Saturday, January 2, 2010

Greenhouse gas abate and the Jacksonia Mode of Discourse

Ted Gayer's piece seems to be a possible example of non-Jacksonian mode of discourse which I would applaud. There is a puzzle about the negative MC of abatement in the McKinsey report:

The main point of the McKinsey study is provided in their Exhibit B, which illustrates a rather peculiar finding that there are a significant number of pollution abatement options that can be achieved at “negative cost.” This finding violates the basic principles of economics. If firms (or consumers) could reduce emissions at negative cost, then they would do so. To say otherwise is to say that they are willingly or ignorantly passing up profits.

What, then, can explain a finding of negative cost? There are four possibilities:

First, the estimated costs of abatement are simply incorrect. ...
Second, the costs of abatement are incompletely estimated. ...
Third, the private discount rate is incorrectly estimated. ...
The fourth possible reason for the negative cost finding is that firms do indeed irrationally forego profit-maximizing activities, or they are ignorant of such activities.

To the category of second falls costs such as information and coordination costs. From the McKinsey report:

Unlocking the negative cost options would require overcoming persistent barriers to market efficiency such as mismatches between who pays the cost of an option and who gains the benefit (e.g. homebuilder versus homeowner), lack of information about the impact of individual decisions, and consumer desire for a rapid payback (typically 2 to 3 years) whn incremental up front investment is required.

Here is a concrete (but not necessarily correct) example:
I'd like to install solar panels. Say for that the upfront cost is $20,000 and the life of the panels is 30 years in which I may recoup the cost in 20 years. But I don't plan to be in the house for 20 years.

Perhaps the panels add value to the house - but how much. Here the cost of acquiring the information is not included. The added uncertainty of this option makes me decide not to install solar panels. There is a role for the government - they could step in and say that when I sell my house they will pay me the difference (in PV terms assuming some "correct" discount rate) of my up-front cost and the amount I've recouped in terms of electricity savings. How do we calculate this savings? Again some cost of information is left out of this equation which needs to be made clear.

These are what Ted Gayer may be saying about incomplete costs and is perhaps a reason why a carbon tax is much easier to implement.

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