humani nil a me alienum puto

random rants about news, the law, healthcare law, economics and anything I find amusing

Friedman Talks about Externalities – No Drill Baby Drill

I love it when someone talks about externalities.  I’m twisted that way.  It gets me going.

As long as I’ve been reading his column, Friedman has continually hit the drum beat for us to recognize the true costs in our use of energy.   The price we pay for our carbon based energy is not fully loaded.  In his article today, he gives us some examples of how we miss these externalities, while he talks about the energy and conservation policies of one of our neighbors to the south.

[I]f a chemical factory sells tons of fertilizer but pollutes a river — or a farm sells bananas but destroys a carbon-absorbing and species-preserving forest — this is not honest growth. You have to pay for using nature. It is called “payment for environmental services” — nobody gets to treat climate, water, coral, fish and forests as free anymore…Right now, most countries fail to account for the “externalities” of various economic activities. So when a factory, farmer or power plant pollutes the air or the river, destroys a wetland, depletes a fish stock or silts a river — making the water no longer usable — that cost is never added to your electric bill or to the price of your shoes.

In fact, there are hidden costs in almost every market.   Many items in a our markets have significant positive and negative externalities.  Friedman provides examples of negative externalities above: the classic example of pollution needing to be recognized in the ‘true’ cost of a product.  But there are also positive externalities.  Accessible public eduction, for example, is the most profound one that has reshaped the United States and our civilization.  If not subsidized through taxes, far fewer would receive education to the detriment of society as a whole.  Tax payers paid more today for a benefit that paid dividends a decade or a generation later.

The bottom line of all this is that if you do not recognize the real cost or benefit of goods and services in a market you will over utilize certain goods and under utilize others.  So, what are we to do if energy markets contain significant externalities?  Well, you and I can’t do much.  We, individually, are  incapable of recognizing these true costs since they are spread out to everyone and energy costs are bundled into just about every downstream derivative product or service we utilize.  Oh sure, a many of us can take actions such as “recycling” and using canvass bags and, maybe, use those lousy fluorescent bulbs to a point.   Stuff that makes us feel good — and it might help to a point.   But externalities have to be addressed systemically — because they are a systemic market problems.

Please do not misunderstand me.  No one should be taking the position that individuals or energy corporations are acting irresponsibly.  Quite the contrary.  They are acting rationally.  It’s the market that’s out of whack.  The objective of a corporation is to maximize return to shareholders within legal constraints.  They have no requirement to identify the true cost of an item to others unless there is some legal contraint that they do so, be it tort law or some regulatory regime.   In fact, if they can arbitrage by exploiting unrecognized externalities, then not only will they, but they must due to their legal directive to shareholders.  And if they do not and their competitors do — they’ll risk being driven from the market.  And you and me, while individuals are as diverse as can be, number in the billions.  In the aggregate and in the longer term, we react en mass to price signals that a market provides more than any other factor.

So, what’s to do?  Well, identifying significant distorting externalities is a core responsibility of government. Friedman gives the example of Costa Rica in his article.

More than any nation I’ve ever visited, Costa Rica is insisting that economic growth and environmentalism work together. It has created a holistic strategy to think about growth, one that demands that everything gets counted.  So it did something no country has ever done: It put energy, environment, mines and water all under one minister… [W]hen Costa Rica put one minister in charge of energy and environment, “it created a very different way of thinking about how to solve problems,”…‘Look, [the minister was able to say,] if you want cheap energy, the cheapest energy in the long-run is renewable energy.  So let’s not think just about the next six months; let’s think out 25 years.’”… [A]nd today it gets more than 95 percent of its energy from these renewables.

So does this mean taxes?  Sure.  Be it direct or a cap and trade system, it’s about taxes.  See Friedman’s article earlier in the week.  We tax a lot of things due to their externalities.  We already tax gas in part because of this in order to maintain roadway infrastructure — which use of gas impacts.  The important point that, if done correctly, and that’s a big ‘if’, the net cost to everyone is far less over time than the cheaper fuel today.

To pay for these environmental services, in 1997 Costa Rica imposed a tax on carbon emissions — 3.5 percent of the market value of fossil fuels … If government policies don’t recognize those services and pay the people who sustain nature’s ability to provide them, things go haywire. We end up impoverishing both nature and people. Worse, we start racking up a bill in the form of climate-changing greenhouse gases, petro-dictatorships and bio-diversity loss that gets charged on our kids’ Visa cards to be paid by them later. Well, later is over. Later is when it will be too late.

I think we’ve finally moved away from the question of whether there are significant externalities in the energy products sector.   You don’t really have to look to ‘global warming’ for this.  You need only realize that carbon based fuels are a finite supply and a critical resource.  The demand/supply curve very possibly will not price the commodity in gradual manner to encourage the infrastructure development to move away from it.  So it’s a pay me now or pay me a lot more later question if sudden price distortions hit the market and then stick around, unlike the 1970s and last year.   So, in any event, we’re finally onto the policy questions:  (a) how big are these unloaded costs and (b) what mechanism or mechanisms do you use to incorporate the true price into these products.

The first is a function of policy choices relying upon terribly incomplete data.  How big is the global warming problem?  What is the probabilities related to loss of GNP in the future due to global warming?  What’s the potential costs of politically fragile regions holding so much of the word’s supply of carbon based fuels?  Carbon based fuels are finite — what is the realistic time frame that they will remain economically cost effective?  Will pricing really gradually rise to encourage alternative development or is the infrastructure costs so huge that we have to encourage significant R&D and infrastructure alternatives earlier?  What effects would major disruption have on supply, the cost of oil and related GNP growth stability?  These are really meaty questions without hard answers.   But we have to make policy judgements on these types of unknows all the time.   Insurers do this every day — they figure out potential costs and probablities of poutcomes and attribute premiums accordingly.  (AIG’s credit swaps, perhaps, excluded. )

And practically, what mechanism is politically possible to pass through Congress?  Can we articulate why we are choosing those mechanisms and the underlying issues.  These are really difficult policy decisions.  And vested interests (and you and me who might not understand why higher prices today mean for much lower overall cost tomorrow) have the ability to block rational policy making.  Still, like Friedman, I remain hopeful.

via Op-Ed Columnist – (No) Drill, Baby, Drill – NYTimes.com.

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Op-Ed Columnist – Greed and Stupidity – NYTimes.com

Brooks believes that there are two overriding narratives that we must pick from to explain the current mess: (1) evil oligarchs took over the financial sector and lubed the wheels of power to allow them to get too big and too leveraged, (2) bankers suffered from an extreme lack of epistemological modesty.

There are many theories about what happened, but two general narratives seem to be gaining prominence, which we will call the greed narrative and the stupidity narrative…The best single encapsulation of the greed narrative is an essay called “The Quiet Coup,” by Simon Johnson in The Atlantic…Wall Street got huge. As it got huge, its prestige grew. Its compensation packages grew. Its political power grew as well… The result was a string of legislation designed to further enhance the freedom and power of finance… There were major increases in the amount of leverage allowed to investment banks…The U.S. economy got finance-heavy and finance-mad, and finally collapsed…In short, he argues, the U.S. financial crisis is a bigger version of the crises that have afflicted emerging-market nations for decades. An oligarchy takes control of the nation. The oligarchs get carried away and build an empire on mountains of debt. The whole thing comes crashing down.

The stupidity part of the equation is less paranoid, but just as disturbing:

The second and, to me, more persuasive theory revolves around ignorance and uncertainty. The primary problem is not the greed of a giant oligarchy. It’s that overconfident bankers didn’t know what they were doing… Many writers have described elements of this intellectual hubris… To me, the most interesting factor is the way instant communications lead to unconscious conformity… global communications seem to have led people in the financial subculture to adopt homogenous viewpoints. They made the same one-way bets at the same time…Jerry Z. Muller wrote an indispensable version of the stupidity narrative in an essay called “Our Epistemological Depression” in The American magazine. What’s new about this crisis, he writes, is the central role of “opacity and pseudo-objectivity.” Banks got too big to manage.

He believes that the latter is the the more compelling explanation, and cautions that if policy-makers believe it is the first, we might over-regulate by restructuring the financial sector.  In other words, he cautions against exchanging the hubris of Washington restructuring for the hubris of Wall Street.

The greed narrative leads to the conclusion that government should aggressively restructure the financial sector. The stupidity narrative is suspicious of that sort of radicalism. We’d just be trading the hubris of Wall Street for the hubris of Washington. The stupidity narrative suggests we should preserve the essential market structures, but make them more transparent, straightforward and comprehensible. Instead of rushing off to nationalize the banks, we should nurture and recapitalize what’s left of functioning markets.

He argues that we need regulatory controls to (1) ensure transparency, (2) reinitiate the separation between “savings banks, insurance companies, brokerages and investment banks”, and (3) ensure that the banks don’t get “too big.”

Hey, I’m in favor of all that.  But what other “restructuring” is really being contemplated?  Aren’t these the most serious and likely regulatory paths?  And when you are constraining growth,  forcing the downsizing of banking entities, or restricting what types of businesses can be integrated, isn’t that fundamentally about the “structure” of the financial sector?

Brooks contends that “one has to choose [among the two narratives] a guiding theory.”  But I don’t think I agree.  I think that both narratives get it partially right, and I think that Brook’s take on the correct regulatory outcome supports that thinking.   Many of the entities got too big to fail, the banking sector and policy-makers were complicit in both de-regulation and allowing this incredible growth of these huge transnational institutions, and these institutions created new markets with new instruments that looked like stocks and looked like insurance but were not regulated like stocks or insurance.   In the end, we (the bankers, the quasi-insurers, our policy makers, our federal reserve, our Congress, and ultimately all of us) were too stupid (or at least ignorant of history) to realize markets like these will cause systemic risk that can cause the whole house to crash down.  No pun intended.  The only way to address this systemic risk is like what came out of the Great Depression.  That is, a regulatory regime that provides transparency and forces individuals as well as institutions to have sufficient assets to secure the leverage that they have taken on.  This might be a gross simplification; the regulatory regime will be far more complex; but I think the principles are very much the same.

via Op-Ed Columnist – Greed and Stupidity – NYTimes.com.

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Op-Ed Columnist – Car Dealer in Chief – NYTimes.com

I think that Brooks has it wrong this time.  I agree that GM cannot restructure itself out of its current situation.  I agree that the Bush administration punted.  I agree that they should have — there needed to be preparation for the imminent bankruptcy.  I also disagree that this one has to remain a political football with Congress or the administration micromanaging GM’s bankruptcy process.   The administration needs to turf this to a real bankruptcy process and then get out of the way.  At the end of the line, it’s a fight between the financial stakeholders, not the politicians.  Throw the bondholders, unions, dealerships and other creditors into the pit (atop the corpse of shareholder equity) and see how it works out.

For 30 years, G.M. has been restructuring itself toward long-term viability. For all these years, G.M.’s market share has endured a long, steady slide…When the economy cratered last fall, the professionals at G.M. went into Super-Duper Restructuring Overdrive… The Bush advisers decided in December that bankruptcy without preparation would be a disaster. They decided what all administrations decide — that the best time for a bankruptcy filing is a few months from now, and it always will be…Today, G.M. and Chrysler have once again come up with restructuring plans…But this, President Obama declares, is G.M.’s last chance. Honestly. Really.No kidding…And yet by enmeshing the White House so deeply into G.M., Obama has increased the odds that March’s menacing threat will lead to June’s wobbly wiggle-out.  The Obama administration and the Democratic Party are now completely implicated in the coming G.M. wreck…The Midwestern delegations, swing states all, will pull out all the stops to prevent plant foreclosures. Unions will be furious if the Obama-run company rips up the union contract… The most likely outcome, sad to say, is some semiserious restructuring plan, with or without court involvement, to be followed by long-term government intervention and backdoor subsidies forever…It would have been better to keep a distance from G.M. and prepare the region for a structured bankruptcy process. Instead, Obama leapt in. His intentions were good, but getting out with honor will require a ruthless tenacity that is beyond any living politician.

via Op-Ed Columnist – Car Dealer in Chief – NYTimes.com.

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Op-Ed Columnist – Are We Home Alone? – NYTimes.com

In his New York Time op ed, Thomas Friedman thinks our political leadership is acting immaturely.  He believes that we are missing the bigger picture by riding a populist rage over the financial sector bonuses, and no one in Washington is showing adult leadership.  “There don’t seem to be any adults at the top — nobody acting larger than the moment, nobody being impelled by anything deeper than the last news cycle.”  He sees Republicans focusing on the AIG bonuses in a non-constructive, opportunistic way, and asks if they think that their “party automatically wins if the country loses?”  In addition, he thinks that the misplaced urge to “villify” persons like Geither will only lead to “ensure that no capable person enlists in government.”

But more than this, he thinks that Mr. Obama missed an important opportunity.  “[Had ]Mr. Obama given A.I.G.’s American brokers a reputation to live up to, a great national mission to join, I’d bet anything we’d have gotten most of our money back voluntarily. Inspiring conduct has so much more of an impact than coercing it.”

I liked the following passage, which summarizes, in my view, a prominent failure in the financial sector’s culture:

‘There is nothing more powerful than inspirational leadership that unleashes principled behavior for a great cause,’ said Dov Seidman, the C.E.O. of LRN, which helps companies build ethical cultures, and the author of the book ‘How.’ What makes a company or a government ‘sustainable,’ he added, is not when it adds more coercive rules and regulations to control behaviors. ‘It is when its employees or citizens are propelled by values and principles to do the right things, no matter how difficult the situation,’ said Seidman. ‘Laws tell you what you can do. Values inspire in you what you should do. It’s a leader’s job to inspire in us those values.'”

Of course, all this populist outrage does not fix the current mess.  It’s the absence of a clear plan to address the banking crisis that has allowed “all kinds of lesser issues and clowns [to ]have ballooned in importance and only confused people in the vacuum.”  But the “big issue — the real issue — [is ]the president’s comprehensive plan to remove the toxic assets from our ailing banks, which is the key to our economic recovery,” not punishing corporate executives, even those that are clearly receiving obnoxious bonuses that they should not.

Personally, I’m not sure we would not, in any event, have these “lesser issues” and “clowns” coming to the fore and distracting the policy debate.  I think there is such a pervasive sense that things have gone very wrong, that I am personally hurting, that my neighbor or family member is ‘really hurting’ through loss of home, loss of employment, and, certainly, loss of retirement savings, that outrage is real.  Let’s hope some adults can focus this outrage in a constructive way to establish some sound policy fixes.  I do hope, as Friedman concludes, that a Geither plan will be out next week, it will be specific and thoughtful, and the “president will pull the country together behind it” because “our country, alas, is not too big to fail.”    Edit Post ‹ humani nil a me alienum puto — WordPress

via Op-Ed Columnist – Are We Home Alone? – NYTimes.com.

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Op-Ed Columnist – Perverse Cosmic Myopia – NYTimes.com

Op-Ed Columnist – Perverse Cosmic Myopia – NYTimes.com.

“As a tiger sinks its teeth into the world’s neck, we focus on the dust bunnies under the bed…[Obama is trying to tackle the four most intransigent policy problems of our times and cannot address the immediate economic problem and the furor over the AIG bonuses]…risk[s] destroying the entire bank-rescue plan”

“[All this ]is not the most idiotic of the distractions…[A] core lesson of the Great Depression is that a global crisis calls for a global response…But the G-20 process is heading toward global impotence because the Europeans are dismissing this approach…The world is in flames and they want directorates and multilateral symposia…Many people used to wonder how the world’s leaders could be so myopic at various points in history — like during the Versailles Treaty or the turmoil of the 1930s. We don’t have to wonder any more. We get to watch the cosmic myopia replay itself in our own times.”

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