The only way a community will be self-sufficient is if local goods and services are less expensive than their non-local equivalents. Because this is not currently a reality, in order to accomplish this task, the government would need to artificially inflate the economic costs of non-local goods and services through taxes. This has been done before in numerous economies and is called import-substitution. The problem with import-substitution is that it decreases the competitive environment of industry. As inefficiencies increase, disparities grow between the real prices of local and non-local goods and services. Once this occurs, the unofficial economy will find a way to bring cheaper , non-local goods into the local economy in order to correct the imbalance. This usually ends in a loss of tax revenue for the government, a monetization of government debt, and finally an implosion of the import-substitution system.
What I have realized (perhaps later than the rest of you) since writing my first blog is that the actual barrier to self-sufficiency is the recognition of only economic costs. Instead of artificially increasing price through regulation, an alternative method for implementing self-sufficiency would be to recognize “true costs.” But when I say “true costs,” I do not exactly mean economic costs + environmental costs. I believe that environmental cost is just another term for “unspecified economic cost.”
At this point, I imagine that most business managers, even if they don’t believe in climate change, would be willing to hedge their bets against its potential economic costs. In other words, they would be willing to pay a premium, however small, as “insurance” against the negative effects of climate change. I would argue that this premium is in fact, "unspecified economic cost" or “environmental cost."
This “insurance” and “premium” relationship is just another way to describe a call option. And I would argue that the premium on a Carbon call option is the environmental cost component of “true cost.” If U.S. businesses were provided access to such options, the cost of insuring against the potential costs of carbon usage would begin to be incorporated into prices, resulting in “true prices.” Does the U.S. government need to implement regulation to “create” a cost of carbon, or "carbon tax?" Not necessarily. Creating a private U.S. market for carbon options would make less carbon-dependent local businesses more competitive than non-local businesses, and would ultimately move local economies toward self-sufficiency.
I don't think I'm following the economic component of your argument at this point. What are these "call options"? How exactly are they incorporated into the price to become a "true price"?
ReplyDeleteThanks for your question, I probably failed to clarify a few things in my post, let me elaborate:
ReplyDeleteI’ll start with the concept of a call option. The owner of a call option pays an upfront “premium” in exchange for the right, but not the obligation, to purchase a stock (or commodity, etc.) at a specified price, on a specified future date.
For example, let’s say that the current price of one share of Apple stock is $100. If an investor believed that Apple shares were likely to increase to $150, such an investor might be inclined to purchase a call option on one share of Apple. That option would give the owner the right, but not the obligation, to buy a share of Apple in the future for, let’s say $125. If shares went up to $150, then the investor would get a good deal at $125. If shares stayed at $100, then the option would expire worthless, because the investor would not pay $125 for a share worth $100.
Now let’s switch one share of Apple for one unit of “Climate Change.” Let’s say that a business person wants to hedge their bets against the future economic costs of climate change. In another words, that business person would be willing to pay an upfront “premium” in order to ensure that their business prospects would remain unchanged, regardless of the effects of climate change. In an ideal world, that business person would simply go out on the private market and buy a call option on “climate change” with the specified future price equal to today’s price. If “climate change” went up in price in the future, the increased value of the option would offset the increased cost to the business. However, total costs to the business would increase, as the business would incur the cost of the option “premium.” Thus, the more “climate change” used by a business, the more money they have to spend purchasing options.
The courageous assumption I’m making in my argument for carbon options is that carbon is a proxy for “climate change.” That is certainly very debatable. However, I believe that the price of carbon will tend to increase, due to government regulation, as the negative consequences of climate change become more acute.
Your equating "climate change" and carbon credits to a commodity that can be bought, sold and optioned is VERY similar to what Enron did with energy. Part of the problem that led to Enron's downfall (and part of what I see as the problem with your idea of options on sustainability-related abstract ideas) is that there was no clear way to quantify what the value was of the various "assets" that Enron was trading.
ReplyDeleteIt's very difficult, if not impossible to place a specific economic value on intangible things/ideas like this. Those who try or choose to believe in the value of these types of "investments" are setting themselves up for one hell of a scary ride when the market as a whole begins to question the intrinsic value of these investments and start asking about what the investments (options) actually represent.
I'm honestly not sure if I completely understand (even after reading your comment clarification) on how the call option works.
ReplyDeleteHowever, I spent the summer in Oxford learning about climate change policy and the mechanisms that might work to help mitigate the problem. Have you considered the idea of carbon credits, taxes or a cap and trade program? All of these options have their pros and cons and potentially they may need to combine multiple policy mechanisms, but until something like this happens negative environmental externalities will continue to occur and people will continue to pollute because it is seen as a cheap way out.
Since I'm not worth much on the "call option" concept, I'll post on a different part of Brian's post:
ReplyDelete"The only way a community will be self-sufficient is if local goods and services are less expensive than their non-local equivalents."
Bravo!! This often gets overlooked in terms of making sustainable development realistic. Next:
"Because this is not currently a reality, in order to accomplish this task, the government would need to artificially inflate the economic costs of non-local goods and services through taxes."
Question: what about the tax breaks/benefits accorded to the oil industry (on everything from drilling equipment to extraction) that make fuel/energy cheap (and subsequently) non-local goods cheap? Before we artifically inflate costs, how about we first remove perverse subsidies?
Chrissy - Completely agree with you regarding eliminating tax breaks for oil companies. That wouldn’t completely solve the problem of local vs. non-local, but it’s a good place to start.
ReplyDeleteNikki – I’m a proponent of government policies like “cap and trade” and “carbon taxes.” However, I think the current political environment would make those ideas impossible to implement. That’s why I think it’s important to find a creative way to encourage private enterprises to move first, without the need for government regulation
Scott – Great work making the Enron connection, you’re correct in that Enron pioneered similar markets in energy trading, and even weather trading. However, I want to make sure to correct you on an important point. Enron did not collapse because the new markets it created were inherently unprofitable, risky, or immoral. On the contrary, former Enron traders are now successfully employed at other firms, where they perform the same very useful service of helping companies to hedge away unwanted risk. The difference between these trading activities now, compared to the Enron days, is that they take place is much more liquid markets. In this way, the market is allowed to determine the market price of “weather”, instead of Enron. That’s pretty much what I am proposing regarding carbon options.
This is easily one of my favorite posts yet. Nothing better than metrics, methods and science to debate over (obvious benefits of replicability, peer-review, near-objectivity).
ReplyDeleteA historical consideration: at least from what I've been exposed to, Import Substitution was typically trialed in the developing world (1960s-early 1990s) and had a heavy emphasis on indigenous Industrialization (Import Substitution Industrialization).
From what I understand, it didn't fail because of real price differences b/w local and imported goods; but, rather had more to do with economic stagnation that resulted from artificially increased currency valuation...which, in turn, hurt exports and subsidized imports (albeit in other sectors, typically). Local markets are rarely large enough to allow accurate price-signaling, and are especially disadvantaged when flooded with imported goods. I'm not quite sure that unofficial ("black") markets provide price-inefficient goods that crowd-out official-market goods; if, taking the real/true-price approach, the transaction costs related to smuggling -- limitations on scale economies, enhanced risk for legal violation, products often characterized by inelastic demand preferences -- might actually raise their monetary costs.
If by "unofficial economic costs" you're referring to externalities, then I completely agree with you. A huge debate in international forestry regulation regards methods for quantifying so-called "ecosystem services" generated by various aspects of varying forest ecosystems.
Also, I agree with you that most business managers would be willing to hedge their bets against the future costs of climate change; however, there are two things that worry me about that: (1) an insurance system related to this could cause a "moral hazard" problem; we've seen this with FDIC and econ-bust bailouts; (2) it seems improbable that the full cost of global warming (or other ecological catastrophes) could be accurately estimated/monetized...let alone to such an extent that individual sectors and business types could be distinguishable enough to be given competitive/equitable insurance quotes.
I also worry about local producers being unable to generate economies of scale, unless they're very competitive exporters. Otherwise, firms with both highly profitable scale economies and well-ordered supply-chains/logistics have a good chance of retaining market control. I like the idea of carbon/emissions taxes though...would really help to monetize the full transportation costs of imported products (but the process of deciding the tax-rate would still be arbitrary because of the above).
you know, Brian, you and I view things much differently. Actually, I should say that we were different lens to see things. Well, maybe the best way to say it is that we have different levels of knowledge in various topics that drives our way to the same means. While, I understood what you were saying (and agree with you at least theoretically), I could have only done that if I was at the top of my game for the day! haha! Anyway, I think you bring up some good points, but I wonder if privatizing the market wouldn't lead to other problems and which one scenario would be worse?
ReplyDeleteGood posts generate good comments. This is an example. Well done!
ReplyDelete"The only way a community will be self-sufficient is if local goods and services are less expensive than their non-local equivalents."
Only is one of those dangerous words like "all."
This may happen if oil costs continue to rise due to either increasing demand from the BRIC nations, population and consumption growth, or decreasing supply (or decreasing cheap supply). For example, if diesel cost over $5/gallon, what would happen to Wal-Mart's supply chain economics?
Another way this could happen is if local goods are deemed to be of higher value than non-local goods, stimulating their demand, or if a local form of exchange took precedence over the exchange of dollars. Many local businesses in Bloomington are supported by customers who are willing to pay more to know the people who provide their goods or services, which relates to the concept of social capital and the premium placed on perceived quality. Local businesses tend to support local suppliers, who are also their customers. The money circulates in a smaller loop and keeps returning to the local economy in a manner that may be more resilient to future oil or other global disruptions.
As for carbon options trading, have you looked at the history of the Chicago Climate Exchange? https://www.theice.com/ccx.jhtml
I had breakfast with the founders once to try to get my arms around the concept. They were a little ahead of their times, perhaps. The concept is sound. We may all wish we had a hedge against the rising cost of carbon someday.
Andrew had an interesting link in his blog that relates to your topic and perhaps your personal project: http://www.treehugger.com/files/2011/09/two-thirds-worlds-biggest-businesses-put-climate-change-central-to-strategy.php?campaign=th_rss&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+treehuggersite+%28Treehugger%29