The Hayek club
Posted by Daniel Hall on December 5, 2007
There’s an interesting discussion going on in the blogosphere about what might constitute a conservative response to climate change. This got started by Jim Manzi’s argument at the American Scene against a carbon tax (actually any emissions pricing policy, whether a carbon tax or cap and trade), and in favor instead of a surge in technology development funding. Ryan Avent has responded at Gristmill (and on his own blog) that we can and should price carbon, and notes that it is odd that Manzi, a conservative, is arguing for an “approach to emissions reduction that favors the wisdom of central planning over market allocations,” (i.e., technology development over an emissions pricing policy).
Manzi has written a subsequent post that clarifies his reasons for opposing a carbon tax, and they essentially boil down to this: “It’s complicated! We won’t get it right!” To defend his opposition to a Pigouvian carbon tax he invokes Ronald Coase:
Ronald Coase’s lecture upon receiving the Nobel Prize in economics is very instructive. When discussing one of the two papers for which he won the award, The Problem of Social Cost, he had this to say:
I was exposing the weaknesses of Pigou’s analysis of the divergence between private and social products, an analysis generally accepted by economists, and that was all. … Pigou’s conclusion and that of most economists using standard economic theory was, and perhaps still is, that some kind of government action (usually the imposition of taxes) was required to restrain those whose actions had harmful effects on others, often termed negative externalities. What I showed in that article, as I thought, was that in a regime of zero transaction costs, an assumption of standard economic theory, negotiations between the parties would lead to those arrangements being made which would maximise wealth and this irrespective of the initial assignment of rights. … I tend to regard the Coase Theorem as a stepping stone on the way to an analysis of an economy with positive transaction costs. The significance to me of the Coase Theorem is that it undermines the Pigovian system. Since standard economic theory assumes transaction costs to be zero, the Coase Theorem demonstrates that the Pigovian solutions are unnecessary in these circumstances. Of course, it does not imply, when transaction costs are positive, that government actions (such as government operation, regulation or taxation, including subsidies) could not produce a better result than relying on negotiations between individuals in the market. Whether this would be so could be discovered not by studying imaginary governments but what real governments actually do. My conclusion; let us study the world of positive transaction costs.
Manzi goes on then to claim that what with transaction costs being so large an emissions pricing policy just won’t work. I think he overplays many of of the practical difficulties, but since Ryan’s post anticipated many of these arguments I’ll leave you to read it.
I want to object rather to Manzi’s disingenuous intellectual sophistry in ignoring the actual message of Coase’s quote. Plainly read, Coase is arguing that Pigou’s externality-solving tax is unnecessary when transaction costs are zero. However, a world with negative externalities and positive transaction costs — and there surely will be some transaction costs to any emissions pricing policy, even if I think Manzi exaggerates them — is exactly a world where the government is needed to intervene in order to produce the socially optimal outcome.
To be fair, Manzi does, after all, want to intervene; it’s just that he thinks we’ll be better off if the government intervenes to support technology development rather trusting that a pricing policy will optimally allocate emissions-generating activities towards their highest value uses, and gradually transform the energy-using system through the invisible hand. To paraphrase Ryan, this is a “conservative” position? Manzi shouldn’t get to so cavalierly dismiss the feasibility of pricing emissions without having to explain how the government is going to be able to pick exactly which emissions-reducing technologies to develop.*
Manzi’s mistrust of the ability of prices to effect fundamental changes in our energy systems flies in the face of another strong free-market advocate, Friedrich Hayek, who wrote about the miracle of disaggregated decision-making in his essay “The Use of Knowledge in Society“:
Fundamentally, in a system in which the knowledge of the relevant facts is dispersed among many people, prices can act to coordinate the separate actions of different people in the same way as subjective values help the individual to coordinate the parts of his plan. It is worth contemplating for a moment a very simple and commonplace instance of the action of the price system to see what precisely it accomplishes. Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes, the supply of all the things made of tin, and their substitutes, and so on; and all his without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes. The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all. The mere fact that there is one price for any commodity—or rather that local prices are connected in a manner determined by the cost of transport, etc.—brings about the solution which (it is just conceptually possible) might have been arrived at by one single mind possessing all the information which is in fact dispersed among all the people involved in the process.
Substitute “carbon” for “tin” and you have a superb, concise explanation of why an emissions pricing policy will be the most effective approach to reducing emissions. Count me as a member of the Hayek club.
*This blog has been absolutely insistent in arguing that there are strong economic justifications for investing in technology R&D that have to do with the positive spillovers that are generated by innovation. Because investors cannot privately capture the entire social benefit of their innovations — indeed, research suggests the social returns to innovation may be four times the private returns — the government should subsidize R&D, and in particular fundamental R&D (rather than deployment policies, which tend to be preferred by lawmakers who need to buy off special interests). However, this does not at all imply that an emissions pricing policy is not needed as the central feature of a cost-effective approach to reducing GHG emissions.