An Energy Bill with a Catch

Yesterday, a monumental energy bill was passed in the House. While liberals and conservatives are shouting out praise or disapproval, respectively, few have looked past party lines to gauge the real effects of the bill.

The bill is attempting to achieve one main objective which is a 17% reduction in economy-wide greenhouse gas emissions by 2020. The proposed strategy is a cap-and-trade system with large amounts of domestic and international carbon offsetting opportunities. There are provisions in the bill which will assist and mitigate the primary objective such as renewable energy requirements on utilities, energy efficiency incentives for consumers and businesses, grants for green jobs, and research and development on carbon sequestering technologies.

Though I support a bill to mitigate use of carbon-producing technologies, I cannot say with confidence that this bill will be able to achieve that. A system of cap-and-trade can be effective but is easily sabotaged with offset credits. The theory behind cap-and-trade (in this case) is that the government will set a limit on CO2 emissions that can be released into the air and then issue permits to businesses to pollute in the specified range. This provides economic incentives to businesses to reduce emissions for whom it is inexpensive to adopt cleaner air technologies. These businesses can then sell their permits to businesses that cannot easily adopt clean air technologies. So far so good. But then the offsets begin. This allows a business to pollute above their permit allowance so long as they invest in carbon offsetting activities. These carbon offsetting activities could be planting trees in Brazil to encouraging US farmers to adopt energy saving farming practices. Businesses will then invest in the offsets until the cost of offsetting reaches the cost of buying permits. The problem is that offsets reverse any intention and effect that capping has - i.e. it is the purpose of the cap to reduce emissions but offsets allow firms to pollute past the cap as long as they pay for it.


Economically, this makes sense. Those who pollute must pay. But the goal of the bill clearly specifies a 17% decrease in greenhouse gas emissions by 2020. If the goal is a reduction, then offsets will not help. If the goal instead is to increase the cost of polluting to reduce consumption, then cap-and-trade with offsets is the right system. it might seem that in both cases the reduction in emissions is realized, but in the first system, without offsets, the amount of emissions is set and final, while the with the offsets, the amount of emissions will depend on a multitude of factors such as firm's cost structures, elasticity of demand for that firms products, elasticity of supply of that firm, etc. And this is where it becomes complicated.

Further, though I have not done the research, it seems a bit far fetched to me that planting forests in South America will offset emissions released in the US. On average, maybe this is true, but this isn't statistics where the average rules. This is our air and I want the air I breath in the US to be clean, not clean "on average."

The Problem with the War on Drugs

There was once a time when Americans were concerned about issues other than the global economic meltdown and journal reported on sex, violence, wars, and drugs. It's the latter that I will touch upon today.

Basic economics classes, and even advanced, teach that a market looks like the diagram below with supply and demand having relatively similar slopes.
In this graph, when supply is shifted to the left (supply decreases), quantity will decrease and price will increase by roughly the same amount. Likewise, when demand is shifted left (demand decreases), both quantity and price decrease by roughly the same amount.

The graph below is what the market for illegal drugs looks like. It has a highly elastic supply curve and a highly inelastic demand curve. The demand curve is steep because of the high incidence of drug addiction which makes drug users relatively unresponsive to changes in drug prices.
In this graph, when supply or demand is decreased, price and quantity will change asymmetrically. This is essentially the problem of the war on drugs.

We must first identify the objective of the war on drugs, which I believe to be decreasing drug consumption in the US (rather than simply increasing the price of drugs). The US has chosen to accomplish this by attacking the supply of drugs. Money is spent checking for drugs smuggled in through ports and the borders, and helping fight drug wars in Mexico. The US government seems set on curtailing the supply of drugs in the US with the intended result of reducing consumption. Unfortunately, the market doesn't allow for such policies to work.

Take the market for drugs shown above. As the US tries to reduce supply, the supply curve will shift left and we will get the resulting graph. Notice that the blue-shaded area is much larger than the brown-shaded area. When you attack a market on the supply side with an elastic supply and inelastic demand, price increases dramatically with a very little drop in quantity. This is essentially what is happening in the US.
If, instead, the US were trying to reduce the demand for drugs, we would get a situation such as the graph below. Quantity and price would both decrease, but quantity would decrease many more times the decrease in price. As identified above, this is the supposed objective of the war on drugs.

So why doesn't the government do this? Well, it could be that it is harder to reduce demand than supply such that a dollar spent will decrease supply by 10 units but only decrease demand by 1 unit, and therefore we would see an inefficient use of money.

The government has implemented some measures to deter drug use such as increasing penalties for persons caught with drugs but it is hard to say if these penalties are working. Since people are risk-averse (even those that use drugs), an increase in the penalty will not deter drug use as effectively as an increase in the probability of getting caught. To increase the probability, the government must hire many more law enforcement agents, which is an expensive process. Though, putting stoners in jail or prison can't be too cost effective either.