Constraints vs. Complements

If you look at recent energy/climate regulatory plans in a lot of places, you’ll find an emerging model: an overall market-based umbrella (cap & trade) with a host of complementary measures targeted at particular sectors. The AB32 Scoping Plan, for example, has several options in each of eleven areas (green buildings, transport, …).

I think complementary policies have an important role: unlocking mitigation that’s bottled up by misperceptions, principal-agent problems, institutional constraints, and other barriers, as discussed yesterday. That’s hard work; it means changing the way institutions are regulated, or creating new institutions and information flows.

Unfortunately, too many of the so-called complementary policies take the easy way out. Instead of tackling the root causes of problems, they just mandate a solution – ban the bulb. There are some cases where standards make sense – where transaction costs of other approaches are high, for example – and they may even improve welfare. But for the most part such measures add constraints to a problem that’s already hard to solve. Sometimes those constraints aren’t even targeting the same problem: is our objective to minimize absolute emissions (cap & trade), minimize carbon intensity (LCFS), or maximize renewable content (RPS)?

You can’t improve the solution to an optimization problem by adding constraints. Even if you don’t view society as optimizing (probably a good idea), these constraints stand in the way of a good solution in several ways. Today’s sensible mandate is tomorrow’s straightjacket. Long permitting processes for land use and local air quality make it harder to adapt to a GHG price signal, for example.  To the extent that constraints can be thought of as property rights (as in the LCFS), they have high transaction costs or are illiquid. The proper level of the constraint is often subject to large uncertainty. The net result of pervasive constraints is likely to be nonuniform, and often unknown, GHG prices throughout the economy – contrary to the efficiency goal of emissions trading or taxation.

My preferred alternative: Start with pricing. Without a pervasive price on emissions, attempts to address barriers are really shooting in the dark – it’s difficult to identify the high-leverage micro measures in an environment where indirect effects and unintended consequences are large, absent a global signal. With a price on emissions, pain points will be more evident. Then they can be addressed with complementary policies, using the following sieve: for each area of concern, first identify the barrier that prevents the market from achieving a good outcome. Then fix the institution or decision process responsible for the barrier (utility regulation, for example), foster the creation of a new institution (to solve the landlord-tenant principal-agent problem, for example), or create a new information stream (labeling or metering, but less perverse than Energy Star). Only if that doesn’t work should we consider a mandate or auxiliary tradable permit system. Even then, we should also consider whether it’s better to simply leave the problem alone, and let the GHG price rise to harvest offsetting reductions elsewhere.

I think it’s reluctance to face transparent prices that drives politics to seek constraining solutions, which hide costs and appear to “stick it to the man.” Unfortunately, we are “the man.” Ultimately that problem rests with voters. Time for us to grow up.

2 thoughts on “Constraints vs. Complements”

  1. I agree with the goal here of pushing for explicit carbon pricing ( a carbon tax of some sort), but I think that the writer is perhaps being a little naïve.
    The last line sums it up: “Time for us to grow up.”
    For those of us interested in mitigating the global warming problems, growing up may also include becoming political pragmatists
    and students of empiricism, not just nicely simplified theory.

    To elaborate, Tom’s general sentiment is that economic theory should be allowed to run it’s course and price things appropriately, but I genuinely don’t believe that this is sufficient in practice, because there are so many other market barriers than generate a lot of noise in the price signal, and because voters and consumers are not economically literate enough to see this.

    That is not to say that I am in favor of LCFS and RPS – I’m not. Instead, I think that much of the most interesting work to do (perhaps at the state level in the US is to be the pioneers and testing grounds for what complementary policies work in each sub-sector, while the Feds figure out the political gumption to price Carbon high enough for there to be a discernable price signal.

    Ian.

  2. I guess it didn’t come out that way in my post, but I’m actually very much in agreement that price running its course alone is not going to do the job. I try not to drink the neoclassical kool-aid. Absent the right kind of complementary policies, the price signal would have to get punishingly high to accomplish deep cuts, and that probably wouldn’t hold up politically. I’d just like to see the states’ pioneering work focus on removing barriers and coordinating activity, rather than setting constraints. LCFS, RPS, etc. just create a proliferation of inconsistent and nontransparent shadow prices. I’d rather see things like getting state DOTs to back off on roadbuilding that’s inconsistent with ambitions for VMT reduction, working on local land use, creating institutions that can improve understanding of of energy decisions, and solving principal-agent problems among owners, tenants and builders.

    Some measures are probably even cultural: I’m currently in Beijing, and the car is now king here. Pedestrian crosswalks and lights seem to be meaningless – even city buses will run you down. It’s not clear what a price signal on carbon would do about that, until it became so high that there were noticeably fewer cars, so pedestrians and bikes could get around better. But some combination of transit, driver ed, traffic enforcement, design for pedestrian/vehicle separation would probably be pretty effective, and would be a true synergistic complement to fuel carbon pricing.

    I agree that it’s important to be pragmatic, but I also think it’s important to state what you think will work best, then look for a political avenue for implementation. The fact that we’re having a hard time getting a strong price signal doesn’t mean that technology and mandates will accomplish much without one. Rebound and other side effects ate up much of the CAFE gains and could easily do so again.

    Thanks for the comment.

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