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Greens’ energy tax would destroy the Australian economy
Gerard Jackson
Green fanatics are talking about cutting emissions by a suicidal 60 per cent. I say suicidal because such a policy would be devastating for living standards. To cut USA Co2 emissions by 33 per cent everything powered by petrol would have to be abandoned. If the emissions cut was raised to about 70 per cent they would have to virtually abandon electricity production. In plain English: these fanatics and their media allies are demanding that Australians should destroy their country’s capital structure and adopt the ‘life-style’ of a medieval peasant.
Some greenies have tried to use the economic concept of discounting to deceive people in thinking that emission cuts would be economically painless. Discounting recognizes the fact that we value present goods more highly than future goods. That is why we have interest. If it were not so, then $100 ten years hence would have the same value as $100 in the hand. In business planned expenditures are discounted by the rate of interest to provide an estimate of their present value. At an interest rate of 10 per cent $100 in a year’s time is worth $91 today. Obviously, the higher the interest rate the lower the present value of a future good.
When a firm, for example, is appraising a potential investment it can calculate its internal rate of return. If the internal return is greater than the rate at which it can borrow, the investment is profitable. (This, of course, is a great simplification of the investment process). Therefore discounting is used by firms to measure and compare future flows of benefits and costs in dollar terms. This is basically what most economic models try to do when they attempt to compare the costs of cutting CO2 with the apparent benefits. But this approach also brings into play the economic concept of cost. Every economist knows that the real cost of anything is not its money price but displaced values: those things that must be sacrificed to obtain the desired good. Economists aptly call these sacrifices opportunity costs.
Thus the real cost of buying a car is all the other goods and services that would have otherwise have been bought. To a firm, its costs would be displaced alternative revenue flows.
The effect, and intention, of reducing emissions is to burden the economy with higher production costs. Thus the costs to society of these green policies will be lower productivity, more premature deaths, fewer opportunities for more productive technologies, especially energy intensive ones, fewer resources for schools and hospitals, the loss of investments yielding more and more better paid jobs, etc. And no amount of discounting can make these costs disappear. In fact, the greater the reduction in Co2 emissions the more savage the cut in living standards
If we focus on the firm for a moment we see that when it considers a potential project it will discount the anticipated stream of earnings and costs and compare them with each other. Should the costs exceed anticipated earnings then obviously the project will be rejected. A crude way of applying the same principle to an economy would be to try and calculate the alleged future costs to the economy of CO2 emissions, discount these alleged costs at a certain rate of interest, divide the result by the population to get a per capita figure and then subtract the figure from per capita GDP.
If the per capita GDP figure is $30,000 and the per capita cost is $10,000 then the loss of income is significant. (The figures are arbitrary and chosen for reasons of exposition). Of course, it will be argued that it’s still worth the cost and it’s only a one-off sum anyway that doesn’t have to be paid at once.
The problem is that it’s not a one-off sum — none of these figures are one-offs. Journalists who claim otherwise are liars. What is being deliberately ignored is that a permanent increase in energy costs will force firms to restrict output by eventually changing their factor combinations in a way that will bring operating costs into line with a lower level of output. To argue otherwise is to assert that rising production costs do not affect output. If this were so, then an immediate doubling of wage rates would not affect output or the demand for labour.
It clearly follows that the reduction in output becomes a permanent feature of the economy. Now a non-green economist could argue that there need not be a permanent fall in living standards or any fall whatever, merely a reduction in the rate of increase in consumption. What this amounts to is that part of those savings that would have gone into increased production will be directed into reducing CO2 emissions. In other words, instead of having a 4 percent growth rate we only get 3 percent.
This argument overlooks the fact that this policy would only slowdown CO2 emissions, which would cause the greens to demand more stringent reductions. This is because the greens’ goal is to use greenhouse taxes to reduce absolute production and not just its rate of growth. In other words, the greens real target is industrialisation. In any case, it’s ridiculous to assert that deliberately slowing down capital accumulation is not a cost to society. Any government action that forcibly reduces investment and consumption is a cost to society. (The Nazi and Soviet economies are graphic examples of this economic truth).
Moreover, the idea of blanket energy taxes and aggregate discounting for the economy are highly questionable, falling into the trap of what I call the tyranny of aggregates. By concentrating on discounting for the economy economists have neglected the key role that the market rate of interest plays in not only equating the supply of capital with the demand for capital but of allocating capital through time. Production takes time, a fact that no one would dispute. The question is: How much time? This is where interest plays its vital hand. If the rate of interest falls naturally, i.e. people are saving more, from 5 percent to 3 percent then this will signal to entrepreneurs that more capital is available.
By definition, this means that the discount rate also falls. Many capital-intensive projects that were ignored because the previous rate of interest made them unprofitable because of their highly time-consuming nature now become profitable at the lower rate of interest. Therefore the effect of market fall in the rate of interest is to lengthen the production structure by adding more time-consuming but highly productive stages to it. (This is what is meant by allocating capital through time).
Imagine the economy expressed as a right-angled triangle with a number of rectangles going through it, with each rectangle representing a stage of production. As the triangle gets longer and wider more and more time-consuming complex stages are added to it, which eventually increases the flow of consumer goods and services. Now take two identical triangles and then have one expand at 5 percent a year and the other at 2 percent. The one expanding at 5 percent will double in size in about 14 years while the other will take about 35 years. We can see that after 14 years of growth the differences in size would be enormous. Let us now superimpose the slow growing triangle A on the fast growing one B. The area outside A but still within B is what B would have had to sacrifice if its growth rate had been cut to 2 percent.
As B is now a far richer economy than A because it has a longer production structure it can allocate more resources to fighting whatever environmental problems it comes to face. This means that instead of imposing an energy tax on production economy B can pay for the environment out of general revenue. In addition, its rapid growth also means that advances in technology would be embodied in its capital structure. On the other hand, the cost to A of fighting environmental problems will be far greater. Greens can argue that there is no time to lose; impending doom in the form of global warming calls for measures now. And that the economic benefits from cutting Co2 emissions will greatly exceed the costs. No and No. In fact, the evidence against the existence of man-made global warming is mounting.
Antarctica is getting colder and accumulating more ice, and sea levels are not rising. The IPPC has conceded that the warming up to 1940 was the result of solar activity during the early part of the century. So the ice caps are not melting and polar bears are not disappearing. The Medieval Warm period — which was much warmer than today — and the Little Ice Age happened independently of human activity, indicating that even severe weather fluctuations are a natural part of global weather patterns.
In other words — don’t let the greens panic you.
Considering the amount of anti-warming evidence that is accumulating, I think people are being wise in questioning the motives of those who are using hysterical language in an attempt to bulldoze us into adopting policies that would destroy our living standards while simultaneously increasing government control over our lives.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 16 June 2007