David R. Henderson  

Physics Applied to Economics

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When I teach my Energy Economics course, in the first problem set, one of the problems is the following:

Name an energy activity that the government is currently engaged in that you think should be eliminated and give your reasons why. Or name an energy activity that the government is currently engaged in that you think should be kept and give your reasons why. Or name an energy activity that the government is not currently engaged in that you think the government should be engaged in and give your reasons why. Do only one of these three. You will be judged on how well you make the case, not on whether I agree with you. Part of a good argument is sound, clear reasoning from premises. Another part is making sure your facts are right. Your argument may be moral or practical, or any mixture of the two. (Economic arguments are generally under the heading of practical). Your answer must also be well-written; that is, it must avoid grammatical mistakes such as misplaced modifiers, etc.

I do it early in the course for a few reasons:
1. To get the students writing something and having to make an argument;
2. To find out "where the students are." This helps guide me in future lectures;
3. To convince the students early that I won't bite their heads off it they disagree with me;
4. To give the students feedback on what a good argument is, good grammar, etc.

I also grade this one problem more leniently than the others.

One of the pleasures of grading their write-ups, whose word length must be between 300 and 700, is seeing them discuss things I don't know about and seeing them stating things in a fresh way that I had never thought of. This post is about the latter.

One of my students, Cyrus Anderson [he gave me permission to name him], criticized government subsidies to energy. This was the paragraph that I particularly liked:

I have been searching the web for the true nature of energy subsidies and all I can really ascertain is that the U.S. government is highly involved and in nearly every form of energy production in existence. I cannot tell which overall direction we are being pushed in, only that there is some pushing in nearly every direction possible. If physics is any indication, controlling an object by exerting force in every direction at once is a very inefficient way of controlling the movement of any body in motion. This is true for energy subsidies as well.


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COMMENTS (26 to date)
Daniel Kuehn writes:

I don't understand the metaphor or the conclusion of the argument.

On the metaphor: Surely we aren't simultaneously subsidizing and taxing anything are we? To the extent that we "tax" something its probably regulating something specific like emissions - so it's that component of the energy production that we are trying to internalize. But you don't see a subsidy for oil of 5% on one hand and a special oil tax of 5% on the other. That would be pushing in different directions. It seems to me (with exceptions for specific components like emissions) we are always pushing in the same direction: subsidizing more energy. Maybe that's wise, maybe it's not (maybe we should only be subsidizing more of a certain kind of energy). But I don't get what he means by talking about these forces working in opposite directions.

On the conclusion: Maybe I'm misunderstanding the conclusion but he seems to think it only makes sense to push on one clear energy activity. Why? I don't push the food market in one single direction. I buy all sorts of food. I've never thought of that as inefficient.

But I feel like I may be misunderstanding the argument.

Kevin writes:
Surely we aren't simultaneously subsidizing and taxing anything are we?

Would you really be that surprised if we were? I wouldn't.

Eric writes:

"Surely we aren't simultaneously subsidizing and taxing anything are we?"

Google "oil subsidies" and "oil taxes"

or

"tobacco subsidies" and "tobacco taxes"

to name just two.

Mark Bahner writes:
Name an energy activity that the government is currently engaged in that you think should be eliminated and give your reasons why.

To borrow a phrase from Homer J. Simpson (when asked which President was on a $10,000 bill):

"All of them."

Why?

To borrow from the wisdom of James Madison, "“I cannot undertake to lay my finger on that article of the Constitution which granted a right to Congress of expending, on...sources of energy...the money of their constituents.”

That's not 300-700 words, but when one uses the wisdom of men like Homer Simpson and James Madison, there isn't much need to use many words.

Bedarz Iliaci writes:

Mark Bahner,
The Govt with charged with general welfare. Thus anything that affects general welfare, the Govt is legitimately interested in.

In 18C, energy was not a matter of general welfare; it did not belong to the commanding heights of economy.

All sectors that belong to the commanding heights of the economy are and must be coordinated with the Govt. This is the reality which can not be wished away by theories or words in the constitutional since the constitution itself lays the charge of general welfare upon the Govt.

mike shupp writes:

Like Daniel Kuehn, I'm unpersuaded by the metaphor. Let me give an alternative: Government subsidies and proddings are analogous to blowing into a balloon. One hopes that the ballon grows in all directions (inflation!) without injury (depression!) until it reaches some preferred size, and yet until that point is reached the balloon will not actually move; it is bound by the blowers's lips.

I suggest the government takes an interest in growing all possible sources of energy, that it actually has no preferred options, and in fact wishes to maintain the current mixture of suppliers in more or less the same relative market status. I.e., government wants both energy growth and stability.

Jay writes:

If the government subsidises all forms of energy then -relative- prices will not change much. Hence it is "a very inefficient way" of conducting energy policy.

andy writes:

I was told that EU is actually considering subsidizing coal power plants. Reason? Private investors are scared to of the government created instability (look at the tax changes, emission trading changes, subsidy changes..it took germany a week to decide to close several power plants). And they need them to have some stability.in the grid.

Aaron Zierman writes:

Taxes do not always take on the form that most people think. Indeed, regulation itself is often the real burden, or "tax", placed on business.

The problem is, some sources of energy are highly taxed (both the traditional tax idea plus regulation) while others are subsidized. For example, oil in the first category, wind, solar and ethanol in the second.

It seems to me that the biggest driver in what is taxed and what is subsidized in the past 20 years has been the environmental lobby. However, I do understand there is a lot of discussion that can go into this topic that cannot be breached in such a short comment.

Joe Cushing writes:

That is an interesting way to look at it and the physics is true. That said, The US policies do not subsidize oil production. What they do is they offer to not take as much money from the oil companies through taxes if they explore for new oil. Other energies get actual subsidies where the government takes money from the people and gives it to the solar industry or the government uses force to get the people to spend money on other energy sources that they otherwise would not spend their money on, such as ethanol. Clearly the government is pushing away from oil but oil is such a dense and low cost source of energy that is persists.

MG writes:

I think your student's knowledge of economics would have positioned him poorly for advancement in the Civil Service or Politics, where: "We don't measure our success by results but by activity." (Sir Humphrey, Yes, Minister, The Compassionate Society).

However his knowledge of physics may have allowed him to see the way out. Newton's First Law would suggest that ONCE the force of the subsidy is applied (in any given direction), no additional force (subsidy) ought to be required to keep the initiative in motion...Unless there is a countervailing force (say, friction).

If what you want is to subsidize things forever, you may have to engage in the taxation/regulation of what you subsidize. The most controllable way to introduce friction is taxation (an intended idiocy) or regulation (an unintended one). Given the right amount of friction, you can now rest assure that your work (pun intended) is never done, and you will have to continue to exert the force (subsidy).

John Fembup writes:

"If physics is any indication, controlling an object by exerting force in every direction at once is a very inefficient way of controlling the movement of any body in motion"

I read "every direction at once" as an intentional overstatement, perhaps simply rhetorical. It's true however that the government both taxes and subsidizes many of the same things as the later comment on oil and tobacco points out.

It seems to me that the "physics" in such cases is less about controlling direction, and more about crushing. Anyway, crushing is consistent with my own general opinion of the effect of this kind of government tax-and-subsidy policies.

RPLong writes:

I think the metaphor is excellent and I am surprised by the fact that other commenters are objecting. One of the major (and, I thought, universally understood) problems with government is its tendency to punish and reward the same kinds of behaviors/industries/whatever, simultaneously.

To choose one of the most widely known examples, we have a corn subsidy that causes problems for sugar producers, so we make up for it with a sugar subsidy. Why is this surprising or controversial? Everyone understands this?

Gov't has been playing the energy game for a long time. Policy goes in fads: One year oil is evil, the next it is our savior. One year nuclear is better than coal, the next year coal is better than nuclear. "Green" energy is expensive and inefficient, so it must be subsidized. Simultaneously, we are engaged in trade policy that favors our oil companies.

As for the strength of the metaphor, assume your objective was to kick a soccer ball into the goal. What's the best way to do this: (a) Have one person try to kick it into the goal with a single kick, or (b) have the entire team circle the ball and kick at it from all directions at once?

Get it?

Daniel Kuehn writes:

On the oil tax/oil subsidy point - I'm not sure what you guys have in mind but it's important to keep gas taxes separate from oil subsidies. We tax gas as a sort of user fee for roads. That's clearly not the only use of petroleum, but it is a use that imposes a maintenance cost so we tax it. Same goes with a carbon tax if that ever gets off the ground. You are internalizing a specific externality. This seems very different.

Now we do have people talking about imposing taxes on oil profits, but that seems to me just people saying "we need to reduce these subsidies", right? They're talking about closing loopholes and credits and that sort of thing.

Roger McKinney writes:

Joe Cushing is right; the government does not subsidize the oil industry. Journalists and politicians have destroyed the meaning of the term subsidize by referring to tax deductions as subsidies. People interested in truth, honesty and economics should not take part in that attempt to fool people.

Business deductions against taxes are not subsidies.

However, the state directly subsidizes, using the correct economic definition, "green" energy.

Daniel Kuehn writes:

Roger McKinney -
Whether differential benefits come on the tax side or the expenditure side, economists refer to them as "subsidies". There is no practical difference. Usually these come on the tax side for political reasons (it's easier to get it passed). I don't know what media says, but I think the economist's approach is entirely consistent with truth and honesty.

Tracy W writes:

Kuhn: like others I find it quite plausible that the government is simultaneously subsidising and taxing the same thing. Governments are not monolithic entities.
See for example http://www.telegraph.co.uk/news/worldnews/europe/9844395/MEPs-plan-tobacco-subsidies-as-Brussels-fights-smoking.html

As for the food market, government intervention in the energy market extends beyond its own purchases and sales. The government often intervenes with a particular grander outcome in mind, such as "cutting greenhouse gas emissions". If the government has conflicting policy goals (eg "energy independence" versus "poor being able to heat their homes in winter"), the logical thing to do would be to decide which goal is the most important, and spend money (or tax) based on that goal. However, governments tend to try to achieve both goals, and wind up wasting money pushing against each other. It's a government failure, the failure to confront trade-offs.

~FR writes:

It may be an inefficient way to control energy subsidies, but it yields the maximum opportunities for rent-seeking, graft, and corruption.

Paging Professor Buchanan to the courtesy phone...

Daniel Kuehn writes:

Tracy W -
Since when do we as economists decide what goal is the most important?!?

Isn't the whole point we need to think on the margin - that multiple goals is just fine and we make tradeoffs on the margin?

This: "the logical thing to do would be to decide which goal is the most important, and spend money (or tax) based on that goal. However, governments tend to try to achieve both goals, and wind up wasting money pushing against each other. It's a government failure, the failure to confront trade-offs."

Does not convince me you know how tradeoffs work.

JKB writes:

When I was in government and became something of a regulation geek, I discovered I could with enough effort find a regulation that said I could do something or one that said I couldn't depending on my desires. The only real risk was someone higher up in the food chain devoted to the other rule. Fortunately, most didn't know the regs very well so you could make your argument with citations and they'd leave you alone.

But what Cyrus has discovered is what I'll call the Theory of Technocratic Guidance. A subsidy is applied to push a policy in one direction, then later the technocrats want to slow the movement or alter the direction so they apply another subsidy or, maybe, a tax. But they usually forget to turn off the first subsidy so they must apply a larger force to stop the first subsidy's acceleration. Eventually they policy settles into a steady-state with, let's call them, "thrusters"(subsidies) acting in all ranges of motion. Sadly, often all are left firing at the same time. On occasion, the Technocrat will choose one to emphasize and thus seek an increase in that "thruster" which becomes the new base force in that direction, which eventually requires an increase in the others to compensate.

Now, notice that the theory operates as if this all happens in null space with no dominant external natural forces, such as the market to create a natural equilibrium. If recognized, such a thing as the market, would logically dictate that a "thruster" wouldn't have to be counteracted but rather simply turning it off. This would permit the natural forces to return the system to its natural equilibrium, but the technocrat has no faith in nature's balance. Actually, they see such a natural state as a threat to their control of the remote should people come to accept the balance of natural forces and no longer look to them for guidance.

Foobarista writes:

A useful Ronnie quote:

If it moves, tax it. If it keeps moving, regulate it. If it stops moving, subsidize it.

Mark Bahner writes:

Bedarz Iliaci writes:

The Govt is charged with general welfare. Thus anything that affects general welfare, the Govt is legitimately interested in.

James Madison begs to differ. And he being the Father of the Constitution and all, I've gotta go with him on interpretation of the General Welfare clause. ;-) Plus, his argument is very persuasive: he points out that the same general welfare clause was in the Articles of Confederation, and nobody thought the general welfare clause of the Articles of Confederation conferred any sweeping power (such as you and others propose) to Congress.

Here is a quote from a Madison letter to Edmund Pendleton in 1792 (bolding added for emphasis):

"Having not yet succeeded in hitting on an opportunity, I send you a part of it in a newspaper, which broaches a new Constitutional doctrine of vast consequence, and demanding the serious attention of the public. I consider it myself as subverting the fundamental and characteristic principle of the Government; as contrary to the true and fair, as well as the received construction, and as bidding defiance to the sense in which the Constitution is known to have been proposed, advocated, and adopted. If Congress can do whatever in their discretion can be done by money, and will promote the General Welfare, the Government is no longer a limited one, possessing enumerated powers, but an indefinite one, subject to particular exceptions. It is to be remarked that the phrase out of which this doctrine is elaborated is copied from the old Articles of Confederation, where it was always understood as nothing more than a general caption to the specified powers."

I assume you got your interpretation of the General Welfare clause either from your childhood education or the media. In any case, some advice from Malcolm X:

"Oh, and I say it again, you've been had. You've been took. You've been hoodwinked. Bamboozled. Led astray. Run amok!"

P.S. The Founding Fathers (with the exception of Alexander Hamilton, that sneaky monarchist!) would probably would have been appalled by the use of the phrase "commanding heights" with respect to the power of the federal government to interfere in the economy and the lives of The People.

Alan Clift writes:

Sounds like diversification,which is good right?

We are taking about multiple forms of energy, each having a force applied to it. Not one energy form having multiple force vectors.

Bedarz Iliaci writes:

Mark Bahner,
The Govt can not be limited by words on a paper but by the understanding the powerful people have of these words, and what other people let them do.

The Constitution, by necessity, lets Govt do what it takes to promote General Welfare. For instance, the Govt may suspend fundamental rights in grave emergencies.

I do think that history shows Madison to be over-optimistic in regards to what his constitution could do to limit Federal Govt.

John Fembup writes:

@Bedarz, "I do think that history shows Madison to be over-optimistic in regards to what his constitution could do to limit Federal Govt."

That seems reasonable. History also shows that almost all republics before the U.S. was formed eventually became monarchies or "tyrannies". The delegates at the Constitutional Convention in 1787 were well aware of that historical fact.

In fact, Madison's own notes of the Convention reflect some speculation among the delegates as to how long the republic they had created would last. As I recall, the longest estimate was 150 years.

1787 + 150 = 1937.

Close enough, yes?

Tracy W writes:

Daniel Kuhn: The problem with governments is that they often don't make trade-offs.
Take the case of tobacco, as being simpler than energy. And simplify further. Assume that on the one hand you have the goal of reducing people dying from lung cancer. On the other hand you have the goal of avoiding tobacco farmers going bankrupt and leaving their farms.

Now there's a trade-off between reducing consumption of tobacco and increasing consumption of tobacco. If you confront it, and you decide that the health goal is more important, then you might decide to tax tobacco, but tax it less than you might if you didn't care about farmers going bankrupt - give farmers more time to adjust.
Conversely, if you decide the bankruptcy goal is more important, you might decide to subsidise tobacco, and not tax it, but subsidise less than if you didn't care about the health goal at all. That's making the trade-off on the margin.

But what governments often do is fail to make the trade-off. Instead they like to be seen to be doing something. So when potential voters write to them about the high cost of lung cancer, they can point to the tobacco tax, when they get letters complaining about the struggling rural economy the politicians can point to the subsidies.

And overall people are worse off, as they are paying more in taxes to cover the subsidies, they're getting more smoking and thus lung cancer, and they're paying for civil servants to administer both the subsidies and the taxes. Plus there's the private sector regulatory costs.

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