Court Rejects EPA's Latest Rule for SO2 Emissions Trading. Where to Next?

Last week, the United States Court of Appeals for the District of Columbia rejected an EPA rule known as the Cross-State Air Pollution Rule (CSAPR). The rule was supposed to have gone into effect at the beginning of 2012, but the same court had previously stayed its implementation on procedural grounds. Last week’s ruling is the first to address CSAPR on its merits.

CSAPR governed emissions of sulfur dioxide (SO2) from Midwestern coal-fired power plants and other sources. SO2, along with oxides of nitrogen (NOx) and others is a precursor of acid rain, which causes widespread environmental damage not only in the states where the sources are located, but also those downwind. >>>Read more

Latest CBO Projections Underline Need for a Goldilocks Budget Deal

The latest analysis from the Congressional Budget Office (CBO) shows a sharp divergence between  a baseline projection and an alternative fiscal scenario for the U.S. economy. To put it in language a child could understand, the baseline projection is too cold while the alternative scenario is too hot. It is clear from the report that we need a Goldilocks budget deal to get things just right.

The CBO’s baseline assumes no changes in current law. Paradoxically, no change in the law would mean big changes in policy. That is because we are facing the so-called fiscal cliff–a set of measures that include  allowing the Bush tax cuts to expire as scheduled, making sharp cuts in Medicare payments to doctors, ending extended unemployment benefits, and allowing mandatory cuts to defense and nondefense spending to come into force. The CBO projects that those changes would shrink the budget deficit to about 4.0 percent of GDP, compared with a projected 7.3 percent for 2012. The deficit would decline to 1 percent of GDP by 2016. >>>Read more

Economists Should Love Paul Ryan’s Support of Policy Rules—but are they the Right Rules?

Economists love the idea of rules for monetary and fiscal policy. Many politicians hate them, preferring the discretion to do whatever seems like a good idea at the time. For that reason, if no other, economists should love Paul Ryan, an atypical politician who supports policy rules. But there is a catch—are the rules that Ryan backs the right ones?

Why We Like Policy Rules

Economists prefer rules to unlimited political discretion because they improve the chance that policy will be appropriate and timely.
Some of the reasons are technical. Lags in data collection and decision making make it hard to take monetary or fiscal policy actions until well after a problem begins to develop.>>>Read more

It’s Unanimous: All Indicators Show Inflation is Slowing, Even the Index of Sticky Prices

To no one’s surprise, today’s inflation numbers from the BLS showed that U.S. inflation is slowing according to almost every indicator anyone has thought to report. Seasonally adjusted monthly data for the headline consumer price index, the core CPI and the Cleveland Fed’s trimmed-mean CPI are running well below the Fed’s 2 percent target. The year-on-year versions of the same indicators are also falling, and are all now running at or below the target. . . .

 Continue reading the full analysis here; follow this link to view or download the latest inflation charts and data in a convenient, classroom-ready slideshow format.

Why We Should Repeal the Ethanol Mandate and Replace it With a Carbon Tax

During the debate over the Obama administration’s health care policy, Republicans came up with the catchy phrase “repeal and replace.” I’ll get back to health care in another post, but for now, I’d like to filch the phrase for the increasingly lively debate over the federal ethanol mandate, or Renewable Fuels Standard (RFS), as it is formally known. “Repeal and replace” is the right approach when a problem is real and existing policy addresses it in so a clumsy a way as to make it worse.

With every passing day of drought in the American Midwest, the outcry against the RFS grows louder. The latest to weigh in is Jose Graziano da Silva, Director-General of the Food and Agricultural Organization of the United Nations. Writing in the Financial Times, he urges the U.S. government to suspend the ethanol mandate, which is expected to consume up to 40 percent of the reduced 2012 corn crop. Otherwise, he fears, the world will approach a tipping point where further supply shocks could cause a global food crisis.

Worries about corn state votes have so far kept both major party presidential candidates on the side of ethanol, but opponents of the RFS also have significant support in Washington. Backed by livestock interests, among others, more than 150 members of Congress have urged the EPA to suspend the ethanol mandate for the duration of the drought. Some livestock producers are hoping that emergency drought-relief legislation will include a clause forcing the EPA to act.

Suspending the RFS for the duration of the drought is not enough, however. The ethanol mandate is bad policy that should be scrapped permanently. It should be replaced with a policy that directly addresses the problem of overconsumption of carbon-based fuels. A carbon tax on transportation fuels—or better, on all forms of energy—would be an excellent choice. >>>Read more

Choice of Ryan as VP Puts Tax Reform Back on the Table. How Will They Handle It?

I am thrilled by Mitt Romney’s selection of Paul Ryan as his running mate. I say that not because of its effect on the outcome of the election, which has yet to play out, but because it puts tax reform squarely back on the table.

Fixing the tax code is a two-part process that simultaneously lowers tax rates and broadens the base by closing loopholes. Those elements of reform are essential whether they are implemented in a way that increases revenue or is revenue neutral. Ryan has been very clear about the first element. He advocates a two-bracket personal income tax with 10 and 25 percent rates. He is not so clear about the second. In principle, he also endorses broadening the base, but he has refused to specify just which deductions, exclusions and preferences will have to go.

As long as he was just Congressman Ryan, head of the Budget Committee, he had a convenient alibi for his reluctance to be specific. As he told Fox News back in March, ““That’s what the Ways and Means Committee is supposed to do. That’s not the job of the Budget Committee.”

It was the old Wernher von Braun defense. In the words of Tom Lehrer’s song, “Once the rockets are up, who cares where they come down. That’s not my department, says Wernher von Braun.”

As vice-presidential candidate, Ryan will find it harder to use that dodge. The presidential team is supposed to lead, not sit back and wait for Congress to make back-room deals. If an interviewer or debate opponent asks just which tax breaks should go, there is no place for Ryan to hide, nor is there any place for Romney to hide, since he is the one who put tax reform back on the table by choosing the Wisconsin Congressman.

That brings us to Romney’s own tax situation. Things would be easier for the GOP team if his failure to release more returns indicated nothing more than a character defect, but that is not all that is at stake. As I argued back in January, Romney’s taxes highlight what is wrong with the whole system, especially the perverse way that high corporate tax rates interact with low personal rates on capital income.

Candidate Ryan is going to face frequent, pointed questions about his often-stated views on tax reform. How is he going to answer? I see three possibilities:

1.       “Don’t be frightened off by my rhetoric. We aren’t really serious about tax reform; we’ll be happy just to keep rates low for top earners and leave the rest of the system as it is.”

2.       “I was serious when I told The New York Tmes that ‘The tax code is patently unfair: many of the deductions and preferences in the system — which serve to narrow the tax base — were lobbied for and are mainly used by a relatively small group of mostly higher-income individuals.’ I stick by what I have said: the wealthiest Americans should pay an effective tax rate of around 25 percent, and that starts with my running mate.”

3.       “As a team, we’re serious about the concept of tax reform, but we’re going to let Congress fill in the details. If you’re among the 16 percent of Americans who think Congress has been doing a good job, vote Romney-Ryan!”

Somehow, all of these answers seem awkward, but Paul Ryan is a smart guy. Maybe he’ll think of something better.

Update: Since this was first published on Economonitor.com, the Romney campaign has issued a set of talking points that distances the campaign from details of the Ryan budget plan and includes extremely vague language on tax reform.

Will the Dutch Disease Kill Hopes Raised by Colombia's Free Trade Agreement?

After a torturous journey through Congress, the United States-Colombia Trade Promotion Agreement (CTPA), first signed in 2006, came into effect on May 15 of this year. The agreement has raised high hopes in Colombia, for which the United States is by far the largest trading partner. However, while the CTPA was fighting its way through a six-year obstacle course, a new threat to Colombia’s economy has emerged in the form of the dreaded Dutch Disease, which afflicts resource-rich countries in many parts of the world. >>>Read more

TEN BILLION: Return of the Population Bomb?

A generation ago—no, two generations ago, already—Paul Ehrlich scared us all out of our wits with his book, The Population Bomb. It turned out to be a bomb that we gradually learned to live with. Yes, it exploded—the world’s population did double between 1960 and 2000, the shortest doubling time in human history. No—it didn’t kill us.

As University of Michigan professor Donald Lam told us in a 2011 presidential address to the Population Association of America, the shift from large families making low investments in their children to small families making high investments in their children is a fundamental dimension of economic development that gives us reasons to be optimistic about the future.

Now the population bomb is back, this time in the unlikely form of a sold-out, one-man play, entitled TEN BILL10N, at London’s Royal Court theatre. I haven’t seen the play, but I would like to comment on the reviews, which, after all, are likely to be as influential as the play itself.


The thesis of the play seems simple enough. In the words of actor/scientist Stephen Emmont, “We’re f**ked.” Emmont, a professor of computational science at Oxford, goes on to tell his audience how we will be done in by the twin forces of overpopulation and climate change. More people eat more food, growing more food means more deforestation and transportation, more of those mean more CO2, more CO2 means more unstable weather, and so on.

The reviewers, including those in the Guardian (two reviews), the Independent, the Financial Times, and the New York Times, all take the play’s message pretty much at face value. More than that; they report being shaken by it. So, are we doomed? Or is a world population of 10 billion something we can handle? Here is what I think (condensed from a longer discussion in my book, TANSTAAFL.)

1. Yes, we have a big problem. Without adequate policies—ones that insist that polluters and resource users pay in full for all environmental impacts–our planet faces steady environmental degradation even without runaway population growth.
2. Yes, population is part of the problem. Population, at the margin, is not environmentally neutral. More people increase the urgency of adopting sound environmental policies. Past, smaller populations could find harmless places to dig up cheap resources and dump their wastes; future, larger populations will not be able to.
3. Yes, there is a need to act but no need to despair. The world's population, now 7 billion and counting, will not double again. The fearsome total of 10 billion or so people by the end of the 21^st century is projected to be the all-time peak. Demographic changes already in place guarantee that will be the case, barring an unexpected reversal of the near-universal trend toward smaller families. Given sound environmental policies, 10 billion people should be able to live together in a sustainable manner.

In short, we have the tools at hand to confound the mindless linear extrapolations that reviewers of the play found so frightening. I don’t know about the play itself, but there is no mention in any of the reviews of elasticity of demand, substitution in production or consumption, prices, or any other element of economic thinking. There is no suggestion that, in places where people are given the incentive, they find ways to use energy more efficiently, to change their diets, to cut back extraction and increase recycling. If we provide those incentives, the outlook changes.

True, the rational pessimist in me recognizes that market-based environmental policies are not politically popular. Too often that leaves us a choice between policies like ethanol subsidies or CAFE standards that are wildly suboptimal (which only adds to their unpopularity), or no policies at all. The lure of the free lunch is strong, even when it is free only in the short term, at the expense of our own descendants.

On the other hand, I am optimistic in the belief that market forces are not imaginary. They saved us in the past from the disasters we faced when we ran out of whale oil to light our homes and charcoal to fuel our blast furnaces. If we allow them to operate, they can save us again. Yes, that would mean unpopular measures like carbon taxes, highway user fees, and establishing property rights for ocean fisheries, but all of these have worked where tried. It is about time for each of us to take responsibility for our planet.

A slightly abbreviated form of this post was first published on Economonitor.

US Job Growth Improves in July but Unemployment Rate Rises a Bit

A recent on-line discussion of the Fed’s continued inaction in the face of worsening economic data included the following exchange of comments:

Commenter 1: When you got nothin’ but blanks left you just stand there with the gun and pretend you might pull the trigger
Commenter 2: Maybe Bernanke should just throw the gun

Now, two days after the Federal Open Market Committee’s midweek meeting, we get another weak jobs report. True, the BLS news release tries to put a good face on things, headlining a gain of 163,000 payroll jobs and reporting that the unemployment rate was “essentially unchanged.” A closer look at the numbers, though, shows that the report contains more bad news than good. >>> Read more

Follow this link to view or download a classroom-ready slideshow with charts of the latest employment data

Case Study in Supply and Demand: Will Fracking Enrich India's Guar Farmers?

The following post was originally published on Economonitor It is reproduced here for classroom use, along with a slideshow that demonstrate how the theory of supply and demand can be applied to events in the guar market. The slideshow is ready to cut-and-paste into your lecture. Follow this link for the classroom-ready slideshow.

A New York Times story last week featured a picture of a happy Indian farmer in his new house, a replacement for a miserable mud hut. His sister, a scarf modestly hiding her face from the photographer, extends her arm to show a new silver bracelet and ring. The house and the silver were bought with profits from guar, a crop for which India holds a global market share of 80 percent or more. The price of guar has soared recently, largely because it is a key ingredient in fracking fluid.

What is going on here? Will India’s near-monopoly of guar production be a lasting source of riches for India’s farmers? Will it be a lasting strategic headache for advanced economies, something like China’s monopoly of rare earth elements? A look at the factors behind the recent run-up in guar prices will show why the gains to India’s guar farmers are likely to be transient.


What on Earth is Guar?

Unless you are one of those health nuts who reads the list of ingredients on everything  you eat, you may never even have heard of guar. Guar is a small bean, Cyamopsis tetragonoloba, whose name means “cow food” in Hindi. In practice, though, not much is fed to livestock. Guar has other, more valuable uses in the modern world. It is the source of guar gum, a substance that forms a gel when mixed with water. Guar gum is a key ingredient of many industrial food products, from baked goods to ice cream, that need to retain moisture in order to have a long shelf life.

The ability of guar gum to form a gel also makes it useful in fracking. One of the environmental objections to fracking has been the reluctance of oil and gas producers to disclose the composition of the fluids they use for hydraulic fracturing of deep rock formations. (See this earlier post for a discussion of fracking and the environment.) The use of guar, which fortunately is nontoxic, has never been a secret, however. Halliburton alone, the leading supplier of fracking services, uses some 12 million pounds a month.

According to Halliburton CEO Dave Lesar, quoted by Bloomberg, guar gel can account for as much as 30 percent of fracking costs. From 2005 to May of this year, guar prices soared three fold to 35 cents a pound, helping to fuel a 25 percent increase in fracking costs last year, and further increases so far this year. Since May, however, guar prices have fallen back by half. What is behind the price volatility, and what lies ahead?

The Demand Side of the Market

When discussing demand, economists like to distinguish between the effects of price changes taken in isolation and the effects of structural changes that shift the relationship between price and demand over time—movements along demand curves and shifts in demand curves, if you remember that lecture from your Econ 101 course. The effects of price changes on the quantity demanded are measured by elasticity of demand—the percentage change in the quantity of a good demanded as the result of a 1 percent change in its price.

Guar is a good with no important final uses. As an input for industrial uses, is elasticity of demand depends on its share in total production costs, the availability of substitutes, and the elasticity of demand for the final products it goes into—oil, gas, and food products.

Together, those factors keep the elasticity of demand low. With regard to its use in energy production, demand for oil and gas is itself inelastic and there appear to be no good substitutes for guar in fracking fluid. Those considerations offset the fact that the share of guar in production costs, as noted above, is substantial. Demand for food products that use guar is more elastic than for oil and gas, and substitutes are available in some cases. For example, the U.S. company TIC Gums offers a product called Ticaloid GR4520 that it claims performs as well as guar gum for industrial baked goods, although at a somewhat higher cost. However that consideration is offset by the fact that guar accounts for only a small share of the cost common foods.

When elasticity of demand is low, short-run changes in market conditions can lead to large fluctuations in price, as happened in the guar market earlier this year. For example, according to a Reuters report, at least part of the price run-up in the spring of 2012 stemmed from Halliburton’s efforts to accumulate a 4-month stockpile to protect itself from possible interruptions of supply. Also, there were some problems in the futures market that led Indian regulators to suspend trading in March. Reports in the Indian business press suggested attempts to manipulate prices and corner the market. Those transitory influences have now passed, hence the recent decrease in prices.

In the long run, demand responds to trends that operate independently of prices. Over time, population growth and rising incomes throughout the world are likely to increase demand for both food and energy. For food, rising income typically brings substitution of industrial foodstuffs, including those that use guar gum, for home-cooked foods, that do not. At the same time, oil and gas produced by fracking seem certain to increase as a share of all energy. Fracking is as yet widely used only in the United States, but many other regions have oil and gas deposits that could potentially be tapped using the technology.

The Supply Side 

Assuming demand does hold up, the long-run prospects for Indian farmers depend on what happens on the supply side of the market. Key questions include how quickly supply increases in response to rising demand and where those supply increases take place.

In the short run, the supply of a farm crop like guar is moderately elastic. Within any region where guar is now cultivated, it can quickly be substituted for other crops that farmers would plant instead. Already Indian farmers have announced plans to expand acreage by at least a third for the fall harvest. True, actual yields will depend not just on the sown area but on the monsoon rains, which are late this year, so nothing is yet certain. To encourage risk-averse farmers to plant more guar, some Indian processors are promising a fixed income per acre planted regardless of the outcome of the harvest.

The more interesting question is whether India will maintain its large market share if prices continue to rise. India has a head start. Guar is a well established crop there, with varietals suited to the local climate. Farmers are familiar with methods of cultivation. There is a well-developed infrastructure to supply seeds, equipment, and processing services.

However, having a head start is a long way from having a natural monopoly. China, Australia, Argentina and the United States all have areas potentially suited to guar cultivation, and all now produce small amounts. Large-scale production has not been profitable at prices that have prevailed in the past, but a few years of higher prices would very likely change the situation. After a period of learning by doing, farmers elsewhere could certainly master guar cultivation. For example, one U.S. producer, West Texas Guar, Inc., has not only grown the crop, but is willing to share what it has learned about adapting guar to local weather conditions and farm equipment. The company even reports a bonus: when it rotates guar with cotton, cotton yields increase by some 12 percent.

The bottom line: Markets overcome monopolies when they are allowed to work

When we view the impact of fracking on the market for guar, it looks as if supply and demand are, in most respects, working as they should. In a widely cited paper Friedrich Hayek once described how the discovery of a new use for any good causes its price to rise. The price increase, in turn, sets of a cascade of substitutions in production and use, the discovery of substitutes for substitutes, and so on. That is what is happening in the market for guar now.

Much the same is true in the market for rare earth elements, where China has held a market share even larger than India’s share of guar. As discussed in this earlier post, China’s monopoly of rare earth elements is also being overcome by market forces. The difference is that the time scale is much longer for rare earths than for guar, because substitutes take longer to develop and because larger investments are needed to gear up production in new locations. The market for guar is capable of responding faster, so temporary shortages of that commodity have a much smaller strategic impact than recent shortages of rare earths.

However, there are some caveats. Markets are best able to do their job of overcoming monopolies when they operate in a favorable policy climate. Some policies, such as trade protection, overtly block competition, but even seemingly unrelated policies can have unintended consequences that are no less damaging.

Consider, for example, the effects of crop insurance. Already an established element of U.S. farm policy, crop insurance is likely to become more important as a result of the farm bill now working its way through Congress. Federally subsidized crop insurance protects farmers against both crop failures and low prices. In some cases, insurance coverage is so generous that—much to the dismay of conservationists—it is worth plowing up idle land to plant a crop that is certain to fail.
Since almost no one grows guar, there is no guar lobby to compete in Washington with the cotton lobby, the soybean lobby, or the corn lobby. With no lobby, guar is not covered by crop insurance, making U.S. farmers reluctant to plant it. As a result, when markets say “grow more guar,” the signal falls on deaf ears. Instead, farmers hear the siren song of subsidies, which say “grow more cotton,” even though the world appears to have enough, or more than enough, of that product.

In short, increasing demand for guar may be a modest boon to farmers in India; perhaps to farmers in Australia and Argentina; and perhaps even to U.S. firms like TIC Gums that produce guar substitutes. What is less likely is that Country and Western artists will, any time soon, be writing ballads about “them ol’ guar fields back home” in Texas.