Thursday, June 05, 2014

Greenhouse Gas Emissions and Becker's Household Production Theory

Gary Becker did seminal research on household production theory.  In this blog post, I would like to talk about household production theory and its relevance for thinking about decarbonizing our economy.   Paul Krugman has a tough blog post about Roger Pielke Jr. today and my post will link back to some of Dr. Krugman's points.

In Becker's basic setup, households gain utility from such producing such fundamental goods as "comfort", "quality children", "safety".    Households recognize that they face a finite time budget constraint and they have finite resources. Taking the market prices for commodities as given, they choose to allocate their time and their purchases of such market inputs as "furniture",  "energy", "private schools",  home structure, location, to maximize their utility.

How does energy enter into the Becker consumer setup?   Depending on the outdoor temperature, the household will need heating and cooling services to be "comfortable".  The amount of energy consumed will depend on the durable goods the household owns and the size of the home and the number of hours that people are in the home each day.

In the United States, many people have moved to the suburbs as they have sought larger homes, in better school districts, featuring less crime than in the center city.  The net effect of this suburbanization is to increase energy demand because suburbanites drive more and live in bigger homes.   Are you beginning to see the unintended consequences for household energy demand as a function of "quality" of lifestyle? The same points arise for commercial real estate as well.  

This microfoundation explains why all else equal that energy consumption rises with income.   Today, there is a lot of talk about the identity that;

World GHG emissions =  population * GHG emissions per $ of GNP per-capita  *  $ of GNP per-capita

Paul Krugman correctly notes that the middle term of this equation would fall sharply if every nation adopted a carbon tax of roughly $30 per ton of CO2.  Such a tax would incentivize both demand side and innovation responses.   Such directed technological change would mean that we could "have it all" in that the world economy could grow and the risk of severe climate change would fall.

The question Krugman can't answer returns to Becker's household production theory. For households who own fossil fuel cars and live in the suburbs and have "locked in" to an energy intensive lifestyle,  what will they lose in the short term and medium term by adopting a carbon tax?   There is a large suburban population who believe they should not have to pay for their past choices.   Holian and I document this in this paper.    To blunt this political opposition, moderate Democrats such as Mary Nichols of California's ARB are embracing a "go slow" ramp up of the carbon cap targets. The problem with this is that this relatively weak price signal will not induce innovation or behavioral change for a long time.  What happened to the "cold turkey" shock therapy approach that Jeff Sachs advocated in the 1980s in Eastern Europe?

If this case was a Gary Becker problem set, he would ask us to solve an expenditure function problem to calculate the minimum amount of $ that a suburban household would have to be transferred such that its well being was no worse off in the presence of the carbon tax than in its absence.   Complicating this problem would be the Becker and Ehrlich self protection function that the student would need to calculate the marginal benefits of reducing the risk of climate change in the future relative to the current extra marginal cost of facing higher prices for producing safety, comfort and transportation services.  This would be  a hard homework!  The student would need to wrestle with issues of discounting, uncertainty, risk aversion, durables adjustment, global public goods and free riding (i.e if the U.S raises its carbon tax will any other nations follow?).