Environmental Economics

Econ 101ism and Environmental Economics

I just finished reading a great book that substantially changed how I think about economics - "Economism: Bad Economics and the Rise of Inequality" by James Kwak.  In a nutshell, the book describes "economism" - which has also been called "Econ 101ism". It is the over-reliance on basic microeconomic principles (the kind I teach in my principles of microeconomics course) and the failure to realize (or admit) that the predictions and prescriptions of these simple models often fail in the real world. 

One of the most popular examples of an Econ 101ism argument is the argument against increasing the minimum wage.  We all know from principles that an increase in the minimum wage will hurt the very people that it is supposed to help, because it will create a surplus in the labor market, i.e. unemployment.  We can even prove that it's true with a nifty graph!  But, it's probably not true. (Here is an excerpt from Kwak's book with more on the minimum wage argument.)

Econ 101ism arguments are usually employed by libertarian-conservative types who argue for less government/more laissez-faire.  Lower taxes, less regulations, etc.  Most Econ 101ism devotees would admit that there are exceptions and instances where government intervention can improve things, like in the case of environmental externalities. 

But, sometimes these 101ism arguments are also employed by the left.  For instance, the left across American and Europe is making a lot of pro-immigration and pro-trade arguments, while many on the right are arguing for isolationism and protectionism.  In this case, it's the left that is on the side of Econ 101ism, since "free trade benefits both sides" is another tenet of 101ism. Of course, that doesn't make it wrong. But we should be wary of arguing about important and complicated issues using simple models that I can teach an undergraduate in 5 minutes.

What does this have to do with environmental policy?  It occurs to me that even we environmental economists may be guilty of relying too heavily on Econ 101ism when arguing for policy.  Specifically, environmental economists often feel that it's their primary mission in life to convince as many people as possible in the virtues of Pigouvian pricing relative to any other environmental policy.  Environmental economists often will go so far as to scoff at any alternative policy.  I've done this myself!  Several times! Even in this blog!

Preferring Pigouvian pricing to command-and-control policies is fine, and most probably taxes are more cost-effective.  But economists may be guilty of letting the perfect be the enemy of the good by constantly reminding everyone around them of the inferiority of alternative policies.  Larry Goulder gave a talk at the AERE luncheon at the ASSA meetings earlier this month in Atlanta, arguing that the "probability of implementation" ought to be a desideratum of environmental policy alongside cost-effectiveness.  If a command-and-control policy, like a federal clean energy standard, is more likely to pass than a tax, that might trump its lack of cost-effectiveness.

Alternatively, environmental economists could think more carefully about making environmental pricing more popular and therefore implementable.  My colleague here at Georgia State University, Stefano Carattini, recently published a comment in Nature describing his research that returning carbon tax revenues to households increases their popularity. 

One of the most illuminating points made by Kwak in "Economism" is that, when making arguments appealing to Econ 101ism, the arguers will often claim intellectual superiority by insisting that anyone who disagrees with them only does so because of their ignorance.  "If you understood economics, you wouldn't support the minimum wage." Some of us environmental economists may be guilty of the same hubris.  Lots of research has been done on the political science of environmental policy, and there is a lot of opportunity for economists learn something from it.

An estimate of the demand elasticity of Saudi oil exports

WSJ (Saudis Plan New Export Cuts in Hopes of Lifting Oil to $80 a Barrel): 

Saudi Arabia is planning to cut crude exports to around 7.1 million barrels a day by the end of January in hopes of lifting oil prices above $80 a barrel, according to OPEC officials.

The new strategy comes as the kingdom seeks to cover a large government spending boost. It said last month that it planned to increase its expenditures by 7% in 2019—the equivalent of about $20 billion—as the country struggles to fund ambitious plans to diversify its economy beyond petroleum products.

Crown Prince Mohammed bin Salman, the de facto Saudi ruler, has faced a sharp decrease in oil prices since October amid a supply glut. The brutal killing of journalist Jamal Khashoggi by Saudi operatives in October has also deterred foreign companies from working in the kingdom and investing in its economic development plans.

The new Saudi budget requires oil prices to rise to as much as $95 a barrel, according to an official with the Organization of the Petroleum Exporting Countries. But the kingdom would be satisfied with prices at $80 to $85 a barrel, a range that would limit its need to dip it into its financial reserves, according to people familiar with its thinking.

To cover proposed expenditures, Riyadh is set to reduce crude exports by up to 800,000 barrels a day from November levels.

Saudi Arabia exported about 7.3 million barrels a day of crude last month. That was already down from around 7.9 million barrels a day in November and 7.7 million barrels a day in October.

Brent crude, the global benchmark, rose 1.2% to just under $59 a barrel and WTI jumped 3.5% to just under $50 a barrel Monday after The Wall Street Journal reported Saudi Arabia planned to deepen export cuts.

The own-price elasticity of demand is equal to the percentage change in quantity demanded divided by the percentage change in price. Here are some calculations from my interpretation of the excerpt above:

• % change in quantity = (7.1 - 7.9)/7.9 = -0.11
• % change in price = (80 - 59)/59 = 0.36

According to me, the elasticity is -0.28. What am I doing wrong?

And one more thing:

The U.S. market will see the largest reduction in Saudi oil exports, according to an OPEC official. Overall, the export cuts would go beyond the six-month commitment it made in early December to OPEC. ...

Oil prices fell below $80 a barrel in October after Saudi Arabia turned up the spigots in response to U.S. pressure to replace sanctioned Iranian oil. The increase turned out to be more than the market needed.

President Trump is going to need to place another phone call to get U.S. gas prices back down. 

Identity Economics and Environmental Policy

I recently got around to reading the 2010 book "Identity Economics: How our Identities Shape our Work, Wages, and Well-Being," by George Akerlof and Rachel Kranton.  It is a lay summary of some of the work that Akerlof and Kranton have been doing to incorporate identity and social norms into economic modeling of decision-making.  Basically, identity economics modifies a person's utility function - in addition to caring about the normal stuff like consumption, people also care about how their actions conform to the norms of the identity that they belong to.  For example, if an employer wanted its workers to work harder or better, standard economic theory would suggest that the employer could modify the contract and include standard economic incentives like merit pay or output-based bonuses, since workers respond to these incentives.  Identity economics suggests that the employer alternatively could attempt to create norms for the workplace and encourage workers to identify with those norms, such that the norms themselves and workers' identities would provide incentives for working hard.  I might work hard or long hours because I get paid more to do it, or I might do so because I feel like I am an important part of a team, and I believe in the mission of the firm, etc.

After reading it I was struck by the potential application to environmental policy.  We want people to reduce their energy consumption, say, by purchasing fuel efficient cars or appliances.  Standard economic theory (Pigou) would suggest that we can price the externalities from energy consumption correctly so that everyone's incentives are such that they purchase the right amount of fuel efficient cars and appliances based on financial considerations alone.  Looking out my window, it seems pretty obvious that lots of people who buy fuel efficient cars like hybrids and electrics (perhaps most of them) are doing so for other reasons - and perhaps the financial reasons aren't a part of it at all.  People buy a hybrid because they are (or want to be seen as) a "green" - this doesn't mean that they're image-obsessed jerks, but it does mean that identity economics seems to play a part in these decisions.

This is somewhat related to the idea of intrinsic motivation, and how it may be crowded out by government policy (some people have studied this in relation to environmental policy).  And it's also kind of related to the huge "behavioral nudge" literature on environmental policy (maybe). 

But I think there's something innovative about the approach of identity economics that can yield some insights into the optimal design of environmental policy.  Someone should write a paper, I decided, incorporating identity economics into a model of optimal externality policy.

Then a few days ago I see that someone basically did.  "Environmental Policy When Consumers Value Conformity," by Alistair Ulph and David Ulph, has recently been online-published by JEEM.   Their model is one in which consumers value conformity - sticking with the norms of a group.  This is similar to the modification of the utility function in identity economics, though (I think) they don't have in their model the endogeneous creation of norms for different identity groups (e.g. the greens and the browns).  This yields some striking policy implications, including the fact that the Pigouvian tax could be welfare-reducing.

At What Cost? Legislators come up with solutions to Harmful Algal Blooms. Environmental Economists come up with cheaper solutions.

The Legislature of the State of Ohio is currently considering legislation to reduce Phosphorous loadings into Lake Erie by 40%.  This is a good thing, as reducing Phosphorous going into Lake Erie will reduce the incidence and impact of Harmful Algal Blooms in the Western Lake Erie Basin.  

The proposed legislation establishes a Clean Lake 2020 plan that includes:

A significant new Clean Lake Capital Fund that may appropriate up to $100 million per year for five years for both Lake Erie algae reduction, and agricultural best practices.  Funding may include establishing facilities to improve manure application processes, projects to reduce open lake disposal of dredged materials, funds to local governments for water quality-based green infrastructure, water management projects to help reduce nutrient and sediment runoff impacting the lake and other strategies.

A new Soil and Water Support Fund, with some of the funding provided directly to soil and water conservation districts to assist farmers in soil testing, nutrient management plans, installing edge of field drainage devices, encouraging inserting of nutrients (subsurface placement), and agreed to conservation methods that may include riparian buffers, filter strips and cover crops.

To the casual observer, this all looks good.  The proposed bill has widespread support among agricultural groups, and local and state authorities. As one of the bill's sponsors notes:

“These are not brand new ideas, just a greater sense of urgency to implement them,” Arndt said.  “There appears to be widespread agreement with state officials, environmental and agriculture groups, tourism advocates and business leaders that many of these strategies will make a big difference.”

And he is right, these strategies could make a big difference. 

But as economists we are trained to ask, 'At what cost?' 

How are the economy (and environment) doing--without reference to politics?

Since most of the major news outlets (CNN, MSNBC, FOX, Drudge (?),...) spend all of their time having partisan shouting matches, I thought I would update everyone on some ongoing economic and environmental trends, without mentioning or crediting or discrediting the contribution to those trends by any particular President past or present.  I will leave the attribution of credit or blame to those who choose to participate in such attribution exercises.

All data sets are pulled from the Trading Economics website.  Trend lines are added to some of the graphs for your reference.  

Feel free to use this information in your barroom discussions.

@CEA -- Bonus points on your final exam to the first person to explain the blue shaded area to @realdonaldtrump

5 out of 7 continents isn't bad, right?

We're working on PhD recruitment this week (if you applied to OSU AEDE and were accepted, join us, we're FUN!).  I put together a Google map with our PhD placements since 2007.  A bit scary that I might be influencing thinking for this many people and this wide an area.   

 

When it comes to easily measured economic outcomes, President Trump 'has had a reasonably good year...but...'

FiveThirtyEight's assessment of President Trump's first year:

The upshot? Few dramatic changes in either direction. Jobs in the manufacturing and coal mining industries ticked up, the trade deficit shrank a bit, and the number of murders in some big cities decreased. The uninsurance rate got worse — the only change in the opposite direction of Trump’s goal. The biggest movement in the direction Trump hoped to see was the increase in oil and natural gas production.

So, according to these measures, Trump has had a reasonably good year. Of course, that doesn’t mean Trump was personally responsible for all of this change — in fact, many of these trends began long before Trump was elected. But presidents often get credited with whatever happens while they’re in office anyway.

[emphasis added, because that's the important part]

Hot Dog! A nice clean example of the relationship between elasticity of demand and revenues

There's a well known result in Econ 101 (I need to write this chapter for Env-Econ 1010 sometime) that if the demand for a good is elastic*, lowering the price will increase revenues, and vice-versa.  If the demand is inelastic, then lowering the price lowers revenue.  Unfortunately it's rare to get a nice clean real world example to demonstrate this.  But here's one:

Sports fans who have long criticized their favorite teams for the prices they charge at the stadium might finally get their wish of cheaper concessions.

That's what could happen if others follow the lead of Atlanta Falcons and United owner Arthur Blank, whose group revealed Thursday that, despite lowering their food and beverage prices to the lowest in all of major professional American sports, fans actually spent more.

Steve Cannon, CEO of the AMB Group, Blank's holding company, told ESPN that although food and beverage prices were 50 percent lower in its new Mercedes-Benz Stadium than the prices in the Georgia Dome the previous year, fans spent 16 percent more.

"There's a huge value in delighting your fan base, to make them as happy as they could possibly be," Cannon said. "We started with one of the biggest pain points and it paid off."

 

EnvEcon 101: Understanding Marginal Tax Rates (and other unnecessarily complicated stuff)

If you haven't heard, the U.S. Congress is likely to pass a new income tax bill this week.  CNN.com has a graphic with the existing and new income brackets and associated tax rates.  This seems like a good time to talk a little about the difference between the marginal tax rates, total tax bills, and the average tax rate paid, as I have found that principles students (and other adults) often find this confusing.     

First a few definitions:

The marginal tax rate is the tax rate that you pay on the last dollar you earn.  For example, if your taxable income is such that you fall into the 33% tax bracket, that means you will pay 33% of the last dollar you earn to the federal government.  An important note is that this does NOT mean that you pay 33% of all of your income to the federal government.  Just 33% of the last dollar you earn.

Your total tax bill is calculated by adding up the marginal tax you pay on each dollar of taxable income you earn, up to the last dollar you earn.

Your average tax rate is found by dividing your total tax bill by your taxable income.

I know I just made things more confusing.  So let's look at a simple example, and then we will look at the actual tax rates that exist currently and the proposed new tax rates to illustrate the concepts.

A simple example:  Let's suppose there are only two defined income brackets.  The lowest income bracket goes from $0 to $50,000 of taxable income.  This income bracket is taxed at a marginal rate of 10%.  The second income bracket is anything greater than $50,001 of taxable income.  This income bracket is taxed at marginal rate of 25%. 

The correct way to to interpret these brackets is as follows:  No matter how much taxable income you earn, each dollar of taxable income you make, up to $50,000, is taxed at a rate of 10%.  So if you make $25,000 a year in taxable income, each of your dollars is taxed at a marginal tax rate of 10%, meaning your total tax bill will be $25,000 * 0.10 = $2,500. 

If you earn $35,000 of taxable income, then you still fall in the 10% marginal tax bracket, and your total tax bill will $35,000 * 0.10 = $3,500.

If you earn $50,000 of taxable income, then you still fall in the 10% marginal tax bracket, and your total tax bill will $50,000 * 0.10 = $5,000.

But hear's where things get interesting (and probably more confusing).  Suppose you earn $50,001 of taxable income.  You now fall in the 25% marginal tax bracket.  Many people interpret this to mean that your tax bill will now be $50,001 * 0.25 = $12,500.25.  But this would be WRONG.

The correct way to calculate your new tax bill is to recognize that you pay a rate of 10% for each dollar you earn up to $50,000 of taxable income, and then you pay 25% for each dollar you earn above $50,000 of taxable income.  So if your income is $50,001 of taxable income, then you will pay 10% in taxes for each dollar up to $50,000 ($50,000 * 0.10 = $5,000) plus 25% for the $1 you earned over $50,000 ($1 * 0.25 = $0.25).  So your total tax bill is now $5,000 + $0.25 = $5,000.25.  

To calculate your average tax rate, you now divide your total tax bill ($5,000.25) by your taxable income ($50,001) and convert to a percentage (100 * $5,000.25/$50,001) to get an average tax rate of 10.0003%.  Notice that the average tax rate is below the marginal tax rate (25%).  This will always be the case.

Let's extend the example.  Suppose your salary is $125,000 of taxable income per year.  Everyone pays 10% on the first $50,000 of taxable income earned, so you pay $5,000 on the first 50,000 of taxable income. On the remaining $75,000 of taxable income (the $75,000 above $50,000), you will pay a marginal tax rate of 25% ($75,000 * 0.25 = $18,750), so your total tax bill is $5,000 + $18,750 = $23,750, and your average tax rate is 100 * $23,750/$125,000 = 19% (notice it is still below the marginal rate of 25%.

So that's the end of the simple example (SIMPLE?!, IKR).  So what does the new tax bill do to income brackets and marginal tax rates?

Here are the current and new income bracket and marginal tax rates under the proposed bill for unmarried individual filers (that's right, to make things even more complicated, tax rates change depending on your filing status--individual, married, or married filing individually, but that's for a later post): 

Let's take a look at someone making $50,000 of taxable income per year.  Under the current tax plan, this person will pay:

• 10% of the first $9,525 of taxable income earned: $952.50
• 15% of each $1 earned between $9,525 and $38,700 of taxable income (($38,700-$9,525)*0.15) = $4,376.25
• 25% of each $1 earned between $38,700 and $50,000 of taxable income (($50,000-$38,700)*0.25) = $2,825

Adding these together, the current total tax bill for someone making $50,000 of taxable income per year is $8,153.75, and the average tax rate is (100 * $8,153.75/$50,000) = 16.31%

The new tax bill drops the marginal tax rates in the second and third income brackets to 12% and 22% respectively, so the total tax bill for someone making $50,000 of taxable income per year falls to $6,939.50 and the average tax rate falls to 13.88%.

It looks like the new tax plan offers a tax cut to someone making $50,000 of taxable income per year.

And that's true...IF WE ONLY BASED TAXES ON INCOME AND DIDN'T FILL THE REST OF THE TAX BILL WITH DEDUCTIONS, LOOPHOLES, GIFTS, POLITICAL PAYOFFS AND RIDICULOUS CRAP THAT KEEPS ACCOUNTANTS EMPLOYED* AND POLITICIANS HAPPY. 

I'VE BEEN CAREFUL THROUGHOUT THIS POST TO MAKE SURE I QUALIFY INCOME AS TAXABLE INCOME.  WHAT THIS POST FAILS TO EXPLAIN, BECAUSE NO ONE CAN REALLY EXPLAIN IT BECAUSE NO ONE HAS ACTUALLY READ THE TAX BILL, IS THAT TAXABLE INCOME WILL CHANGE DUE TO CHANGES IN DEDUCTIONS, LOOPHOLES, GIFTS, POLITICAL PAYOFFS AND RIDICULOUS CRAP THAT KEEPS ACCOUNTANTS EMPLOYED* AND POLITICIANS HAPPY. 

OK, that's out of my system.  As you can see from the tax table above, comparisons between current and new tax bills get more complicated as incomes increase, because not only do marginal tax rates change, but the income brackets change too.  For example, someone who makes $175,000 per year currently falls in the fourth income bracket, but under the new bill falls in the fifth bracket.  I won't bore you with all of the calculations, but,

• Under the current system, someone making $175,000 in taxable income pays a marginal tax rate of 28%, has a tax bill of $41,842.75 and an average tax rate of $23.91%
• Under the new system, someone making $175,000 in taxable income pays a marginal tax rate of 32%, has a tax bill of $37,689.50 and an average tax rate of $21.54%

*In full disclosure, my spouse is gainfully employed by a tax accountant and makes her living by helping people take advantage of DEDUCTIONS, LOOPHOLES, GIFTS, POLITICAL PAYOFFS AND RIDICULOUS CRAP THAT KEEPS ACCOUNTANTS EMPLOYED AND POLITICIANS HAPPY.