Saturday, December 21, 2013

Latest Economic Growth Data Give Cheer to Market Monetarists, or, What is the NGDP Gap and Why do we Care?

The headlines for the latest report on U.S. economic growth mostly focused on the revised 4.1 percent growth rate for real GDP. As the following chart shows, that made it the best quarter in two years, and only the second quarter since the recovery began in which growth hit the 4 percent mark or better. A deeper look into the tables put out by the Bureau of Economic Analysis reveals another number that will bring even more holiday cheer to at least some economists:  Nominal GDP growth has also begun to accelerate and the NGDP gap has finally started to close.

What is the NGDP gap and why do we care?
If you’re a real econ wonk, you can skip this section. Otherwise you’re probably wondering just what the NGDP gap is, and why we should care. Here goes. >>>Read more

Follow this link to view or download a classroom-ready slideshow with more charts of the latest GDP data.

Thursday, December 19, 2013

Update: Fed's Taper Puts Brazil's Currency Volatility Back in the Spotlight

Brazil’s volatile currency is back in the spotlight, thanks to the Fed's announcement that it will soon begin to taper its program of asset purchases known as Q3. The following chart shows that the exchange rate for Brazil's currency, the real, is approaching the low reached after the August taper scare and is almost back to the five-year low reached in March 2009.

An article in the Financial Times puts Brazil at the head of what it calls the "fragile five," along with India, Indonesia, South Africa, and Turkey. To say that the Brazilian government is nervous about the situation would be a grave understatement, with a national election and the World Cup coming up next year.

If the weak real is causing despair in Brazil today, the country must have been dancing in the streets with joy two years ago when the currency was headed for record highs. But no--the it was in despair then, too. At that time, its finance minister, Guido Mantega, characterized the Fed's policy of quantitative easing as a “currency war” at his country’s expense.

What explains the paradox that both appreciation and depreciation of a country's currency are both perceived as harmful to the economy? I wrote about this back in August when tapering was only a threat on the horizon. Now that it is actually about to start, the issue takeson a new relevance. Here is a somewhat abbreviated version of the earlier post. >>>Read more

Saturday, December 14, 2013

Budget Deal Locks in Procyclical Fiscal Austerity

A proposed budget deal brokered by Senator Patty Murray and Representative Paul Ryan is headed for the Senate after passing a the House on a bipartisan vote yesterday. Not everyone is happy about it. Conservatives would have liked to see more new deficit cutting measures. “In the coming days, members of Congress will have to explain to their constituents what exactly they achieved by increasing spending, increasing fees and offering up another round of promises waiting to be broken,” grumbled Michael Needham of Heritage Action. Many liberals are unhappy with the deal, too. “Here we are still having the conversation about how to cut government instead of how to improve the prospects of the long-term unemployed and improve the overall economy, which would take expanding spending, not shrinking it," economist Laura Dresser lamented to The Progressive. 

With both the right and the left denouncing the deal, who is the real winner? If we look at the numbers, it is hard not to conclude that the pending deal, which would lock in the status quo, is a victory for the deficit hawks who have pretty much had their way with fiscal policy in recent years. True, on the downslope of the recession, first the Bush and then the Obama administrations tried fiscal stimulus. Without their actions, the downturn would very likely have been even deeper. However, the stimulus has long since run its course. Since the recovery officially began in mid-2009, fiscal policy has tightened markedly.

Some people evidently don’t believe that. The Tea Party News Network, for example, continues to rant about “years marked by runaway spending and out-of-control deficits,” but those years ended some time ago. To see what has really been going on, we need to take a closer look at the evolution of fiscal policy over the course of the Great Recession and the still-incomplete recovery from it. >>>Read more

Follow this link to view or download a classroom-ready slideshow with charts and analysis of the budget deal

Monday, December 9, 2013

Are Cheap Fossil Fuels Really a Such a Boon to the World’s Poor? A Reply to Bjørn Lomborg

How can we make life better for the world’s poor? Environmentalists often tell us that one way would be to slow climate change by cutting fossil fuel use. They warn that the poorest people in the poorest countries are likely to bear the brunt of rising sea levels, droughts, and storms. Carbon taxes or other policies that would raise the prices of fossil fuels would help by reducing demand for coal and oil and spurring investment in green alternatives.

Skeptical environmentalist Bjørn Lomborg seems to think otherwise. Writing recently in The New York Times, he argues that people who care about the world’s poor should work to lower the price of fossil fuels, not raise them. He points out that 3.5 million people around the world die from indoor air pollution caused when they burn wood, dung and other traditional fuels in open fires or leaky stoves to cook and heat their homes—more than die from outdoor air pollution. “There’s no question that burning fossil fuels is leading to a warmer climate and that addressing this problem is important,” he goes on, “but doing so is a question of timing and priority. For many parts of the world, fossil fuels are still vital and will be for the next few decades, because they are the only means to lift people out of the smoke and darkness of energy poverty.”

Is Lomborg right? Although we should not dismiss the problem of indoor air pollution lightly, I think that much of what he says fails to stand up to scrutiny. >>>Read more

Saturday, December 7, 2013

US Recovery Shows New Strength with GDP Growth up to 3.6 Percent and Unemployment Down to 7 Percent

Data released this week by the Bureau of Economic Analysis showed that the U.S. economy grew at a respectable annual rate of 3.6 percent in the third quarter of 2013. That made it the first quarter since early 2012 for which growth was fast enough to make a significant dent in the output gap. The advance estimate released last month had put growth at 2.5 percent.

The upward revision should be interpreted with caution, since, as the following table shows, it was due almost entirely to an increase in the estimated growth of inventories. Faster inventory growth is an ambiguous indicator. In some cases, it can mean that businesses are stocking up in anticipation of higher future sales, but inventories can also grow when firms produce more than they had hoped to sell or order raw materials but fail to use them at the rate they had expected. On a more positive note, the contribution of fixed investment was also revised upward, with residential and nonresidential structures leading the way.

Thursday, November 21, 2013

US Inflation at Four-Year Low on Falling Gasoline Prices

A big drop in gasoline prices brought the US inflation rate for October, as measured by year-on-year change in the consumer price index, to just 0.95 percent, its lowest level in four years. The y-o-y inflation rate for the core CPI, which excludes food and energy, was 1.69 percent. As the following chart shows, trends for both the all-items and core CPI have turned downward over the past two years.

Year-on-year data give a good picture of medium-term trends, but it is also worth looking at monthly data, which tell us what is happening right now. The latest monthly data reveal not just a slowing of inflation, but an actual fall in the price level for October. As the next chart shows, the seasonally adjusted CPI decreased at a .71 percent annual rate in October. Without seasonal adjustment, the CPI fell even more sharply—an annual rate of decrease of 3.05 percent. >>>Read more

Follow this link to view or download a classroom-ready slideshow with charts of the latest inflation data

Monday, November 18, 2013

Could America’s New Energy Abundance Spark a Trans-Atlantic Environmental Race to the Bottom?

Environmentalists often pillory China, with its opaque city air, dirty water, and contaminated food as the leader of a race to the bottom. By spending as little as possible on pollution control, they say, it keeps production costs to a minimum and boosts exports. If Chinese producers had to bear the full external costs their pollution imposes on others, the critics go on, a good part of the its competitive advantage would disappear. The environment would be cleaner and good jobs would return to the United States. So China’s behavior is an outrage, is it not?

Now, however, there is a looming danger of a new race to the bottom, this one with America as the leader and the Atlantic rather than the Pacific as the arena. Is this prospect any less outrageous?

Appropriate vs. affordable energy pricing

As I detailed in a three-part series earlier this year [1] [2] [3], economists across the political spectrum see appropriately high energy prices as a key to an efficient, environmentally sustainable economy. “Appropriate,” in this case, means prices that include charges for environmental harms—local pollution like smog and mercury emissions, groundwater pollution from fracking, climate change caused by greenhouse gas emissions, everything. Higher prices, in turn, would provide incentives for conservation and clean energy innovation. >>>Read more

Friday, November 15, 2013

New Slideshow: Do Banks Take Excessive Risks?

Banks perform essential economic functions, but they are risky. One of the important questions in financial policy is whether banks take risks that are excessive from the point of view of the economy as a whole.

 This slideshow explores three of the main reasons why many economists believe that banks do take excessive risks: Contagion effects such as bank runs, moral hazard arising from deposit insurance and the too-big-to-fail doctrine, and agency problems that occur when financial executives have incentives to gamble with their shareholders' money.

This slideshow is designed for classroom presentation. Feel free to cut-and-paste it into your lecture or assign it as a supplementary reading to students.

Follow this link to view or download the complete slideshow

Thursday, November 14, 2013

Case Study in Supply and Demand: Cows, Bees, and the Soaring Price of Almonds

Almond prices are soaring. As the following chart shows, some varieties are selling for double the price of five years ago, others for three times more. What is driving the upward price trend? Supply and demand is the easy answer. Behind the supply and demand curves lies a more complex story of nuts, cows, and bees.

Cows are out, nuts are in

One of the factors behind the increase in almond prices is a shift in tastes toward foods that consumers perceive as healthier. Milk from cows is out. U.S. consumption of cow’s milk, which consumers associate with artery-clogging cholesterol, has fallen more than third since the 1970s. It is a generational thing. According to an analysis of government data by, each population cohort drinks less milk than the one before. In the late 1970s, Americans of all ages drank, on average, about one glass of milk a day. Thirty years later that was down to about two-thirds of a glass. And it is not just adults who are giving up on cow’s milk. Over the same period, children aged 2 to 12 years cut their daily milk intake from 1.7 glasses to 1.2. >>>Read more

Follow this link to view or download a classroom-ready slideshow that applies supply and demand theory to the market for almonds.

Friday, November 8, 2013

US Adds 204,000 Jobs in October Despite Government Shutdown

The Bureau of Labor Statistics today released its report on the October employment situation. Observers who have been apprehensive about the impact of the partial government shutdown will find the headline numbers surprisingly good. Nonfarm payroll employment increased by 204,000 jobs. The unemployment rate was up, but only by a whisker, rising from 7.24 to 7.28. However, for a number of reasons, these numbers do not fully reflect the impact of the shutdown on the economy.

Let’s begin with the payroll numbers, where the explanation is fairly simple. Payroll jobs are based on a survey of employers. They report how many employees worked or received pay for the pay period that included a certain reference date, in this case October 12th. Even though the reference date fell during the shutdown, all federal workers, whether on furlough or not, met this requirement, thanks to the generosity of Congress, who decided to award them back pay for days not worked. For that reason, the shutdown had no effect on the number of federal payroll employees. There could well have been effects in the private sector, for example, if a hotel near a national park sent workers home for the season who otherwise would have stayed through the end of October, but those effects were evidently small.

What is more, payroll job numbers for August and September were revised upward by a total of 60,000 jobs. When we take both the new data and the revisions into account (as shown in the following chart), recent payroll numbers do not look at all bad. The 605,000 job gain over the three months from August through October is a healthy improvement from the 452,000 for May through June. (Of course, the September and October numbers are still subject to final revision, so this result could change.) >>>Read more

Follow this link to view or download a classroom-ready slideshow with complete charts of the latest employment situation

Thursday, November 7, 2013

US GDP Growth Rises to 2.8% in Q3. Will it Affect the Fed's Decision to Taper?

Today’s advance estimate from the Bureau of Economic Analysis showed U.S. real GDP growing at a 2.8 percent annual rate in the third quarter of 2013, the fastest growth reported since early 2012. The estimate, which reflects economic activity from June through September, was not directly affected by October’s government shutdown, although the data release itself was somewhat delayed. In addition to the growth estimates, the report includes a set of inflation indicators drawn from the national income accounts. These showed that inflation remained below the Fed’s 2 percent inflation target.

The advance estimate, which the BEA bases on data from early in the quarter and extrapolations for later months, is subject to significant revision. For example, the advance estimate for Q2 was 1.7 percent. In the third and most recent estimate for the quarter, that was raised to 2.5 percent. >>>Read more

Follow this link to view or download a classroom-ready slideshow with complete charts of the latest GDP estimates

Saturday, November 2, 2013

Delayed Data Show that September Was a Quiet Month for Inflation

Were you waiting nervously for September’s report on the Consumer Price Index? You can relax now. The data, delayed by the government shutdown, are finally out and they hold no big surprises. None at all.

The all-items CPI rose in September at a seasonally adjusted 2.18 percent annual rate. On a year-over-year basis, the CPI was up just 1.18 percent.

The September increase in the CPI was spurred by an uptick in energy prices, which rose 0.8 percent in the month. The increase, however, was entirely due to seasonal adjustment. On an unadjusted basis, energy prices actually dropped in the month. Another way of removing seasonal influences is to note that energy prices in September 2013 were 3.1 percent lower than they were in September 2012.

Food prices, another CPI component that is often volatile, were unchanged for the month, both with and without seasonal adjustment. The food index was up 1.4 percent for the year.
Removing both food and energy gives the core CPI, often thought to better reflect long-term inflation trends. The core CPI rose at a seasonally adjusted annual rate of 1.2 percent in September. Year-on-year it was up by 1.7 percent.

The following chart shows that both the all-items and core CPI have followed a gentle arc over the past three years. After falling essentially to zero at the depth of the recession, inflation speeded up until the middle of 2011, when the trend lines for both the core and all-items CPI reached the 2 percent mark. Since then, inflation has lost steam and shows little sign of turning up any time soon. More data will be coming soon, but this release provides little to support the arguments of those who would like to tighten either monetary or fiscal policy.

Follow this link to view or download a classroom-ready slideshow with additional charts of the latest inflation data. This post was originally published at 

Friday, October 18, 2013

Is the Recovery of the Baltic Economies a "Success Story for Austerity"? Lessons for US Fiscal Policy

While EU members along the shores of the Mediterranean struggle with a seemingly endless slump, others who dip their toes in the Baltic are making a strong comeback. As the following chart shows, real GDP growth in the Baltic 3—Estonia, Latvia, and Lithuania—has recently run well above the euro area average. Meanwhile, the Med 4—Greece, Italy, Spain and Portugal—continue their downward trajectories. Official forecasts call for their economies to bottom out in 2014, but predictions have been wrong before.

Some readers might object that this chart is misleading, since, to facilitate comparison, it shows output in all of the economies on a scale with 2004 equal to 100. Isn’t it simply the case that the Baltic countries are much poorer, and it is easier to grow from a low base? Besides, what is there to brag about when real GDP in the Baltic 3 hasn’t even gotten back to its pre-crisis peak? >>>Read more

Friday, October 11, 2013

What Should We Do About China's and Japan's Currency Manipulation?

Recently a bi-partisan group of 60 U.S. Senators made headlines with a letter to Treasury Secretary Jack Lew. The letter urged him to add a clause to the proposed Trans-Pacific Partnership (TPP) trade agreement prohibiting currency manipulation. The Senators cited a Peterson Institute study that claimed currency manipulation had cost the United States 5 million jobs. Subsequent discussion of the issue focused on China and Japan as the biggest manipulators. How big is the threat? What should we do about it?

China’s traditional currency manipulation

There is no doubt that China is a currency manipulator in the traditional sense that it treats its exchange rate as an explicit goal of economic policy. It shares this distinction with other countries whose currency regimes are of the “fixed” or “managed float” varieties. We could quibble about which of these categories China belongs to. Its currency regime is less rigidly fixed than, say, the currency boards of Bulgaria and Hong Kong, but less flexible than the managed float of, say, Russia. Either way, as the following map shows, currency manipulators—the light green and blue countries—are clearly in the majority among the world’s economies.

What is at issue, then, is not whether China is a currency manipulator, but rather, how effective its manipulation is and whether and how that manipulation poses a threat to the United States. Over the past three years, I have written a series of posts [1] [2] [3] arguing that China’s currency manipulation has not been highly effective and that the harm done to the United States is often exaggerated. >>>Read more

Thursday, October 3, 2013

As We Move into Budget Chaos, Just How Bad is our Fiscal Policy?

Those of us who live in the United States woke Tuesday morning to a “partial government shutdown.” Partial means, roughly speaking, that air traffic controllers go to work but park rangers do not. The shutdown is the result of the failure of Congress to pass a budget—or in lieu of a budget, a continuing resolution—in time for the October 1 start of the 2014 fiscal year.

Even if the shutdown is resolved in the next few days, another round of chaos looms at mid-month, when Congress must authorize an increase in the debt ceiling in order for the government to continue making interest and principal payments on debts that the same Congress previously authorized the government to accumulate.

Many conservative Republicans say that measures like government shutdowns and debt-ceiling freezes are necessary because taxation and government spending are out of control and public debt is rapidly  becoming unsustainable. How much truth is there to those charges? Just how bad, really, is U.S. fiscal policy, and what should be done to fix it? >>>Read more

Friday, September 27, 2013

US GDP Growth Holds at 2.5% in Q2, Corporate Profits at Record High, Key Inflation Index Falls

The Bureau of Economic Analysis released new data today showing that corporate profits reached an all-time nominal high in the second quarter of 2013. Profits before tax rose to 12.53 percent of GDP from 12.22 percent in the previous quarter, as the following chart shows. That was just fractionally short of the all-time high of 12.60 percent reached in the final quarter of 2011. At the same time, the BEA confirmed that GDP grew by 2.5 percent, the same as the August estimate.

Meanwhile, proprietors’ income was flat in Q2. Popular discussions often treat proprietors’ income as a proxy for the income of small business. It includes the current income of unincorporated businesses that have the legal forms of proprietorships, partnerships, and tax-exempt cooperatives. It does not perfectly match up with small firm size because some small firms are incorporated and some proprietorships, partnerships, and cooperatives are large.

Proprietors’ income has lagged behind corporate income in recent decades. In the 1950s and 1960s, the shares of corporate profits and proprietors’ income were roughly the same. Now, corporate profits are half-again greater. The gap between the two hit an all-time high in Q4 2011, when corporate profits reached 168 percent of proprietors’ income. (This earlier post discussed some of the reasons for the increasing disparity between large and small-business profits, including changes over the years in tax and healthcare policy.)

In addition to data on GDP and its components, the latest BEA report included new estimates of inflation based on the national income accounts. The broadest measure of inflation, the GDP deflator, grew at just a 0.6 percent annual rate in Q2. The deflator for personal consumption expenditures, closely watched by the Fed, actually fell at a 0.1 percent annual rate. Previously the PCE deflator had been estimated to have been unchanged in the quarter.

Overall, the latest report on GDP and its components contained few surprises. Compared with August’s second estimate, today’s third estimate shows the same overall rate of growth of real GDP, at 2.5 percent. Inventory accumulation and the growth of exports were slightly less rapid than previously estimated. Those changes were offset by slightly faster growth of consumer spending and a slightly less rapid decrease in the government’s contribution to GDP.

Follow this link to view or download a classroom-ready slideshow with charts of the latest GDP, profits, and inflation data.

Monday, September 23, 2013

Whatever Became of the Money Multiplier?

If you are teaching or taking an introductory macroeconomics course this fall, you will, at some point, encounter the money multiplier. The multipier posits that there is a stable ratio between M2, the stock of ordinary money in the economy, which consists of currency and bank deposits, and the monetary base, also known as high-powered money, which consists of paper currency issued by the Fed plus reserve balances that commercial banks hold on deposit at the Fed.

Your textbook will go on to explain that the money multiplier gives the Fed great power over the economy. The Fed is able to use open market operations (purchases and sales of government bonds) to control the monetary base. The monetary base, in turn, serves as the raw material from which banks create ordinary money for the rest of us. If the money multiplier has a value of, say, eight, then banks can and will create eight dollars of deposit money for each dollar of high-powered money. Add in the assumption that the quantity of money in circulation powerfully influences investment and consumption spending, and you can see why we obsess so much about quantitative easing, who will win appointment as the Federal Reserve Chair, and every comma in every press release that issues from the stately Eccles building on Constitution Avenue.

There is just one problem. As the following chart shows, something has gone badly wrong with the money multiplier in recent years. For most of the 1990s and 2000s, it was steady as a rock. From 1994 to 2007, the 12-month moving average of the multiplier stayed in a narrow range, between 8.0 and 8.4. Then it fell off a cliff. By July of this year, it had reached a record low of 3.24.

What happened? To answer that question, we need to look a little more closely at the textbook explanation of how the money multiplier is supposed to work, at some features of the banking system that the multiplier model downplays, and finally, at some recent research. >>>Read more

Sunday, September 22, 2013

US Working Age Poverty Remains Near Record High in 2012

The Bureau of the Census released data for U.S. poverty rates and family income today. The headline poverty rate for all individuals was essentially unchanged from 2011, at 15 percent. The poverty rate reached an all-time low of 11.3 percent in 2000. Median family income declined from $51,100 to $51,017, a change that is not statistically significant.

One of the most striking trends in recent poverty data has been the rise in poverty among the working-age population. As the following chart shows, when the government first began to publish poverty data, the elderly were the poorest segment of the population, with children in second place. Since that time, poverty rates among the elderly have fallen dramatically, while those of children have changed little. Meanwhile, the poverty rate for working-age individuals (defined as 18 to 65 years) has risen, and has continued to rise during the current economic recovery. It reached 13.7 percent of the population in 2010, and has not showed a statistically significant change from that level since.

One might wonder why working-age poverty would not have decreased as a result of the gradual fall in unemployment rates. Another data series helps explain why it has not.>>>Read more

Saturday, September 21, 2013

What Does the U-6 "Broad Unemployment Rate" Really Tell Us?

During the recent deep recession and slow recovery, U-6, an alternative measure of unemployment issued by the Bureau of Labor Statistics, has received increased attention. People often refer to U-6, which includes several groups of workers in addition to the officially unemployed, as the “broad unemployment rate.” No doubt, part of its popularity stems from the simple fact that the broad measure of joblessness makes the employment situation look worse than the standard one, and bad news attracts readers and viewers. Beyond that, thought, just what does U-6 really add to our understanding of labor market conditions?

What U-6 tells us

The main contribution of U-6, as I see it, is to remind us that those whom the BLS defines as unemployed—those who are not working for pay even an hour a week but have looked for work within the last four weeks—are not the only ones who suffer when labor markets are weak. U-6 brings in two groups of people who feel  labor market distress even though they do not fit the official definition of unemployed:>>>Read more

Monday, September 9, 2013

US Unemployment Rate Falls to 7.3 Percent in August, a New Low for the Recovery

The U.S. unemployment rate edged down from 7.39 percent in July to 7.28 percent in August, according to data released today by the Bureau of Labor Statistics. The decrease did not, however, reflect an across-the-board strengthening of the labor market. According to the BLS household survey, the civilian labor force, the number of unemployed, and the number of employed all decreased slightly for the month, both before and after seasonal adjustment. The labor force participation rate and the employment-population ratio also decreased on the month.

The BLS also publishes data on a broader measure of unemployment and undermployment known as U-6. That measure takes into account people who are working part-time but would prefer full-time work, and so-called marginally attached workers. The latter incude people who have not looked for work because they think none is available and people who would like a job and are available for work, but who did not look for work in the previous four weeks because of study, family responsibilities, or other reasons. Both involuntary part-time workers and marginally attached workers decreased for the month, bringing U-6 to 13.7 percent. As the chart shows, that also was a new low for the recovery.

According to the separate survey of business establishments, the number of payroll jobs grew by 169,000 during August. The establishment survey excludes farm workers and the self-employed, does not correct for workers holding two jobs, and differs in other details of methodology. It is not unusual for the household employment data and the payroll jobs data to point in opposite directions. >>>Read More

Follow this link to view or download a classroom-ready slideshow with charts of the latest jobs data

Wednesday, September 4, 2013

Brazil's Volatile Real: Why Currency Fluctuations are Painful

Brazil’s volatile currency, the real, is back in the news. Two years ago, the real hit all-time highs against the dollar. The rise prompted Brazil’s finance minister, Guido Mantega, to accuse the central banks of advanced countries, the Fed in particular, of conducting a “currency war” at his country’s expense.  Now the real is heading back toward the lows it reached in 2008, at the depth of the global financial crisis. One might think that if a strong real is bad, then a weak real must be good, but that has not been the reaction. Instead, the recent depreciation has caused Brazil’s central bank president to complain about the “adverse winds from a strong dollar.

Why are currency fluctuations, regardless of direction, so painful, and not just for Brazil? The traditional notion is that exchange rate movements, whether appreciation or depreciation, produce roughly equal gains and losses. Some of them come from the effects on trade in goods and services. When a country’s currency appreciates, its exporters find it harder to sell their products abroad and domestic producers have a harder time competing with imports. They are losers. Meanwhile, firms that use imported inputs and consumers of imported goods are winners. There are also financial effects. People whose foreign currency assets exceed their foreign currency liabilities gain from appreciation of the domestic currency, and those with foreign currency liabilities greater than foreign currency assets lose.>>>Read more

Saturday, August 31, 2013

US GDP Growth Revised Up to 2.5 Percent on Stronger Exports; Inflation Falls

The Bureau of Economic Analysis reported today that the U.S. economy grew at an annual rate of 2.5 percent in the second quarter of 2013. The advance estimate for Q2, released last month, had shown a 1.7 percent growth rate. Higher exports and lower imports were a major factor behind the stronger growth estimate. As the following chart shows, Q2 growth appears to have picked up from its slower pace in Q4 2012 and Q1 2013. The Q2 data are subject to further revision in a third estimate that the BEA will release next month.

The next table breaks the latest growth data down according to the contributions of each major sector of the economy. The contribution of consumption expenditure was essentially unchanged at 1.21 percentage points, a little slower than the average growth of consumption over the previous eight quarters. Investment contributed a little more to growth than previously reported, but the upward revision was entirely attributable to higher nonfarm inventory investment. Inventory investment is an ambiguous indicator. Higher inventory investment can indicate either that firms are optimistically stocking up in anticipation of stronger future sales, or that goods they had planned to sell were unexpectedly piling up in warehouses and store shelves because of disappointing demand. >>>Read More

Follow this link to view or download a classroom-ready slideshow with charts of the latest GDP data

Monday, August 19, 2013

Alexei Navalny: To Change Russia's Economy, Start with Moscow

Alexei Navalny, lawyer, blogger, and opposition activist, has a simple slogan for his campaign to become mayor of Moscow: Change Russia, start with Moscow. His program urges a broad spectrum of changes to legal, political, educational, and healthcare systems, but reform of Moscow’s and Russia’s economy underlie all of them.
Russia’s economy certainly could use a shot in the arm. When Vladimir Putin first became president of Russia, the economy was just beginning to emerge from the chaos of the 1990s. Putin promised, rashly, to double GDP in ten years. If you pick the right measure of GDP and the right years, he managed to do it. (See this earlier post for details.) However, as the next chart shows, the Russian economy was hit hard by the global crisis. In its best post-recovery year, 2010, it grew at barely half the pre-crisis average. Year-on-year growth of real GDP through the second quarter of 2013 has been just 1.2 percent. The economy may have technically entered a recession in the second quarter, although Bloomberg quotes Deputy Economy Minister Andrei  Klepach as saying that there was no recession, only stagnation.

What could the mayor of Moscow do about Russia’s GDP? More than one might think. For one thing, the city of Moscow, all by itself, accounts for a quarter of the country’s economic output—about the same share as the top 20 U.S. cities contribute to the American economy. More importantly, though, Moscow exhibits all of Russia’s economic ills in microcosm. Change there really could spark change throughout the country. >>>Read more

Tuesday, August 13, 2013

How Fuel Subsidies Around the World Burden the Rich and the Poor Alike, with Lessons for the US

I have posted frequently (most recently in a three-part series that starts here) on the topic of underpricing of energy in the United States, but we are not the only offender. Many countries around the world subsidize consumer energy prices in ways that bring them to levels even lower than what U.S. consumers pay. These policies burden the rich and the poor alike—rich countries like Saudi Arabia and poor ones like Egypt, and within each country, both rich and poor citizens.

How subsidies hurt the poor

Fuel subsidies both help and hurt consumers. The trouble is that poor consumers get a disproportionately small portion of the help and a disproportionately larger share of the hurt.
The help comes because subsidies make fuels more affordable. That not only reduces direct costs for cooking and lighting, but also indirectly holds other prices down, for example, by reducing transportation costs for food. For individual families, the price reductions can be most welcome. For example, a study by Arze del Granado and others, cited by the IMF study, found that an increase of $.25 per liter in the price of fuel would reduce the real purchasing power of a poor household by more than 5 percent. >>>Read more

Sunday, August 4, 2013

US Unemployment Rate Falls to 7.4 Percent in July, a New Low for the Recovery

The latest data released by the Bureau of Labor Statistics show the US labor market continuing to recover. The unemployment rate fell to 7.4 percent, a new low for the recovery. Payroll jobs increased by a moderate 162,000, as shown in the following chart. May and June job gains were revised downward.

Payroll job increases were concentrated in service sectors, with retail trade, leisure and hospitality, and business services all showing strong growth. Goods producing industries gained slightly, with job losses in construction more than offset by gains in manufacturing. The government sector showed a rare increase in jobs, most of them in at the local level. Federal and state governments employed fewer workers in July. As the following chart shows, the long decline in total government employment appears to be tapering off. >>Read more

Follow this link to view or download a classroom-ready slideshow with charts of the latest employment situation

Friday, August 2, 2013

How GDP Revisions Change Our Picture of the Great Recession: The Story in Charts

On July 31, the Bureau of Economic Analysis released revised data for US national income accounts. The revised data give us a new view of the Great Recession that began at the end of 2007. It still merits its name as the most severe economic downturn since the Great Depression of the 1930s, but the contraction now looks a little shallower than previously thought and the recovery a little more robust.

The following chart compares the old and revised real GDP data over the past six years. The old and new data series are not directly comparable. Not only was the old series stated in 2005 dollars and the new in 2009 dollars, but there are numerous statistical and methodological differences as well, as discussed below. For easier comparison, then, the chart displays both the old and new data in the form of an index with the peak of the previous cycle, Q4 2007, equal to 100.

Several features stand out in the chart. First, the contraction from peak to trough was not quite as deep as reported earlier. Instead of falling by 4.7 percent, real output fell by 4.3 percent. Beginning from the trough, which came in Q2 2009 in both series, the expansion is somewhat stronger according to the new data, especially in 2011. From Q1 2011 to Q1 2012, the economy is now seen to have grown by 3.3 percent rather than the previously reported 2.5 percent. By Q1 2013, real GDP was 3.9 percent above the previous peak, rather than just 3 percent, as reported earlier. >>>Read more and view the rest of the charts

Thursday, August 1, 2013

US GDP Grows 1.7 Percent in Q2, Beating Expectations, Major Revision to Earlier Quarters

The Bureau of Economic Analysis today released its much anticipated advance estimate of second quarter GDP growth, along with rebenchmarked data for earlier quarters. Q2 growth was reported as 1.7 percent, hardly scintillating, but better than some analysts had expected. However, growth for Q1 was revised down from 1.8 percent to just 1.1 percent, and Q4 2012 was revised down from a feeble 0.4 percent to a near standstill at 0.1 percent. All the numbers are quarterly data stated at annual rates.
The best way to see what has been going on since the first of the year is to look at the old, the rebenchmarked, and the newly revised data on a sector-by-sector basis, as in the following table:

The first thing we see in this table is that the contribution of consumption to real GDP growth slowed from  1.54 percentage points in Q1 2013 to 1.22 percentage points in Q2. Q1 consumption, in turn, was revised downward from a contribution of 1.83 percentage points. Consumption of durable goods picked up slightly in Q2. The slowdown was about evenly divided between services and nondurable goods.>>>Read more

Follow this link to view or download a classroom-ready slideshow with charts of the latest GDP data

Monday, July 29, 2013

The Dubious Economics of Crop Insurance

Insurance is an essential part of the financial infrastructure of a market economy. By spreading losses among members of a group with similar exposure, insurance encourages people to take prudent risks while protecting individuals from ruin in case they are the unlucky ones. Not all risks are insurable, however. Attempts to insure the uninsurable create incentives to take excessive risks and burden the economy with costs to the many that exceed the gains to a few. So-called “crop insurance,” which has become a central feature of U.S. farm policy, is a case in point.

Why crop losses are not insurable

Over time, insurers have developed rules that identify which risks are insurable and which are not. Crop insurance violates at least three of them.

Not a pure loss.  Insurance is normally limited to situations in which people face a pure loss. For example, if I insure my house against fire, I either experience a fire, in which case I suffer a loss, or I do not, in which case I have neither a loss nor a gain. In contrast, if I build a house for resale, I may suffer a loss if no one likes it or if the market declines, or make a profit if someone falls in love with it and pays me a premium price. The risk of fire is a pure loss, and is insurable; the risk of a business venture that carries the possibility of gain as well as of loss is not.

Insurance against crop risks, especially in the popular form of crop revenue insurance, departs from the pure loss principle. Crop revenue insurance does not just protect farmers against bad harvests due to natural causes like drought or floods. It also protects their profits against the economic risk of low prices, even when a good harvest is the cause of the low price. In fact, if the premium is low enough and the benchmark price is high enough, crop revenue insurance provides a guaranteed profit no matter what happens. >>>Read more

Monday, July 22, 2013

Will Peak Phosphate Doom Humanity, or will Supply and Demand Save Us?

Although climate change catches the headlines, it is not the only doomsday scenario out there. A smaller but no less fervent band of worriers think that peak phosphate—a catastrophic decline in output of an essential fertilizer—will get us first.

One of the worriers is Jeremy Grantham of the global investment management firm GMO. Grantham foresees a coming crash of the earth’s population from a projected 10 billion to no more than 1.5 billion. He thinks the rest of humanity will starve to death because we are running out of phosphate fertilizer.  This post on Business Insider from late last year provides an array of alarming charts to back up his warning.

Foreign Policy agrees that phosphate shortages are a potential threat. “If we fail to meet this challenge,” write contributors James Elser and Stuart White, “humanity faces a Malthusian trap of widespread famine on a scale that we have not yet experienced. The geopolitical impacts of such disruptions will be severe, as an increasing number of states fail to provide their citizens with a sufficient food supply.”

What is going on here? Is this really “the biggest problem we’ve never heard of,” as Elser puts it? Or are phosphate shortages something that global markets can cope with? Let’s take a closer look. >>>Read more

Follow this link to view or download a classroom-ready slideshow that features peak phosphate as a case study in supply and demand.

Wednesday, July 17, 2013

US CPI Inflation Rose Sharply in June. How Concerned Should We Be?

U.S. consumer price inflation jumped to a seasonally adjusted annual rate of over 5.9 percent in June, according data released today by the Bureau of Labor Statistics. That was up from an inflation rate of just 1.8 percent in May. In March and April, the CPI actually decreased. How much do we need to worry about the sharp increase in inflation, or the increasing volatility of inflation over the past year, both of which are evident in the following chart? Here are some points to consider.

First, the jump in the monthly inflation rate and the volatility of recent months are almost completely due to ups and downs in the seasonally adjusted price of gasoline. It rose 6.1 percent in the month of June alone after no change in May and decreases of 8.1 percent in April and 4.4 percent in March (all monthly changes, not annualized). The price of gasoline is notoriously volatile. It depends not only on world oil prices, but also on the dynamics of domestic refining and on driving habits.>>>Read more

Follow this link to view or download a classroom-ready slideshow with complete charts of the latest consumer inflation data

Monday, July 15, 2013

Why Libertarians Should Support a Carbon Tax—Even if They Can’t Love It

In the first two parts of this series, I discussed the reasons why both conservatives and progressives should love a carbon tax, and why many of each political persuasion do. In this third installment, I take up the more difficult case of libertarians.

There is no way that a good libertarian could love a carbon tax, or any tax, for that matter. Classical liberal principles hold that the state should play a role in economic affairs only when there are problems the cannot feasibly be handled in the private sector. Even those who support a role for the state in, say, criminal justice or national defense, do so only reluctantly. They secretly pine for a libertarian utopia like that in Robert Henlein’s The Moon is a Harsh Mistress, where even those functions were the responsibility of the marketplace.

Nonetheless, I think it is possible to make as good a case that libertarians should support a carbon tax as that they should endorse a government role in courts or the military. Here are some reasons why.

The polluter should pay

To begin, the principle that the polluter should pay has long been a part of libertarian theory. In his 1962 classic, Man, Economy, and State, Murray Rothbard expressed it this way:
In so far as the outpouring of smoke by factories pollutes the air and damages the persons and property of others, it is an invasive act. . . . Air pollution is not an example of a defect in a system of absolute property rights, but of failure on the part of the government to preserve property rights.
A person whose pollution harms another’s person or property should pay for the resulting harm. People do not pollute just for the fun of it. They do so because polluting, when unrestricted, is a cheap way of disposing of wastes. Paying for waste disposal is just as much a proper cost of business or household management as paying for any thing else—energy, labor, transportation, or whatever.

A polluter cannot escape the duty to pay for harm to others simply because it would be expensive to avoid polluting. Yes, it may cost more to build a smokestack with a filter than one without, or more to treat sewage than to dump it directly into a river. Beyond some point, the harm, at the margin, may be less than the cost of abatement, in which case releasing pollutants into the environment may be the economically efficient decision. Efficient or not, however, the polluter should still pay for any remaining harm done even after the efficient degree of abatement has been carried out.

All this leaves open the question of how to ensure that the polluter pays. First, though, we need to address another important issue.

Are greenhouse gas emissions really harmful?

Specifically, we need to ask whether carbon dioxide and other greenhouse gasses (GHGs) are, in fact, harmful pollutants. If they are not, libertarians are off the hook: No harm done, no payment due, no need for a tax. However, if you are tempted to seek that escape route, you need to ask yourself, which comes first? Are you evaluating the relevant science objectively, or is your judgment of the scientific evidence influenced by an a priori aversion to taxes or other government interventions?

The libertarian icon Friedrich Hayek saw attitudes toward science as one of the key distinctions between libertarians (he preferred the term “liberal,” in the European sense) and conservatives. In his famous essay, “Why I Am Not a Conservative,” he wrote:
Personally, I find that the most objectionable feature of the conservative attitude is its propensity to reject well-substantiated new knowledge because it dislikes some of the consequences which seem to follow from it—or to put it bluntly, its obscurantism. I will not deny that scientists as much as others are given to fads and fashions and that we have much reason to be cautious in accepting the conclusions that they draw from their latest theories. But the reasons for our reluctance must themselves be rational  and must be kept separate from our regret that the new theories upset our cherished beliefs. . .  By refusing to face the facts, the conservative only weakens his own position.  . .  Should our moral beliefs really prove to be dependent on factual assumptions shown to be incorrect, it would hardly be moral to defend them by refusing to acknowledge facts.
He was not writing specifically about climate change (the example he gave was the theory of evolution), but his point applies. We should separate our rational evaluation of climate science from our regret that human responsibility for climate change might upset our cherished beliefs about the ability of a market economy to operate justly and efficiently without the intervention of government.

Mere uncertainty is not enough. Some aspects of climate science are almost universally accepted,  for example, that concentrations of GHG in the atmosphere influence the climate and that human activity has affected concentrations of GHG. Other points are not fully settled, for example, the sensitivity of global temperatures to a doubling of CO2, the interaction of natural and anthropogenic climate drivers, and the relationship between climate change and specific weather events. However, complete certainty is not required in this case.

There are many areas of both private life and public policy where we act to avoid harm that is not certain to occur, or, if it does occur, is not easily quantified. We accept limits on driving while intoxicated even though there is a good chance that any individual drunk driver will make it home from the tavern without hitting anyone. We allow victims of assaults or negligent acts to sue for pain and suffering even though placing a monetary value on the pain is highly inexact. By the same token, we should be willing to accept restraints of GHG emissions if we think the preponderance of evidence suggests that they are harmful, and to place an estimated value on the harm even if we know it may only be an approximation.

If you have looked dispassionately at the relevant science, and you are satisfied, based on the preponderance of evidence, that GHG emissions pose no risk, so be it. Otherwise, read on.

How should polluters be made to pay?

If we accept the principle that polluters should pay, and accept that GHG emissions are a form of harmful pollution, we still have to deal with the issues of how polluters should be made to pay.

For many libertarians, the preferred approach is to rely on private negotiations backed by the right to take legal action for the pollution-related torts of trespass, nuisance, or negligence. If toxic fumes from a neighboring factory damage your health or your property, sue the owners for damages or ask for an injunction requiring them to stop. A 1982 paper by Rothbard, “Law, Property Rights, and Air Pollution” describes this approach in detail.

Unfortunately, the tort law approach to making the polluter pay works less well as the number of pollution sources and victims grows. Yes, you, or you together with a group of close neighbors, can very likely get somewhere with a lawsuit against pollution from a factory next door, easily traced to its source. However, when there are many sources, some of which are far from the many victims, it is difficult to show that pollution from any one source caused the harm to any one individual, even if the harm is collectively large. That is often the case with air pollution, not only climate change, but also urban smog or acid rain.

When a large number of sources and remote victims make the tort law approach unworkable, we have to choose a second-best approach. Our options include regulations that require specific technologies or impose source-by-source emission standards, placing a price on pollution by means of a tax or cap-and-trade mechanism, or doing nothing.

Command-and-control regulations, which are both intrusive and inefficient, are the least attractive alternative to libertarians. Doing nothing would be the preferred alternative in cases where the harm was trivial. When the harm is not trivial, a policy that puts a price on pollution should be the preferred approach.

This is not the place to get into a long discussion of the relative merits of pollution taxes vs. cap-and-trade. Briefly, it seems to me that on libertarian grounds, pollution taxes are less objectionable than cap-and-trade for three reasons. First, they are arguably the more economically efficient alternative. Second, they are less complex and less open to political favoritism and corruption. Third, revenue from pollution taxes can be used to reduce marginal rates on other taxes that produce well-known distortions of market incentives, such as payroll taxes or corporate profits taxes.

The bottom line

The issue of climate change is a source of cognitive dissonance for libertarians. It creates a tension between the principle that pollution is an unjust assault on the persons and property of others, and the principle that disputes are best resolved through private negotiations and civil law. Some libertarians, like many conservatives, manage to suppress the dissonance by convincing themselves that greenhouse gas emissions are harmless. If they are unable to do that, it is reasonable for them to support the least intrusive, least inefficient government intervention available to deal with the problem. In my view, that alternative is a carbon tax. Even if it is a tax that libertarians cannot love, it is one they should support.

This is the conclusion of a three-part series. The first two parts were Why Conservatives Should Love a Carbon Tax—and Why Some of Them Do and Why Progressives Should Love a Carbon Tax—Although Not All of them Do

For more on the topic of this post, see my book TANSTAAFL: A Libertarian Perspective on Environmental Policy,  and also my two-part post on Austrian Environmental Economics.

Addendum: About a year after I wrote this, Jerry Taylor, formerly of the Cato Institute, founded the Niskanen Center, a libertarian 501(c)(3) think tank that works to change public policy through direct engagement in the policymaking process. The center's blog Climate Unplugged quickly became a leading source for libertarian support of a carbon tax and libertarian critique of conservative views on climate change.

Why Progressives Should Love a Carbon Tax—Although Not All of Them Do

Progressives should love a carbon tax. Most progressives love the environment and believe that carbon emissions cause environmental harm. Unlike conservatives, whose attitudes toward carbon taxes were the subject of my last post, progressives have no generalized aversion to taxes. Carbon taxes should be a natural for progressives, then, if they can accept the power of economic incentives to slow the destruction of the planet.

To be sure, many progressives do express strong support for carbon taxes. Here are just three of many examples:
  • The Center for American Progress has put out a position paper titled “A Progressive Carbon Tax Will Fight Climate Change and Stimulate the Economy.” It argues that climate change, economic growth, and fiscal responsibility are intimately linked, and that a price on carbon should be part of a policy to deal with each of these issues.
  • Gernot Wagner, an economist at the Environmental Defense Fund, argues that it makes eminent sense to tax what you want less of in his excellent book, But Will the Planet Notice: How Smart Economics Can Save the World.
  • In Green Illusions: The Limits of Alternative Energy Ozzie Zehner argues against the wishful thinking that solar, wind, or other technological fixes will bring a future of cheap, clean, and abundant energy. Insisting that a strong push for energy conservation has to be part of the mix, he advocates carbon taxes to counteract what he calls “the boomerang effect”—the tendency for subsidies for clean energy to make energy in general cheaper, therefore discouraging conservation.
Yet, not all progressives are convinced. Many are skeptical on principle of our capitalist economic system and instinctively distrust market-based environmental policy. Others fear that a carbon tax would disproportionately harm the poor. Still others have ethical objections to the whole idea of bribing people to do things they ought to choose voluntarily, out of love and respect for the planet. Let’s look at each of these objections in turn.

Doubt that people really respond to market incentives

One reason that some progressives are skeptical of a carbon tax is a simple doubt that people really respond to prices. If you want to get people to stop doing something, they think, you need a government regulation that commands them not to do it in no uncertain terms.

For example, here is how Earthjustice President Trip Van Noppen puts it in an interview published on the organization’s website:
The problem with a carbon tax, as a nice and tidy solution for climate change, is that some things we tax we still use. We've got really, really high cigarette taxes, and people still smoke. It doesn't necessarily guarantee the reductions that you'd need to have to prevent climate change. So in other words, we wouldn't know whether the tax would be at a sufficient level to change behavior at the pace we'd need to change behavior . . . we don't really know how much the market would respond.
The economic term for the responsiveness of demand to a change in price is elasticity. A large negative value for elasticity of demand means that people make a large reduction in the quantity they buy when the price rises. For example, an elasticity of -0.8 would mean that a 10 percent rise in the price of a product would lead to an 8 percent decrease in the quantity purchased. So what is the price elasticity of demand for carbon-based energy?

The fuel for which economists have most extensively studied elasticity is gasoline. One widely cited source is a 1996 meta-analysis by Molly Espey. She concluded that the best estimate for the price elasticity of gasoline demand was -0.26 in the short run and -0.58 in the long run. A 2011 study by Todd Litman of the Victoria Transport Policy Institute provides a comprehensive review of the literature since Espey’s paper. Litman finds long-run fuel price elasticities in the range of -0.4 to -0.8. Those numbers suggest that a tax that added $1 per gallon to the cost of gasoline—still leaving it well below European levels—would cut use by 10 to 20 percent. (For a more detailed discussion of the evidence on elasticity, see this earlier post.)
If elasticity numbers are too abstract, here is a chart from the Litman study, which shows a convincingly tight relationship between fuel prices and fuel use across OECD countries. Can it really be just coincidence that the United States, with the lowest fuel prices, also has the highest fuel consumption?

Prices are having an effect on fuel choice in other industries, as well. One of the strongest trends is increased replacement of coal by natural gas in the generation of electricity.  Duke Energy is one of several big utilities that are rapidly moving from coal to natural gas, in large part because of lower gas prices. According to a report in Forbes, Duke Energy’s chief executive, Jim Rogers, is calling for the government to put a price on carbon with either a tax or a cap-and-trade system. According to Rogers, who should know, doing so would accelerate a trend away from coal, not only toward gas but also toward solar and wind power.

In short, the preponderance of evidence is that prices work, both to promote energy conservation in general and to motivate the choice of cleaner over dirtier sources of energy.

A carbon tax would hurt the poor

Critics of a carbon tax frequently object that any policy that raises the cost of energy would disproportionately hurt the poor. They base the claim on data that indicate that lower income families spend a higher percentage of their budget on transportation, home heating, and electric utilities than do the more affluent. However, even if we accept the truth of that claim, it does not constitute a valid objection to a carbon tax.

The main reason is that policies to keep energy prices low are a poorly targeted way to help the poor. Just do the math. Start with data indicating that families in the bottom half of the income distribution spend an average of about 20 percent of their budgets on energy, compared with less than 10 percent for those in the top half. Combine that with the fact that households in the lower half of the income distribution receive only about 20 percent of all income. Comparing 10 percent of 80 percent to 20 percent of 20 percent makes it clear that lower-income families, despite their greater relative expenditures, consume only about a third of all energy. The much smaller number of households that fall below the federal poverty line probably consume only about 15 percent of all energy. That would mean that for every dollar by which national consumer energy costs decrease, the poor gain only 15 cents.

There are many proposals for combining a carbon tax with targeted mechanisms for offsetting its impact on the poor. One way to do so would be to refund part of the tax directly to low-income households, either through a special rebate or by expanding some existing program like the Low Income Home Energy Assistance Program. As long as the rebate came in a lump sum, rather than in proportion to energy use, it would offset the distributional effect of the tax without reducing its incentive to conserve.

Another approach—one that is consistent with revenue neutrality—would be to use some of the money from a carbon tax to lower the marginal rate of the payroll tax. Because the payroll tax is inherently regressive, reducing it would disproportionately help lower-income households. With either of these approaches, just a fraction of the revenue from a carbon tax would be enough to compensate low-income households. The rest would be available for other purposes—reducing the deficit, lowering the rates on other tax rates, or expanding other federal programs.

There is also another way to think about the effect of a carbon tax on the poor. Keep in mind that the reason for such a tax in the first place is the belief that carbon dioxide emissions are harmful to the environment. If so, it is just as true for the CO2 emitted by the poor as by the rich.

We do not, as a rule, exempt poor people from restrictions on socially harmful behavior. We do not suspend rules against littering in public parks on the basis of income. We do not allow poor people to shoplift their food from supermarkets; we give them food stamps, instead. By the same token, it is reasonable to require poor people to behave responsibly toward the environment. If we are concerned that a carbon tax pinches the budgets of poor households, we should provide relief through other channels, not give them a pass on the need to conserve energy and reduce pollution.

We should protect the planet because we love it

A third objection voiced by some progressives is that we should protect the planet because we love it, not for purely economic motives. Ethical objections to economic incentives are not limited to carbon taxes; they apply to all efforts to put a price on pollution, whether through taxes, marketable pollution permits, carbon offsets, or other mechanisms.

Harvard philosopher Michael Sandel, author of What Money Can’t Buy: The Moral Limits of Markets, has expressed this view with particular force. All policies that rely on economic incentives, he says, pose the danger that those who pay a pollution tax, buy a carbon offset, or trade pollution permits are likely to consider themselves absolved of any further responsibility for climate change. Such incentives become “a painless mechanism to buy our way out of the more fundamental changes in habits, attitudes, and ways of life that may be required to address the climate problem.”

He applies his moral reasoning not just to individuals, but also to nations. Suppose that some wealthy county imposes a carbon tax or cap-and-trade mechanism. “Letting rich countries buy their way out of meaningful changes in their own wasteful behavior,” he says, “reinforces a bad attitude—that nature is a dumping ground for those who can afford it.” Whatever the efficiency of market-based mechanisms for combatting pollution, they “make it harder to cultivate the habits of self-restraint and shared sacrifice that a responsible environmental ethic requires.”

The best response to this ethical argument, in my view, is one made by Gernot Wagner in his book But Will the Planet Notice, cited at the beginning of this post. Here is what he writes in response to Sandel:
By all means, make the moral case. Teach it in philosophy classes and preach it from the pulpits, but let’s not wait for it to have an impact while the planet burns.
By all means, declutter your life. . . Downsize your apartment. Carry around a canvas bag. Bike. . . But everyone else won’t catch up to your good deeds voluntarily—not in time, and not with sufficiently strong action.
That’s where economics enters the room There’s simply no way to go about tackling this problem other than taking seriously the incentives all of us face. Getting several billion of us to behave differently—to behave morally—means guiding market forces in the right direction, making it in our interest to do the right thing. It’s the only way to make the planet notice.
The bottom line

The good news is that, despite initial skepticism, progressives are increasingly supportive of carbon taxes and other market-based environmental policies. Ironically, it is now conservatives who are more likely to reject them.

That is not to say that progressives have come around all the way. One sign of the sometimes half-hearted acceptance of market-based policies is an insistence on a belt-and-suspenders approach: Carbon taxes, marketable permits, or carbon offsets are acceptable as a supplement to existing command-and-control regulations, but not as a replacement for them. For example, a position statement from the Sierra Club reads as follows:
The Sierra Club advocates the establishment of pollution taxes which would make it less expensive for a polluter to adopt alternative processes or invest in additional equipment to curtail releases to the environment than it would be for him to continue as before. Such taxes would supplement, and not replace, standards on maximum permissible emissions.
That attitude poses a significant barrier to the kind of coalition-building that will be necessary if progressive and conservative advocates of carbon taxes are ever to agree on mutually acceptable legislation. Conservative advocates of market-based environmental policy like it, in large part, because it would replace the mish-mash of grossly inefficient taxes and regulations that they see as shackles to business. To many of them, adding a carbon tax on top of CAFE standards, clean energy mandates, ethanol subsidies, and the rest would make matters worse—not only worse for the business environment, but worse for the physical environment.

In a rational world, there would be room for a win-win compromise. Conservatives could make concessions to progressives on the need to protect the poor, for example, by using part of the revenue from carbon taxes to lower payroll taxes. Progressives, in turn, could offer conservatives some relief from the red tape of overlapping mandates, subsidies, and performance standards. In exchange they would get market-based policies that have lower compliance costs, but are equally or more effective in cutting pollution. Whether such a rational compromise is possible in today’s politically polarized America is, of course, another question.

This is the second part of a series. Follow these links for the first part, “Why Conservatives Should Love a Carbon Tax—and Why Some Do,” and the  third part, “Why Libertarians Should Support a Carbon Tax—Even if they Can’t Love It.”  

Originally posted at