catallaxy files

catallaxy in technical exile

Price or quantity restrictions?

with 33 comments

There is an article in the SMH today repeating the claim that an ETS is the cheapest solution to AGW. Economists say so (emphasis added).

AN emissions trading scheme is the cheapest and most efficient way to achieve the greenhouse gas cuts the Federal Government is aiming for from the Copenhagen Accord, economists believe.

”Our view is that the direction has clearly been set by the Copenhagen Accord, and sooner or later we are going to need substantial emissions reductions,” said Nathan Fabian, chief executive of the Investor Group on Climate Change, which represents institutional investors that collectively manage about $500 billion.

”This means that there has to be a price on carbon. To investors, the best way to do this is by emissions trading because it offers least-costs abatement.”

Well, yes. I’m sure ‘investors’ (read speculators) would love another dodgy financial instrument. Since the trading floors got shut, speculators can’t bet on two flies crawling up the wall, or the skirt length of the next female to walk by. But do economists really believe an ETS (a quantity restriction) is the best solution to AGW?

Actually, no. The situation is a bit more nuanced. The policy choice between a price control (tax) and a quantity control (ETS) depends on the elasticities (slopes) of the marginal cost and marginal benefit functions. The marginal benefit elasticity is most important. If the marginal benefit curve is shallow (elastic), then a price instrument imposes fewer deadweight costs on the economy than does a quantity instrument. If the marginal benefit curve is steep (inelastic), then a quantity instrument will impose lower deadweight costs on the economy than does a price instrument. Australia is a small polluter; if acting alone, the marginal benefit elasticity will be close to perfectly elastic. In the absence of an international agreement, this suggests a tax would be better than an ETS.

From the academic literature:
W.A. Pizer Journal of Public Economics 85 (2002) 409 –434

The resulting welfare analysis indicates that taxes are much more efficient than permits for controlling GHG emissions – by a factor of five to one ($337 billion versus $69 billion in net benefits). This derives from the relatively flat marginal benefit curve associated with emission reductions.

M. Hoel, L. Karp Resource and Energy Economics 24 (2002) 367–384

Even though we chose parameter values from the plausible range in such a way … making it more likely that quotas dominate taxes … our calculations indicate that taxes lead to higher welfare. Even if the larger (based on Reilly) estimate of g is too small by a factor of 1000, … taxes would still dominate quotas if the firm and the regulator were “reasonably flexible”. If the estimate of g is too small by a factor of 100, taxes would still dominate quotas even if the firm and the regulator are inflexible. Consequently, in spite of the data limitations, our results support the use of taxes rather than quantity restrictions to control greenhouse gasses.

The best discussion of this I have seen is by Cameron Hepburn in a 2006 paper published in the Oxford Review of Economic PolicyRegulating by prices, quantities or both: an update and an overview‘. Unfortunately, the document won’t let me cut and paste so have a look at pages 237 – 239. He suggests that if we think tipping points are likely to occur (something the AGW lobby regularly predict) then an ETS is the way to go, otherwise a tax is suggested. The big problem (as I read his argument) is that the international community have been promoting an ETS type solution over a tax and there is some sort of institutional lock-in. That argument seems very weak to me, but the overall message is that (neoclassical) economic theory generally suggests a tax to be the solution to AGW and an ETS is only suggested under very specific circumstances.

As an aside: John Humphreys is taking a lot of stick over this article. I’m not sure its entirely fair. I would prefer that greenies employ charity before they lobby government for new taxes. In that sense I agree with John – let these people put their hands in their own pockets before they put their hands in my pocket.


Written by Sinclair Davidson

December 23, 2009 at 11:19 am

Posted in Uncategorized

33 Responses

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  1. I hate it when journos put a blanket “economists believe” as if there is a uniform view by economists on this. I’m an economist and have long been against an ETS – a carbon tax is superior, more predictable, more effective and less likely to be gamed/corrupted. Generally behind every supporter of an ETS you’ll find a rent seeker.

    Samuel J

    December 23, 2009 at 11:57 am

  2. The last time we heard “economists believe,” this increasingly spineless profession of dirigiste chickens told us how fantastic multi-gazillion dollar “stimulus” plans were.


    December 23, 2009 at 12:11 pm

  3. We must also remember that famous letter, signed by 364 economists, thta contained the opinion that the Thatcher Government’s policies would be disastrous for the British economy. It turned out that the Iron Lady and her advisors new a lot more than those 364 economists.

    Rococo Liberal

    December 23, 2009 at 12:42 pm

  4. It turned out that the economists were right, raising taxes did increase unemployment however easing monetary policy eventually turned the economy around.

    Lets not forget that post budget Thatchers popularity plummeted to 25%


    December 23, 2009 at 5:35 pm

  5. So according to Rog, economics is a popularity contest.

    Righto, rog. Thanks for the deep and meaningful insight.


    December 23, 2009 at 5:39 pm

  6. I heard on the news the Indian Environment Minister admitting that he along with China were responsible for sabotaging any agreement at Copenhagen on the grounds that neither were going to endanger their current and future economic development by engaging in emissions reductions.

    According to this post, a tax in these circumstances is preferable to an ETS. My judgement is that with neither China or India planning to reduce emissions neither a tax nor a trading scheme is preferable if the object of the policy is to reign in temp rises (assuming the science is correct which I don’t) since it cannot hope to achieve this without China and India.


    December 23, 2009 at 5:52 pm

  7. Ken Nielsen

    December 23, 2009 at 5:58 pm

  8. Moonbat is a freaking loon.

    So what happens now? That depends on the other non-player at Copenhagen: you. For the past few years good, liberal, compassionate people – the kind who read the Guardian – have shaken their heads and tutted and wondered why someone doesn’t do something. Yet the number taking action has been pathetic. Demonstrations which should have brought millions on to the streets have struggled to mobilise a few thousand. As a result the political cost of the failure at Copenhagen is zero. Where are you.

    No kidding but he makes plimer look good.


    December 23, 2009 at 6:06 pm

  9. “No, d_b, Monbiot says it was the US Senate.”

    But, of course.


    December 23, 2009 at 6:13 pm

  10. Yes, I liked the line:
    “good, liberal, compassionate people – the kind who read the Guardian – ”

    Do you need to swear that you qualify before being allowed to subscribe? But what about the website?
    How do they keep the neo-liberal economic rationalists out?

    Ken Nielsen

    December 23, 2009 at 6:17 pm

  11. Ken:

    These people live in sheltered freaking workshops. they just can’t envision how anyone could not group think like they do.


    December 23, 2009 at 6:21 pm

  12. rog
    The economists did not just argue that unemployment would increase, but that the whole economy would collapse due to Howe’s budget, which completely bucked the dirigiste consensus that had triumphed since the War and helped reduce Britain to a country of little hope. They were utterly incorrect.

    Margaret Thatcher won the next election in a landslide. And no matter how popular the Falklands War had been, she would have lost in 1983 if the economic situation hadn’t improved markedly.

    Those 364 economists were ‘experts’ just like the Climatologists of the IPCC are supposed to be now and they were just as wrong as the modern anti-capitalist alarmists who have perverted the course of science in th name of a dirigiste, quasi-religious bit of hocus-pocus.

    I fear your problem is that you haven’t learned, as Anthony Powell put it, that even at the top of government and the professions just as much stupidity and eccentricity exists as anywhere else. I my work I regularly deal with many brilliant lawyers, who are an intellectual match for any scientist. Once three of my partners told me that I was wrong about a very complex tax issue. One of them had written the textbook and another was known as one of Sydney’s most technically gifted tax lawyers. All 3 were stating the acceted interpretation. I then approached a leading silk who agreed with me. The ATO later conceded and my point was upheld, even though 8 out of ten leading tax practitioners would have said I was wrong. My partners were neither stupid nor evil, they just didn’t want to abandon a consensus which allowed them to be known as experts. Interestingly, 2 of the 3 identfied as lefties, and the 3rd was apolitical.

    Rococo Liberal

    December 23, 2009 at 11:03 pm

  13. Recently in a public, another tax lawyer who is supposedly an expert broke the Solicitors’ Rules and denigrated me and my opinion of how the tax law applies to the new market that one of my clients is developing. When questioned it was clear that he could raise no legal objection, but just couldn’t come to grips with the novelty of the whole thing. The ATO is now very close to granting a postive ruling which I will take great delight in waving in this expert’s face. Moral: put not your trust in someone merely because he is an expert.

    Rococo Liberal

    December 23, 2009 at 11:13 pm

  14. Ken
    There is a great line in the play ‘Jeffrey Bernard is Unwell’ where the eponymous hero recalls a story about a man who was so hen-pecked that he let his wife talk him into cutting off his own penis. Bernard’s comment was : “I bet she reads the Guardian.”

    This demonstrates the real truth that Guardian readers are in fact illiberal and cruel.

    Rococo Liberal

    December 23, 2009 at 11:17 pm

  15. RL says that with 42.4% of the vote Thatcher won a “landslide victory”


    December 24, 2009 at 6:59 am

  16. Cheap shot, rog. The UK doesn’t have a two party preferred system. In a first past the post system Thatcher did have a landslide victory.

    Sinclair Davidson

    December 24, 2009 at 7:42 am

  17. RL: I must try to get a copy – I enjoyed JB in the Spectator but missed the play. Great line.
    Still, the Guardian is a fairly good paper. Most of its columnists are batty (with the very honourable exception of Ben Goldrick) yet it does a pretty good job of separating news from comment. Better than quite a few in this country.

    Ken Nielsen

    December 24, 2009 at 8:24 am

  18. No sinkers the reason for the ‘landslide was the large vote for the Social Democrats which nearly was as much as the labour vote.

    Thatcher was quite unpopular until the Falklands war.

    the UK did have stagflation and you get rid of that through either a recession or a prices and incomes policy.

    The 364 economists were right in the S/T but wrong in the L/T.

    UK is a very good example of how poor first past the post elections are for the country

    Butterfield, Bloomfield & Bishop

    December 24, 2009 at 10:42 am

  19. When Homer’s not around Rog has the con to make the most stupid ignorant comments around.


    December 24, 2009 at 10:43 am

  20. the UK did have stagflation and you get rid of that through either a recession or a prices and incomes policy.

    A price and incomes policy.. hahahahahhaahhhahahahahahahahhahahahahaha

    Homer’s got the con.


    December 24, 2009 at 10:45 am

  21. So says the man who thinks the Government has no assets and believes Italian bonds are a bargain.

    We shouldn’t forget his memorable historic statement that Jim Cairns gave all Australian secrets to the Soviets

    Butterfield, Bloomfield & Bishop

    December 24, 2009 at 10:47 am

  22. Homer;

    let’s recap..

    I. I never said Italian bonds are a bargain. You’re lying as usual.

    2. The government doesn’t treat “assets” in the same way as commercial enterprise.

    3. Whitlam was told by the Americans that they didn’t trust Cairns.

    You’re so fucking stupid that all you have left is to distort what people say.

    Have a really fucking merry xmas , homer, you dishonest nimrod.


    December 24, 2009 at 10:52 am

  23. Homer
    Inflation is always and everywhere a monetary phenomenon. Even the unions can’t be blamed for inflation.


    December 24, 2009 at 10:52 am

  24. Jase:

    Don’t feed the idiot with any economic logic. He obviously wants to go back and talk about Keating ….. Again.

    The nazi economist loves control, which is why he only wears brown shorts and silly long brown socks now.


    December 24, 2009 at 10:55 am

  25. 1)Lets recap you are lying.
    you said Italian bonds were better value than Australian bonds because of our ‘massive’ debt.

    2) yes they do as the budget shows.Gosh it is even in accrual accounting and has been since 1990.
    It is the Balance sheet you also said didn’t exist

    3) No you said Cairns gave away secrets to the Soviets. That is totally different

    You are an expert on dishonesty and lying Forrest.

    Butterfield, Bloomfield & Bishop

    December 24, 2009 at 10:56 am

  26. Statman you didn’t live during the early 80s here or most of the Western world during the first oil price hike.

    Butterfield, Bloomfield & Bishop

    December 24, 2009 at 10:58 am

  27. Homer – there may well be many reasons for her landslide victory, but that doesn’t change the fact that under the UK voting system she did have a landslide victory.

    Sinclair Davidson

    December 24, 2009 at 11:00 am

  28. Homer the early days:


    1. Not exactly. I said Italy’s debt default swaps were trading lower Australia’s for a very good reason. They have less debt than we do, as consumer debt here is 150% of debt and climbing while their consumers are net savers.

    2. Homer commercial accounting isn’t the guiding principle in government. Government assets are not treated the same way.

    3. No homer I didn’t say that at all about Cairns, you nimrod.

    Homer stop the lying, you dishonest skank.


    December 24, 2009 at 11:10 am

  29. I would have thought that the numerous ad homs were the cheapest of shots


    December 24, 2009 at 11:12 am

  30. Folks go to Andrew Norton’s blog and see if Forrest is lying or not that is where he said The government had no assets and also where he said Cairns was giving away Secrets to the Soviets.

    1) doesn’t matter strong hint Iceland

    Butterfield, Bloomfield & Bishop

    December 24, 2009 at 11:34 am

  31. Yes everyone please go to andrew’s blog… do a search and you’ll see I said what I’m saying now.

    Homer, the big difference between you an me is that I’m not a moron like you and if I say something that’s screwed up i take it back and apologize. That’s the opposite of you, you skanke

    1. my strong hint is that you’re an idiot.


    December 24, 2009 at 12:00 pm

  32. [Please provide a valid email address if you want to comment. Sinc]


    December 24, 2009 at 12:50 pm

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