TEXAS POWER CRISIS. MARKET OR REGULATORY FAILURES?

 

Viewed as independent countries California and Texas would both rank among the ten largest economies in the world. One Democrat and the other Republican, the feature they now have in common is failure to prevent extensive and disruptive interruptions to power supply – California in 2001 and Texas in February 2021. In both states near-catastrophic failures raise questions as to the viability of highly market-driven power systems, which contrast with the stability of more integrated models of the East Coast of the US, and internationally. The answers matter, not just for Texas, but for developed and developing economies everywhere.

In California, the new market structures had only recently been introduced. California had copied many features of the UK 1990 model, which had worked successfully, or at least without major mishap, for ten years. With the benefit of hindsight and a lot of analysis, there seems to be a reasonable consensus that the failures resulted from a combination of factors:

·         Weaknesses in the design of the new market structures

·         State regulatory authorities’ imposition of a price cap, which prevented the market working as it should, to reduce demand and increase supply.

·         Market abuse by Enron, notoriously exploiting the rules to gain large economic rents. Enron went on to become a major corporate scandal, but California was the setting for some of its most egregious wrongdoings.

The recent failures in Texas, celebrated as an example of liberalised market reform, are harder to explain. Unusual weather conditions may be a proximate cause but are hardly an adequate excuse for one of the wealthiest advanced economies in the world, in a liberalised power sector that has appeared to operate without serious mishap since the late 1990s. The other factor cited, the intermittency of wind, can be dismissed as a credible explanation; if relevant at all, it is a known risk that should have been easily managed in a well-functioning sector. We need to look further for adequate explanations of failure to provide reserve capacity.

Creating incentives for private operators to provide the level of reliability that the public want has always been a potential weakness of market-driven systems, usually resolved by the imposition of reserve margins, and financial incentives or penalties. Peter Cramton[1]  is Vice-Chair of ERCOT, the body that has coordinated the Texas power sector over this period, and has described[2] the approach taken to this problem in Texas. It is an administered scarcity price similar to that used in the 1990 UK reforms, which operated successfully up to the introduction of further changes in 2000.

A market in reliability

The Texas model, according to Cramton, sets out the rules to determine an administered scarcity price, in periods when there may be very high or peak demand or low supply.  In theory this should incentivise sufficient capacity (Q) at all times. The administered price aims to reflect the value of lost load (VOLL), and a high VOLL should in consequence result in high reserve margins for generating capacity. Texas sets a high value for VOLL. ^[3] Simple economics suggests high rewards will bring forward more than adequate supply.

One possible explanation for the current failure is simply that this scheme lacks credibility. If we look at these incentives for investors in potential reserve capacity, then the return on investment – the future revenue stream – may depend on achieving ultra-high prices in periods with an ultra-low probability of occurrence. This probabilistic estimate may indicate good “expected value” returns, but the very high chance of zero revenue is not attractive as a basis for large scale investments. Paradoxically the higher the value of VOLL, the rarer the occurrence of periods of scarcity and the less credible the projected revenue becomes. 

Closely linked is the matter of regulatory credibility: if prices need to go that high, as they must do to validate the investment in reserve capacity, and particularly if the price spikes impact on consumers, will the regulatory or political authorities really stand aside and let them happen? The 2001 California experience, at least as suggested in many accounts of that event, suggests otherwise.

What do UK market models tell us?

The UK used its own version of an administered scarcity price from 1990 up to 2000. Fortunately, this was a period with a legacy of surplus capacity, so the method was not subject to severe stress tests. It worked well but was also criticised for potentially allowing larger generators to exploit their market power. It was replaced in 2000 by trading arrangements which had no formal mechanism for capacity. It rapidly became apparent, however, that these would not incentivise new capacity, and would pose an increasing risk to reliability of supply. The UK moved gradually towards the establishment of capacity markets to supplement the new arrangements.

In practice this means that investment in new capacity does not depend on investors responding to market price signals and guessing future prices in the “energy only” electricity market.  Virtually all new UK generating capacity results either from government choices, long term contracts (nuclear plant), from feed in tariffs, or from capacity auctions.

If fixing prices (P) doesn’t work, try fixing quantities (Q)? P or Q?

Economists will be familiar with markets where the choice is to use price or quantity as the appropriate instrument of policy. A good illustration is the energy policy choice between a carbon tax (P) and setting emissions quotas (Q) which can traded. It is possible for the price and quantity outcomes to be the same under either regime, but the choice is important and is usually made on an empirical or pragmatic basis, of what is likely to work best or be more politically and socially acceptable. The UK approach, de facto, for reliability, is to concentrate on fixing Q.

In this context, capacity markets can fix Q if a central authority – government, regulator or utility – decides on the reserve margin and the reliability standard, and invites tenders to provide that capacity. This has the advantage of much more certainty that the reserve will be provided, but it places the onus on the central authority, not just to decide how much capacity but also, in practice, to determine the right technology mix, and to monitor delivery. It represents the abandonment of most of the tenets of a market fundamentalist approach to the power sector.

Regulation and Governance for the Power Sector

It is always tempting to read too much into a single event, when there will inevitably be multiple interpretations of what has happened, and rarely one simple explanation. Another focus will no doubt be on the general governance and regulatory arrangements in Texas, and the role of ERCOT (see below). However, the “standard model” of unbundled utilities, wholesale and retail competition, independent regulation and excessive reliance on markets, however flawed, must come under more scrutiny. Pioneered in the UK, promoted by the World Bank, the European Commission and others, it looks increasingly incapable of responding to today’s policy challenges, of which the climate emergency is just one.

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[1] Cramton is an academic economist, who has described and indeed promoted market-driven models for the power sector. He described the role of ERCOT and the power sector in Texas in a paper - Electricity Market Design - in the Oxford Review of Economic Policy.

[2] Oxford Review of Economic Policy, Volume 33, Issue 4, Winter 2017, Pages 589–612

[3] In Texas VOLL was set administratively at $9,000/MWh—367 times higher than the average energy price of $24.62/MWh in 2016.

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Additional Notes.

A regulatory issue. There is another feature of the power sector in Texas which is at odds with the “standard model” of liberalised markets and independent regulation. The Electric Reliability Council of Texas (ERCOT) effectively controls the functioning, in operational terms, of the Texas power system. It is an umbrella organisation, whose membership includes the utilities, generators and other stakeholders in the sector. It implicitly assumes responsibility for reliability and by its nature provides scope for formal or informal coordination within the sector. This might be interpreted as a quasi-regulatory role, violating one of the conventional principles of sound regulation, namely that the regulator should be independent of ownership and management.  There is an additional oversight from a Texas Public Utilities Commission, but it is unlikely this will have had the knowledge or expertise to probe ERCOT too closely, especially on technical issues

It is possible to argue that ERCOT also provides a vehicle for informal planning or informal guarantees for future investment, and that coordination and more rigorous planning disciplines, plus technical monitoring of capacity, should have been applied.  I would argue in this instance that it was reliance on a “market” mechanism that is the more likely prime cause of the failure.

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California. See for example Weare, Christopher (2003) The California Electricity Crisis: Causes and Policy Options  ISBN 1-58213-064-7;

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There is another important alternative to administered scarcity prices. It is to allow scarcity prices to be set in a market by consumer choices and consumer valuation of reliability, but that is generally seen as currently impractical, because consumers lack the technical capability to respond quickly to price or crisis signals. However increasing digitalisation, and concepts like differential reliability and supplier managed loads- see my tariffs paper - will take us in that direction in the future. 

 

CULTURE WARS, COST BENEFIT ANALYSIS, RISK AVERSION AND INTER-GENERATIONAL JUSTICE.

Apologies to regular readers who expect this site to provide analysis or comment on the subject of climate change or the low carbon economy. My excuse for writing about the pandemic here is that the parallels and connections with climate questions will become ever more apparent, and will be with us for the foreseeable future.

Cost benefit struggles with the big issues, but it does help to expose the questions. The economy versus public health poses a false dichotomy. The real debates should be about inequality. And in terms of inter-generational divides, climate change is a much more relevant matter. 

As many people[1] are starting to observe, the debate over how to balance protection from the virus against maintaining economic activity is already playing into the culture wars that have developed over the last few years.  Very loosely, Trump, vocal Brexit supporters (but not necessarily a majority of those who voted for it), opposition to climate action and denial of climate science, market fundamentalism, Tory donors, and much of the political Right are to be found on one side, arguing for the primacy of “the economy” and that “the cure [lockdown] is now worse than the disease”. Internationally one might add, at different times, populist authoritarians such as Bolsonaro, Erdogan and Duterte.  Those favouring the “cure” include the WHO, internationalists[2], most medical professionals, many Left-leaning liberals, (typically) climate activists sometimes citing environmental factors as a likely cause of the pandemic, and currently the greater part of public opinion. If one had to sum up in a phrase the collective position of many in this group, then “… no return to business as usual” might be an approximation.

These loose coalitions are of course both stereotypes. Both sides will in future be forced to recognise the difficulties inherent in maintaining consistent positions that assign absolute priority to either health or national income. Both will also have to reconcile inevitable pressure for less future reliance on global supply chains (less of China) with an equally powerful case for more, or at least better, international cooperation both in health and wider economy issues. Most governments are caught in the middle, enforcing restrictions while hoping for “business as usual”.

With hindsight of course it seems likely that early and effective action, as in Germany, would have avoided some of the stark choices now confronting us. But we (in the UK) are where we are, and for a variety of economic, health and social reasons, long term total lockdown is also proving untenable. The direction of travel is towards a compromise – the search for gradual relaxations that keep infections within some degree of control.

However, the cost benefit arguments remain important, not least because they reflect so much on our implicit values and choices, and represent dilemmas that will continue to haunt us for some time.  It is worth evaluating the arguments, in the first instance on the wisdom of imposing strict lockdowns rather than just advisory and fairly minimal social distancing.  And in order to concentrate on the essential choice, rather than unhelpfully suggesting that the answers lie, as they often do, “somewhere in the middle”, we should contrast the first extreme, the primacy of the economy and the need to avoid negative impact on GDP, with the range of policies that are effective in reducing infection but result in major economic shutdown.   The purist cost benefit argument is that an enormous economic cost has been incurred in order to protect the lives of predominantly elderly and infirm people, and that that cost will in turn bring its own health costs through increased poverty, unemployment and inequality. The cost is typically quantified either in terms of likely lost GDP or of the cost to the Treasury (c. £350 bn) and the public purse, which can be set against an estimated number (perhaps 250,000) of (disproportionately elderly) lives saved. The implied valuation of human life comfortably exceeds the values normally implicit in government policies, in health and elsewhere.

Attaching a value to human life in this way is not a heartless obsession with financial indicators or economics. It is simply a recognition of reality, especially in almost anything involving health or safety. In health policies the concept is explicitly recognised and refined as “quality of life adjusted life-years” (QALYs). In a resource constrained world most people would accept that, forced to choose between life-saving treatment for children and young adults, on the one hand, and short life extensions for the elderly on the other, the former would usually win. QALYs form a realistic basis for assessing the relative value of different medical interventions, and are widely accepted as a starting point for an informed discussion of what should be prioritised in a health system.

Calculations appear to show an “excessive” expenditure from current policies to save a relatively small number of QALYs. It is additionally argued that the economic impact of lockdowns will itself lead to large amounts of not necessarily well-recorded ill health and death, including treatments postponed or not sought, and increases in domestic violence and mental illness.

Finally, this can be seen as yet another example of inter-generational inequity in which the young are made to suffer for the benefit of the old.

At first sight these look like powerful arguments, founded on both explicit cost benefit analysis, in this case loss of output (GDP) or public spending versus value of life, and an implicit cost benefit comparison in terms of different health outcomes. But, as often happens with really big issues, simple arguments can collapse under closer examination. There are several counter arguments:

·         the assumed counterfactual is incorrect; the implicit assumption that, had there not been lockdown, personal behaviour and the economy would have carried on more or less as normal, can now be seen to be demonstrably wrong. One reason is that individuals are risk averse and do not take the actuarial approach to personal risk implied in cost benefit analysis. A corollary is that, in the immediate context, the notion of a collective choice between public health and the national economy is, to a large extent, a false dichotomy.

·         poor health outcomes associated with macro-economic problems do not generally stem from lower GDP per se. They stem from inequality not from overall lower incomes. Promised government spend goes part of the way to redressing the uneven short-term effects of the crisis, and protecting the most severely affected. But the longer-term impacts, particularly if there are significant structural changes in the economy, will be much more important. Prevention or remedial action on any increasing inequality stemming from that will be essential. But that action is necessary anyway.

·         inter-generational injustice is an overstated issue; mortality means there are a limited number of ways in which one generation can steal from the future, and it is not obvious that this is one of them.

The counterfactual – not imposing lockdown and “letting the pandemic take its course”.

Countries have taken approaches that differ in detail, but most have been essentially similar in their approach. Even where fewer formal restrictions are imposed, as in Sweden, actual behaviours and outcomes are not so very different. Tellingly, many in the UK were already modifying their behaviour, and creating their own forms of social distancing before formal lockdown was imposed. With a full-blown explosion of cases and deaths, and hospitals collapsing under the weight of new cases, it is inconceivable that we would not have seen massive changes in personal behaviour, seeking the same outcomes, albeit in uncoordinated and less effective ways, and very likely  a degree of panic, with broadly similar damage to economic activity. The difference is that the damage would have been the result of individual consumer choice, not of government imposed restriction. Most of the economic damage therefore became inevitable as soon as the virus spread into much wider national populations. In reality there never was any way of avoiding the shock and its economic consequences, although there were and remain ways of handling the crisis well, badly or very badly.

There is a reason for this. In matters of life and death, people do not adopt the actuarial approach to personal risk that the cost benefit approach implicitly assumes.  Actuarial-style weighting of probabilities and multiplication by an assumed “cost of damage” makes sense in a policy context of comparing different health interventions. But it does not apply to personal choices. A simple well-known test demonstrates this – the Russian roulette question. “How much of your personal wealth would you sacrifice to avoid participation in the game?” The probabilities can be varied, and the actuarial assumption would be a linear progression from zero (infinitesimal risk) to 100% (when faced with certain death). Students and others faced with this (fortunately hypothetical) question invariably volunteer significantly more than the “expected value” of their survival.

This is not irrationality. It is simply personal preference. Faced with threats to life most people are substantially risk averse, and will make significant sacrifices for the safer option. We can argue that wide public support for lockdowns reflects rationality and risk aversion, rather than mass hysteria.

It's about inequality, stupid!

There is no doubt that the stress on health services is, unless treatment of Covid-19 patients were refused, inevitably bringing some unavoidable collateral damage through diversion of resources from other health problems. But the policy argument is usually much more focused on the potential mid and longer-term health effects of lower incomes and higher unemployment. The economic impact is already and will continue to be very unequal, with some untouched while others are devastated. Sensibly most current remedial measures are about protecting the worst affected individuals, in respect of mortgages and rents, and a degree of protection that will allow businesses, and future jobs, to continue to pay wages and survive the crisis.

In other words, the policies that enjoy almost universal support are about remedies for an immediate and horrendous inequality. It’s ironic that they should be implemented (in the UK) under a governing party not known for its commitment to equality objectives or public spending. But the same considerations should apply to medium term health impacts. It is the extent of inequality that matters, much more than the overall level of GDP. The point is well summarised in a recent Canadian Medical Association Journal article.[3]

“It should not be surprising that economic growth does not lead to improved health. A wide range of research studies of rich countries have revealed that greater national wealth, by nearly any measure, does not lead to better human welfare. The United States, with the highest GNP per capita in the world, has a lower life expectancy than nearly all the other rich countries and a few poor ones, despite spending half of the world’s health care bill. The United States also has the greatest levels of poverty of any rich country, with correspondingly poor health outcomes and huge health disparities. Its population’s health is on a par with that of Cuba, a poor nation that has faced economic embargoes for the past 50 years. The population of the United States is also less healthy than the population of Greece, whose economic status lies in between.

What leads to health in the industrialized countries is not absolute wealth or growth but how the nation’s resources are shared across the population.  Above a certain threshold of inequality, a more egalitarian income distribution within a rich country is associated with better health.”

It will be interesting to see how far the lessons of the current crisis are carried through into future tax, expenditure and social policies.  It is again ironic that politicians and commentators, mainly on the Right, who give overwhelming primacy to the economy, and are now anxious to play up the social and health impacts of lockdown, have usually been those least concerned with the phenomenon of inequality. 

Inter-Generational Justice

It has always been the case that you are more fortunate to be born, or to reach the employment or housing market, in good times rather than bad. But the idea that one generation can collectively, and to its own advantage, permanently deprive its successors is more difficult. Mortality ensures that this is possible, essentially, in only two ways.

The first is through running up external debt. This is impossible in global terms. It is possible nationally, although since most countries will face similar challenges, there is no automatic reason to assume that it will happen. Measures to protect employment and businesses, will lead to an expansion of national and personal debt, but this consists of debts that we owe to each other. Since the holders of that debt tend to be excessively concentrated in higher income groups, or among older generations, there will be an enhanced case for redistributive taxation, and we have already identified the necessity for reducing inequality as a necessary condition for a healthy society.

The second is through running down the capital stock, of plant, buildings etc and also human capital. This is a more challenging question. There is no particular reason to expect physical destruction of capital stock, though there is likely to be significant re-assignment if consumer preferences and public choices change after the crisis.   

But this takes us to an even more important subject. The only way in which we are obviously and dramatically running down our capital stock is through continued destruction of the natural environment. That really is the impossible and undeserved legacy that we are bequeathing future generations.

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[1] Culture wars are infecting the UK’s pandemic strategy. Robert Shrimsley. Financial Times, 20 April 2020.

[2]A general term to include supporters of international institutions and cooperation as a general principle. I would have added the “Remain” camp, but a quick survey of FT online comments suggests this group may be quite divided on the issue.

[3] https://www.cmaj.ca/content/181/5/281.short  

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A CLIMATE FOCUSED ELECTION IN THE UK? IT’S NOT HAPPENING.

Because that would mean confronting other difficult issues too.

Positive policies also bring with them more inconvenient truths. With climate, policies threaten entrenched ideologies[1]. Politicians are reluctant to talk honestly about costs at election time. But the biggest silence is around the fundamental implications for trade of any realistic global climate regime, and trade remains at the centre of the Brexit dilemma. 

It was widely supposed, only a few months ago, that climate change would be a major feature in the next UK election. This year has seen growing public concern over the threat of climate change as the most important challenge our society has to face. An eight country poll[2] revealed widespread alarm that the crisis is on the brink of spinning out of control, with 64% in the UK agreeing that “time is running out to save the planet”.  At least three-quarters of the public think there is a “climate emergency”, and of climate breakdown risk as “extremely dangerous”.

Climate breakdown was viewed as the most important issue facing the world, ahead of migration, terrorism and the global economy, in seven out of the eight countries surveyed. Only in the US did it come third, behind terrorism and (understandably given the US dismal ranking in international health comparisons) affordable healthcare. An overwhelming majority in each country – 74% in Britain – said they were already seeing the influence of the climate crisis in extreme weather events, such as heatwaves and floods, and around two-thirds described it as a direct threat to ordinary people in their country.

Moreover, the last few months have brought more extreme weather events across the globe, just as anticipated by the science, and a rising level of alarm over increasing carbon emissions and global governmental failure to take effective action. And we have also seen direct action protests from the Extinction Rebellion movement. Prima facie the public is “way ahead” of politicians in recognising the scale of the climate crisis.

But in the election campaign so far climate has been the dog that does’nt bark. All the major parties are committed to the zero carbon by 2050 target or earlier, but since they will never be held to account for failure on that timescale, what matters more is the credibility of their specific policies. The smaller parties have made the best efforts, but the current Prime Minister appears reluctant to debate the subject in front of the electorate, perhaps understandably given the climate sceptic history of many in his party. Labour has a better story to tell, not least with Blair’s ground-breaking 2008 Climate Act, but has preferred to concentrate on other issues.

So why is this critical subject getting so little attention.

The real reason for reticence on climate is that it would put a spotlight on trade, and raise difficult questions about Britain’s future post Brexit.

Both major parties are anxious to avoid any discussion whatsoever of the future for British trading relationships with the rest of the world. The Conservative government is promoting a “Get Brexit done!” message in the hope that it can avoid impossible to answer questions of exactly what benefits will flow from that, and in the certain knowledge that the actual outcome will be strongly negative if not disastrous. The Labour Party is also trying to avoid the subject altogether in its campaigning, in the vain hope of satisfying fundamentally opposed sections of the electorate, and moving on to what are (for Labour) “safer” subjects.

To see why the Conservatives are anxious to avoid scrutiny, we need look no further than the complications posed by their ambitions for a US trade deal. Since 2015, US Trade Representatives are bound by Congress not to include mention of greenhouse gas emission reductions in trade agreements and there are no prospects this ban will be lifted in the near future.[3]

Under any viable global regime climate, trade policy can be an important mechanism to incentivise and facilitate participation in global agreements to limit emissions. There are at least four potential approaches[4] that can impact on climate policies:

-       leakage and competitiveness issues, in which low carbon economies lose competitiveness in particular industries and “export” carbon emissions to potentially “dirtier” competitors who emit more carbon;

-       sanctions against non-participation in and non-compliance with international agreements ;

-       placing more of the cost of abatement on the responsible parties, whether in production or consumption; and

-       maintaining a free-trade regime that allows and encourages technology transfers.

Conversely dysfunctional trade agreements can have the opposite effect. It has been claimed[5] that the NAFTA agreement locks North America into continued exploitation of the dirtiest fossil fuels.

It is immediately clear why a US President, who considers climate science a hoax and wants an “America first” trade policy, and whose political base includes huge coal interests, would not want the subject mentioned in trade talks. The US still has substantial coal exports to Europe, and will not want to see any measures, such as international agreement on carbon pricing, or even a limited bilateral accommodation, that would reduce the competitiveness of its own industry. In addition the US has a longstanding interest, most evident in pharmaceuticals, in allowing greater opportunities to exploit intellectual property rights. In the climate policy context, this limits the rate of transfer of low carbon technologies to developing countries, generally those with the highest rates of growth in energy use and CO₂ emissions.

Against this background the EU, strongly influenced by the UK and France, and despite some of the weaknesses and limitations in its climate policies, has been one of a very small number of major economies taking the climate issue seriously.

So, on the one hand we have a Conservative government reluctant to admit that its break with the EU, and promised strategy of a US trade deal, will almost certainly reduce its international influence on climate, and seriously damage future prospects for successful global policies. On the other is a Labour party, alarmed by the prospect that too much focus on climate will spill over into the Brexit issues it is trying to avoid.

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[1] The biggest connection is that between neo-liberal orthodoxy, with its emphasis on a small state and deregulation, and its support for unsubstantiated denial of climate science.

[2] https://www.theguardian.com/environment/2019/sep/18/climate-crisis-seen-as-most-important-issue-by-public-poll-shows . The countries were UK, US, Canada, Brazil, Poland, Germany, Italy and France.

[3] This is referenced in the recent leaked documents on US/UK trade negotiations, and appears to be a well established US position.

[4]  Trade and Climate Change: The Challenges Ahead. 2010.. Jaime de Melo (jaime.demelo@unige.ch) and Nicole Mathys

[5] https://canadians.org/sites/default/files/publications/report-nafta-people-or-polluters.pdf
I have not tried to verify this claim.

A BREXIT ELECTION OR A CLIMATE CHANGE ELECTION? THE BATTLE LINES ARE THE SAME.

There can be no doubt about which issue is of greater importance for our future, but the “usual suspects” (our politicians and the commentariat) largely divide along the same lines on both. And in each case trade should be a crucial element in the policy mix and the political arguments. 






Brexit may be a forgotten issue in twenty years’ time (although it might not be wise to put money on that), but we can guarantee that climate  change will still be with us, most likely with ever more serious manifestations in terms of extreme weather and disruptive droughts and floods, but also with less time left to avoid climate catastrophe. We can also guarantee that under these conditions it, or rather the politics of mitigation and adaptation, will be climbing steadily higher on the political agenda.

So there is a strong case for arguing that climate issues should be the primary focus of our big political choices. The contrary case of course is that climate change is a global problem and requires global solutions. UK commitment to zero carbon targets is of little value unless it is widely matched across the world. (Hence the importance of the Paris Agreement). In consequence the decisions that will have the biggest near and medium term consequences, in terms of employment, income and general well-being, will be those that relate to our trading relationships with our nearest neighbours in Europe, in other words the Brexit debate.

But these two issues have, in the context of British and US politics, become inextricably linked together by the motives and ideologies of the main protagonists in the debate.

I wrote extensively on this subject inJuly 2016.

“Predictably, in the light of the Brexit vote, Nigel Lawson’s Global Warming Policy Foundation has called for a de facto reversal of UK policy in relation to climate issues.  This is wholly unsurprising given that so many of the moving spirits in the Leave campaign – Lawson himself, Redwood, Rees Mogg, together with several of the small band of Brexit economists, and the Institute for Economic Affairs, have for many years engaged in passionate denial of both the climate evidence and the climate science.

The reasons for the correlation are clear. Commitment to and support for neo-liberal views of unfettered free markets and a minimal state are threatened, both by a Europe that does not always share those views and by a global danger whose resolution depends on global cooperation. Should this further attempt to advance the neo-liberal agenda be a cause for any concern?” 

I argued, correctly in the event, that the Lawson pitch would not be heeded. “The answer is almost certainly not. The costs of Brexit for the power sector may be high, but the climate policy imperatives are likely to be unchanged.”

The historic link between support for Brexit and climate science denial is however indisputable.  It has extended not only to many other Conservative MPs, but to Farage and UKIP (forerunner of the Brexit party), to Donald Trump and even to Brexit voting Labour MPs such as Graham Stringer, given his close association with Lawson’s Global Warming Policy Foundation. Also indisputable is the connection, in ideological terms, between promotion of Brexit and small state, minimal regulation, low tax, free trade ideologies.

What is interesting now is the speed with which the Conservative party is abandoning, or pretending to abandon, most of the electorally inconvenient elements of this ideology. It is now committing itself, belatedly, to the kind of strong commitments on climate – zero carbon by 2050 for the UK – pioneered by Tony Blair in the 2008 Climate Act. But it is also, at least in its promises, committing to much higher levels of public spending, and an enlarged public sector, which are equally incompatible with the neo-liberal vision of the world.

For those of us who recognise the overwhelming imperatives for action on climate issues, it will be important to recognise the impact of Brexit on UK energy and climate policies, including some of the conflicts with other cherished beliefs and policies. Brexit would not necessarily have an immediate impact on UK freedom of action on climate related measures, other than through its almost inevitable consequence of reducing national income and hence affordability.

This is partly because EU-wide policies such as the emissions trading scheme have been of limited success, and partly because the physical infrastructure of interconnections with Europe will remain and be used for mutually beneficial trades. The UK might even in principle enjoy greater freedoms in state aids for the energy sector without the restrictions of a Europe wide competition policy.

As the EU scheme develops however it may provide members with potentially more efficient means to meet their carbon targets through trading, but it will be a scheme from which the UK is likely to remain excluded. Much more important however will be the longer term loss of UK influence on global climate initiatives, and most important will be the likely collision of climate policies with UK aspirations for international trade.

Increasingly countries making serious attempts to reduce carbon emissions will find it difficult to tolerate the export of jobs in energy intensive sectors to countries that pursue more lax policies. Climate policies will necessarily intrude into trade negotiations.

Since the Conservative Brexit narrative, despite the blizzard of other danger signals on pharmaceuticals, agriculture and regulatory standards, is based largely around a new trade deal with the US, this creates a serious inconsistency between their promises on carbon reduction and their post Brexit philosophy on trade. The US has already removed itself from the Paris Agreement, and is likely to retain a strong interest in protecting its own coal industry and promotion of coal exports, while countries adopting more responsible climate policies will not be willing to see their own industries penalised. This leads on to issues that the Conservative party has so far been unwilling to confront.

Brexiters will have many more questions to answer.

SERIOUS US RECOGNITION OF CLIMATE CHANGE RESPONSIBILITIES. BUT IDEOLOGICAL DIFFERENCES NEED TO BE PUT ASIDE.

A more urgent approach to climate issues is stirring again among US politicians and opinion formers. A recent FT article highlights apparent conflicts of approach, and the need to reconcile them. In part any conflict might be seen as just another illustration of the deep ideological divide between believers in the ability of unfettered markets to resolve all problems, and proponents of a much greater role for state intervention. The reality is that effective policy on mitigation of climate change will always demand a combination of coordinated actions at government level with the powerful incentives that economic instruments can provide. There is no single silver bullet. Markets won't work on their own, and we also need both effective action on infrastructure and focused regulation.

Martin Wolf is always worth reading on economics and this remains true when he turns his attention to climate issues (The US debate on climate change is heating up. FT, 19 February 2019). This recent article suggests that informed opinion in the US, perhaps for the first time since the early days of the Obama administration, is moving towards increasing recognition of the fact that the US, widely seen as a laggard on climate related policies, cannot stand back from its global responsibilities in relation to curbing emissions. The US, as a country, still has the greatest historic responsibility for CO₂ (the most significant of the greenhouse gases), even though it has now been overtaken by China on current emissions. It is also still close to the highest for current per capita emissions, where it is matched  only by a few countries such as Australia (coal once again at the heart of the problem) and surpassed in the oil states of the Middle East by countries such as a Saudi Arabia with a notorious history of wasteful subsidies to energy consumption.

Data source: CDIAC (1751-2013) and BP (2014-2015)

Wolf highlights two recent announcements. The first is an “economists’ statement on carbon dividends”, endorsed by 3,333 US economists, including four former chairs of the Federal Reserve and 27 Nobel laureates. Its main elements are

·         a carbon tax starting at $40 a ton

·         combined with a “carbon dividend” approach to return the proceeds to US citizens

·         border tax adjustments for the carbon content of imports and exports

·         prices to act as a substitute for unnecessary regulations.

This plan is also to be proposed to "other leading greenhouse gas emitting countries".

Source: Union of Concerned Scientists

The ideas per se are not new. Most economists view emissions pricing as a necessary if not sufficient part of any solution. Others have discussed carbon wealth fund, and tax and dividend approaches. (The “Carbon wealth fund” tag links to three earlier articles.) Helm and Hepburn[1] were early proponents of border tax adjustments.  But bringing them together as a coherent package, and recognising the seriousness of the issue (where economists have often been slow), is very welcome.

The second announcement is the Green New Deal proposed by a group of House Democrats, led by Alexandria Ocasio-Cortez. It is a proposal to transform the US economy by moving to zero carbon sources for power generation and upgrading all buildings to achieve maximum energy efficiency. The approach is strong on regulatory intervention and infrastructure investment, but ignores the incentive effects of prices and markets. Activists vigorously oppose market-based mechanisms, emissions trading and offsets. With even more Utopian fervour they also dismiss major technology options such as carbon capture and storage, nuclear power, waste-to-energy and biomass energy, when the selection of at least some of these options is at least helpful, and very likely necessary for a low or zero carbon future.

Opposition to so many alternative technologies, and a refusal to countenance economic measures, sadly reduces the credibility of the Green New Deal. But we should be almost equally critical of any assumption that a pure market approach is capable of solving all our problems. (Indeed I suspect this is an assumption that may well not be shared by most of the 3,333 signatories). The criticisms are both theoretical and practical.
1.    The starting point of $40 per tonne is too low on its own to incentivise much or most of the investments and behavioural. Moreover, signalling a profile of carbon prices rising over time runs in the opposite direction to the environmental value of emissions reduction, which ought to prioritise current emissions[2].
2.    Inter alia a rising profile leads to the well-known Green Paradox[3], where fossil producers have an incentive to advance their production of the most polluting fuels.

3.    Border tax adjustments make a great deal of theoretical sense, but pose huge practical and administrative issues in measuring carbon content. Given the existing complexities of international trade, rules of origin, etc, and in the current global trade environment, they could quickly fall into a tangled web of complex negotiations and disputes.

4.    The major investors willing to fund big infrastructure projects at a low or modest cost of capital, eg pension funds and sovereign wealth funds, demand secure revenue streams that markets on their own will not provide. This necessarily implies either government guarantee in some form, or some equivalent in terms of monopoly status and mandated moves towards low carbon. (This argument is explored in more depth on another page on this site).

5.    Effective strategy is highly dependent on innovation, and the market failures related to innovation are well documented. Again this implies significant interventions as well as price signals that incentivise investment.

6.    There are numerous instances where regulation on its own can achieve significant gains. One of the most dramatic illustrations of this is the effect of the change in US road vehicle regulation, in the late 1980s, relaxing the Corporate Average Fuel Efficiency (CAFE) standards for vehicle fuel efficiency. Technical progress in engine efficiency, implying a falling consumption per tonne, but without the CAFE targets the efficiency gain simply translated into heavier (ie more wasteful in energy terms) vehicles, and vehicle fuel efficiency improvement came to an end.

Trends in engine efficiency contrasted with trends in vehicle fuel economy, responding to relaxation of US Corporate Average Fuel Economy (CAFE) standards in late 1980s. Source; Lutsey and Sperling.

It is clear that the two competing different strands for realistic climate policy need to come together. At least there is a common objective. To quote Wolf: “Time is limited, talk plentiful and action negligible. But we can only start from agreement that there is indeed a threat worth addressing.” That at least now looks possible in the US. Let us hope it can be translated into more effective policies, and not just in the US.

The reality is that effective progress depends on a fusion of the two camps. The propositions are not mutually exclusive but mutually reinforcing. Many of the “other leading greenhouse gas emitting countries”, to whom the proposals are to be put, have long recognised (as has the World Bank) that a trio of policy instruments is required. 

·         Markets and taxes are the instruments with which economists are most at home, framed to reflect the massive externalities of future environmental damage that are not captured without an intervention of the kind proposed by the US economists.

·         Innovation and  infrastructure, which for the most part are only partly and insufficiently incentivised by market signals, and usually depend heavily on additional intervention with some form of government support and (typically) financial or regulatory guarantees.

·         Regulations and standards which only governments can enforce, to support  policy objectives and promote behavioural change where that is part of the solution.  

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[1] Helm D, Hepburn C, Ruta G (2012) Trade, climate change, and the political game theory of border carbon adjustments. Oxford Review of Economic Policy, 28: 368-394.

[2] This is discussed at much greater length in the author’s earlier paper. Cumulative Carbon Emissions And Climate Change: Has The Economics Of Climate Policies Lost Contact With The Physics?, John Rhys, OIES Working Paper EV 57, July 2011.

[3] The “Green Paradox” is usually attributed to a controversial book by German economist, Hans-Werner Sinn, describing the observation that policies that becomes greener with the passage of time acts like an expressed intention to expropriate fossil resources for the owners, inducing them to accelerate extraction and hence to accentuate the problems.