Friday, January 19, 2007

Oil Demand Elasticity

In the light of the story in column 5 of today’s Wall Street Journal, I’d like to amend my application for membership in Greg Mankiw’s Pigou Club. To quote my earlier position,
I have to confess that my rationale is not 100% Pigovian. It seems clear to me that, even if Al Gore is only a little bit right about the causes and consequences of global warming, the optimal Pigovian tax is extremely high – much higher than what would be politically feasible (in the US) even in my wildest dreams. Energy demand is just not elastic enough, even in the long run, and the social costs of global warming are too high. So, for practical purposes, I see any increase in energy taxes more as a nondistortionary tax than as a Pigovian tax. There is a standard argument that taxes don’t do any harm if they don’t change behavior; in this case, changing behavior is gravy. (As for global warming, well, I’m just glad I’m going to die in another 40 years or so.)
“Energy demand is just not elastic enough, even in the long run…” After today’s news, I’m not so sure:
Oil consumption fell in the developed world last year for the first time in more than 20 years…
Never mind the rest of the article; the first half of the headline is enough. I thought oil consumption might fall eventually, but I was sure it would take a big recession to accomplish that. But instead here it is: good, old-fashioned demand elasticity. Make energy more expensive, and people just buy less of it. I feel like a kid who is old enough not to believe in Santa Claus but then sees a man in a red suit climb out of the fireplace.

I still think the optimal Pigovian tax is considerably higher than anything that might conceivably be politically feasible in the US. But I’m willing to say now that this is more a problem with the US political climate than with the enormity of the economic problem surrounding climate change. The economic problem is still a big one, but perhaps not so gargantuan as to be unsolvable. And I guess I can be a true Pigovian now, rather than a Ricardian masquerading as a Pigovian.

I temper my newfound optimism, however, in a couple of ways. First, as implied above, given political reality, I do not think a Pigovian tax would be sufficient to solve the problem (especially when you recognize that the US – indeed the whole developed world – is only part of it). Second, I’m not quite sure this guy in the red suit is really Santa Claus: a lot of what has happened recently is a shift of energy-intensive production from the developed world to the developing world, and most of the products are still consumed in the developed world, so it’s not clear how much of this ostensible reduced demand is really just a geographic shift in where the energy is used to satisfy existing final demand. Still, I didn’t expect to see anyone in a red suit coming out of the fireplace, so I’m pretty impressed, even it’s just Uncle Joe who decided to do something crazy after the 20th eggnog.

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26 Comments:

Anonymous Pigou Club said...

Just wait a little and santa's flying raindear will be visible :)

Mon Jan 22, 01:54:00 PM EST  
Anonymous Anonymous said...

It seems to me that if Bush was able to sell the Iraq war based on lies, then the next presisent (or Bush if he so desires) should be able to sell the need for carbon (and methane) taxes based on the (inconvenient) truth. It appears that Al Gore has done most of the leg work already, so it should not be so hard to ask the American people to accept some responsibility and to also work on the international scene to harmonize policies. Surely, imposing import taxes on offending polluting countries (as France wanted to do to Canada - what's the right measure to trigger penalties? net (of credits) carbon emitted per dollar of GDP?) would work.
By the way, that Daniel Kahneman article is absolutely brilliant.

Mon Jan 22, 09:19:00 PM EST  
Anonymous Pigou taxes fan said...

Maybe Bush (or more likely the next president) could sell the Pigouvian taxes on the basis that they could be used to finance social security and universal health care, (aside from the direct benefit of reducing harm to the species, assuming the elasticity is high enough to reduce consumption enough). It seems so logical (and efficient).

Tue Jan 23, 09:07:00 AM EST  
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