Energy and the Environment:
Policy Advice for the New
Administration
The Matrix
Jeffrey Frankel
Harpel Professor for Capital Formation and Growth, Harvard
Kennedy School
Joint session of the American Economics Association and the
Association of Environmental & Resource Economists
San Francisco, January 3, 2009
The Principle of Targets
and Instruments
2
Targets & instruments
• Politicians are tempted to think that a policy to
help one environmental goal will also help
other environmental goals, and sometimes
even non-environmental goals -- that it will be
“good for everything.” (E.g., Porter hypothesis.)
• Economists tend to presume tradeoffs,
and the principle of targets & instruments,
– which says you cannot expect to hit more than
one bird with one stone, except by coincidence.
• Examples go either way.
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My favorite example of hitting several birds
with a single stone is a gas tax.
I claim this one instrument hits 7 targets:
•
•
•
•
•
•
•
Traffic congestion (time lost)
Traffic accidents
Local air pollution (including health benefits)
Global climate change
National security (cutting oil import dependence)
Trade deficit (oil imports are a big component)
Budget deficit, or else use revenue from a higher gas tax
to reduce other distortionary taxes (fix AMT or eliminate
payroll taxes on low-income American workers).
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But my main point: independent policy
instruments have independent effects.
A policy measure that helps one goal
might hurt another.
• An example of an initiative that successfully
addressed one important environmental goal
with the side effect
of making another worse:
the Montreal Protocol.
– It successfully addressed
stratospheric ozone depletion,
– but banning CFCs led to substitution of HFCs and
(worse) PFCs, which are Greenhouse Gases (GHGs).
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Another example,
• arousing greater passion:
whether to start building nuclear power plants again.
– On the plus side, nuclear power is an energy source
that does not create GHGs;
– on the minus side, nobody wants to store the nuclear
waste in their state.
• Even the national security implications go both ways:
– on the plus side it helps reduce dependence on
imported oil,
– on the minus side, nuclear plants in other countries
increase proliferation risk.
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• Government in practice makes major
decisions in largely independent policy
processes (“stovepipes”).
• We need an overarching framework such as
the matrix I am now suggesting.
– Across the top are the labels of columns
each of which represents a different objective:
– Down the side are the labels of rows
each of which represents
a different policy instrument.
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Objectives →
Policy
Measures ↓
GHG measures,
Miti- Clean Cut
gate
Air traffic
GCC
Natnl. Species
Taxes/Budget
Water
Secur- Habitat &
& Econ.
Bio-diversity
ity
efficiency
+
+
+
+
+/-
Long run
-
-
-
+
-
_
Coal-to-liquids
-
-
-
+
e.g., energy taxes *
Drill Medium Run
Ethanol Subsidies
-
-
Help Everglades;
Hurt Amazon?
+
+
+
+
+
+
End import quotas
on Brazil sugar
+
+
+
+
R&D
+
+
+
+
Forestation (vs.ag.)
+
+
Ban fossil fuel subsidies
+
+
+
+
SPR: Short Run
+
-
+
-
+
-
+
+
+
+
-
+
Long Run
Nuclear
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* Measures to reduce GHG emissions
include a wide variety of possible policies -• Domestic measures include:
– Tightened CAFE standards
– Subsidy of renewables
– Price
•
•
•
•
Cap & trade for power sector
Oil tax
Gas tax
Carbon tax
• Effects of some differ from others’. Thus they
cannot all be captured by the single first row.
• Any measure to cut GHGs would of course more likely
help slow GCC if undertaken as part of a multilateral
successor to the Kyoto Protocol.
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Most of these GHG measures would also
work in the same direction with respect to
local air pollution, traffic congestion,
accidents, and improving national security.
• But CAFE standards –
– as other performance standards or “command &
control” policies, are an inefficient way to attain a
given environmental goal, and so should receive
a “minus“ in the Economic Efficiency column.
– The decision to grant more lenient standards to
“light trucks” probably allowed the SUV craze,
thereby perversely worsening emissions and
increasing congestion & traffic accidents.
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GHG measures
continued
– Alternative energy sources
(wind, solar, nuclear & hydro…)
would help plug-in hybrids come in on
a mass scale, reducing tailpipe emissions.
• But they (like R&D to improve gas mileage) would continue the
trend toward higher miles driven, and thus have adverse effects
in the “Traffic congestion & accidents” column.
– Subsidies to renewables of course
have a negative effect on the budget.
– Most of the other measures, however, could
both correct a distortion & raise revenue.
– Hence the “+/-“ entry in 2nd-to-last column.
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Using the table for policy-making
– In principle, the President should choose simultaneously
a combination of policy measures that are listed along
the left column, so as to attain the goals along the top.
– Technically, it is a matter of formulating a big objective
function, and then solving Lagrangian equations
(or linear programming, if environmental constraints are absolute)
– Of course one could debate the signs of some entries
– I particularly welcome such a discussion – and
one could add some additional policy measures & goals.
– But this sort of framework is the appropriate approach,
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not the “stove pipe” approach government uses.
Let’s move to today’s policy
context, January 2009
• Priority #1 for the new Administration will be a
fiscal stimulus package.
• Making it “green” is a good idea, so long as it
doesn’t lead to wasteful spending in the name of
the environment (like synfuels, corn-based ethanol....)
• Try to (1) disburse quickly, but (2) commit now
to reinstate fiscal discipline in future
• So (1) spend green in 2009
(E.g., money to states to keep public transit in operation)
(2) tax green in future years
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Current political context,
cont.
• If the President issues an endangerment
finding for CO2, it would tie up progress
with litigation and accomplish little – R.Stavins
• A top principle should be measures to
raise gradually the price of energy/carbon
• Decide today to raise future energy taxes
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Three ways to make energy tax
more palatable politically
1. Commit to a future path of gradual tax rise
1. Micro: right signal.
2. Macro: upward price trend not unwelcome at time of
deflation threat
2. Commit to a floor under domestic fuel
prices at current levels.
1. The political resistance is to change.
2. Floor would make low-energy investments profitable.
3. If another 9/11 happens (g.f.),
when the public asks how it can sacrifice,
answer not “go shopping,” but “oil tax/tariff.”
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Appendix: In two places, I have distinguished
the long run from a shorter or medium run
1. The Cheney-McCain policy of “drill, baby, drill,”
i.e., free up oil leases in ANWR & other federal lands, and
allow a resumption of offshore drilling.
Leases are often given to industry at below-market rates, even
aside from a premium for externalities -- inefficient
economically. Drilling has received a new “lease on life” in
the name of national security, especially after record high oil
prices in 2008.
– In the short run, new exploration & drilling will have little effect,
because the start-up time is at least 10 years.
– In the medium run, I have scored drilling a “plus” for national
security: oil flow reduces (slightly) our vulnerability to political
risks among Gulf or other oil producers.
– But in the long run, I have scored it a national security “minus”:
if the worst were to happen and the West were cut off from the
Gulf for a prolonged period of time, we would have already
drained the last drops from domestic oil reserves.
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2. The SPR
• I have assumed that a federal
policy of adding to the Strategic Petroleum Reserve
– would raise the price of oil a little in the short run (with
positive environmental effects), whereas
– it would lower the price of oil a little in the long run (with
negative environmental effects, but positive national
security implications).
• Some economists would argue that government
stockpiles simply displace private stockpiles.
– But this argument neglects the political economy facts of
life: there is no way that a government can credibly
commit that in the event of a future shock that raises the
price of oil to $300 a barrel it will allow private stockpilers
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to keep the full “windfall profits” accruing to them.