The economic costs of CA's global warming law: debate continues

The California Air Resources Board (CARB) yesterday released an assessment of the welfare impacts of AB32, the landmark legislation Governor Schwarzenegger signed in 2006 to reduce the state's greenhouse gas emissions to 1990 levels by 2020--a 25% reduction. The report serves as a rebuttal to analysis reported last fall by a couple of Sac State business school profs (Varshney and Tootelian) that estimated the legislation would impose a dramatic burden on the economy--costing $500 billion and nearly 4 million jobs. The CARB analysis, on the other hand, shows the regulation has virtually no impact on the state's rate of economic growth, its labor demand or income. I'll confess to having read neither report, though I did read the abstract of the Sac State study and the executive summary of the CARB analysis (Hey, this is about as much attention as our legislators will give to these studies!). I have, however, read Matt Kahn's blog post about the reports, as well as his op-ed with Jim Sweeney in the LAT yesterday.

The CARB analysis has the implicit blessing of some of the leading environmental and energy economists in the country (some of whom I have had the opportunity to meet), including Jim Sweeney (Stanford), Chris Knittle (UC Davis), Larry Goulder (Stanford), and Jim Bushnell (Iowa State), who sit on CARB's Economic and Allocation Advosirory Committee. I am inclined to trust these guys on such matters. At the same time, however, I agree with Matt Kahn that these big, "black box" CGE models make me nervous. And, while reading (okay, skimming) the exec summary of the CARB report, I found this amid the three paragraphs devoted to summarizing economic impacts:

While Energy 2020 modeling results show an increase in energy prices (i.e., cost per unit), the increases in efficiency throughout the economy helps reduce fuel expenditures in California relative to the reference case by 4.9 percent by 2020. These results suggest that the increases in energy prices in California from the measures in the Scoping Plan are offset by the resulting decreases in fuel use.

Now, it is surely true that any policies that attempt to internalize the externality associated with GHG emissons will raise energy prices. It is also surely true that, amid higher energy prices, efficiency will be in greater demand. But to suggest the net welfare effect on energy consumers is positive (or at least non-negative) is absurd. The energy consumers will have to invest in energy efficiency to achieve the demand reductions CARB anticipates. These investments will be costly.

I also have to quibble with Kahn a bit. On his blog, he talks about how California (in partnership with other climate change progressives like Washington and Oregon) can create a home market effect to justify our leadership in carbon regulation. The benefits of the home market effect, he contends, can overcome the risks associated with being the nation's laboratory and the costs of investing in a "non-appropriatable" future benefits. I don't doubt that these states form a big enough market to generate green investment. Our state regulators have long held the view that California is big enough to make the markets respond to us, and they are probably right. But incenting change alone does not secure benefits to Californians. And there is little evidence that California will be able to export green goods that are costly to transport and assocated with significant scale economies--as is required to establish a "home-market effect."

To comment generally on Khan, CARB, and Varshney/Tootelian, it seems to me quite obvious that our existing industry will experience welfare losses under AB32. If we consider AB32 as essentially a tax on energy (or a price on the right to emit GHGs), then producer surplus will decline. Some firms may leave the state and take their jobs and tax dollars with them. This is the big cost of AB32.

The benefits may be two-fold: climate change mitigation and the recruitment of green jobs to California. On CC mitigation: it is unclear that California's unilateral action (to essentially adopt the Kyoto Protocol by 2020) will have any impact on climate change--or even on GHG emissions. The principle of "leakage" predicts that carbon intensive firms will relocate where regulation is more lax. When a country adopts regulation, the leakage problem may not be a big concern because the costs to frms or relocating in other countries (and transporting goods and services across national borders) may be too great. But when a state like California does it unilaterally, the costs of relocating (e.g. to Nevada or Texas) are much lower. Because GHGs are global pollutants, it doesn't matter where they are emitted; they contribute to climate change and to global welfare losses whether they are emitted in San Diego or San Antonio. Imagine that as AB32 is implemented, it imposes higher costs on in-state energy producers. Our energy production can all be done out of state and transported in-state essentially at no cost, so that higher costs could shift supply of our energy to out of state firms who do not face the costs of GHG regulation. If our energy production does move out of state, the net effect of AB32 will be to have reduced GHG emissions from energy production not at all, but to have reduced the stock of jobs in California. This leakage problem is a real concern. It means that not only may we not see cooler temperatures for our forward-leaning policy, but we may not even see reduced GHG emissions.

The second potential benefit of AB32, which we here a lot about today in the context of the federal stimulus, US EPA efforts to regulate carbon, and congressional proposals for climate change legislation, is green jobs. It is certainly true, as Kahn argues, that California's AB32 will attract green investment and create jobs researching new solar panels and installing new windmills. But these jobs need not be created in California. They can be created in other states with friendlier business climates, like states that don't tax the carbon emitted in production of green technologies! There is no reason to expect that all of the green jobs created to serve demand for green products in California will be given to Californians. True, we have been a leader in innovation, and Silicon Valley is ready to become the Green Capital of the World. But we are far from the only ones hoping to capitalize on the green economy created by regulation. With the energy example again, AB32 doesn't even guarantee work to install green technologies in California, let alone to invent them. Green energy capacity could all be installed out of state and then put on the grid to power our homes--a boon to the green economy but not to California's.

In their op-ed, Sweeney and Kahn say of the Varshney/Tootelian study:

First, they assume there will be no increase in innovation in the world of clean energy technology. While innovation is hard to measure, it is completely misleading to assume there will be none. Few in California would debate the powerful impact of innovation on our state's economy. Policies like AB 32 create market incentives. Everyone in a market economy responds to these incentives, but Varshney and Tootelian assume instead that California businesses and consumers will suddenly become oblivious to market forces. This defies 200 years of economic logic dating to Adam Smith.

Second, their study assumes that all investments in "greening" California homes and businesses are simply dollars tossed out of the state's economy, with no positive impact on its bottom line.

Some such investments may go out of state -- for example, the builder of a new net-zero-energy house might purchase solar panels from Oregon. But others will not. When a family pays for those solar panels to be installed, or for a weatherizing company to improve their home's energy efficiency, that money goes to California salaries and supplies. Workers and suppliers then buy their own goods and services locally, and the ripple effect continues. With the California economy now experiencing more than 12% unemployment, such economic stimulation should not be ignored.

Sweeney and Kahn kind of acknowledge my point about leakage, but what struck me is how this argument sounds an awful lot like the argument for government paying people to dig holes and fill them in. It gives people jobs that give them money to spend on things other people make. To the extent this recruits new money into the economy (e.g. from the green investors Kahn notes are standing on the sidelines pending resolution of GHG regulation uncertainty), then it has a short-term stimulus effect, but it only has a real benefit if the investment is in something worthwhile. Now, I don't intend to suggest installing solar panels is as worthless as digging holes only to fill them in again. Its not if you assume, as I do, that cleaner energy is a good thing. But the fact that jobs are created does not in and of itself guarantee real benefits accrue. If leakage means there are no GHG emissions reductions from all of this new investment, then the difference between building windmills and digging holes is not so great.

It seems to me that, while climate change policies are probably a good thing because man-made global warming is probably happening (Even if you doubt anthropogenic climate change, so long as you place a non-trivial probability on it occuring, then some investment in mitigation is worthwhile.), Californians are getting stuck holding the bag in a big way with AB32. We may not reduce GHGs, but we''ll pay for it in energy prices and jobs. This, of course, is why an international consensus on climate change is so difficult to create. The argument among proponents of AB32 is that California, by taking the lead, can induce others to follow. To some extent, this has been our track-record. But by imposing green regulations on our economy, we give other states (and countries) a comparative advantage in the brown economy. In essence, our leadership on climate policies reduces their incentives to adopt GHG emissions policies. The Chinese, no doubt, are chearing as leaders in California, the U.S., Europe take the lead in this arena. Its a gift to their industries.

GHG emissions are correlated with emissions of pollutants, like particulate matter and sulfur dioxide that are harmful to human and environmental health. To the extent AB32 reduces emissions of these pollutants, Californians will benefit. These benefits accrue to the GHG emission reducer neighbors, not the entire world.