Thursday, August 16, 2012

My OP-ED Piece about California's Anti-Carbon Legislation

The Sacramento Bee has published an opinion piece that I wrote with Bo Cutter.   We argue that California's AB32 (the legislation intended to sharply reduce the state's greenhouse gas emissions) is off to a good start.  While AB32 embodies many different rules and regulations, I view it as essentially creating a new set of "rules of the game".   Households and firms are continually making investment decisions.  Rational investors should anticipate that this regulation will tighten energy efficiency standards, fuel efficiency standards, and it will induce changes in land use patterns, changes in the pricing of electricity and changes in requirements for renewable power to be a larger share of the electricity mix.     Some households and firms will easily and happily adapt to these new rules while there are other households and firms who will face greater compliance challenges.    I am well aware that no regulation is ever a "free lunch".

I am a big believer in "induced innovation". This AB32 regulation will induce innovation that will "bend the curve".   I am highly optimistic that the combination of California smart engineers, entrepreneurs, venture capitalists and committed environmentalists  will co-ordinate through free markets to figure out next generation technologies for buildings, cars, power generation that uncouple economic growth form carbon dioxide production.  In the absence of AB32, there would not have been the "nudge" for the venture capitalists and the engineers to direct their scarce time and talents towards this sector.   In the absence of Federal legislation, we as a society need someone to be the "green guinea pig". As I have said many times,  the rest of the nation should thank California and send us a check for providing public goods (i.e new ideas) for the rest of the nation and world.

Since ideas are public goods, for those green ideas that are proven to be cost effective by California's field experiment, they can then diffuse widely and those ideas tried out under AB32 that fail can be scrapped and not repeated elsewhere.   Don't take my word for this,  here are some quotes from Paul Romer.

"But ideas can. Human beings, Romer says, possess a nearly infinite capacity to reconfigure physical objects by creating new recipes for their use. By coming up with new ideas on how to increase, say, the power of a microprocessor, humans can boost productivity, spawn new opportunities for profit, and ultimately drive economic growth.

And the great thing about ideas, says Romer, is that they are nearly limitless. "On the ideas side you have combinatorial explosion," he says. "There's essentially no scarcity to deal with." Take, for instance, all the possible bitstreams you can turn into a CD-ROM. The number, he notes, comes to something in the range of 10 to the power of 1 billion, virtually ensuring that we'll never run out of software to discover. "There isn't enough mass in the universe to make that number of CDs," he says. Romer argues that because the number of ways to rearrange an object and to create something of greater value is so vast, the prospects for economic growth are far greater than economists would normally have us believe."

As a society, we need more experimentation.  We need more modesty from our political leaders. They must admit that they "know that they do not know" what policies work and don't work.  Those who are too confident that they know "the true model" will never run an experiment because there is nothing to learn.
AB32 represents a type of field experiment.  The rest of the nation is the control group.  Under AB32, the Air Resources Board (ARB) is changing the "rules of the game" and we will see how California households and firms respond. The leaders of the ARB are well aware of California's unemployment rate.  They have the right political incentives to take steps to minimize any nasty employment consequences of tight environmental regulation.  The applied economists continue to debate the size of these effects.
Here are three relevant papers;

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