Tag: externalities

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A new era for climate change policy?

 
With the election of Joe Biden, the USA will have a president committed to tackling climate change. This is in stark contrast to Donald Trump, who has been publicly sceptical about the link between human action and climate change and has actively supported the coal, oil and gas industries and has rolled back environmental protection legislation and regulation.

What is more, in June 2017, he announced that the USA would withdraw from the UN Paris Accord, the international agreement to cut greenhouse gas emissions so as to limit global warming to ‘well below’ 2°C above pre-industrial levels with efforts to limit it to 1.5°C. The USA’s withdrawal was finalised on 4 November 2020, a day after the US election. Joe Biden, however, pledged to rejoin the accord.

A growing number of countries are pledging to achieve carbon neutrality by mid-century or earlier. The EU is planning to achieve a 55% cut in greenhouse gas emissions by 2030 so as to reach neutrality by 2050. This will involve various taxes, subsidies and public investment. Similar pledges to achieve net zero emissions by 2050 have been made by Japan and South Korea and by 2060 by China. In the UK, legislation was passed requiring the government to reduce the UK’s net emissions 100% relative to 1990 levels by 2050 and thereby achieve net zero emissions.

Constraints on action

Short-termism. One of the problems with setting targets a long time in the future is that they take away the urgency to act now. There are huge time lags between introducing policies to curb carbon emissions and their impact on the climate. The costs of such policies for business and consumers, however, are felt immediately in terms of higher taxes and/or higher prices. Thus politicians may be quick to make long-term pledges but reluctant to take firm measures today. Instead they may prefer to appease various pressure groups, such as motoring organisations, and cut fuel taxes, or, at least, not raise them. Politically, then, it may be easier to focus policy on the short term and just make pledges without action for the future.

Externalities. Various activities that cause carbon emissions, whether directly, such as heavy industry, dairy farming, aviation and shipping, or indirectly, such as oil and coal production, thereby impose environmental costs on society, both at home and abroad. These costs are negative externalities and, by their nature, are not borne by those who produce them. There are often powerful lobbies objecting to any attempt to internalise these externalities through taxes, subsidising green alternatives or regulation. Take the case of the USA. Fossil fuel producers, energy-intensive industries and farmers all claim that green policies will damage their businesses, leading to a loss of profits and jobs. These groups were courted by Donald Trump.


International competition. Countries may well be reluctant to impose green taxes or tough environmental regulation on producers, when competitors abroad do not face such constraints. Indeed, some countries are actively promoting dirty industries as part of their policies to stimulate economic recovery from the Covid-induced recession. Such countries include China, Russia and Turkey. This again was a major argument used in the Trump campaign that US industries should not be hobbled by environmental constraints but should be free to compete.

Misinformation. Politicians, knowing that taking tough environmental measures will be unpopular with large numbers of people, may well downplay the dangers of inaction. Some, such as Trump in America and Bolsonaro in Brazil deliberately appeal to climate change deniers or say that technology will sort things out. This makes it hard for other politicians to promote green policies, knowing that they will face scepticism about the science and the efficacy of their proposed policies.

Biden’s climate change policy

Although it will be difficult to persuade some Americans of the need for tougher policies to tackle climate change, Joe Biden has already made a number of pledges. He has stated that under his administration, the USA will rejoin the Paris Climate Agreement and will play a leading role in the November 2021 UN COP26 climate change conference summit in Glasgow. He has also pledged a Clean Energy Revolution to put the USA on an ‘irreversible path to achieve economy-wide net-zero emissions no later than 2050’.

But readopting the pledges under the Paris Agreement and advocating a clean energy revolution are not enough on their own. Specific measures will need to be taken. So, what can be done that is practical and likely to meet with the approval of the majority of Americans or, at least, of Biden’s supporters?

For a start, he can reintroduce many of the regulations that were overturned by the Trump administration, such as preventing oil and gas companies from flaring methane on public lands. He could introduce funding for the development of green technology. He could require public buildings to use green energy.

According to the Clean Energy Revolution, the US government will develop ‘rigorous new fuel economy standards aimed at ensuring 100% of new sales for light- and medium-duty vehicles will be zero emissions and annual improvements for heavy duty vehicles’.

One of the biggest commitments is to tackle external costs directly by enacting ‘legislation requiring polluters to bear the full cost of their climate pollution’. This may be met with considerable resistance from US corporations. It is thus politically important for Biden to stress the short-term benefits of his policies, not just the long-term ones.

Given the damage done to the economy by the spread of the pandemic, perhaps the main thing that Biden can do to persuade people of the benefits to them of his policies is to focus on green investment and green jobs. Building a green energy infrastructure of wind, solar and hydro and investing in zero-emissions vehicles and charging infrastructure will provide jobs and lead to multiplier effects throughout the economy.

Articles

Questions

  1. Identify three specific climate change policies of Joe Biden and assess whether each one is likely to succeed.
  2. Draw a diagram to illustrate why a free market will lead to over production of a good which produces negative externalities.
  3. To what extent can education internalise the positive externalities of green consumption and production?
  4. What was agreed at the Paris climate change conference in December 2015 and what mechanisms were put in place to incentivise countries to meet the targets?
  5. Will the coronavirus pandemic have had any lasting effects on emissions? Explain.
  6. How may carbon trading lead to a reduction in carbon emissions? What determines the size of such reductions?
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All change for the railways

The UK rail industry was privatised by the Conservative government in the mid-1990s. As Case Study 14.8 on the Economics 10th edition website states:

The management of rail infrastructure, such as track, signalling and stations, was to be separated from the responsibility for running trains. There would be 25 passenger train operating companies (TOCs), each having a franchise lasting between seven and fifteen years. These companies would have few assets, being forced to rent track and lease stations from the infrastructure owner (Railtrack), and to lease trains and rolling stock from three new rolling-stock companies. …In practice, the 25 franchises were operated by just 11 companies (with one, National Express, having nine of the franchises).

In 1996, at the start of the franchise era, the train operating companies were largely private-sector companies such as National Express, Stagecoach, Virgin Rail and Prism Rail. By 2020, most of the franchises were operated by a foreign state-owned business or a joint venture with a foreign state-owned firm.

As a result of poor performance (see above case study), Railtrack was effectively renationalised in 2002 as Network Rail – a not-for-profit company, wholly dependent upon the UK Treasury for any shortfall in its funds.

TOCs had mixed success. Some performed so poorly that their franchise contracts had to be temporarily taken over by a state-owned operator. For example, in June 2003 the Strategic Rail Authority withdrew the operating licence of the French company Connex South Eastern. The franchise was temporarily taken over by the publicly-owned South Eastern Trains from November 2003 until March 2006 before being returned to a private operator.

Perhaps the most troubled franchise has been the East Coast Main Line between London and Scotland. It was renationalised in 2009, reprivatised in 2015 and renationalised in 2018.

The effect of the coronavirus pandemic

The spread of the coronavirus and the accompanying lockdowns and social distancing saw a plummeting of rail travel. Passenger numbers fell to just 10% of pre-pandemic levels. In March 2020, the UK Government introduced Emergency Measures Agreements (EMAs), which temporarily replaced rail franchise agreements. TOCs were paid a 2% fee (based on pre-Covid costs) to run trains and losses were borne by the government.

When the EMAs ran out on the 20 September, they were replaced by Emergency Recovery Measures Agreements (ERMAs), set to last until no later than April 2022. Under these measures, the fees paid to TOCs were reduced to a maximum of 1.5%. These consist partly of a fixed fee (again based on pre-Covid costs) and partly on a performance payment, depending on punctuality, passenger satisfaction and financial performance. As with the EMAs, the new arrangements involve virtually no risk for the TOCs (except for the size of the performance-related fee). Costs and revenue will be passed to the Department for Transport, which will bear any losses.

TOCs were required to run a virtually full service to allow reduced passenger numbers to observe social distancing. Despite journeys still being only 30% of pre-pandemic levels, social distancing on trains meant that many trains were sold out.

The ERMAs also contain provisions for the replacement of franchises when they come to an end. The precise nature of these will be spelt out in a White Paper, which will respond to the recommendations of the Williams Review of the railways. This review was set up in 2018 in the aftermath of difficulties with various franchises and a chaotic nationwide timetable change. The review’s findings were originally scheduled to be published in Autumn 2019, but were then put back because of the general election and the disruptions caused by the pandemic. The government hopes that it will be published before the end of 2020.

It is expected that the review will recommend replacing the franchise system with something similar to the currents ERMAs. TOCs awarded a contract will be paid a performance-related fee and revenues will go to the government, which will bear the costs. While this is not quite renationalisation, it is not the previous franchise system where TOCs bore the risks. It is in effect a contract system where private companies are paid to deliver a public service.

The CrossCountry franchise

The first test of this new approach to contracting with TOCs came this month. Arriva’s franchise for running CrossCountry trains ran out and was replaced by a three-year contract to run the services, which span much of the length of Great Britain from Aberdeen to Penzance via Edinburgh, Glasgow, Newcastle, Sheffield, Birmingham, Bristol and Plymouth; from Bournemouth to Manchester via Reading, Oxford, Wolverhampton and Stoke; from Cardiff to Nottingham via Gloucester, Birmingham and Derby; and from Birmingham to Stanstead Airport via Leicester and Cambridge.

The contract will last three years. The Department for Transport will gain the revenues and cover the costs and pay Arriva (owned by Deutsche Bahn) a management fee that is ‘performance related’ – as yet unspecified. This, like the EMAs and then the ERMAs, will remove the risks from Arriva.

Nationalisation in Wales

The Welsh government has announced that Transport for Wales will be taken over by a publicly owned company in February 2021. TfW operates many of the routes in Wales and the borders and most of the branch lines in Wales, including the valley commuter lines into Cardiff. It is currently owned by KeolisAmey (a joint company owned 70% by the French company, Keolis (part of SNCF), and 30% by the UK company, Amey), which took over the franchise in 2018 from Arriva. The Welsh government considered that KeolisAmey would collapse if it did not provide support. Ministers decided that nationalisation would give it greater control than simply subsidising KeolisAmey.

James Price, chief executive of the Welsh Government, stated that this allows it:

to reduce the profit we pay to the private sector massively over time, and make sure that when the revenue comes back, it comes back in to the taxpayer.

Under emergency measures, KeolisAmey has already been supported by the Welsh government to the tune of £105 million (£40 million in March and £65 million in June) to continue operating the franchise. Passenger numbers fell by 95% as the pandemic hit.

Is nationalisation a better way forward, or should private train operating companies continue with the government taking on the risks, or should the franchise system be amended with greater support from the government but with the TOCs still bearing risk? The articles below consider these issues.

Articles

Questions

  1. Explain how the franchising system worked (prior to March 2020).
  2. To what extent could each franchise be described as a ‘contestable monopoly’?
  3. What incentives were built into the franchising system to deliver improvements in service for passengers?
  4. What were the weaknesses of the franchising system?
  5. In the context of post-pandemic rail services, compare the relative merits of nationalisation with those of awarding contracts where the government receives the revenues and bears the costs and pays train operating companies a fee for operating the services where the size of the fee is performance related.
  6. What are the arguments for subsidising rail transport? What should determine the size of the subsidy?
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Davos and tackling climate change: commitment or posturing?

At the annual World Economic Forum (WEF) in Davos, Switzerland, world political and business leaders are meeting to discuss pressing economic issues of the day. This year, one of the key themes is climate change and “how to save the planet”.

The approaches of leaders to the climate crisis, however, differ enormously. At the one extreme there are those who deny that emissions have caused climate change, or who reluctantly acknowledge climate change but think that governments need to do nothing and that technological advances in green energy and transport will be sufficient to curb global warming. This has been the approach of President Trump, President Bolsonaro of Brazil and Prime Minister Scott Morrison of Australia. They may claim to support the general goals of reducing greenhouse gases, but are keen to protect their coal and oil industries and, in the case of Brazil, to continue cutting down the Amazon rain forest to support mining, ranching and the growing of crops.

At his speech at the WEF, President Trump said that he supported the initiative to plant one trillion trees worldwide to act as a carbon sink. However, he gave no details of just what the nature of the support would be. Would there be subsidies or tax breaks, for example, for landowners to plant trees? In the meantime, his administration has relaxed regulations to curb air and water pollution. And he has withdrawn the USA from the Paris climate agreement.

Other leaders, urged on by activists, such as Greta Thunberg, have talked about tougher action to tackle emissions. Countries such as Canada, Norway and the EU countries have adopted a number of initiatives. Policies range from taxing emissions, capping/regulating emissions with penalities for those breaching the limits, tradable permits, subsidising green alternatives, setting local emissions targets with incentives for meeting them, investing in green infrastructure such as roadside charging points for electric vehicles, making environmental education part of a national curriculum, investing in public transport, and so on. But, say, activists, only large-scale measures that truly recognise the scale of the climate emergency will be sufficient.

The year starts with climate being addressed at Davos; it ends with the annual Conference of the Parties (COP26) to the United Nations Framework Convention on Climate Change (UNFCCC). This year it will be in Glasgow. There is much hope pinned on this conference, given the growing realisation of the effects of climate change, from bush fires in Australia, to floods in Indonesia and other parts of southeast Asia, to more extreme hurricanes/typhoons, to rapidly melting glaciers and retreating sea ice, to rising sea levels, to crop failures and the displacement of humans and the destruction of wildlife and habitat.

COP25 in Madrid made little progress; it is hoped that COP26 will be much more successful. Sir David Attenborough has warned that the world faces a ‘climate crisis moment’. He hopes that the world will be ready to take much stronger action at COP26.

But there remains the fundamental economic problem of the tragedy of the commons. As long as the atmosphere and other parts of the environment are free to ‘use’ to pollute, and as long as the costs of doing so are borne largely by people other than the direct polluters, the market will fail to provide a solution. Australia’s bush fires can be directly attributed to climate change and climate change is exacerbated by coal-fired power stations. But Australia’s use of coal as a power source is only a tiny contributor to global climate change. Presumably, the Australian government would rather get a ‘free ride’ off other countries’ policies to cut emissions rather than bearing the economic cost of reducing coal-fired generation itself for little gain in terms of reduced global emissions.

However, people are not entirely selfish. Many are willing to make personal sacrifices to lead a more environmentally sustainable life. Many people, for example, are choosing electricity tariffs that are slightly higher but where the electricity is generated with zero carbon emissions. Firms have shown a readiness to respond to demands from their consumers for more sustainable products.

Articles

Questions

  1. Draw a diagram to show how the external costs of carbon emissions cause a more than socially optimal output of products emitting CO2.
  2. What is meant by the ‘tragedy of the commons’? Give some environmental examples.
  3. Discuss possible solutions to the tragedy of the commons.
  4. Why was COP25 generally regarded as a failure?
  5. Identify four possible policies that governments could adopt to reduce carbon emissions and discuss their relative advantages and disadvantages.
  6. Are meetings such as the annual World Economic Forum meetings at Davos of any benefit other than to the politicians attending? Explain.
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The economics of climate change

There is increasing recognition that the world is facing a climate emergency. Concerns are growing about the damaging effects of global warming on weather patterns, with increasing droughts, forest fires, floods and hurricanes. Ice sheets are melting and glaciers retreating, with consequent rising sea levels. Habitats and livelihoods are being destroyed. And many of the effects seem to be occurring more rapidly than had previously been expected.

Extinction Rebellion has staged protests in many countries; the period from 20 to 27 September saw a worldwide climate strike (see also), with millions of people marching and children leaving school to protest; a Climate Action Summit took place at the United Nations, with a rousing speech by Greta Thunberg, the 16 year-old Swedish activist; the UN’s Intergovernmental Panel on Climate Change (IPCC) has just released a report with evidence showing that the melting of ice sheets and rising sea levels is more rapid than previously thought; at its annual party conference in Brighton, the Labour Party pledged that, in government, it would bring forward the UK’s target for zero net carbon emissions from 2050 to 2030.

Increasingly attention is focusing on what can be done. At first sight, it might seem as if the answer lies solely with climate scientists, environmentalists, technologists, politicians and industry. When the matter is discussed in the media, it is often the environment correspondent, the science correspondent, the political correspondent or the business correspondent who reports on developments in policy. But economics has an absolutely central role to play in both the analysis of the problem and in examining the effectiveness of alternative solutions.

One of the key things that economists do is to examine incentives and how they impact on human behaviour. Indeed, understanding the design and effectiveness of incentives is one of the 15 Threshold Concepts we identify in the Sloman books.

One of the most influential studies of the impact of climate change and means of addressing it was the study back in 2006, The Economics of Climate Change: The Stern Review, led by the economist Sir Nicholas Stern. The Review reflected economists’ arguments that climate change represents a massive failure of markets and of governments too. Firms and individuals can emit greenhouse gases into the atmosphere at no charge to themselves, even though it imposes costs on others. These external costs are possible because the atmosphere is a public good, which is free to exploit.

Part of the solution is to ‘internalise’ these externalities by imposing charges on people and firms for their emissions, such as imposing higher taxes on cars with high exhaust emissions or on coal-fired power stations. This can be done through the tax system, with ‘green’ taxes and charges. Economists study the effectiveness of these and how much they are likely to change people’s behaviour.

Another part of the solution is to subsidise green alternatives, such as solar and wind power, that provide positive environmental externalities. But again, just how responsive will demand be? This again is something that economists study.

Of course, changing human behaviour is not just about raising the prices of activities that create negative environmental externalities and lowering the prices of those that create positive ones. Part of the solution lies in education to make people aware of the environmental impacts of their activities and what can be done about it. The problem here is that there is a lack of information – a classic market failure. Making people aware of the consequences of their actions can play a key part in the economic decisions they make. Economists study the extent that imperfect information distorts decision making and how informed decision making can improve outcomes.

Another part of the solution may be direct government investment in green technologies or the use of legislation to prevent or restrict activities that contribute to global warming. But in each case, economists are well placed to examine the efficacy and the costs and benefits of alternative policies. Economists have the tools to make cost–benefit appraisals.

Economists also study the motivations of people and how they affect their decisions, including decisions about whether or not to take part in activities with high emissions, such air travel, and decisions on ‘green’ activities, such as eating less meat and more vegetables.

If you are starting out on an economics degree, you will soon see that economists are at the centre of the analysis of some of the biggest issues of the day, such as climate change and the environment generally, inequality and poverty, working conditions, the work–life balance, the price of accommodation, the effects of populism and the retreat from global responsibility and, in the UK especially, the effects of Brexit, of whatever form.

Articles

Report

Questions

  1. Explain what is meant by environmental externalities.
  2. Compare the relative merits of carbon taxes and legislation as means of reducing carbon emissions.
  3. If there is a climate emergency, why are most governments unwilling to take the necessary measures to make their countries net carbon neutral within the next few years?
  4. In what ways would you suggest incentivising (a) individuals and (b) firms to reduce carbon emissions? Explain your reasoning.
  5. For what reasons are the burdens of climate changed shared unequally between people across the globe?
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Evolving Economics

The linked article below, by Evan Davis, assesses the state of economics. He argues that economics has had some major successes over the years in providing a framework for understanding how economies function and how to increase incomes and well-being more generally.

Over the last few decades, economists have …had an influence over every aspect of our lives. …And during this era in which economists have reigned, the world has notched up some marked successes. The reduction in the proportion of human beings living in abject poverty over the last thirty years has been extraordinary.

With the development of concepts such as opportunity cost, the prisoners’ dilemma, comparative advantage and the paradox of thrift, economics has helped to shape the way policymakers perceive economic issues and policies.

These concepts are ‘threshold concepts’. Understanding and being able to relate and apply these core economic concepts helps you to ‘think like an economist’ and to relate the different parts of the subject to each other. Both Economics (10th edition) and Essentials of Economics (8th edition) examine 15 of these threshold concepts. Each time a threshold concept is used in the text, a ‘TC’ icon appears in the margin with the appropriate number. By locating them in this way, you can see their use in a variety of contexts.

But despite the insights provided by traditional economics into the various problems that society faces, the discipline of economics has faced criticism, especially since the financial crisis, which most economists did not foresee.

Even Davis identifies two major shortcomings of the discipline – both beginning with ‘C’. ‘One is complexity, the other is community.’

In terms of complexity, the criticism is that economic models are often based on simplistic assumptions, such as ‘rational maximising behaviour’. This might make it easier to express the models mathematically, but mathematical elegance does not necessarily translate into predictive accuracy. Such models do not capture the ‘messiness’ of the real world.

These models have a certain theoretical elegance but there is now an increasing sense that economies do not evolve along a well-defined mathematical path, but in a far more messy way. The individual players within the economy face radical uncertainty; they adapt and learn as they go; they watch what everybody else does. The economy stumbles along in a process of slow discovery, full of feedback loops.

As far as ‘community’ is concerned, people do not just act as self-interested individuals. Their actions are often governed by how other people behave and also by how their own actions will affect other people, such as family, friends, colleagues or society more generally.

And the same applies to firms. They will be influenced by various other firms, such as competitors, trend setters and suppliers and also by a range of stakeholders – not just shareholders, but also workers, customers, local communities, etc. A firm’s aim is thus unlikely to be simple short-term profit maximisation.

And this broader set of interests translates into policy. The neoliberal free-market, laissez-faire approach to policy is challenged by the desire to take account of broader questions of equity, community and social justice. However privately efficient a free market is, it does not take account of the full social and environmental costs and benefits of firms’ and consumers’ actions or a fair distribution of income and wealth.

It would be wrong, however, to say that economics has not responded to these complexities and concerns. The analysis of externalities, income distribution, incentives, herd behaviour, uncertainty, speculation, cumulative causation and institutional values and biases are increasingly embedded in the economics curriculum and in economic research. What is more, behavioural economics is becoming increasingly mainstream in examining the behaviour of consumers, workers, firms and government. We have tried to reflect these developments in successive editions of our four textbooks.

Article

Questions

  1. Write a brief defence of traditional economic analysis (i.e. that based on the assumption of ‘rational economic behaviour’).
  2. What are the shortcomings of traditional economic analysis?
  3. What is meant by ‘behavioural economics’ and how does it address the concerns raised in Evan Davis’ article?
  4. How is herd behaviour relevant to explaining macroeconomic fluctuations?
  5. Identify various stakeholder groups of an energy company. What influence are they likely to have on the company’s behaviour?
  6. In an era of social media, web-based information and e-commerce, why might it be necessary to rethink the concept of GDP and its measurement?
  7. What is meant by an efficient stock market? Why may the stock market not be efficient?