Infernal Ramblings
A Malaysian Perspective on Politics, Society and Economics

Green Incentives and Disincentives

Written by johnleemk on 8:41:24 am Jun 11, 2007.
Categories: ,

Today, I read a column in the newspaper advocating the use of "green carrots" — utilising carrots such as subsidies for green energy sources instead of sticks such as taxes for pollutants — to get the world out of its dependency on non-renewable, polluting sources of energy.

The column was written in response to the recent testy debate between world leaders about how the world should structure its policies in "greening" our economies.

While I admire the author's willingness to think out of the box, it is regrettable that the column does not consistently apply economic thinking. The author correctly notes that one common criticism of green policies is that they harm economic growth, so he suggests that instead subsidies be applied to foster such growth.

While this would probably result in an increase of gross domestic product in many countries, the GDP is far from an accurate indicator of economic growth (as evinced by the fact that if a natural disaster wipes out a town, the GDP indicates the economy has grown because of the economic expenditure burying the dead, healing the living and rebuilding the town).

Moreover, the author has forgotten to account for the opportunity costs of green subsidies. Every dollar spent on subsidising a "clean" energy source could have been spent on fighting malaria, curing cancer, or wiping out poverty. The damage to potential economic growth is no less real.

However, the fatal blow to this postulation that positive incentives are a free green lunch is that economic theory strongly suggests taxes, not subsidies, are what the present situation demands.

I was thinking about the example of fluorescent lightbulbs. Many policymakers have lamented that although these bulbs save people money in the long run, they are still reluctant to buy them (as a bird in the hand is worth two in the bush, so is a dollar today often worth more than two dollars tomorrow in the eyes of most people).

The simplistic solution would be to subsidise the bulbs, but this does not necessarily lead to the most efficient outcome. If we want to increase sales of fluorescent lightbulbs, then yes, by all means, let us subsidise them.

But that is not our end goal — our end goal is to move the world towards less polluting and more efficient uses and sources of energy. And the most efficient and effective route to that end goal implies a tax on polluting energy sources.

In the eyes of most economists, there is no point subsidising flourescent bulbs. People have already accounted for all the costs and benefits that accrue to society through using these bulbs, because there are no external costs or benefits. For the same reason, there is no point taxing incandescent lightbulbs.

What makes sense is to tax energy sources like oil and coal proportional to the damage they inflict to the environment, because this is a negative externality — an external cost — borne by society as a collective, not falling on the shoulders of the polluter. To internalise the externality, it stands to reason that we must tax pollution in proportion to the damage it does to society.

This reasoning is so impeccable that even economists like Harvard professor and former chair of the George W. Bush administration's Council of Economic Advisers Greg Mankiw support a carbon tax. (Mankiw has been roundly and perhaps unjustly criticised for, among other things, supporting a reduction in direct taxes and supporting trade to the point of approving outsourcing.)

Why do we need a tax? Because if we subsidise green energy sources, it is guaranteed we will be selective in what we subsidise; our decisions will be subject to interest groups and lobbyists (witness what happened to ethanol in the United States). Potential green energy sources which go initially overlooked by the government will not get subsidised appropriately.

If we tax polluting energy sources, however, then there is no loophole; people must now choose to move to green energy, and they individually decide for themselves what green energy source or usage is best for them. Different things are best for different people. Because there are no selective subsidies, the market will not be distorted.

The concept of "green carrots" is a tantalising idea. Unfortunately, it is also an unrealistic one.

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Infernal Ramblings is a Malaysian website focusing on current events and sociopolitical issues. Its articles run the gamut from economics to society to education.

Infernal Ramblings is run by John Lee. For more, see the About section. If you have any questions or comments, do drop him a line.

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