Hard Cash and Climate change

by John Quiggin on October 6, 2005

Tim Worstall gets us past that pesky NYT paywall to link approvingly to a John Tierney column arguing that the way to encourage energy conservation in the US is not to fiddle with standards but to raise prices. Broadly speaking I agree. At a minimum, getting prices right is a necessary condition for an adjustment to sustainable levels of energy use. Nevertheless, the rate of adjustment and the smoothness with which adjustment takes place can be greatly enhanced by the adoption of consistent pro-conservation policies, or retarded by the adoption of inconsistent and incoherent policies.

This is as good a time as any to restate the point that, given a gradual adjustment, very large reductions in energy use and CO2 emissions can be achieved at very modest cost. Rather than argue from welfare economics this time, I’ve looked at the kind of adjustments that would be needed to cut CO2 emissions from motor vehicle use (one of the least responsive) and argued that price increases would bring this about over time, without significant pain.

Nicholas Gruen has some related thoughts

With the price of gasoline in the US passing $3/gallon and most of the remaining sceptics now conceding the reality of human-caused climate change, it seems like a good idea to re-examine some fundamental assumptions in the debate over climate change. Rather than focus on the short-run arguments about the Kyoto protocol, it seems more useful to focus on the question of whether anything can really be done to stop climate change.

A common estimate is that to stabilise the global climate, we would need to reduce emissions of carbon dioxide by 60 per cent, and proposals to achieve this by 2050 have been put forward. Assuming only a limited role for alternative energy sources, it seems reasonably to look at a 50 per cent reduction in primary energy use.

It’s a widely-held view that the kinds of changes required to stabilise the global climate must imply a fairly radical reduction in our material standard of living. This view is shared by radical environmentalists, who see such a reduction as a good thing, and by opponents of such changes most of whom, at least in developed countries are on the free-market right.

The fact that radical environmentalists view the modern economy as critically dependent on unsustainable patterns of energy use is not surprising. On the other hand, supporters of the free-market generally praise the flexibility of dynamism. Currently, energy use accounts for about 6 per cent of GDP. The suggestion that reducing this proportion to, say, 3 per cent, is beyond our capacity seems to represent a very pessimistic view of our economic potential.

There’s a standard economic technique for giving a rough estimate of the economic cost of such a shift. Begin with the assumption that in the long run, the demand for energy is sufficiently flexible that a 10 per cent increase in costs will eventually produce a 10 per cent reduction is usage, relative to the underlying trend. Although energy use responds slowly to price changes in the short run this is a fairly conservative estimate of price responsiveness over periods of a decade or more.

Given this assumption, halving energy use would require a 100 per cent increase in prices (by coincidence this is about the change that’s been seen in US gasoline prices in the last few years). A standard economic calculation suggests that the reduction in economic welfare associated with such a tax would be somewhere between 50 and 100 per cent of the revenue raised, or between 1.5 per cent and 3 per cent of GDP. That’s about one year’s worth of economic growth. Remember that this estimate is not for the modest first steps required under Kyoto, but for a reduction in emissions on the scale required to stabilise climate.

Is such a broad-brush estimate reasonable? One way to check is to look in detail at the kinds of changes that would be needed to achieve such a reduction in the most sensitive single category of energy use, that of private motor vehicles.

Consider changes over twenty years, a period long enough for the vehicle fleet to turn over, and for people and firm to make adjustments to home and work locations, commuting and shopping patterns, and so on.

First, a significant reduction could be achieved simply by improvements in the technical efficiency of fuel use. The motor vehicle industry, although technologically mature, still exhibits steady improvements in the efficiency of engines and other aspects of vehicle design. When fuel prices are low, much of the effort is allocated to improving performance.

When fuel prices are high, and policy is oriented towards reducing energy use, innovations that improve fuel economy are favoured. Over 20 years, and with support from publicly funded research, it seems reasonable to anticipate a 20 per cent improvement in fuel economy, for all types of vehicles, relative to the ‘business as usual’ trend.

Second, some shift towards alternative fuels could be anticipated. While radical alternatives such as ethanol and hydrogen and alternatives to internal combustion such as electric cars have so far proved disappointing, an increase in the effective cost of petrol would encourage greater use of existing alternatives such as LPG and diesel, which are more efficient in terms of carbon emission.

Yet further improvements could be achieved with measures to reduce traffic congestion, including purely technical innovations such as more sophisticated management of traffic lights and market innovations such as congestion charges.

Next, the mix of vehicles in the fleet would change over time. The gain from this source can be illustrated by a simplified example. Suppose that half of fleet uses 10l/100km, and half uses 5l/100km, yielding an average of 7.5l/100km. If the proportions changed to 25:75, the average would fall to 6.25,and fuel use would fall by 15 per cent. Most of this change would arise as a result of consumer responses to changing prices. However, existing policies that favour the use of large, inefficient vehicles (such as the special treatment of SUVs in US fuel economy regulations) should be scrapped, and replaced by policies pointing in the opposite direction.

A small further saving, say 5 per cent, could be achieved through discretionary decisions on which vehicle to use for a given trip. Given high fuel prices, a household with a small car and a 4WD might be more inclined to use the small car when dropping the kids off at school, for example.

A similar small change, say a 5 per cent reduction in fuel use, could be achieved through improved driving habits. These include stricter adherence to speed limits on open roads, and avoiding excessive acceleration and braking in urban areas.

So far, we’ve considered changes which involve no change at all in travel patterns (with the exception of congestion pricing, which would actually improve things), and only marginal adjustments in lifestyle. The biggest single change, in the fleet mix, would do little more than restore the mix prevailing in, say, 1980. Yet taken together, these changes would be sufficient to reduce energy use by between 30 and 40 per cent and CO2 emissions by an even larger amount.

Now consider some changes in travel patterns. The most important single variable is the distance travelled by each person. To get an idea of feasible magnitudes let’s consider a 20 per cent reduction in distance travelled. For commuting, the biggest single use of time, this could be achieved if people chose to live a little closer to work, to rearrange schedules to allow a four-day week, or to telecommute one day each week. Similar savings could be made on shopping and leisure travel with only modest costs.

The fuel cost of travel also depends on the extent to which people share cars. The average occupancy of cars has declined steadily reaching about 1.1 persons per vehicle for commuting trips in the US in 2000, and about 1.5 persons per vehicle for all trips. A partial reversal of this trend, raising occupancy to 1.65 persons would reduce fuel use by 10 per cent for a given number of person-km travelled.

Finally, there’s public transport and alternatives to cars like bicycles and walking. Doubling the share of these would reduce the number of vehicle trips by around 10 per cent, though the reduction in fuel use would be smaller since mostly short trips would be avoided.

Adding all of these modest changes together would yield a reduction in fuel use of more than 50 per cent Some of these changes would be imperceptible, others would require marginal adjustments over a couple of decades. Taken all together, they would be barely noticeable relative to the changes in lifestyle that most people experience over such a period.

You might think that adding together a whole lot of small changes in the same direction is stacking the deck in some sense. But this is the way markets work. An increase in the effective cost of some commodity generates adjustments on many different margins, all in the direction of economising on that commodity.

It is also the way coherent public policy works. If a goal of reducing energy use or CO2 emissions is properly embedded in public policy, it will be reflected in modest shifts in many different dimensions of policy, producing a significant aggregate impact.

The combination of price responsiveness and public policy can be seen working together in the reduction in tobacco use over the forty-odd years since the link between smoking and cancer was first officially recognised in the US in the Surgeon-General’s report of 1964. At the time, the proportion of men who smoked was 52 per cent and smoking among women was rising rapidly as older social taboos lost their effect. In 2000 the proportion who smoked was down to 25 per cent for men, and 20 per cent for women and was declining for both groups.

Admittedly, the health risks of smoking are borne mainly by the smoker, so the link between giving up and receiving benefits is direct and personal. Against this, nicotine is possibly the most addictive drug known to humanity. Giving up smoking requires an effort far greater than the modest changes discussed above.

The reduction in smoking was achieved by a combination of higher taxes, aggressive public information campaigns and public policies that gradually limited smoking in various public places, but without any radical changes or any element of compulsion comparable to Prohibition of alcohol or of the many drugs that are currently illegal.

What is true for driving and smoking is even more so for other forms of energy use, particularly in business and industry. Given a consistent upward trend in prices and a coherent set of public policies, massive reductions in energy use would follow as surely as night follows day.

{ 26 comments }

1

rea 10.06.05 at 7:04 am

“Given a consistent upward trend in prices and a coherent set of public policies, massive reductions in energy use would follow as surely as night follows day.”

It won’t be as easy as you think, at least here in the US. With the exception of a few large cities, most of the country is built around extensive use of the autombile. My own moderate-sized midwestern town is surrounded by a ring of bedroom communities 20 miles from downtown. Is everybody going to move? What’s going to happen to real estate values, remembering that home ownership is the prime savings vehicle for most middle class families? Or are we going to spend a few trillion dollars on light rail everywhere?

Not that we won’t have to do it, mind you, but it’s a daunting task.

2

derek 10.06.05 at 8:26 am

The crazy thing about a gas tax is that it’s massively regressive, so the rich ought to like it, as long as they’re not actually oil company executives. And small-government types have nothing to worry about either, since they can use the oil revenue to offset massive cuts in other taxes, without having to borrow.

[It’s clear by now that the amount of money the US government spends each year bears no resemblance at all to how much tax it takes in that year. Lower the tax under Republicans and it spends no less, raise the tax under Democrats and it spends no more. The only difference between the two parties is that one finances the government by taxes in its administration, and the other finances the government by taxes in its opposition’s future administration]

So a gas tax is not even a problem for Republicans. Its only downsides are that it hurts oil company stocks and that it frightens and angers short-sighted traditionalists.

3

Isaac 10.06.05 at 8:27 am

There’s a standard economic technique for giving a rough estimate of the economic cost of such a shift. Begin with the assumption that in the long run, the demand for energy is sufficiently flexible that a 10 per cent increase in costs will eventually produce a 10 per cent reduction is usage, relative to the underlying trend. Although energy use responds slowly to price changes in the short run this is a fairly conservative estimate of price responsiveness over periods of a decade or more.

Really? Not aggressive, just wondering. Is there some cite for this?

4

ed_finnerty 10.06.05 at 8:40 am

Actually Rea they will just buy more fuel efficient vehicles not move. It is relatively easy for most people to double the fuel efficiency of their vehicle fleet which would allow for a doubling of the price of fuel without penalty.

Assuming high fuel prices are here to stay, the SUV generation will be a lost one.

5

paul 10.06.05 at 9:08 am

With the exception of a few large cities, most of the country is built around extensive use of the autombile.

As a result of a lot of deliberate (and some not-so-deliberate) policy decisions ranging from zoning changes and property-tax methodology to road-building doctrine and parking subsidies. All of which also produced sectoral and property-value winners and losers. (Just take a look at Detroit.)

During the oil shocks of the 70s, countries managed to break the correlation between energy use and GDP growth fairly effectively, proving that using less energy (or properly speaking, less fossil fuel) doesn’t have to mean a drop in living standards.

The trick will be figuring out which private entities stand to profit most, so that they can be convinced to buy the required legislators. And disguising as much of the initiative as possible, so that the frogs will be mostly boiled before noticing.

The fact that reducing CO2 emissions and curbing nonrenewable energy use over the course of 20 years or so will require a turnover of much of the nation’s capital stock in transportation, housing and generation could in many ways be seen as an opportunity rather than an obstacle. The auto industry is moribund in part because the replacement interval for cars has more than doubled in the past 20-odd years; the building trades are currently propped up by a bubble that is faltering even now, and calling the US’s energy infrastructure superannuated would be polite.

A few hundred billion as a matter of national security could do wonders for these industries.

6

eudoxis 10.06.05 at 9:18 am

“A common estimate is that to stabilise the global climate, we would need to reduce emissions of carbon dioxide by 60 per cent, and proposals to achieve this by 2050 have been put forward. ” I think you mean that CO2 as a greenhouse gas would be stabilized. Global climate is modeled differently and I don’t think any model shows stabilization assuming a 60% CO2 reduction by 2050.

7

Blar 10.06.05 at 9:31 am

Does there need to be a worldwide drop of 60% in CO2 emissions? If so, your plan for US transportation – increase efficiency by making it more like Europe – may not generalize very well.

8

otto 10.06.05 at 9:31 am

“consistent pro-conservation policies”

The US political system, decentralised, fragmented and disaggregated, is not capable of producing consistent, coherent long-term policies. (Long term foreign policy mobilisation by ethnic groups where there are few direct costs on other US citizens, like the embargo on Cuba, are a partial exception). But it’s a nice thought.

9

Tom T. 10.06.05 at 10:09 am

John, as Isaac notes in #3, you make an assumption about the responsiveness of energy use to changes in costs. Isn’t this assumption testable with real data, by comparing relative gasoline use under the sharply variant tax regimes in the US and Europe?

10

jim 10.06.05 at 10:19 am

“the way to encourage energy conservation in the US is not to fiddle with standards but to raise prices”

This is a false dichotomy. Do both. They have a synergistic effect. Higher prices push people to buy more fuel efficient cars; stronger CAFE standards ensure that more fuel efficient cars are available to be bought.

11

Thomas 10.06.05 at 10:26 am

“Currently, energy use accounts for about 6 per cent of GDP. The suggestion that reducing this proportion to, say, 3 per cent, is beyond our capacity seems to represent a very pessimistic view of our economic potential.”

I thought that energy expenditures this year (2005) were expected to amount to more than 8% of GDP. Further, I’d expect that the increases in price will cause actual energy consumption to go down. In other words, why would we think there’s a connection between how much of GDP is energy expenditures and how much energy is consumed? Isn’t the goal to cut energy consumption, not energy expenditures? (We’d all be happy if they were linked, but it seems to me that they’re not necessarily.)

As for the rest: a single citation is often more persuasive than a thousand casual, back of the envelope calculations.

12

Richard Bellamy 10.06.05 at 11:17 am

Now, I’m no free market purist, but when gas prices were $1.50 a gallon, people though a 100% tax would be a good idea to drive down demand and spur behavioral changes.”

Maybe that’s a good idea, and maybe not. But now that gas is $3.00 a gallon, why is the response not “Good, now demand will decrease and behaviors will change,” but rather “Let’s raise taxes to drive down demand and change behavior”?

I recently bought a Prius. Lots of people I know have done the same. Why do we think “taxes” will do a better job than “naturally high retail prices”?

13

jlw 10.06.05 at 11:18 am

I’m not sure how useful the money spent on energy as a percent of GDP relates to its importance as a part of the entire economy. Virtually every economic activity involves some energy use–if nothing more that the streetlights under which hookers advertise their wares. And there is always the danger of unintended consequences, viz. the reduction of energy consumed by the American manufacturing sector becoming the increasing demand in China.

That said, the general thrust of your argument is right on the money: We need not pack up and join a commune (after killing off three of our neighbors) in order to control global greenhouse emissions. The currently projected future emissions are disasterous, but based on a relatively straightforward extrapolation of current trends. And as those trends are an outgrowth of a set of particular public and private sector policies–encouraging suburban and exurban housing, shipment of merchandise by truck, multiple trips by single-occupancy vehicles, and so on–that can be changed. I mean, we changed the previous ways of doing things to the present set; we can change back, too.

Yes, people with a stake in the current set of policies will lose out. But if the changes are made consciously and thoughtfully, then the potential losers (most notably, owners of exurban housing) can be compensated in order to buy their cooperation. But without such changes we are most suredly all going to be losers and our grandchildren will look at all of us with daggers in their eyes.

14

lemuel pitkin 10.06.05 at 11:31 am

Why do we think “taxes” will do a better job than “naturally high retail prices”?

Part of the answer is who captures the surplus. Suppose that a $1/gallon price increase is required to achieve the necessary reduction in consumption (“necessary” either in the short run to bring demand in line with supply, or in the long term to reduce CO2 emissions). A dollar increase in market prices or a dollar increase in taxes will achieve that end equally well — but the latter will do more to finance investment in conservation and other public goods.

Counterintuitively, a period when prices are spiking is the best time to raise prices. Since supply is fixed in the short run, the ultimate market price is going to be the same regardless of the tax rate — namely, whatever it takes to bring demand down to supply. So the the only effect of a tax increase is to transfer monopoly rents from producers to the public sector.

Of course, raising gas taxes when there’s negative shock to supply might discourage investment in increasing capacity — altho that’s by no means a sure thing. But if we want to reduce consumption in the long run, that’s an added benefit, not a cost.

15

lemuel pitkin 10.06.05 at 11:32 am

Er, that should be

“a period when prices are spiking is the best time to raise taxes

16

dp 10.06.05 at 12:07 pm

Petrol prices in the UK are hovering around 92p/litre. With an exchange rate of $1.77 to the Pound, that works out to about $6.17 per gallon. Are people in the UK abandoning their cars?

17

Urinated State of America 10.06.05 at 12:54 pm

Excellent point John. The costs of CO2 mitigation will be modest; I remember that the UN’s UNCTAD estimated that, with emissions trading, the cost to the US to meet Kyoto would cost $20 billion/year; not cheap, but certainly less than the cost of more Katrinas.

Even one of the more expensive ways of mitigating CO2 emissions, CO2 capture and sequestration from power stations, works out *with current technology* to be ~$70/tonne. That’s equivalent to 80 cents on a gallon of gasoline. Not trival, but not back-to-the-stone-age either.

I find it strange that the technophile conservatarians who tout technology as the answer don’t understand that to get a technology developed, you have to create a market for it by price signals. If the cost to the polluter of emitting CO2 is zero, there’s little demand for technologies to mitigate CO2 emissions.

18

lemuel pitkin 10.06.05 at 2:11 pm

Not so strange. Just keep in mind that

the single most sensible thing said in political philosophy in the twentieth century was JK Galbraith’s aphorism that the quest of conservative thought throughout the ages has been “the search for a higher moral justification for selfishness”.

Conservatives’ technophilia is a means, not an end.

19

soubzriquet 10.06.05 at 3:52 pm

dp, re 16: No, they haven’t. But it isn’t really and apples-and-oranges comparison, since the infrastructure is so different in the two countries. Part of this is due to relative size, but much of it is by choice. The US has predicated much of housing, agriculture, and shipping on the assumption of the continued existence of cheap oil (among other things).

20

Arkaneli 10.06.05 at 3:57 pm

This discusion of the arcana of elasticity, tax regimes etc. is academically interesting and a chance to thump tubs, but completely misses the point. Positive feedback is starting to appear in mechanisms that warm the atmosphere and oceans. One example is the thaw in the Siberian tundra, releasing huge amounts of greenhouse gases. No human action matters anymore.

21

Jake McGuire 10.06.05 at 4:17 pm

Hmm… assume that the price elasticity of demand for energy is 1.0 instead of looking at any of the research in the field; confuse person-trips/vehicle-trip for a small subset of trips with person-km/vehicle-km for the fleet at large, claim that in one move I can be 20% closer to work, the ski resort, and the dirtbike park, double-count fuel efficiency gains, all in the name of quantitivity.

Yup. It’s John Quiggin. I think that this one isn’t quite as good as claiming that freeing Eastern Europe from Soviet domination wasn’t worth the expected 100 million deaths from world thermonuclear war, but it’s up there.

22

Tracy W 10.06.05 at 5:43 pm

I’m a bit doubtful about the potential for ever-more improved energy efficiency in existing technology. I’m remembering back 10 years to something I studied at university and then never again used, but if I am remembering right there are some pretty hard limits on how efficient engines can be. And it’s lower than 100% efficiency (does Cournet engines ring a bell to anyone?).

Furthermore, the closer you get to the theoretical limit, the harder it comes to get any closer. The approach is asymptotic. Consequently, I don’t think that just beause automative engineers made, say, 20% efficiency gains in the last 20 years, that we can depend on them making 20% efficiency gains indefinitely.

23

W. Kiernan 10.07.05 at 6:27 am

tracy w: You’re thinking of the Carnot cycle, which limits thermal efficiency in internal combustion engines, but, for example, fuel cells powering electric motors are not subject to its limitations. Nevertheless, regarding your “indefinitely,” I’m sure you’re correct, as you obviously couldn’t improve on 100% thermal efficiency, but that doesn’t mean we can’t do anything effective today. Without any new technology at all we could increase the mileage of the U.S.A.’s automobile fleet fifty percent by simply slapping a $50,000 gas-guzzler tax on all these 8000 pound, 300 HP trucks that all my idiotic neighbors insist on buying for their daily solo commutes to work.

24

Tim Worstall 10.07.05 at 6:41 am

w.kieran.
Quite. Solid oxide fuel cells are about 60% efficient (more when in a stationary combined heat and power system).
I’m sure John will enjoy the slight irony of a TCS contributor both advocating higher gas taxes and (coff, coff) working with and paying for some of the research into such fuel cells.

25

cm 10.07.05 at 11:17 am

In an economy where costs can be inflated away by printing more money, or can be “diluted” by cutting other essential things, the effectiveness of price signals is limited. There is enough anecdotal evidence for me that many (not all) people are simply taking the gas cost hit, continue driving macho cars, and try saving on other expenses. The economy will respond by reducing goods & services quality, more outsourcing, and further cutting employees’ compensation/benefits packages.

26

Steve Reuland 10.07.05 at 7:40 pm

I’m a bit doubtful about the potential for ever-more improved energy efficiency in existing technology. I’m remembering back 10 years to something I studied at university and then never again used, but if I am remembering right there are some pretty hard limits on how efficient engines can be. And it’s lower than 100% efficiency (does Cournet engines ring a bell to anyone?).

Well obviously, 100% is the theoretical limit, because an engine can’t do more work than the energy you put into it. But ICE engines are currently something like 25-30% efficient, which is horrible. So there’s a lot of room for improvement, assuming there is adequate economic incentive to do so. And gas-electric hybrids increase efficiency further by taking energy that would otherwise be wasted as heat (for example, when breaking) and storing it in a battery. I do not think it is unreasonable that we will see 100mpg prototypes within a few years. They are also experimenting with “plug-in” hybrids that give the batteries an initial charge, which keeps the gas engine from needing to be used for short trips, when it is least efficient. Some tinkerers have modified their own hybrids to produce cars that exceed 100mpg, but of course the extra energy ultimately comes from a power plant, which may be worse for the environment than burning gas. But this is where the technology is heading.

PEM fuel cells are far more efficient than ICEs, something like 60% or more, but there are so many problems with hydrogen that it’s not really worth considering. The penultimate emissions-free vehicle will be an electric car with litium-ion batteries, which will have the same range as today’s cars and will be about 90% or more efficient. The transitional species will be gas-electric hybrids, and after that, plug-in hybrids. The real challenge will be to produce large amounts of electricity without pollution or greenhouse gas emissions. This is no small order, but since the transition will be relatively slow, we’ll have time address that problem.

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