Can $15 Per Ton Be The Right Price?

The figure commonly thrown about for damages from global warming is roughly $15 per ton of carbon. This startlingly reasonable number has left me wondering whether our methods of damage estimation are correct.

I haven't scrutinized these exact estimates but typically we do damage estimation by calculating either the willingness-to-pay to avoid the externality or the willingness-to-accept to live with it.

That is, we figure out either how much people would pay, if they could, to get rid of the problem of global warming or how much we would have to pay them so that they would rather take global warming and the money than be without either.

This is all very normal and accepted.

The problem comes in when the people who are creating the externality and the people who are going to suffer from the externality are radically and systematically different. In this case the United States is the world's largest producer of carbon emissions and also happens to be the wealthiest nation in the world. On the other hand by many account Bangladesh will suffer some the worst consequences of global warming and is among the poorest nations in the world.

All else being equal the more money you have the higher your willingness-to-pay to avoid externalities will be, this is in part because rich people have more time to be concerned with these types of things, but more importantly its because rich people simply have more money to pay.

Before my economist readers pooh-pooh this line of reasoning as being dealt with by Kaldor-Hicks let me weave a story that I think is important.

Suppose we continue with the example of the US and Bangladesh. The US is emitting carbon which we will assume has little to no impact on the quality of life in the US but will potentially kill roughly 10 Million Bangladeshis because of the rise in sea levels.

Now we could say - Look America, the Bangladeshis have a right to life and property which you are infringing upon. Please cease and desist. By many accounts this would be fair. I don't have the right to fire bullets into a crowd or start uncontrollable fires in my backyard because I could be taking other people's lives. Why does the US have the right to pump carbon into the atmosphere? The fair thing to do would be to make America stop.

Economists rush in, however, and say - Look, it may or may not be fair but it is certainly not efficient. No particular Bangladeshi will die with certainty in the floods and many risk death every day from other things. I think some of them would rather have money which they could use to buy food and medicine for their families and then just chance the flood.

So, we figure up how much medicine we'd have to give the Bangladeshis to make them indifferent to global warming and we call that the damages. If we just charge that to the US then by the miracle of markets we've managed to make the Bangladeshis whole and reduce the cost to the US to a mere fraction of what it would be if we stopped carbon all together.

The problem with the story is this - The miracle was possible in large part because Americans had to give up very little happiness in the form of money to make the Bangladeshis very happy with medicine.

In other words here, the major gain is that in this example there are huge gains from trade between the United States and Bangladesh. That gain, however, is only realized if in fact we trade with Bangladesh. If we keep the tax money and use it to reduce our own income taxes we haven't taken advantage of that gain and so the calculations we used to come up with the marginal damages are invalid.

Another way to think about this, suppose that each human being has the right to produce a given amount of carbon, a personal carbon permit. Bangladesh would have about half as many permits as the US but a fraction of the carbon. They would gladly trade some of their permits in exchange for life saving resources.

America, in desperate need of permits would take the exchange. However, in the end this transaction involves two parts. A given reduction in US carbon emissionas and an increase in medicine in Bangladesh. The first part does not make sense without the second.

If we aren't going to give the money to Americans then we have to ask another question. What would an American pay to avoid the consquences the average Bangledeshi is going to experience. My guess is that that number is significantly higher.

hat tip to mankiw

I Share Goolsbee's Lack of Outrage

I was happy to find a kindred spirit in Austan Goolsbee The hand wringing over the subprime meltdown has left me a little confused.

Money was cheap and to steal a phrase from the A Bronx Tale the subprime borrowers "took a shot, what I am going to say." That is, they tried to stretch their way into a house. When you take a shot, sometimes you miss. There is nothing wrong with that. Would you prefer that they never had a shot in the first place? Maybe the lenders where too desperate and let people in the door they shouldn't have. Maybe. I am still not sure about that.

There is uncertainty in the world and sometimes even calculated risks don't pan out. Either way, however, its the lender that ends up holding the bag. The subprime borrower looses his house, but he didn't have a house to begin with. And his credit? His credit was already subprime, whats really the loss there.

I just don't see who is made better off by preventing these transactions from happening.


hat tip to Mankiw

Skill Shock and Stagflation

Something occurred to me while I was looking through Bernanke's statement yesterday. Bernanke mentioned the oft repeated fact that while it was easy for employers to find low skilled workers the market for high skills is becoming tighter and tighter. These tight conditions keep alive concerns that inflation will remain high even as the economy weakens - a mild case of seventies style stagflation.

What I hadn't thought of before, however, was that the decline in skilled labor represents a supply side shock of the same type we experienced during the oil crisis. The economy increasingly depends on skilled workers for growth but the supply growth is slowing and may even decrease in the coming years.

This drives up the price of skill labor but it doesn't do much to drive up the average productivity. The result is a real supply side shock - the kind that can lead to slower growth and higher prices. If this is true then stagflation may prove unavoidable.

What are your thoughts?

Rudy's A-

Saw Rudy Guliani on Kudlow and Company. Overall I was impressed. I have never seen someone so openly support classical liberal ideals. It didn't come across a pure rhetoric either, he seemed to have some grasp of the underlying issues.

Unfortunately Rudy suffers from Supply Side Syndrom (SSS) - an irrational belief that cutting taxes will always raise revenue. Moreover, he seemed to be too taxaphobic in general.

As Mankiw says to many Republicans fall into the following trap

A) Taxes are bad

B) Carbon Taxes are a Tax

C) Therefore, Carbon Taxes are bad.


In its place Rudy prefers regulations. Over estimating the cost of taxes and underestimating the cost of regulations is a significant problem among todays republicans. More later this week on how to over come that.

Higher Taxes Might Induce More Education - Seriously

Greg ponders whether or not Ed Lazear should follow his gut and assume that taxes discourage people from becoming more educated or follow Larry Katz’s analysis that there is no relationship.

This situation exemplifies a common conundrum for policy advisers like Eddie. In the absence of hard evidence, should he act as if there is no effect, as Larry seems to be suggesting here? Or should Eddie rely on the general principle that people respond to incentives and make an educated guess about the magnitude?

The problem, however, is we don't even know what the sign is. That is we don’t know if taxes increase or decrease the incentive to become more educated.

It could be that higher tax cause people to increase their educational attainment.


Also, the term higher/lower taxes is a bit misleading.

Raising the child credit would count as "lower taxes" for most policy makers. Show me the economic model where raising the child credit increases human capital accumulation.

I can build at least two strong arguments around a child credit decreasing human capital accumulation, especially of course among women.

Now if you said that we are going to specifically find ways to reduce the return to education then ok, at least you now have an ambivalent effect.

On the one hand lower returns to education would cause people to substitute towards other forms of wealth generation. On the other it would have a negative wealth effect for the talented which could cause them to seek more education.

One of the deepest problems for policy advisor is that the general equilibrium effects of a policy can be exactly the opposite of what you would first expect. When you tax something you get less of it, right?

Well, not necessarily. It depends on how you tax it, what you do with the tax revenues, and what options people have for avoiding the tax burden. The devil is in the details and the details are always a mess.

Spin Nation

There are no spending programs. Now there are only fully refundable transferable tax credits.

From Senator Coburn's Medi-Choice Proposal.

Under the Act, Americans would be eligible for a tax rebate to purchase health insurance. The “Medi-Choice” rebate would be made directly to a patient’s health insurer and would be worth $2,000. Families would receive a $5,000 tax rebate.

This my look like a "check" and may be payable to someone who is performing a government service, but in reality it is a tax cut. Trust Us.

By the way Senator Coburn's idea does look like a good spending proposal. But it does in fact increase spending.

Answer to Arnold

Arnold asks for comments on his theory of government.

His basic point is that government is the entity which can enforce arbitration between private parties. For this to work, we must turn over power to the arbiter. Once we have done this there is no stopping the arbiter.

I generally agree although my story goes a little bit like this:

You and I could come to various agreements about how we are going to live in peace.

However, in the absence of government we face a prisoners dilemma. No matter what you do it will always be better for me to sneak into your house in the middle of the night and kill you. Once I kill you there is nothing more you can possibly do to me. The permanence of death prevents us from getting out of this prisoners dilemma through repeated interaction. In any period even if I don't gain that much from killing you, I might do it just to prevent you from killing me later.

Now this is balanced against the fact that most of us don't like to kill and we want to have friends, etc. However, the incentive is always there underneath the surface and it will result in rent dissipating activity.

I might install some sort of early warning system, or I might expend energy appearing tough or macho so that you believe your efforts to kill me will be unsuccessful, or I might just live farther away and only trust my relatives or people I have grown up with.

This rent dissipation brings the opportunity for profit and profit seeking firms will take advantage.

This ives rise to the first evolution in government - Small For Profit Government.

In reality this takes the form of a group hero or leader, somone who mediates disputes and in return receives respect, admiration and likely a higher share of resources.

However, there are increasing returns in the production of violence. Small For Profit Government eventually gives way to Large For Profit Government often in the form of franchises. We call this feudalism.

The human story is that heroes from different tribes get together and either agree to work together or go to war. If they work together they themselves select a hero who will mitigate their disputes and so on up the chain until there is a king, a nobility below him, and knights below them. If they go to war then the winners simply institute the previous scheme among themselves.

Because this process reduces rent dissipation there are enormous social returns. Unfortunately, the government is in a position to capture all of the returns. After all, without them there would be no society.

Unsatisfied with this government people have looked to Not For Profit Government. This is where some subset of the populace revolts and creates a corporate governance structure where everyone who meets a basic criteria (male, land-owning, adult) is a shareholder.

This is where we are in the western world today. Yes, government has the golden scepter as Arnold puts it, but its not because we go along with it to make the system work. It is because the market abhors unclaimed rents, and if there is no Not For Profit Government in place the for profit ones will form.

Arnold's example of the heroin dealer is poignant because For Profit Governments (the Mafia and after their demise street gangs) dominate the illicit drug trade.

Government is inevitable because murder prevents us from escaping the prisoners dilemma through repeated action. Without government there is a huge profit to be made in deincentivizing murder.

Effecient Markets and the Booyah

So can the Efficient Market Hypothesis (EMH) stand up in the face of market manipulations by hedge fund managers.

Shouldn't it

A) Be impossible to manipulate and Efficient Market and

B) Be unprofitable to try

My answer is no is on both counts. The EMH says that the market has priced in all publicly available information. Cramer's antics are based on altering the information available to market analysts. As long as the market in information provision is not perfectly competitive this will be possible.

That is, as long as their are trusted information sources who have the power to single handedly change people priors it will be profitable to make money by manipulating those sources.

Kids Make You Miserable

Greg, posts a link to an article in Slate which reveals that happiness reaches a minimum at age 45. We are happy we are young, we are happy when we are old. We are miserable in middle age.

The economists behind the research suggest that perhaps during middle age your sense of invincibility is crushed leading to less happiness. By the time you are old you have come to terms with it.

Baloney.

You are crushed in middle age. You are crushed by the responsibility of taking care of whining rug rats. Sure you say, you are more often happy because of your kids than mad. Yet, the true cost of kids isn't simply whether or not they make you pull your hair out. It's what you give up to have them. Its romantic nights together with your significant other, trips to Europe and Asia, and the chic loft downtown. Its giving up the sports car in favor of a minivan and replacing salsa lessons with soccer practice.

Kids, in short, make you miserable.

Yet, there are few desires more strong, few life choices more satisfying than having children. All of which serves to underscore one of the most important points about happiness research - what we want to do and what will make us happy are not the same thing.

Sure people want to be happy. They just don't want to do the things that make will make them happy. They want to do the things they are emotionally driven to do. This may or may not end in happiness.

For economists this means that there is no reason to suppose maximizing utility and maximizing happiness will produce the same results.

The EMH vs. Jim Cramer

The business world is a buzz with reports on Jim Cramer's market manipulation admissions.

Cramer confesses that a hedge fund manager "must" use false rumors and strategically placed purchases to create the impression that a stock price is headed in the direction he wants. For example, Cramer argues that one could buy a bunch of puts on Apple stock and then call the reporters and say that someone in Apple has told you their relationship with the mobile phone carriers is breaking down.

Puts are contracts which allow you to sell your stock for a set price even if the market price plunges. The presence of a bunch of puts and negative rumors will lead many people to think that Apple stock is headed down. Cramer could then swoop in and buy it cheap.

So, a natural question for economists is - can the Efficient Market Hypothesis (EMH) hold up in the face of market manipulations like the ones Cramer describes?

Comments are welcome. My thoughts tomorrow.

Background Here

WikiAccuracy

Msnbc says that educators are upset by wikipedia.

I am actually thrilled by it. I use it myself to refresh my memory on economics topics or to uncover fomulas otherwise burried inside my heap of reference books.

Moreover, its a living demostration of the power of volutanry association. There are some inaccuracy where hot but topics are considered but in general I have found it reliable. On the few occassions where I noticed an error, I simply hit refresh on my browser and the error removed. In the time it took me to read it and recognize it, someone had already corrected it.

Up or Down

The brouhaha continues over the Federal Reserve's statement.

For non-Nerds the Federal Reserve, those are the guys with the printing presses, decided to keep interest rates where they are. In the accompanying statement, however, they changed the language they use about future decisions.

For what its worth I believe that the firming bias was remove - the Fed isn't leaning towards raising rates anymore.

Yet, I believe this was a mistake. Not only has inflation been running high but inflationary expectations have been creeping up. There are those who are beginning to question whether the 90s was a fluke. The Fed needs to send a strong signal that price stability will be maintained in the face of temptation.

Genetic Inequality

Like many academics I have become increasingly convinced of the power of genetics over the last decade. I was first awaken from my blank slatist slumber by E.O. Wilson but the evidence has since come in on all fronts.

Sociobiology or Evolutionary Psychology, as I think it has now morphed into, is becoming increasingly undeniable.

This has lead at least one pundit to declare that the new definition of a liberal is someone who believes in evolution but not in biology. That's clearly a jibe at old notions of class warfare and income inequality caused by injustice inherent in the "system"

Perhaps I am the only one to experience this but the triumph of sociobiology has actually made me less libertarian not more. If anyone was theoretically capable of anything then why tax people on the basis of their choices. In Jim the Janitor is sad because he earns less than Cecil the CEO then he should change his career path.

Tabula Rasa means the we, and our parents, are ultimately completely responsible for our lot in life. Even if society had a hand in it somewhere it certainly wouldn't help things for society to start rewarding behavior it didn't want in the first place.

If its not all a blank slate, however, then maybe Jim the Janitor could have never been a CEO, no matter how bad he wanted it, no matter how hard he studied, no matter what sacrifices his parents made to send him to the best schools. It just wasn't going to happen for him.

In crew (that's rowing for the uninitiated) we talk about stroke volume, or how much blood your heart can pump in a single beat. By the time you're on a college crew team either you have it or you don't. You can train you guts out. You can be in the gym everyday, but you will simply never beat a guy who has a physically much larger heart.

Its a sad thing to see guys struggling, and know that they can never achieve their goals. Its sad and we don't want it to be true. But it is true. I have seen men pass out as their hearts pumped away in a furious yet ultimately futile attempt to keep their muscles oxygenated.

The experience is made bearable only by the notion that not everyone can make the "A" boat and it wouldn't be a sport if they could. Yet, how does one deal with the notion that not everyone can be economically productive - at least not at the level many of us take for granted.

No matter how hard they try, now matter how much they train they simply can't do it. They just weren't made that way. Its hard to have a cold heart in the face of that reality.

Is Wage Insurance What I've Been Looking For?

Greg brings up the new wage insurance proposal that I have been meaning to blog about.

He's skeptical. I'm interested.

In part my reasons are political economy. I am looking for a mechanism that will prompt all Americans to buy into to globalization and technological change. I understand that globalization per se is overly blamed for job losses but I think that's the term the populace uses for "things beyond our control."

I want to assuage their fears and let them know that the things beyond their control are evolving in a way that on average will benefit them more than it will hurt them.

Secondly, I am concerned about the welfare implications of policies which pass our basic cost-benefit test. If I am forced to choose between assuming that the marginal utility of income is constant across the population or that everyone has the same utility function with respect to aggregate consumption, I won't hesitate to choose the later.

For non-nerds I mean that if I either have to assume that $1000 means just as much to Bill Gates as it does to Bill the Plumber or to assume that Bill Gates would value $1000 the same as Bill the Plumber, if he had Bill the Plumbers income then I am going to go with the second one.

This means that I have to worry about who gets what benefit. I believe there was a time when Milton Friedman's comment that we are generalized in consumption and therefore will all benefit from lower prices was enough. However, I think that the new economy is systematically biased in favor of talented people in ways that cannot be ignored.

Practical Education

Bryan Caplan gratiously writes that he is lucky to have me as a reader. He calls me Prof. Smith which not only still sounds icky but makes me wonder whether my addressing him as Bryan was too familiar.

Nonetheless, his point about overestimating practicality is well taken. Though, I wonder how truly ivory tower one must be to suffer from this form of bias.

I am also still curious as to how university education, with its professors spending more time on research than in the classroom, could be the most effecient form of signaling the market can muster.

Some university education is highly subsidized for sure. Yet, there is competition between states and for charity dollars. If anything this compeition seems to be reinforcing the research university model not replacing it.

Moreover, why do young scholars in North Carolina dream of going to Duke not Davidson. Davidson was recently named the most difficult undergraduate institution. Surely, it must be a great signal when one graduates from it with a 3.5.

Yet, accross the country education seems to be moving away from the intensive liberal arts model towards a much more don't-bother-us-while-we're-in-the-lab reseach university model.

If there is not some sort of important human capital transfer going on then quite frankly why is the rest of the world so willing to put up with research professors' you know what.

But, perhaps I'll have to wait for Prof. Caplan's book?

Home Ownership Might Still Be Good For America

Greg and Tyler have both mentioned the result by Andrew Oswald that high levels of home ownership are associated with high levels of inflation.

Now, as you all may know, the mortgage interest deduction is a perennial whipping boy for economists. Liberal economists see it as a tax give away to upper middle class owners who are more likely to itemize. Conservative economists view it as turning potential investors away from the stock market towards the less productive real estate market.

While I am sensitive to both those arguments the question remains - is more home ownership in and of itself a good thing or a bad thing for America as a whole. At first blush Oswald's results seem to suggest that it is a bad thing.

I am, however, not so sure. Home ownership exposes families to more systemic risk. That is, if the your local economy turns bad not only are you out of a job but you are stuck in a home which is decreasing in value.

On the other hand it shields people from idiosyncratic risk. That is, suppose that your town is doing well but your business just happens to do poorly this year. Well, at least you still have the house. Even if you have to tap it for equity or sell and scale down, you still get to keep whatever premium your neighborhood commands.

My thought is that the second result might be more important than the first. People are attached to their communities and buying a home helps the hedge against the risk that their personal fortunes will not match those of their neighbors. It allows them to keep their kids in the same schools even if those schools are in greater and greater demand.

All together I think home ownership decreases the risk level homeowners face and perhaps that's precisely why they face higher unemployment. They are more willing and more able to hold out for a better position. If that's the case the home ownership may be good for America after all.

Markets Out in Front

In two posts Greg Mankiw discusses why Milton Friedman felt economists should ignore political realities and why Milton's son David believes that they must not.

Irrespective of political reality markets, I say, must be out in the front of the policy discussion. The truth of politics is if no good solutions to a perceieved problem are offered bad ones will be excepted. You can't be something with nothing. You have to be responsive to the concerns of the electorate and that means proposing market based solutions to the problems they face.

Whether its widening inequality, global climate change or the dismal performance of our K12 system failure to offer solutions grounded in economics only empowers the command and control set.

Arnold Makes a Good Point

Arnold's point about self education is well taken. There is a strong possibility that part of what students are buying is "personal training" for knowledge.

That is, they need some guidance about what to learn and more importantly they need an accountability partner. They need someone to test them and say look - you really didn't study this as in extensively as we originally planned.

Formal education then is explained by some form of hyperbolic discounting, or in common parlance lack of self control.

There is no wonder then education is less valued by entrepreneurs. Among the traits necessary for being a successful entrepreneurs is a high degree of self motivation.

My Answer to Bryan's

Query on his on selection bias.


I think those who spend their lives in academia will tend to underestimate the return to education.

As Card points out the return to education is higher for those who have limited access. Moreover, academics tend to enjoy the education process and will seek education beyond the point where the marginal pecuniary return is exceeds the marginal cost.

This will lead academics to conclude that education doesn't pay.

Indeed, I felt this way myself until leaving academia to make my fortune on the Internet and subsequently losing it all. My stint in working class America lead me to believe that if anything the return to education is smaller for those with talent than those without. Indeed I suspect that the standard OLS measures may underestimate the return average return.

That is marginal benefit falls with increasing talent but 'disutility' falls faster causing the talented to seek more education and downwardly biasing the estimates.

Why Are We Teaching These Kids?

The first page from Byran Caplan's new book summarizes a position he is stated many times about education - that it is mostly a waste of time. There are several points I'd like to make relating to the economics of Bryan's assertion and how he arrived at it. To maintain the reader's interest I'll address the juicer ad hominem points first.

First, Bryan says that education, for him, was mostly a waste of time. I would say much the same about my classroom education. Yet, in my case, and I suspect Byran's, this wasn't because there was too much learning going on but too little.

I could absorb material much faster than the teacher taught it. So much faster that I was better off simply to read the book and struggle with it myself rather than waiting for the class to come along.

This problem, however, exists for a small minority of children. Most children actually tend to lag behind the school systems highest expectations. Just because the best could do better on their own doesn't mean that most could.


Secondly, Bryan confesses that he has never really worked outside of academia or even spent much time outside of the education sector. This, I suspect, is the real culprit. Byran doesn't realize just what it means to be uneducated because he has not worked closely with uneducated people.

Its one thing to think that obscure memorization of multiplication tables or facts about rivers basins is useless. Its another to try to build a creek side patio with someone who doesn't know these things.

You don't often use much of the trivia you learn in grade school but when you do it can be vitally important.

Perhaps, if we were all perfectly specialized in our occupations and could predict what we wanted to do from an early age it wouldn't matter. You could just learn what you needed on the job. There would be no need for a generalized education.

Yet, when the demand for new houses rises, reminding a group of new apprentice carpenters what right triangles are and teaching a bunch 30 year-old guys who have never heard of an angle are radically different.

Ironically, when you work in the knowledge economy it can be easy to forget just how important knowledge can be. In jobs where knowledge aquistion is the goal, intellectual horsepower has a greater return than possesion of the very knowledge you are working to make obsolete. In most other feilds intelligence matters but well established empirically verified knowledge matters more.

Third, from a economics prospective its hard to reconcile the notion that there is too much schooling with the literature showing that the returns from schooling are high. I am not talking about simple minded studies that show educated people make more money. More careful examinations conclude that the causal effect of education on earnings dominates most of the return.

Indeed, at the margin education seems to be most important for groups that are disadvantaged in their ability to obtain it.

Lastly, there is the market test. If education is so useless why is the market so incapable of finding an alternative. Fast track programs are common in finance, consulting and now even retail. Shouldn't it pay to snag brilliant 16 year-olds and put them to work in I-Banking before they waste time in high school and college.

Despite the severe shortage of talented labor no one has thought of a way to do this?