by Judith Curry
David Montgomery has testified twice in the past few weeks on the economics of climate change. Lets take a closer look at his testimony, and at some of the critiques of his testimony.
Who is David Montgomery?
I found this biosketch:
Dr. W. David Montgomery is Vice President of CRA International and co-head of CRA’s global Energy and Environment Practice. He is an internationally recognized authority on economic issues in climate change policy, and was one of the first contributors to the academic literature on emission trading, for which he received the Association of Environmental and Resource Economists 2005 award for a “Publication of Enduring Quality.” Dr. Montgomery was a Principal Lead Author of the IPCC Second Assessment Report, Working Group III, and has authored a number of peer-reviewed studies of climate change policy over the past decade. He also advises major energy companies on incorporating future climate policies in their strategic planning process.
Prior to joining CRA, Dr. Montgomery held a number of senior positions in the United States Government. He was Assistant Director of the U.S. Congressional Budget Office and Deputy Assistant Secretary for Policy in the U.S. Department of Energy. Dr. Montgomery has a Ph.D. in economics from Harvard University, and has taught economic theory and environmental economics at Caltech and Stanford University.
His c.v. with publication list is here.
Hearing on Climate Change: Examining the Processes Used to Create Science and Policy
Climate change is a global phenomenon driven by global emissions. Concentrations of greenhouse gases in the atmosphere are what matter, not emissions in a single year, and these concentrations change very slowly. Stabilizing global temperatures at any level requires ultimately reducing carbon dioxide emissions from energy use to near zero. To avoid unnecessary economic harm, policies must involve comparable efforts by all countries, mandates for emission reductions must not get out ahead of technology readiness, and effective R&D policy is essential.
Reducing greenhouse gas (GHG) emissions will have a cost. All the comprehensive economic models used to study past proposals have agreed on this point. Model results do differ about the size of these costs, but the differences stem from the models‟ varied assumptions about future technology and the effectiveness of a global emission trading system. All models also find that the deeper are the emission cuts, the higher is the cost of making them. Some recent studies that make claims to the contrary have recently garnered undue public attention, but the fact remains that regulatory or cap and trade policies will not lead to a net increase in U.S. jobs, nor will they create conditions for a U.S. clean energy industry able to compete more effectively in global markets.
Studies that purport to show that GHG controls will produce these outcomes make a number of common errors. To be sure, if fears about climate change are correct, curbs on GHG emissions will have some benefit. But the harm to the U.S. that can be avoided directly by U.S. action is often greatly exaggerated. Most of the damage from climate change will occur in countries without adequate public health systems and with poor, undernourished and unempowered populations. Four points are crucial to keep in mind. First, if the U.S. were to act without solid assurance of comparable efforts by China, India, and other industrialized countries, its efforts would make almost no difference to global temperature, especially if industrial production and associated emissions are simply exported to other countries. Second, even global action is unlikely to yield U.S. benefits commensurate with the costs it would incur in making steep GHG emission cuts. Third, globally, even with moderate emission reductions, benefits would not be much greater than costs, and, fourth, conflicting economic interests will make international agreements on mandatory limits unstable.
Response from Paul Baer
Real Climate Economics has posted a response to Montgomery’s testimony by my colleague at Georgia Tech, Paul Baer, entitled “Why is the conventional wisdom of climate economics so pessimistic?” Some excerpts:
First, Montgomery holds two beliefs that are in tension: one, that capital and labor markets are “efficient” and can be assumed to be generally at equilibrium at times of “normal” economic growth (that is, profits are being maximized and labor is receiving its marginal product), and two, that there is an unpriced externality to GHG emissions. He claims that since investment in pollution regulation MUST have lower private returns than available alternatives (otherwise it would be done already by rational firms), therefore labor productivity, total wages and total economic output must all fall if the quantity of allowable emissions is reduced by regulatory fiat. However, if there is any externality at all, by definition social welfare can be improved by internalizing it. This will lead to a drop in output in the industries affected, and to a drop in the wages and profits in that industry, but again, overall welfare – something that includes, but is not limited, to economic output (GDP), will go up. On average, workers and everyone else will be better off. . . How those gains are distributed is another question, of course. But those gains can be real and potentially significant, especially if one considers other co-benefits of emissions reductions.
Second, Montgomery assumes that nations do in fact – and normatively should – balance their own economic costs of emissions reductions against only their own benefits from avoided damages, not global damages. He describes this as an appropriate empirical characterization of what countries do, and normatively justifies it on the basis that if that’s what a country expects other countries to do, it would be useless and thus normatively unwarranted to do otherwise. This is importing game theoretical reasoning, and ignoring the possibility that other normative reasons to want to act justly or virtuously might be warranted. Crucially, however, the basic theoretical framework makes it perfectly possible for a nation to incorporate the well being of non-citizens into its own domestic welfare function, and whether to do so or not is a choice, not a fact. The importance of course is that if one believes – as Montgomery apparently does – that countries cannot be persuaded to empathically value the well being of those harmed by their pollution, then pessimism about global cooperation is inevitable. However, some level of other-concern is plainly evident; what role it may yet play remains an open question, but it a place where one might find some possibility of hope.
Montgomery’s Testimony at the Hearing on EPA’s Greenhouse Gas Regulations and Their Effect on American Jobs
Montgomery’s testimony can be found here. His testimony responds to a recent report by Ceres/PERI that finds that investments to clean and modernize U.S. power plants will create significant new job growth. His testimony defies easy summary (by me anyways), here are excerpts from his summary:
I discuss how a study of green jobs released last month by Ceres and PERI gives a biased and incomplete picture of the effects of regulation and of how jobs are created. I also discuss estimates made with CRA’s MRN-NEEM model of the effects of EPA’s proposed greenhouse gas regulations on energy prices, employment and competitiveness.
These regulations undeniably raise the cost of doing business. Tradeoffs must be made between economic costs and environmental benefits in designing regulations, and pretending there is no cost does not help those deliberations.
The PERI study and its like predict job gains because they leave out of their calculations all the jobs lost in the rest of the economy because of regulatory costs. Indeed, the logic of the PERI report implies that the greater the unproductive investment caused by a regulation, the greater its impact on jobs. The result is absurd because the ‘logic’ upon which it is based is nonsense.
Using CRA’s models, even highly cost-effective greenhouse gas regulations plus the other pending regulations would increase wholesale electricity prices by 35 – 40%%, reduce average worker compensation by about $700 per year, and shrink coal, electricity and energy intensive sectors of the economy. Using Clean Air Act Authorities to create a system of command and control regulations will cost far more, because they are designed by bureaucrats who know next to nothing about the circumstances of individual businesses. Therefore, their orders cannot possible lead to the same cost-effective solutions that managers would find for their own businesses when facing a price on greenhouse gas emissions.
Response from James Heinz
Again at Real Climate Economics, James Heinz rebuts Montgomery’s testimony in this post. Some excerpts:
A central theme in Dr. Montgomery’s testimony is that regulations raise the cost of doing business. However, the discussion of costs should be framed in the appropriate context. Most economists would agree that pollution also represents an important cost, but one that is external to the decisions made by utility companies. Utilities with high levels of emissions are not paying the full cost of their activities, the rest of the population is. This is the standard economics concept of an externality (costs that are ‘external’ to economic decision-making) – a source of market failure, suggesting that government action can result in improved outcomes. The existence of such externalities directly influences investment decisions. Because utilities do not pay the full cost of their activities, there is a strong motivation not to invest in capital improvements which would modernize electric generation capacity in the U.S. Furthermore, the costs that businesses pay are not the only ones worthy of consideration. The regulations actually lower the costs that are currently paid in terms of health and environmental problems. Finally, Dr. Montgomery tends to assume that any capital investments in response to pollution control are unproductive. However, this ignores the supply side impacts of getting the incentives right – utilities will invest in capital improvements which have real impacts on productivity and efficiency, relative to the efficiency of out-dated plants. These productivity improvements will tend to lower costs.
Dr. Montgomery correctly argues that the job gains presented in the Ceres/PERI report would not be evident if the economy were operating at full capacity. There is no disagreement here: if the economy were at full-employment then you wouldn’t get a net change in jobs through regulations that correct market failures and improve incentives. This is by definition – full-employment means there is no extra labor to be employed. Moreover, when the economy is truly operating at full-employment, the resources needed for the kinds of investments behind the jobs estimates would have to come from somewhere else in the economy – i.e. there is the potential for crowding out. So, yes, if the economy were operating at full-tilt, with low rates of unemployment and no excess capacity, there could be something to this argument. However, the current reality is significantly different. Unemployment remains at historically high levels and one glance at the data on the financial sector from the Federal Reserve shows that lending has not recovered. Mobilizing idle resources through new investments does create jobs, since the resources were not productively employed in the first place.
Most economists would argue that investments should be channeled to uses that raise the productivity of the scarce factor of production (you get more bang for your buck this way). In the U.S. economy, labor is currently not scarce – with a 9 percent unemployment rate. What is scarce is non-renewable energy and the capacity of the environment to absorb pollutants over time. Given this, the right economic argument would be that we should channel investment towards activities which raise energy efficiency or reduce reliance on non-renewable sources of energy, and make the most of the environment’s capacity to assimilate pollutants in a sustainable way (e.g. through investments in pollution control). There are many ways to think of productivity – and we would be well advised to consider the productivity of our scarce energy resources when making policy choices.
JC’s comments: I think the issues raised by Montgomery’s testimonies are of critical importance on the global warming debate. I don’t really know how to evaluate merits of his arguments. I found Baer’s critique to be not very convincing, although I thought Heinz’s critique was much more convincing. Your thoughts? Other good references on this topic?