Too clever by half

posted at 11:34 am on October 2, 2009 by King Banaian
[ Economics ]   

Reader jw sends along a post that claims that cap-and-trade legislation is actually good for our economy.

To counter the argument that the energy economy would grind to a halt if the president were to sign a climate bill, Steffen points to an economic principle called Harberger’s Triangle, named after an economist of the same name. In terms that the noneconomists among us can understand, Harberger accounts for the economic growth that is surrendered when the government imposes limits that weren’t there before, like in the case of carbon legislation. But this surrendered growth is not a loss. Instead, it’s actually a transfer of economic activity from the emitters to those who monitor the system and grant the permits to emit. The only real loss is what Harberger’s theory calls dead weight, which accounts for the inefficiencies in the system. And if we’re really in pursuit of economic efficiency, the inefficiencies should be abandoned anyway.

Yes, it’s a convoluted and immensely theoretical argument. But here’s what you need to know: the loss that many critics suspect would come from such a bill appears objectively minimal. The nonpartisan Congressional Budget Office characterized the economic loss of the House climate bill as being between 0.2 and 0.7 percent of GDP in 2020.

This measurement is also cited by Paul Krugman, who links to this CBO report. The report states that measurement a little more clearly:

Reducing the risk of climate change would come at some cost to the economy. For example, the Congressional Budget Office (CBO) concludes that the cap-and trade
provisions of H.R. 2454, the American Clean Energy and Security Act of 2009 (ACESA), if implemented, would reduce gross domestic product (GDP) below what it would otherwise have been—by roughly ¼ percent to ¾ percent in 2020 and by between 1 percent and 3½ percent in 2050. By way of comparison, CBO projects that real (inflation-adjusted) GDP will be roughly two and a half times as large in 2050 as it is today, so those changes would be comparatively modest. In the models that CBO reviewed, the long-run cost to households would be smaller than the changes in GDP. Projected GDP impacts include declines in investment, which only gradually translate into reduced household consumption. Also, the effect on households’ well-being of the reduction in output as measured by GDP (which reflects the market value of goods and services) would be offset in part by the effect of more time spent in nonmarket activities, such as childrearing, caring for the home, and leisure. Moreover, these measures of potential costs imposed by the policy do not include any benefits of averting climate change.

Let me make the following points about this line of “reasoning”:

1. The emphasis on deadweight cost (i.e., ignoring the transfer of resources from emitters to monitors, to use the first link’s language) ignores the lobbying and other rent-seeking activity around manipulation of climate-change legislation to favor certain types of emissions over others. Safety valves in cap-and-trade legislation just invite this kind of lobbying; money spent on lobbyists doesn’t get spent on consumption or investment goods and services. Thus using the Harberger Triangle understates the true loss of cap-and-trade.
2. It is important to compare apples to apples. Citing the cost of climate change as “0.2% of GDP in 2020″ makes it sound like the total cost of the legislation is 0.2% of that year’s GDP (which would come up to $50 billion.) That would the the cost for that year. The total cost rises over time and would lead to a permanent loss of jobs due to lower investment in capital goods.
3. The laugher part of the CBO paragraph is “the effect on households’ well-being of the reduction in output as measured by GDP … would be offset in part by the effect of more time spent in nonmarket activities, such as childrearing, caring for the home, and leisure.” This is also known as “what you do when you’re unemployed.” If that was supposed to be factored in, we would say fewer bad things about unemployment.

The Harberger story in this case is simply too clever by half. It washes away the rent-seeking, dodges the cumulative costs of the flow of Harberger triangles and (if I may) Tullock rectangles, and then tries to make a virtue of unemployment.

UPDATE: Kimberly Strassel takes up the rent-seeking notion as well.

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