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Why the ETS report and Rudd's carbon tax are a threat to the economy
Gerard Jackson
No matter how it is dressed up any emissions trading scheme (ETS) is in fact a carbon tax which in turn translates into a tax on economic growth and hence living standards. To understand how carbon taxes lower living standards it is vitally important to grasp the fact that economic growth is a process of capital accumulation. It is equally important to comprehend that every economy has a capital structure consisting of highly complex stages of production. Moreover, the capital goods that make up the structure are heterogeneous. Once these facts concerning the nature of growth and capital are understood it becomes far easier to grasp the truly vicious character of carbon taxes.
Frontier Economics produced a report for the Coalition and Senator Xenophon (The economic impact of the CPRS and modifications to the CPRS) which basically laid out the effects of a carbon tax on the economy. The striking thing about the report is that it recognised that a carbon tax will in fact lower Australia's standard of living. It also revealed the terrible weakness of the orthodox economic approach which led to the report massively understating the damage the tax would do the economy.
Because a short article cannot deal with the whole of the report in detail I shall concentrate on its major failing1. Frontier asserts that it is "relatively simple to amend the Government’s CPRS so it is twice as 'green' and one third cheaper". It then goes on to argue that the trading scheme can be so organised as to give prospective investors sufficient confidence "to build the infrastructure necessary to efficiently achieve the emissions target".
This is pie-in-the-sky economics. It would only be credible if it could be shown that coal-fired power stations had an enormous potential to absorb the tax through a prodigious increase in efficiency. Not even fanatical greens have been daft enough to make this suggestion. (If such potential efficiencies exist why haven't these companies exploited them?) A possible alternative is that Frontier assumes the existence of a raft of unused technologies capable of producing the same astonishing result. As no mention was made of such a prospect I must presume that they do not entertain the possibility. In any event, their admission that the carbon tax would lower real wages belies any suggestion — implied or otherwise — that enormous efficiencies are just waiting to be exploited.
The basic economic failure of the report is due to the authors total ignorance of capital theory. While they correctly observe that the costs of a carbon tax would be "unevenly distributed" they evince no understanding of how this would actually affect the economy. This is because they insist on aggregating capital, oblivious to the fact that heterogeneous goods cannot be aggregated. Having fallen prey to the aggregate approach to capital they then assume that capital accumulation is "a function of the expected rate of return on capital".
Capital formation is forgone consumption. In other words, investment is fuelled entirely by savings. No savings, no investment. It therefore follows that increased investment can only come from increased savings2. Differences in rates of return cannot in themselves increase total investment: what they do is signal to investors where profits are being made thereby causing rates to be equalised. Now it is true that this process can cause investment to expand in the more profitable areas of production. But this process should never be confused with a total increase in investment. It's important to stress this fact because Frontier treats the economy as consisting of sectors instead of an integrated structure. The result is that the economy becomes compartmentalised.
It's assumed that electricity companies earn a constant rate of return. As a carbon tax would reduce net earnings electricity companies would have to reduce their "capital stock to maintain the required return on capital". Now it gets interesting. Frontier admits that there could be problems of "structural adjustment...if there are significant amounts of sunk capital". If I didn't know better I would have called this a wonderful piece of irony. They are completely unaware that they just sank their own paper.
Power stations are sunk capital. To put it another way: they are specific and indivisible. Have this lot ever seen a power station let alone been in one? You cannot reduce their size in response to a destructive carbon tax. The only possible alternative is for the company to consume its capital by abandoning long term maintenance. When the power station can no longer cover its costs of production it would close down and much of the machinery would then be sold for scrap. The structure would remain as a monument to green fanaticism and political stupidity. Naturally, the prospect of building more power stations would be out of the question. Yet Frontier completely ignored this fact. Why? It also ignored the fact that if a carbon tax is to achieve its goal then coal-fired power stations must be closed down. Full stop.
Now that it has been admitted that an effective carbon tax would shut down power stations how would that affect the economy? It would shut it down. No amount of subsidies or grants could save Australians from suffering a savage cut to their standard of living. But for some reason Frontier also ignored this fact. Moreover, the company also ignored the fact that the motive behind the carbon tax is the termination of centralised power generation in favour of solar energy and wind farms.
The Austrian approach is to view the economy as an integrated structure. You cannot affect one part without affecting the whole. Power stations play a vitally important role in this structure and belong to its higher stages. It's obvious that output from power stations enter every single stage of production. Moreover, intensive users of electricity also tend to be in the higher stages of production. As the height of real wages are basically determined by the capital-labour ratio a fall in that ratio must lower real wage rates, something that Frontier admits, before getting it wrong again. As we have seen, the result of an effective carbon tax would be to eventually close down power stations in favour of grossly inefficient alternatives. This would shorten the capital structure and lower the standard of living. The figure below illustrates this fact. (Frederich von Hayek, Prices and Production, Augustus M. Kelley 1967, p. 138.)
Before the carbon tax is levied the production structure corresponds to A, D and B'. After the economy adjusts to the tax the production structure now corresponds to A, C and B. The area above A, C and B represents the capital that the tax destroys, which is precisely what the tax is supposed to do. Therefore the effect of the tax is to cause the production structure to shorten. It should go without saying that the consequences for real wages and living standards will be severe. The production possibility frontier can also be used to express the same idea as shown by the figure below. A represents the production frontier before the tax while B shows that the tax forces the frontier to contract.
These figures illustrate that the real cost of a carbon tax is the loss of output. In doing so they make a mockery of Frontier's ludicrously low cost estimates. So how in heavens name could subsidies, grants, tax cuts or what have you offset the massive reduction in output? They can't and Frontier knows it.
Frontier suggests that permits can be used to reward "efficient producers". They have a very peculiar notion of efficiency. The optimum point for a firm is reached when it minimises its average costs of production. But it is clear that a carbon tax will in effect destroy the optimum point, unless your idea of efficiency is to satisfy politicians and green fanatics and not consumers. On closer inspection we find that what they call efficiency (a reduction in carbon emissions) would destroy economic efficiency and would not even leave any room for technical efficiency. In fact, under this regime maximum efficiency would be reached when carbon emissions fell to zero. In plain English, when the firm closes down.
Two other points expose Frontier's ignorance of capital theory. It would define expenditure on so-called alternative energy sources (nukes are never included) as investment. But because these energy alternatives are grossly inefficient they would require vastly more resources than centralised power generation, meaning that their ratio of inputs to output would greatly exceed that of any power station. Yet Frontier would define them as efficient because they emit less carbon! This really is Alice in Wonderland stuff. Under the influence of this kind of thinking the production possibility frontier could actually expand as living standards fell and more and more capital was dissipated. In a sensible world this nonsense would be held up to public ridicule.
The second point is Frontier's evident failure to understand the actual link between investment and wage rates. They argue:
Because the policy reduces real-wage growth, it increases the labour intensity of production and reduces investment.
What they have done is make investment a function of wage rates and assume that labour and capital are substitutes instead of being complementary factors of production. This is an unforgivable error for any economist to make. In a free market the level of investment is determined entirely by the amount of available savings (forgone consumption) and not the height of real wages. (The myth of technological unemployment: another Liberal Party failure).
Frontier's logic leads to the absurd conclusion that industrial development is impossible. If labour can be substituted for capital, and 'cheap' labour makes investment unprofitable then how could South Korea, Japan, Hong Kong, Taiwan, Singapore, China, etc., have possibly accumulated capital? After all, if cheap labour makes the domestic accumulation of capital unprofitable then this means that capital intensive economies cannot compete with labour intensive economies. It also means the Industrial Revolution should never have happened.
If any Liberal politicians have any sense left they will ignore Frontier's report and focus on the basic fact that a carbon tax is a tax on capital that if fully implemented will slash living standards and put an end to economic growth.
The ignorance of Liberal Party politicians
What is there left to say? Tony Abbott, who is considered leadership potential, opined that "the argument is not so much about the merits of an ETS as about whether it makes sense for Australia to have one before the US, Canada, China and India". (Nation held hostage to ETS, Tony Abbott, The Australian, 27 November 2009.) God Almighty! So if these other countries are dumb enough to cut their collective economic throat then it would be OK for Australia to do likewise. When it comes to economic reasoning — or perhaps any type of reasoning — Abbott is utterly clueless. It was just the same with labour market reform. He would phone "informed opinion" and they would then misinform him after which he mindlessly parroted their fallacies.
Andrew Robb, opposition spokesman for climate change, is another hopeless case. He used Frontier's paper to argue "for a greener, cheaper and smarter ETS". (Coalition calls for new Frontier on carbon trading, Andrew Robb, The Australian, August 11, 2009.) Robb is an arrogant economic illiterate who is totally incapable of comprehending even the simplest of economic arguments. For the sake of the Party and his own welbeing he should be kept away from economic policy making and sharp instruments, including pens and pencils.
It's being argued that inner-city MPs like Christopher Pyne and Joe Hockey are in danger of losing their seats if they don't vote for Rudd's carbon tax. It would damn well serve them right. These MPs did absolutely nothing to inform their constituents about the true costs of a carbon tax and the fraudulent nature of global warming. They were every bit as bad on labour market reform. Is it any wonder that not one Liberal Party politician or staffer was able to find a single flaw in Frontier's paper. And this lot have got the nerve to claim they are qualified to lead the country.
Under the brilliant leadership of Generalissimo Graham Bradley the Business Council of Australia betrayed its membership and the country by giving in to Rudd's insane green policies. But Bradley's treason can be excused by the fact that he is a certifiable imbecile who can see no further than his greatly inflated ego.
The Minerals Council of Australia came out swinging. And a damn good thing too. Unfortunately they made the tactical error of targeting the ETS as a tax instead of focussing on real factors. It's not the amount of money the ETS will or will not raise that matters but the severe damage it will do the capital structure and hence output. Like the rest of Australia's business organisations the Council gets its economic advice from the usual suspects.
Right now it is the Nationals who are leading the fight against Rudd's green lunacy. While some Liberals are leading from the rear others like Helen Kroger, Judy Troeth, George Brandis, Michael Ronaldson and Sue Boyce are still threatening for some insane reason to betray the country.
1. The report starts by asserting that the Carbon Pollution Reduction Scheme (CPRS) will raise the costs of goods and services "to reflect the damage that greenhouse gases are doing to the environment". This is a barefaced lie. Carbon is not a pollutant: it is a nutrient and the building block of life. Furthermore, there has been no increase in global temperatures in ten years. Thanks to the release of emails and documents held by the University of East Anglia's Climate Research Unit we have now learnt that global is the greatest scientific hoax in history.
It is true that the report was released before the global warming scandal broke. Nevertheless, this is no excuse for the false claims it made about Co2 and damage to the environment. My point is that any report based on an easily refuted lie should be treated with the greatest circumspection. Even worse is the fact that there was absolutely no need for Frontier Economics to lend its support to green propaganda because its purpose was to assess the consequences of the proposed carbon tax and not to determine whether it was scientifically justified. So why did they do it?
2. Why Obama's big spending big taxing regime will cripple the US economy
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 30 November 2009
