Arnold Kling  

The Economics of "Going Green"

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A reporter called me to give the "anti" side of the case for going "green." It's not hard. It is a matter of basic economics.

1. Suppose that a gallon of gas costs $2.50 and an hour of labor costs $10. If you are a business, then you should be willing to use an additional quarter hour of labor to save a gallon of gas. No more, no less. If it takes an additional hour of labor to save a gallon of gas, then the market prices are telling you to use the gas, not the labor.

2. If you are an anonymous, competitive firm, you have basically no choice. If you "go green" and use an additional hour of labor to save a gallon of gas, your competitors will drive you out of business. "Going green" only makes sense for a firm with some monopoly power and public-relations needs.

4. The best thing to do to satisfy the Green ideology is to choose the lowest-cost production method. Chances are, over time this will use less carbon fuels, and you can claim that your latest methods are "greener," when you are only doing what you would have done, anyway.

5. The next best thing to do is something very visible but only slightly inefficient. Secretly choosing an inefficient production process that cuts down on carbon emissions is not as good as doing something that has almost no impact on carbon but which is highly public. Burn coal in your manufacturing plant, but have your delivery trucks run on ethanol--and paint the trucks in striking colors that say "eco-friendly."

6. When you choose an inefficient production process in order to be "green," you are second-guessing market prices. You could easily go wrong. The input that you substitute for a carbon-based fuel could turn out to be produced by a carbon-intensive process. You have to substitute your scientific and engineering judgment, as well as economic computations and ethics, for what market prices are telling you to do. For all we know, the all-in carbon footprint (taking production methods into account) could be bigger for a Prius than for a Camry.

Once you stray from using market prices, you can have all sorts of unintended consequences. How many gallons of fresh water should you be willing to use up to save a pound of carbon emissions? Do you know how much more water is used in the manufacturing of biofuels compared with the refining of gasoline? The whole point of market prices is to do these calculations for us.

7. In theory, if government planners knew enough about the scientific, engineering, and economic properties of the economy, they could come up with the right tax on carbon fuels. Even though they do not know these things, the planners probably would be better off guessing on a tax than doing something that assumes even more fine-grained knowledge.


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COMMENTS (21 to date)
Stewart Ulm writes:

I think the beauty of this Hayekian logic is water off a duck's back for most people. It's a fantastic post even still.

Ironman writes:

As sharp-eyed readers have noticed, Arnold left off Reason #3. Your mission, should you choose to accept it, identify what the mysterious Reason #3 against going green might be!

Milton Recht writes:

Production costs do not adequately capture disposal, repair and part replacement "green" costs during the useful product life. These additional expenses can significantly increase the "going green" costs when included and in some cases show that the original process is more beneficial and eco-friendly than the "going green" process.

For example, compact fluorescent bulbs contain mercury, a neurotoxin and soil contaminant, while incandescent bulbs do not. The cost of properly disposing of CFLs to prevent mercury related illnesses and soil contamination exceeds the cost of disposing of incandescent. CFLs lower electrical use and their associated carbon output at the expense of increasing mercury contamination and side effects. These disposal costs (and possibly health costs especially for workers in high concentration areas such as garbage workers) are currently an externality not included in the purchase price of the more energy efficient CFLs. A correct comparison of the relative merits of incandescent bulbs versus compact fluorescents bulbs requires including these postproduction and post consumer use costs.

Hybrid and electric cars use batteries and sophisticated electronic components that are composed of heavy metals and toxic materials. In addition to the costs of proper disposal, auto accidents will potentially release toxic materials to the occupants, first responders, and the local community. The "green" costs associated with an accident are not part of the production costs or purchase price.

Likewise, hybrid and electric car parts will need replacement while the cars are still in use. A typical hybrid car may need to have its batteries replaced once or twice during its life. A "going green" process, even if adequately priced at time of production, will not be correctly priced for environmental effects after the "green" costs of replacements are included in its total costs.

Jayson Virissimo writes:

"As sharp-eyed readers have noticed, Arnold left off Reason #3. Your mission, should you choose to accept it, identify what the mysterious Reason #3 against going green might be!" -Ironman

Clearly, number three was so obvious he was able to leave it unwritten.

valter writes:

The issues raised in point 6 are crucial, but the rhetoric on market prices is misleading: The whole point of "going green" should be that one believes market prices do not reflect appropriately some kind of environmental externalities.

There is a real danger of doing more environmental harm than good by going from low-price-but-apparently-bad-for-the-environment production process A to high-price-but-apparently-good-for-the-environment production process B because we do not really know whether B is really (not just apparently) better for the environment - and sufficiently better to justify its extra cost.

But, if market prices do not already internalize the environmental externalities, then second-guessing them is the best thing an environmentally conscious agent can do.

P.S.
A side issue: if enough people start to second-guess the environmental cost of their goods, then this will have an impact on their prices which will become even noisier signals for resource allocation.

I guess this strongly suggests that the best thing to do is to go with points (7) and (6) together: let the government impose a full set of Pigouvian taxes based on current scientific evidence and then ask everyone to pretty please maximize their profits at current market prices without worrying about green.

Unless, of course, we think that the government is going to set Pigouvian taxes based on current lobbying budgets - in which case we can only throw our hands up in despair.

Ben writes:

3. 'going green' signals that profits aren't your primary concern; not good for investor confidence.

-perhaps?

Torben writes:

On the second point: You are correct IF the question is for a single firm. If you think about an industry going green or an economy going green, I think as long as relative costs remain the same economics doesn't in any way imply anti.... and the conclusion "ONLY makes sense for a firm with some monopoly power and public-relations needs" unwarranted.

Jeremy, Alabama writes:

That's too many words for a reporter and waaaay too many for an American. You should have gone straight to the fresh water quote.

Jody writes:

You are correct IF the question is for a single firm If you think about an industry going green

Substitution goods. *Everything* has substitutes, even if imperfect.

Jake Russ writes:

@Torben

Imagine all firms in a given industry go green. Assume all relative cost positions stay the same.

Society loses if the present value benefits of the green practices do not outweigh the present value of the additional costs for producers, consumers and the inefficiencies associated with the choice of being green.

Even in a hypothetical scenario where all firms go green, the fact that they all make this choice does not, by itself, make it the right choice.

Economics definitely makes a case for being anti-green, if the PVB are less than PVC, conditional on calculating benefits and costs accurately. Which I concede is a strong assumption.

mason_anton writes:

Torben writes:


On the second point: You are correct IF the question is for a single firm. If you think about an industry going green or an economy going green, I think as long as relative costs remain the same economics doesn't in any way imply anti.... and the conclusion "ONLY makes sense for a firm with some monopoly power and public-relations needs" unwarranted.

This seems like a zero-sum fallacy... there may be reasons to favor going "green" as opposed to being "anti-green" even if costs are the same. As Valter writes, "The whole point of "going green" should be that one believes market prices do not reflect appropriately some kind of environmental externalities"... so, until conclusive scientific data has the ability to determine the exact costs of not "going green" (thus pulling those externalities into the equation), cheaper will still trump greener... provided that people have perfect information (and that's no simple conditional).


It seems to me that due to the nature of the rhetoric surrounding "going green," whether or not "going green" is better, cheaper, more efficient, or even more GREEN, the American sheeple will likely follow the status quo--and that seems to be pro-green.

~Anton


Victor writes:

On the second point:
When the firm is "going green" its signalling to others that they care about the environment, this strategy may increase the demand for this firm products.

Justin Vallon writes:

So long as I am able to discard a CFL light bulb with no cost, there will be no incentive for me to consider the "cost" of disposal. However, I have (already) considered the cost of my own cleanup - if you have ever read the warnings or articles about mercury (esp from the EPA), you will understand that breaking a CFL bulb demands a hazardous materials cleanup.

The EPA argues that the mercury in a CFL is less than the amount of mercury saved due to reduced power consumption - but that is conditional on mercury-producing power. True green power would not produce mercury, and CFL is therefore anti-green as it contains toxins.

I think the only thing that the government should do is to prevent the back-doors of pollution. Do you want plastic? You need to clean up the by-products (down to bio-degraded, no environmental impact). Nuclear? Store the waste for 1000 years (pre-paid!). Gasoline? Pay to filter the junk out of the air. Emit CO2? Own some trees. Cigarettes? Contribute to a medical fund.

So long as externalities are just that, the economics will conclude that the externalities will ignored. An "eco-friendly" sticker signals that some externality has become internalized (in some respect), but it is not comprehensive due to all the untold secondary externalities (manufacturing of eco-friendly products, non-eco-friendly inputs, corporate jets).

Unless the environment can process what we are pumping into it or continue to regenerate what we take out of it, we will eventually reach a resource limit - pollution will build up and become a "real" problem, or the resource (water, land) will become scarce and also be a "real" problem. We should start pricing the cost of no-environmental-impact into our behavior before we reach that limit...

But, the next (economics) question is: Why should we? Is it better (optimal) to defer the cost until it might be catastrophic, or incur the cost now? Our markets won't be able to answer that question if we don't capture the true costs.

-Justin

Dan Weber writes:
if you have ever read the warnings or articles about mercury (esp from the EPA), you will understand that breaking a CFL bulb demands a hazardous materials cleanup
Argh. No, it does not. You should take care when cleaning it up, but you don't need any kind of hazmat tools.

I think we should do like bottle deposits for CFLs. $1 tax when you buy it, $1 paid by the state when you turn one in. (And instead of banning incandescents, they should have been taxed moderately. The same $1 tax would work, but you can't turn it in for $1 back.)

kebko writes:

#3 is to do what you always did, but change the narrative. For instance, I send large amounts of scrap paper to the landfill as part of my carbon sequestration program.

cjd writes:

#3 is indeed too obvious to state: "your customers don't want to pay for the increased costs of going green."

The corollary of which is just as simple: the only reason to go green is that your customers demand it and are willing to pay for it. That will indeed open up some market niches for smart investors.

For example, there are emerging green technologies for building new houses that will provide some who can afford it a snob and brag value in certain social circles that they will no doubt be willing to pay extra for.

Walt French writes:

Let's suppose further that each gallon of gas comes with $2 of external costs, currently imposed on all the world's population, but soon, due to (ahem) more complete markets that we're all fond of, to be borne by the carbon consumer.

Then, in order to maximize utility (profits) by understanding and adapting to the predicted new environment better, an even more rational business would invest some human capital, maybe even some equipment (e.g., Prius taxis) into unfamiliar technology that will be optimal, before the prices fully reflect the awareness of one's economic environment.

Contrary to what one might believe by looking at the many examples trotted out (say, on the Op Ed pages or in testimony to Congress) by business mouthpieces whose interest is dumping their sewage onto others -- a negative-sum game if there ever was one -- one doesn't have to be a troglodyte to enjoy the benefit of clear economic thinking!

Justin Vallon writes:

Dan Weber wrote:

Argh. No, it does not. You should take care when cleaning it up, but you don't need any kind of hazmat tools.
I am exaggerating, but see http://www.epa.gov/mercury/spills/index.htm. Why, as a "green" consumer, should I encourage a solution to an energy problem that entails the (risk of) exposure to such materials?

Use of a CFL may reduce mercury concentrations in the environment, but you need to compare that with the (non-zero) likelihood that a CFL will be broken, and there will be (non-zero) exposure to such materials.

Dan Weber also wrote:

I think we should do like bottle deposits for CFLs. $1 tax when you buy it, $1 paid by the state when you turn one in.
What happens to the mercury after you "recycle" it? Do you think you have paid for the reclamation of the mercury? Or, will it be cost prohibitive to reclaim such a small amount of material?

Embedded in the cost of the bulb should be a reclamation fee in addition to a high deposit (to discourage disposal). But, that is my opinion. I don't know how to translate the "zero-impact" goal into an economic argument (public goods, etc).

I don't understand the point behind a tax or a mandated reduction. If incandescent bulbs really do cost more (ie: total operating cost) than alternatives, it will fall out of favor. A tax is an artificial (political, societal, business) incentive, unless it is being used to reclaim externalities.

Dr. T writes:

"if you have ever read the warnings or articles about mercury (esp from the EPA), you will understand that breaking a CFL bulb demands a hazardous materials cleanup."

No, you will have read a scare-mongering piece of propanganda that is typical of regulatory agencies. The amount and type of mercury in a compact fluorescent light bulb is not enough to constitute a hazard, even if you consumed it (without the broken glass, of course). You would need the mercury from over 100 CFL bulbs to fill a mercury medical thermometer. I remember handling mercury in school science lessons: the droplet I had on my palm was 200-300 times what's in a CFL bulb. I somehow managed to survive the toxicity and become a physician and father.

Mercury can be toxic, but it isn't readily absorbed. It takes years or decades of continual low-level exposure before symptoms occur. The EPA has overstated the hazards of elemental mercury and is doing the public a disservice.

kebko writes:

Walt French,

Unfortunately, I do not share your clear economic thinking, because for the life of me, I can't come of with a reliable method for arriving at your $2/gallon external cost.

How do you know it's not $20 dollars, or 5 cents? (Many nations subsidize the cost of fuel. Does this indicate a negative price?) Does it change over time as the market changes like other prices, or is it set at $2 by the laws of nature?

green living writes:

On point 2. Surely these days any firm who can show green credentials can get some good publicity out of it , if they go about it the right way.

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