REBLOG: AQUANOMICS ON PIGOUVIAN TAXES

From David Zetland's excellent water economics blog:

Pigouvian taxes do NOT produce deadweight losses

For my final exam question, I asked students to compare the pros and cons of cap and trade and Pigouvian taxes for reducing the negative externality from pollution. Many students gave useful answers, but many also made two big mistakes.

The first was to claim that an advantage was their propensity to reduce consumption (an excellent example of rewriting the question as the answer :).

The other was simultaneously frustrating and enlightening to me. Many students claimed that Pigouvian taxes created a deadweight loss, i.e., the tax would reduce surplus-generating activity.* That statement is true, in general, of fiscal taxes designed to generate revenue (e.g., income, property or expenditure taxes) that the government would spend elsewhere,** but it's NOT true of Pigouvian taxes that are designed to reduce behavior that generates harm that is not reflected in the price of the good being taxed, e.g., taxes on cigarettes to pay for additional health costs or taxes on fuels to reduce and/or ameliorate the costs of pollution.***

The trouble that my students encountered -- and many teachers of economics fail to clarify -- is that fiscal taxes distort prices to generate revenue while Pigouvian taxes correct prices to affect behavior. (We explore the tension between these two goals in this paper on groundwater taxes.)

Bottom Line: We use the same word ("tax") to refer to two different policy instruments. Fiscal taxes generate revenue with some reduction in efficiency; Pigouvian taxes generate revenue as they improve efficiency. (That's why they are called win-win, but don't tell that to the people creating the pollution!)

* Miscalibrated taxes of all types create deadweight losses from being set at the wrong level, but those losses are not present in theory.

** Deadweight losses will be lowest when behavior changes by the smallest amount, i.e., it's best to tax the most inelastic behavior.

*** For more on why politicians prefer command and control over Pigouvian taxes, read this paper [pdf] by Buchanan and Tullock. Buchanan just died; he and Tullock are responsible for much of Public Choice theory, i.e., the idea that politicians and bureaucrats may serve themselves, not the public interest. Here's my review of their brilliant book on constitutions and laws.

WORTHWHILE ACADEMIC GOALS!

I just attended the parent-teacher meeting for my six and a half year old daughter who is in year two of an international school in Norway. As part of the meeting I received a written academic performance assessment including a statement of winter learning targets:

• Improve handwriting style by beginning to join up letters,
• use capital letters and full stops correctly in writing,
• Count in 2's, 5's, and 10's forward and backward,
• Know addition number bonds to 20,
• Do some problem solving activities with money and time.

I don't really care/worry so much about the former two targets, but the latter three really warm the heart of an economist. How about that last one - isn't it fantastic?!! I can't wait for her to be able to solve utility-maximizing problems involving two constraints!!!

English Tags: Economics, education, humor

MILJØØKONOMENE is a Norwegian environmental and resource economics blog built on the concept of the US blog Environmental Economics. We mostly write in Norwegian and address environmental and resource issues particularly relevant to Norway. However, from time to time, we will post English language discussions that might be of broad relevance to people with general interests in environmental and resource economics. These can be found under the tag ("etiketter" on the lefthand side): English Blog.

THE SWEDISH COUNTER-FACTUAL (PART 1)*

Prior to 1970, Norway's GDP per capita had been lagging that of Sweden for many decades. In fact, the ratio of GDP per capita for Norway to GDP per capita for Sweden was about the same in 1970 as it had been in 1905 (the year that Norway gained its independence from Sweden), roughly 75% (see, for example, this report from Statistics Norway).

Since then, the macro economy of Norway has grown at a significantly higher rate than the economies of the other Nordic countries, including that of Sweden, both in nominal and real terms and regardless of whether differences in purchasing power are adjusted for or not.

The graph below plots the ratio of Norwegian to Swedish GDP per capita between 1970 and 2011. The graph is based on data extracted from the OECD database. As can be seen, GDP per capita for Norway is today about 150% that of Sweden. 

It is intriguing to consider the above graph a Swedish counter-factual scenario, as suggested by the this Statistics Norway analysis. How might the Swedish economy have evolved if the neighbor land to the west with its"black gold" had stayed under Swedish rule?

Or from Norwegian perspective, what would the economy of Norway look like today without the discovery of massive petrolium reserves in the North Sea in the late 1960's?

Many people in Norway - ordinary folks, politicians, and even some researchers - seem to be in denial about how important the oil industry has been for the rise to prominence of the Norwegian economy.

I will write more about this denial, the alternative hypotheses proposed, and implications for current Norwegian economic and environmental policies at a later point here at MILJØØKONOMENE.

*MILJØØKONOMENE is a Norwegian counterpart to the Environmental Economics blog. We mostly write in Norwegian and address environmental and resource issues particularly relevant to Norway. However, from time to time, we will post English language discussions that might be of broad relevance to people with general interests in environmental and resource economics. These can be found under the tag ("etiketter" on the lefthand side): English Blog.

FRIDAY BEERPOST: THE EDIWM CHALLENGE

Every fall semester I teach bachelor-level and master-level microeconomics at the University of Stavanger, Business School. I am teaching the former course for the fifth time and the latter course for the third time.

Each semester, I put forth what I call a "tattoo challenge" to the students in each course, respectively. In the passed, the promise has been that I will get a market (demand - supply) equilibrium  graph tattooed on my upper arm if (and only if) all students pass the course.

This year, I have refined the challenge (with permission from my brilliant, beautiful, and lovely economics wife): If all students, in either course, pass the exam, I will get a tattoo of the EDIWM logo.*

I figure this is the closest I will ever  get to feeling like a sailor. From back in the days when men were men, travelled out to sea,  and came back permanently inked with various images (including those of nude ladies)!

Cheers & Happy Friday! Greetings from MILJØØKONOMENE!  

*This promise is conditional on approval from the image-owner and that a tattoo artist guarantees it will come out visually cool on my biceps!

GJESTEBLOGG: FREMTIDIGE OLJEPRISER*

DON'T CALL ME STUPID!

Craig A. Bond

Associate Professor

Department of Agricultural and Resource Economics

Colorado State University

English Tags: nonrenewable resources, finance, oil, rent-seeking

In the New York Times on April 10 former Congressman from Massachusetts Joseph P. Kennedy II (D) essentially advocates for the elimination of the futures market in oil (or “speculation”, as he terms it). I say “essentially” because he wants to ban “pure” speculators…those that don’t take physical delivery of oil. Why? Apparently because speculation has caused oil prices to “become disconnected from the costs of extraction.”

So what determines the price of oil? In class this week, we learned that the physical constraint on the extraction of non-renewable resources causes a divergence between the marginal benefit and marginal cost of extraction, known as marginal rent, which must rise at the rate of discount in order to be intertemporally efficient. Even if marginal costs were constant, the slope of the demand curve would determine how quickly prices would ultimately rise But in any case, so long as there is real economic scarcity, the price of oil will be greater than marginal costs.

Of course, since we don’t know future prices with certainty, any individual or firm looking to extract must forecast the future and behave accordingly. How might these agents forecast future prices? Any number of ways: Flip a coin, draw random numbers, assume last period’s price, etc. But of course, better decisions can be made with better information.

Where might we get that information? Well what we really need is an unbiased expectation of the future price of the actual asset. Wherefrom might this be found? Why, a futures market of course!

Not all futures markets function perfectly, but in many cases, they provide excellent, market-disciplined information on future prices, especially in global commodity markets with many players. So, in essence, the former Congressman seems to want to restrict information and at the very least distort, and at most ban, the futures market in order to regulate the oil market. Perhaps he really is that ignorant of the role of price signals in the economy. Or perhaps he thinks the voters are?

*Professor Craig Bond is an up-and-coming resource economist from the United States, currently visiting the University of Stavanger Business School for the main purpose of teaching natural resource economics to the master students in the course MØA350: Environmental and Resource Economics. His academic webpage can be accessed here.

GJESTEBLOGG: NATUR RESSURSER*

LAND USE IN NORWAY
Craig A. Bond

Associate Professor
Department of Agricultural and Resource Economics
Colorado State University

English Tags: environmental policy, resource economics

One of the key concepts in understanding natural resource economics is the value of a particular resource. This is a very old question, of course, dating back at least to Adam Smith, David Ricardo, and Thomas Malthus, all of whom had various theories of value. A simplified, but reasonable interpretation of modern neoclassical economics is that the value of a good or service to an economic agent is the maximum willingness (and ability) to give up another good or service in order to get it. If we interact this notion with various institutional structures (such as property rights and a more or less competitive market), we can predict if a particular observation of prices or other observable statistics truly reflects “value” from a particular accounting stance (say, the perspective of market participants, or alternatively the perspective of “society” at large).

In practice, this general idea can be used for “natural capital” as well. Resources such as an individual land parcel in a particular use (say, agricultural or forestry), the right to fish for a certain share of total allowable catch, or the endogenous information gained in a learning-by-doing resource extraction problem can all be valued, in theory, by applying this idea. The value concept can also be used to predict outcomes of changes in economic parameters as a result of market activity or policy.

Especially as both the developing and developed world continue to evolve and face choices related to population changes, urbanization, and other outcomes that provide important services such as housing and food while impacting the direct (e.g., wood for fuel or timber products) and indirect (e.g., ecosystem services) flows of services provided by the natural world, understanding the notion of value as a trade-off is essential to making good decisions. For example, as mentioned in the Norwegian Ministry of the Environment – State of the Environment page about land use in Norway, the conservation of agricultural land is looking to be an important political topic in Norway over the next twenty years, and approximately 69.8% of annual conversion of land to urban uses comes from forested or transitional lands.

I invite readers to use the neoclassical notion of resource value to comment on these land use challenges (and any others that might be of interest, of course). Some examples might be to think through the sources of variation in land values and how these interact with existing institutions to shape the Norwegian landscape (i.e., an objective analysis), or to do a thought experiment about what a “socially optimal” land use pattern might look like (i.e., a normative analysis). Why might these differ? What policies could be used to move the system closer to the optimum, and what are the advantages and disadvantages of them? How might land use decisions differ in the developed and developing world?

I look forward to interacting with this blog’s readership (and authors, for whom I am grateful for the opportunity to contribute to this great project!) during my stay at the University of Stavanger Business School, and hope we can learn something from each other.

*Professor Craig Bond is an up-and-coming resource economist from the United States, currently visiting the University of Stavanger Business School for the main purpose of teaching natural resource economics to the master students in the course MØA350: Environmental and Resource Economics. His academic webpage can be accessed here.