Bringing the profession into disrepute


Tim Leunig is right here, it's very rare that economists prefer regulation over prices. But he then claims that climate change makes the difference and we really should be preferring regulations. There are two basic errors I'm afraid.

The first is looking at a carbon tax as a means of changing behaviour: something which if he'd actually understood the Stern Review he claims to support he would know isn't the point at all. As Pigou pointed out way back in 1912 when he first outlined the idea what we want is to internalise the external costs of an action into the market price. So the tax is not set so as to reduce the level of that activity to some target (as Leunig assumes in his example) it is set at the social cost of the action itself. And we know what the social cost of petrol use is, Lord Stern, in that report, told us: 11 p a litre. So scare stories of £18 a gallon are just that, scare stories.

The second is here:

The reality is that prices work very well when supply is able to increase when the price goes up. If demand for clothing goes up, people plant more cotton. But prices don't work very well to ration a given amount of goods.

What? But that's when prices are at their most effective! Substituitability old boy, substituitability! This can come from the supply side (a couple of years back the rise in platinum prices led one chip manufacturer to start plating the pins with niobium instead of platinum) or the consumption side: shank's pony as opposed to a car. But much more important than even this is technological change and the incentives that changing prices give to it.

If the price of carbon emissions goes up as a result of us taxing carbon itself more highly this does not simply limit us to consuming this fixed number of carbon units and rationing them by price. Other technologies which allow us to perform the same tasks (transport, fertilisers, heating, whatever) become more attractive as they are and investigation and investment into further such also become more attractive.

Which is of course what we actually want: not a reduction in transport or fertilisers or heating but a way of having more of them, more cheaply than at present, just without the carbon emissions. And prices are a much better way to get this than regulation is.

And to think, Tim Leunig is teaching at the LSE these days: O Tempora, O Mores.