases. That means lots of opportunities for entrepreneurs to supply wind, solar, tidal, and other clean-energy technologies, like making jet fuel from algae, and roof shingles that double as solar panels.” (1:48)
This is true as far as it goes, but Keohane never mentions the downside: higher energy prices (and prices of other goods that rely on energy). After all, the reason we don’t make jet fuel from algae right now, is that it would be absurdly inefficient compared to making it from crude oil. Air travel would be prohibitively expensive if jet fuel had to be made from algae anytime soon.
It’s no surprise that by artificially suppressing competing technologies through an arbitrary “cap,” the government can spur all sorts of new “innovation.” For example, if the government placed an annual (and shrinking) cap on how many pounds of meat U.S. restaurants could serve each year, the demand for meat-free meals would increase. That would mean lots of opportunities for entrepreneurs to supply fish tacos, tofu burgers, and asparagus skewers, because the permit for a T-bone steak would eventually cost $500. This would clearly make consumers worse off.
Of course, there is an argument to be made that carbon emissions involve “negative externalities” and that a cap-and-trade program corrects the market signals. Yet Keohane doesn’t discuss any of this. It is amazing that an economist could make a case to the public and list the (alleged) benefits of a program without even alluding to the fact that there are huge costs. Indeed, someone watching Keohane’s video—of cute little smokestacks turning into wind turbines—would have no idea that the CBO’s own analysis (back in 2009) showed that the Waxman-Markey bill would likely have no net economic benefits to the U.S. In other words, the CBO’s own numbers show that uninterrupted climate change poses a smaller threat to the U.S. (measured in terms of GDP loss) than the cap-and-trade program proposed under Waxman-Markey.
“The bill also allows smart companies to profit, by cutting their pollution even more than is required.” (2:04)
This segment of the video features a “clean” company selling its permits to the “dirty” company. It’s true, this is the aspect of cap-and-trade that leads its supporters to call it a “market-based solution.” Rather than the government passing precise, top-down commands on how emissions should be cut, a cap-and-trade program leaves it up to the market place (through the secondhand-market for emission permits) to make the cuts in the cheapest possible way.
However, this analysis overlooks the fact that it is government officials who pick the size of the “cap,” and who determine all of the other minutiae involved with the program, such as “safety valve” thresholds, how many permits are “bankable,” and how much of the cap can be satisfied through the purchase of “offsets” (e.g. planting trees in Brazil instead of reducing emissions in the U.S.). It’s hardly a “market-based solution” that relies on a massive bill that takes lawyers to interpret.
Furthermore, Keohane doesn’t tell his viewers that the determination of which groups get the coveted emission permits in the first place is a process fraught with corruption. Using standard economic analysis, this study found that in practice the Waxman-Markey climate bill would redistribute income from the poor to the rich, because the higher energy prices (due to the shrinking cap on emissions) would be partially offset by free allowances given to large corporations (owned by rich shareholders).
“Europe is already using cap-and-trade to cut carbon emissions. An MIT study shows it’s already working there.” (2:54)
If we look at the bibliography at the end of the video, we see that Keohane is referring to a 2008 paper by Denny Ellerman et al. on the European Union’s Emissions Trading Scheme.[ii] Although that particular paper does not appear to be online, Ellerman is the co-author of a similarly titled 2008 piece for the Pew Center on Global Climate Change, which presumably offers the same evidence of the “success” of the EU’s cap-and-trade program. Here is an excerpt from the Executive Summary of that paper:
The performance of the European Union’s Emissions Trading System (EU ETS) to date cannot be evaluated without recognizing that the first three years from 2005 through 2007 constituted a “trial” period and understanding what this trial period was supposed to accomplish….The trial period was a rehearsal for the later more serious engagement and it was never intended to achieve significant reductions in CO2 emissions in only three years. In light of the speed with which the program was developed, the many sovereign countries involved, the need to develop the necessary data, information dissemination, compliance and market institutions, and the lack of extensive experience with emissions trading in Europe, we think that the system has performed surprisingly well.
Although there have been plenty of rough edges, a transparent and widely accepted price for tradable CO2 emission allowances emerged by January 1, 2005, a functioning market for allowances has developed quickly and effortlessly without any prodding by the Commission or member state governments, the cap-and-trade infrastructure of market institutions, registries, monitoring, reporting and verification is in place, and a significant segment of European industry is incorporating the price of CO2 emissions into their daily production decisions.
…
The deeper significance of the trial period of the EU ETS may be its explicit status as a work in progress. As such, it is emblematic of all climate change programs, which will surely be changed over the long horizon during which they will remain effective. The trial period demonstrates that everything does not need to be perfect at the beginning. In fact, it provides a reminder that the best can be the enemy of the good. [Emphasis added.]
That doesn’t sound too promising, does it? If you had left town for a week, while carpenters were working on your house, would you be reassured on the phone if the guy in charge used language like this—his workers were going through a “trial period” on your house and that there were “rough edges” and you have to understand that his renovations were a “work in progress” that “does not need to be perfect at the beginning?” If we can all agree that such language would be very alarming concerning just your house, why should we be eager to sign up the whole economy for the program?
Ellerman’s excuses would be one thing if the EU cap-and-trade program got off to a rocky start—it was just a “trial,” you see—but then in the second phase, it really kicked in hard and reduced emissions dramatically, even though this would seriously hamper economic growth in the affected countries.
But Ellerman (and Keohane who cited him) didn’t know what the results would be, when writing that assessment. His paper came out in 2008, yet he was explicitly saying that the period 2005-2007 shouldn’t be held against the system, even though that was the only experience he had seen.
For those interested in the details, some of the “rough edges” that Ellerman has in mind include the fact that during Phase I of the EU ETS, from 2005-2007, total emissions of the participating nations increased 1.9 percent, and increased dramatically among certain countries (e.g. Finland’s emissions increased 28.5 percent in that three-year stretch). Moreover, the emission allowances were distributed so generously that their market price fell to €0.10 per ton in September 2007.
No one denies that a cap-and-trade scheme can “work”—if the government imposes serious enough penalties on greenhouse gas emissions, of course businesses will reduce them. But the most draconian governments can’t overturn economic law. The reason industry operates in its current configuration, is that this is the way to deliver the most output to consumers at the lowest possible prices. If the government imposes new constraints on businesses, this will necessarily reduce product quality and/or increase prices, compared to what otherwise would be the case.
Conclusion
The White House’s new man at the National Economic Council is no doubt a smart economist with extensive experience studying greenhouse gas policy. Unfortunately, Keohane’s educational video for the public reveals someone who only sees one side of the issue.
Academics can make a case for giving the government even more power over the economy—in the name of fighting climate change—but Keohane didn’t even make such a case. Instead, he presented the benefits while completely ignoring the costs of his favored program.
[i] The IPCC’s summary of the climatic changes that have already occurred—and mankind’s possible responsibility—is at the bottom of this link.
[ii] A. Danny Ellerman et al., “Lessons for the United States from the European Union’s Emissions Trading Scheme.” Cap-and-Trade: Contributions to the Design of a U.S. Greenhouse Gas Program (Cambridge, MA: MIT Center for Energy and Environmental Policy Research, 2008).
