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Economics Environment Politics & government

[2066] Of in Down Under revisiting carbon trading and carbon tax debate

Before I begin, I must admit that there is much reading for me to do to understand the current debate on carbon emissions trading in Australia. I have not been following Australian affairs as closely as I should; I am still stuck with the New York Times, the Wall Street Journal and to a lesser extent, the Washington Post. But each time I took a peak at least up until two weeks ago, either The Australian or the Australian Financial Review, emissions trading, and climate change at large, seemed to dominate the headlines.

Even on campus here at the University of Sydney, a number of posters critical of the scheme are up.

While the debate is unique to Australia in a sense that the Liberal and others out of government squabbling with each other — the odd thing is that, the Liberals, who under Howard administration was friendly to the idea (in fact, it was the Liberal government that first introduced the idea), and the Greens are against the idea of carbon trading, at least in its current form as proposed by Rudd government — as well as the fact that the government does not have enough vote to get it past unilaterally, the mechanism of the policy is largely the same.

There is even a possibility of a general election if the bill failed to be passed. It is a possibility because the general sentiment is that, if there is an election today, the Liberals are going to get further beating with the Rudd administration strengthened. WIth that strengthened government’s position within the Parliament, the bill can then be passed without much trouble.

I acknowledge the need to address negative externality associated with greenhouse gases emissions that massively contribute to anthropogenic climate change. I have written it about in the past. As a freshman and later as a junior at Michigan, I wrote two papers related to the issue, though not specifically on the trading scheme. The acknowledgement, really, is the reason what I identify myself as a green libertarian.

For the benefits of those unfamiliar with the term externality and alien to the field of economics, here is a short introduction to it. Externality is a market failure where individual or private cost does not correspond to social or public cost. As a simple demonstration, in a situation of no law against littering at all, an outsider littering in a public space effectively suffer no cost of doing so. The community living in that public space however does suffer from the cost associated with that littering. Somebody has to clean it up but the one causing it does not suffer the cost of cleaning it up. Instead, the community does. That misalignment of private and public cost is externality, or more precisely, negative externality.

Meanwhile, positive externality is where private action brings about public benefit. For instance, if a person has a collection of really good music and he plays it on the radio that he bought, positive externality is when you happen to sit close enough to him to listen to the music without paying anything for it. You get the benefit of good music. Here, he enjoys the music and you do too without paying. Of course, if he plays bad music, the situation immediately switches from positive to negative externality. He enjoys it but you risk deafness, and uncompensated at that.

A model known as Tragedy of the Commons is the most utilized model to impress the consequence of negative differential between private and social cost. In the model, there is a grazing field, henceforth called the commons. Headers of cows have their cows grazing the field freely because it is a commons and an unregulated one at that. It is then in the interest of the herders — assuming that there is little cooperation between them — to have their cows to graze the commons more and more. They compete for the use of the commons and this competition leads to overgrazing as everybody seeks to keep resources from the commons to themselves. Overgrazing then will turn the whole commons worthless as it is left dead without grass. In the end, everybody loses in the long run.

Greenhouse gases emissions is more or less like that. Economic progress in general and definitely in the current framework, requires consumption of energy and by and large, it produces greenhouse gases, in particular, carbon dioxide. Meanwhile, carbon emissions impose little cost to individual emitter, i.e. little private cost. Assuming that economic progress is desirable, it is in the interest of individuals to commit to progress and emit carbon. But if everybody continue to emit carbon, combined emissions contribute to climate change (I will not go into the science) and climate change imposes cost on all in the end, i.e. social cost. There is obviously more nuance — for example, the cost will not be evenly distributed and in fact, some may experience benefits from climate change; one example of such benefits is the opening of sea route up down in the Arctic Ocean — to the whole issue but that simplification here is done to show why carbon emissions phenomenon, which contributes to anthropogenic climate change, is a negative externality.

The solution to this negative externality or tragedy of the commons is to equalize private and social cost. This can be done by pricing the externality. In terms of climate change and carbon emissions, it means pricing carbon.

Two most popular solutions in mainstream discussions involve tradable quota (more popularly called cap and trade) and tax (carbon tax). The tax is also known as Pigovian taxes, named after a British economist that first proposed such tax to align private and social costs, Arthur Pigou.

By quota, it means assigning rights to emit to market participants and then letting these participants trading among themselves given their endowment. The typical setting is that the government gives (either freely or auctioned) certain amount of quotas to all industries (or even individuals) players. Once endowed with permits, all players are allowed to trade it so that these players can reach to their efficient level of emissions, given multiple constrain.

Carbon tax on the other hand is simply a tax on all activities that emit carbon. I am being sloppy with definition here because even human being organically emit carbon. The idea is to reduce carbon emissions from perhaps, mechanical and electrical operations, as well as one of commercial and industrial of nature. Here again, I am being sloppy but let us not dwell on the matter because that is not the reason for this long-winded entry.

Theoretically, the two methods are the same. A certain number of quotas or permits can have the same effect to a certain level of taxation.

However, political impacts of the two policy differ and most often than not, quota is the most the popular one because nobody likes to be taxed. Quota, despite its ability to imitate the impact of carbon tax, does not directly impose tax and therefore, less obvious in its impact. It is being considered in the United States and Australia — with great controversy in Australia — and it is already in force within the European Union.

The granting of quota however is a messy business vis-à-vis carbon tax. I warn though, much written below is not original. The issue has been debated over and over again by various individuals that trying to cite them may seem like trying to cite somebody just to indicate that the sky is blue.

Firstly, the granting of quota appears to be arbitrary. How exactly does the government determine how much quota a particular firm will get? Past emissions? Forecast emissions?

If it is past emissions, paraphrasing the efficient market hypothesis, past data does a bad job at predicting the future because it does not incorporate future data that are not yet available. If forecast is used, clearly the firm has the incentive to provide overly optimistic forecast that the imposition of quota does little or even nothing to align private and social cost.

Secondly, who should get the quota is a huge problem. Relative over-endowment of permits to certain players in the market and under-endowment to others may turn the whole scheme into an unfair wealth distribution exercise rather than a mechanism to reduce carbon emissions. Some firms may find it more profitable to trade permits rather than engage in productive activity.

Thirdly, the quota system is overly open to political compromise that it stops becoming an equivalent of a tax. This happens when quotas are granted freely such as what happened in Europe and may appear to be the case in Australia. Free quotas, coupled with the first issue, tend to render the whole exercise worthless that it is practically business as usual.

Fourthly, for tradable permits to become an equivalent of carbon tax, it needs to be auctioned. The problem is that, the auction component is almost never implemented. In Australia in its current proposed form, only a fraction will be auctioned while most will be given freely. In Europe, auction is a foreign term. In the US, 85% of the permits will be given freely, if the Senate passes the American Clean Energy and Security Act or more commonly called the Waxman-Markey Bill. The House of Representative narrowly passed the bill earlier in June this year. This is perhaps the cost of political compromised.

Fifthly, the auctioning, monitoring as well as the assignment of permits require a kind of bureaucracy which I am, as a libertarian, unwilling to see taking root. That bureaucracy will require resources to run, definitely more than mechanism for carbon tax demands for.

Carbon tax does not suffer from the complexity revolving around bureaucracy and distributive issues. Imposition of tax rate can be introduced uniformly. Sure, some will lobby to be hit with more generous levels of taxation or even request for downright exemption but compared to cap and trade method, carbon tax, even under compromised outcomes, is better. Unlike tradable permits which must be auctioned in order for it to be effective, tax imposes direct cost to carbon emissions to align private cost with social cost.

This is why I prefer carbon tax.

Categories
Economics

[2064] Of it’s the price and supply control, sweetie

Ask a layperson what he or she thinks of the definition of economics. If they do not say it is the art of making money, many of them will mention that it is a study of supply and demand.

In truth, economics is larger than either popular but otherwise misleading definitions. More accurately, it is a study of human behavior. A slightly more restrictive definition would lead to what students of economics typically understand it: economics is a study of the use of scarce resources.

While economics is more than able to explain and rectify the problem of production, distribution and consumption of resources, economic lesson may unfortunately have been lost on the federal government.

The manner in which the government responds to the issue of sugar availability may reveal how poorly they understand economics or, at least, how economics is being ignored by them.

This is not the first time Malaysians are facing a sugar shortage. Almost yearly, the issue keeps returning to the limelight.

The government previously blamed smuggling activities as the cause of sugar shortage. They still do. They have blamed suppliers and other players in the sugar supply chain of profiteering without shame. At other times, they blame Malaysians for consuming too much sugar.

This year, while the official line has yet to be made clear, the government-controlled media is blaming Malaysians yet again. According to them, consumers are panicking and rushing to the stores to get all the sugar they can get. The term that is gaining traction is panic-buying.

At this rate, I wager it would not take long before somebody claims that sugar monsters have been raiding warehouses all around the country.

Lest I am unfairly accused of being hopelessly partisan, that it is always the fault of the Barisan Nasional (BN), there are individuals and groups in both BN and Pakatan Rakyat governments that buy the panic-buying storyline.

Regardless of who is buying what, how does the government try to solve the problem?

The efforts to solve the problem are as wanting as the explanations: wider inspections to catch profiteers, greater enforcement at the border to discourage smugglers, and a campaign to encourage Malaysians to live a healthier lifestyle by consuming less sugar.

Yet, the problem recurs without fail, much like how Malaysians can expect the haze to be a yearly affair. In the past weeks, news in the mainstream media suggests that the same efforts, which have clearly failed, will see implementation again.

There is a reason why the problem of shortage keeps recurring and it is because the government refuses to admit one important aspect of the problem — the government is the problem. Specifically, it is the price control mechanism.

All other issues — be it profiteering, smuggling or overconsumption — are direct consequences of the control mechanism. All previous efforts have failed because they are only symptoms of an inefficient market and not the cause. The act of removing the inferior policy will remove the cause of the problem and address all the symptoms in one swift stroke.

Without doing so, apart from flooding the market with sugar through massive subsidization, the shortage will be a repeating phenomenon. This, by the way, happened frequently in the former Soviet Union, a communist state that implemented wide-reaching price and supply control mechanisms.

To understand how price control causes the shortage, one has to realize that prices act as signals to market participants, be it producers or consumers. Given a particular level of starting price, if it increases, it reflects growing scarcity in the market. That then it suggests that producers should or could produce more, or consumers should or could consume less, or both. If price decreases, it reflects growing abundance and that suggests that producers should or could produce less, or consumers should or could consume more, or both.

When the government imposes a friction in the market by placing a rigid price structure like the price control mechanism, it disconnects prices from levels of scarcity and, effectively, eliminates its function. This is a failure of pricing resources correctly. That failure then causes inefficient allocation of resources and in this case, sugar.

It is easy to identify how the term panic-buying is the failure of pricing and ultimately, a failure of government. It is an act of unneeded market intervention by the government, which causes unnecessary hardship to Malaysians.

The euphemism ”panic-buying” unfortunately strips the real cause of the shortage and shifts the blame from government to individuals. Really, panic-buying is simply an increase of demand. Increase in demand happens all the times before a huge occasion like Ramadan. There is nothing special about it.

In a free market, the possibility of shortages is tremendously reduced because prices adjust to reflect reality.

Prices simply go up to discourage consumers from going to the store and hoarding everything; the market punishes the so-called panic-buying by making it progressively more expensive to do so. In a controlled market, that possibility is ever a concern because sugar remains cheap when panic strikes. In a controlled system such as Malaysia’s, there is no feedback mechanism to counter the panic buying.

Oh, I am sorry. There is a feedback mechanism to counter panic buying. The government actually uses the mainstream media to convince consumers that there is ample supply of sugar and Malaysians should calm down. It is raining sugar, baby!

It is insulting to listen to that.

The real solution is to free the sugar market and, indeed, dismantle the control mechanisms imposed on consumer goods by the government. According to a 2008 list obtained by Reuters from the Information Ministry, 11 items have their prices controlled and another 20 items have their supply controlled. It is no accident that these items — among them flour, yet another item that Malaysians have to hunt for from time to time — are susceptible to shortage.

The control mechanism is typically defended as a mechanism to protect consumers. How creating a shortage protects consumers will be an interesting take.

Shortages only reduce Malaysians’ welfare. In fact, shortages should only occur in less developed countries, with communist or socialist markets.

Even if one does not believe in economics, for some reason preferring to believe in the existence of sugar monsters, then at least take note that all past explanations and efforts have failed. It is time to try a new approach.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

First published in The Malaysian Insider on August 18 2009.

Categories
Economics

[2062] Of crazy suggested policy of the week: encourage congestion

Sometimes, much against the spirit of egalitarianism, I am tempted to suggest that most policymakers must have at least basic background in economics. The reason is that, some of the policies politicians advocate sometimes are very, very disagreeble in terms of its consequences.

Today in The Star, Minister Shaziman Abu Mansor — a minister no less — suggested that toll operators should give discount to motorists for facing congestion during festive season.

RAUB: Works Minister Datuk Shaziman Abu Mansor said highway toll operators should give motorists discounts during festivals to compensate for the congestion.

He said they should be fair to motorists as traffic congestion normally occurs during festivals, forcing them to be on the road for a much longer time before reaching their destinations. [Give discounts, toll operators urged. The Star. August 17 2009]

Does that sound the right thing to do?

Only if you are an economic illiterate.

More individuals are likely to use the highway if the toll is cheaper than what it is at the moment. Lower prices will exercabate congestion problem.

The right thing to do in order to keep travel time reasonably low — barring investment in more roads, better public transportation or some innovative engineering solution — is to increase prices to ensure allocation efficiency!

Higher prices will, among others, encourage pooling, utilization of public transport or travelling out of peak time. All that combats congestion.

Lower prices will come with worse congestion to make everybody worse off!

Surely that is a bad policy.

Categories
Economics Politics & government

[2058] Of does prisoner’s dilemma ring a bell?

In denying the allegation that he received RM10 million from Kuala Dimensi Sdn. Bhd., MCA President had this to say:

I am not surprised that the smear tactics and character assassination against me had picked up pace especially with the latest revelations by the PKFZ Task Force.

If indeed I have received pecuniary and financial benefits for myself or the Party, there will be more reasons for me to protect the interests of the givers, as opposed to proceeding to expose their misdeeds. By doing so, I am risking my personal and family safety as well as my own credibility.

The allegation by Dato’ Seri Tiong King Sing that I have taken the RM10 million “loan” from him for use by the Party’s divisions, are obviously made with several motives, including diverting attention away from the alleged irregularities exposed by the Task Force. It could also be meant to create suspicion among my Party comrades that I have pocketed funds meant for the divisions. The fact that he indicated that it was a loan could mean that he wants the option of taking me to court to further embarrass me. [Smear campaign just another obstacle. Ong Tee Keat. August 12 2009]

I presume, Mr. Ong Tee Keat has never heard of prisoner’s dilemma.

If one applies prisoner’s dilemma, it should not be too hard to understand why somebody is defecting. Of course, this is assume that Mr. Ong was involved in the whole fiasco.

Whether true or not, it is still a possibility. It is not as impossible or ludicrous as Mr. Ong insists at all.

Categories
Economics

[2047] Of euphemism of the day: number forecast operator

Number forecast operator…

PETALING JAYA: All three number forecast operators (NFOs) in the country will benefit in the longer term as the government tries to curb a rise in illegal gaming by increasing the number of legal lottery games, although Berjaya Sports Toto Bhd (BToto) may face some initial pressure from new games awarded to its rivals, analysts said. [Government approves more lottery games. Rachel Kam. The Star. July 28 2009]

I say just call it gambling operator. Or betting operator. Or gaming operator. Or lottery operator.

Number forecast operator…

The industry does not even forecast number.

Sometimes, some people go too great a length trying to whitewash things.