Monthly Archives: August 2012

Automating activities helps us thrive: three examples

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Lynne Kiesling

[... and one of those examples is not using transactive technology to automate individual responses to energy-related variables like price or % renewable! Read on ...]

Digital technologies do more than reduce transaction costs. They open up new activities, new behaviors that were not imaginable before but are now valuable and contribute to individual flourishing. Here are three examples that do indeed reduce transaction costs, but do much more as well. They change our opportunity set, and enable us to be creative in experimenting with new ways to live better.

Healthier, less invasively and less expensively: From Mark Perry and his invaluable Carpe Diem blog comes this note about a sand grain-sized sensor that can be embedded in a pill, ingested, and used to communicate internal health condition information to the person’s phone, for use by that person, caregivers, and clinicians. In addition to the “how cool is that?” factor, I am (of course) intrigued by the device’s ability to use stomach acid for power. Battery engineers, take note! Note also the discussion in the comments about colonoscopy risks and costs, and how technologies like this can reduce those.

Can’t afford a PA? How about a PA app? Technology Review compiles a list of phone apps that can turn your smartphone into a personal assistant. Out of them all, Donna’s the one that caught my eye:

Kevin Cheng, a former project manager at Twitter and cofounder of the stealth personal-assistant software Donna, is attempting to do something similar. Though he won’t get into many specifics about what Donna’s capabilities will be at launch, he says she (yes, he refers to the software as “she”) will help you stay organized and punctual by, for example, letting you know when you should leave to get to a meeting on time—a judgment made by analyzing traffic conditions, weather, and public transportation schedules. He expects Donna to be available this fall.

Note also that “[o]ne startup, Happiness Engines, lets users choose among five different robots (options include Robbie, who will “couch every message in an infectious can-do attitude,” and Haley, who is “quick, witty, and with a touch of friendly sarcasm”).” For you Hitchiker’s Guide fans out there, doesn’t Robbie remind you of the computer? What about a Marvin PA?

Your phone can wait in line for you. This Wired article describes an app that gets rid of those hockey-puck pagers at restaurants when you are waiting for a table.

Here’s how it works: You walk into a restaurant and ask for a table. The host gets your name and phone number, enters the information into NoWait’s app on an iPad (or any iOS device), and then sends a text message with an approximate wait time. If you have a smartphone, you are also sent a link that shows you how many parties are in front of you. You’re then free to go do whatever you want in the time NoWait has granted you. You’re confident that a table awaits, and that the pushy family of four hovering nearby won’t weasel their way to the front of the queue.

On the face of it, it doesn’t look like that valuable an innovation, right? Not a big deal, not likely to have a big impact. Guess again.

In return, the restaurant now has a directory of phone numbers and names to which they can send special offers, such as “show this message to your server for half off our nachos.” Hosts also have the ability to do more than signal someone that their table is ready. The NoWait system allows for a conversation — it could be about table selection or unforeseen delays. Customers can even send cancellation notices, so the restaurant isn’t left hanging when they decide they want Japanese food after all. The system also records average wait times, and the number of customers that come back to eat versus those that walk out. Best of all, the restaurant doesn’t have to worry about lost, expensive pagers.

The downside? If there is any for the restaurants, it’s that you might not stick around to drink at the bar. Still, the restaurants that have signed up for NoWait, including selected Red Robin and TGI Friday’s and locally owned establishments in 45 states, apparently aren’t concerned about that.

This innovation illustrates precisely the effect I highlighted above: sure, the technology reduces the transaction cost between producer and consumer and takes some rough edges off of the challenging situation of prioritizing the wait for a scarce resource (i.e., a table at a popular restaurant at a popular time). But it also opens up all sorts of different ways for producer and consumer to interact to create value/mutual benefit. It generates data for the producer that the producer can use to customize and tailor their offerings to different consumers with different characteristics, and it also generates data (such as average wait times) that the producer can use to optimize operations and make strategic decisions about expansion, pricing, and so on.

It’s these seemingly simple technologies that can have the most transformative effects.

That’s the lesson from these three examples for the electricity industry, and the potential that resides in home energy technologies. Technologies that reduce transaction costs and open up opportunities for producers and consumers to take different activities and change their behavior in unimagined ways can be value creating in ways that belie their simplicity. And consumers are increasingly used to using such technologies in such ways, and welcome them because such technologies can enable them to accomplish more, get more out of life, flourish.

Given these examples and our increasing comfort with and enthusiasm for autonomous coordination using digital technologies, this result from a Consumer Electronics Association 2011 study is striking:

… consumers are concerned about the cost of their energy use, yet lack awareness of emerging energy management systems.

While many consumers turn lights off, shop for energy efficient devices and practice other eco-friendly practices, just 10.2 million of 119 million U.S. households are estimated to have enrolled in electricity management programs. Utility companies, the study found, are in the best position to raise awareness of these programs to boost consumers’ understanding of energy consumption.

Currently, energy management systems allow consumers to control their home air conditioning and heating units through a programmable display. In the future, a smart grid would enable consumers to adjust home cooling and heating systems with a smartphone, run their dishwashers at times of low energy costs, or control home appliances remotely, among other applications.

The CEA thinks that the regulated distribution monopolist is in the best position to overcome this awareness gap among homeowners. But they don’t, and regulatory incentives give them little reason to.

One of the best ways to overcome this awareness gap is retail competition, to enable competing firms to offer a menu of retail contracts with different pricing models over time and over fuel source, and to offer complementary home energy management technologies that they think will appeal to consumers. Consumers shopping among those choices would become aware of ways to manage their electricity use differently, would be able to customize a combination of pricing and technology that enable them to accomplish more, get more out of life, flourish, by automating electricity consumption decisions in their homes.

That’s the technological equivalent of having your PA, Donna, in the house full time, running around and turning appliances and systems off, on, and up/down, without your having to lift a finger. Donna can be your electricity PA.

Regulation: A Primer

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Lynne Kiesling

Susan Dudley of George Washington University and the Mercatus Center and Jerry Brito of the Mercatus Center have recently released an update of their useful analysis, Regulation: A Primer. Whether you are a student interested in learning more about the theory and practice of federal regulation, someone who works in an industry with regulations that you would like to understand better, or just someone who would like to know more about what regulation is and how it affects our daily lives, this analysis is clear and accessible.

The primer provides an overview of the scope of federal regulations, the theory underlying regulation, how regulation is implemented at the federal level, and some of the differentiating aspects of social (health, safety, environmental) and economic regulation. For those of us who work on regulation in particular areas or industries, the point of this primer is not detail about the specifics of regulation, but is rather to provide broad information about federal regulation in all of its manifestations. That’s the particular reason why it’s a valuable document — for example, one chapter describes the various Executive Orders that shape how regulation is supposed to be implemented and evaluated pre- and post-implementation. Another chapter describes the Administrative Procedure Act, when it applies, and what its procedural implications are; if you have ever submitted an expert comment to a regulatory agency in response to a Notice of Proposed Rulemaking (as I have done at FERC with Brian Mannix, and I know Mike and I have done jointly, although I can’t find a good link), the APA is what determines what you and the agency do and how it gets handled. There’s a lot of valuable information here that I wish I had known before I worked on those comments!

Another valuable aspect of how they’ve approached their subject is the integration of political economy and public choice analysis directly into the work, pointing out that the incentives of policymakers and agency bureaucrats influence how regulations get proposed, evaluated, and promulgated (and very rarely eliminated).

If you are one of our electricity colleagues who comes from more of an engineering background, you would definitely get some perspective on the regulatory institutions and processes that affect your daily work. In particular, I’d focus on Chapters 2, 4, 5, 6, and 8, but it’s well written and clear, so the entire primer is straightforward for non-specialists.

Whither solar power in the US?

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Lynne Kiesling

Recently the New York Times ran a Sunday magazine article from Jeff Himmelman profiling some companies in the solar industry in the US. The main thrust of the article is that despite the industry’s technological and economic challenges, it’s starting to look like a better investment:

Two factors have hurt the industry’s growth. The first is abstract and well ingrained in the American psyche: the negative association of “green” technologies with inefficiency and idealistic, hippie-fueled impracticality. The second is concrete and recent: the sleek, vacant headquarters of Solyndra, the infamous federally subsidized solar-panel manufacturer that went bankrupt in 2011. The glassy campus sits just off the Nimitz Freeway, visible to commuters between San Francisco and Silicon Valley as they battle rush-hour traffic each morning, surreptitiously checking their phones.

Though the failure of Solyndra has dominated the political and social discourse around solar power, the reality of the industry — as evidenced by the enormous investments that companies like Google and Bank of America are making in residential solar power — is that it has rapidly become a smart, practical and profitable investment. Despite a lack of widespread acceptance, the market is growing and the competition is getting tight.

Why? According to Himmelman, financial innovation in the residential contracts that solar companies can enter into with residential and commercial customers in which the company retains ownership of the equipment:

The reason that the residential solar industry has begun to buck this general trend is because, instead of appealing to our heartstrings, it has begun to appeal to our checkbooks. The innovation that made this possible — selling solar services instead of solar panels — was pioneered in the commercial market by Jigar Shah. Though Shah was trained as a mechanical engineer, his most important bit of engineering was financial: in 2003, he started a company called SunEdison, which offered something called a solar-power purchase agreement (P.P.A.) to commercial customers.

Instead of having to pay all of the money for a solar installation up front and then having to carry that payment as a debt on their balance sheets, which no publicly traded company wants to do, companies like Whole Foods and Staples contracted with SunEdison to have solar panels put up at no initial cost. SunEdison then charged the companies for the amount of energy that the panels produced at a fixed rate for a period of 20 years — a rate that was less than what the companies were already paying the utilities, and that would ultimately save them even more money as energy prices inevitably rose over time. The bold stroke was that they were selling the power, not the hardware.

Another theme in the article is the regulatory, cultural, and business model obstacles that keep the regulated monopoly utilities from adapting to what may turn out to be a disruptive decentralized generation business model.

Having read that article, later that week it was interesting to read this Greentech guest commentary from David Rubin at PG&E, who sees a bright future for rooftop solar from the utility perspective … except for (1) the regulated retail rate, (2) the existing regulated net metering rules, and (3) regulatory rules limiting rate changes for some customers, which essentially embeds cross-subsidization in the regulated rate structure. Other than that, the future is bright for utilities providing rooftop solar!

Actually, although Rubin’s article reads like the PR essay that you’d expect, I think he does have a point about how regulatory rules introduce distortion, bias, and cross-subsidization into the market for the provision of rooftop solar services. Consider an alternative scenario in which regulated distribution monopolists like PG&E are precluded from offering retail services, including rooftop solar, and the competing firms that Himmelman profiled can compete both in how they structure the transactions (equipment purchase, lease, PPA, etc.) and in the prices they offer. One of Rubin’s complaints is that the regulated net metering rate reimburses the rooftop solar homeowner at the full regulated retail price per kilowatt hour, which over-compensates the homeowner for the market value of the electricity product. In a rivalrous market, competing solar services firms would experiment with different prices, perhaps, say, reimbursing the homeowner a fixed price based on a long-term contract, or a varying price based on the wholesale market spot price in the hours in which the homeowner puts power back into the grid. Then it’s up to the retailer to contract with the wires company for the wires charge for those customers — that’s the source of the regulated monopolist’s revenue stream, the wires charge, and it can and should be separated from the net metering transaction and contract.

The presence of the regulated monopolist in that retail market for rooftop solar services is a distortion in and of itself, in addition to the regulation-induced distortions that Rubin identified.

Another option is Austin Energy’s value of solar tariff (VOST), which takes into account the wires charge point and the fact that solar is usually being used most when the grid overall is under the most capacity stress. It’s still an administered, bureaucratically-determined price proxy for what could be more economically efficient separate retail solar and regulated wires charges. But it seems to be less distortionary than California’s net metering rate that Rubin is criticizing.

Can we finally get the ethanol mandate monkey off of our backs?

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Lynne Kiesling

This summer, corn prices are high. Drought, extreme weather, and other factors combine to increase corn prices, and one of those factors is the federal ethanol mandate/renewable fuels requirement implemented over 20 years ago (as an oxygenate requirement) and extended in 2005. Roger Pielke Jr. points to a Purdue research paper that suggests that a waiver or partial removal of the renewable fuel standard could reduce corn prices by 20% or more. Posting at the Washington Post, Brad Plumer also discusses the issue, and the Purdue paper:

Currently, the EPA’s Renewable Fuel Standard requires refiners to blend a certain amount of ethanol in with their gasoline. In 2013, this will require about 13.8 billion gallons of ethanol. Since corn ethanol is the most viable form of ethanol in the United States at the moment, this creates a hefty—and fairly inflexible—market for corn. And that causes corn prices to rise higher than they otherwise would.

What would happen if the EPA relaxed this mandate? As the Purdue authors note, a lot depends on how quickly refiners and blenders could switch away from ethanol. That’s not as technically easy as it sounds—these refiners have already made preparations for blending ethanol. What’s more, under the EPA program, the producers of ethanol can carry over credits from year to year, giving them some flexibility to deal with shortages. That complicates matters further.

The study analyzes several different scenarios, varying by type of policy change and timing; as Plumer summarizes it:

In the first option, the EPA doesn’t alter its ethanol program at all. Corn prices remain elevated next year — staying around $8.57 per bushel. Under the second option, the EPA doesn’t alter its program at all, but ethanol producers use as many of their existing credits (RINS) as possible to deal with the shortage. Corn prices drop about 7 percent. In the third case, the EPA allows a little more flexibility in its rules, say, by partially relaxing the mandate or by allowing U.S. refiners to use imported sugarcane ethanol. Prices drop by about 13 percent.

Under the fourth option there, the EPA allows a fairly big relaxation of the ethanol rule next year. (A waiver this year is unlikely.) Refiners are required to use 25 percent less ethanol. And ethanol producers can carry over their credits from previous years. In that case, corn prices could drop more than 20 percent, to $6.56 per bushel. That’s about where corn prices would have been if we only had a “weak drought” this year. In other words, by relaxing the ethanol rule, the EPA could essentially turn a “strong drought” into a “weak drought” as far as prices are concerned.

Both posts are worth reading in their entirety. And from the electricity perspective, Ken Silverstein at EnergyBiz summarizes the arguments for waiving or eliminating the renewable fuels standard, and surveys the role that natural gas vehicles, hybrids, and electric vehicles can play in reducing the demand for gasoline.

This year’s drought has been painful and costly, but if in the process it leads to the demise of ethanol subsidies, boutique fuels, and the renewable fuels standard, that’s what I call a silver lining.

Some Friday morning links

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Lynne Kiesling

Some arguments and ideas catching my eye this morning:

At their Why Nations Fail blog this morning, Daron Acemoglu and James Robinson point out that central planning predates Marxist ideology historically, and is an instrument that political elites use to control and “extract resources from society”.

At the Huffington Post, economist Ben Powell points out how government regulations like zoning stifle civil society institutions, such as giving a small number of free lunches to those in need of a meal. Think about that the next time someone tells you that “government is just us working together to achieve a desirable objective”. No; see the remark above from Acemoglu and Robinson.

Tim Kane and Glenn Hubbard have a new blog called Balance of Economics, in advance of their forthcoming book of the same name. The focus: “We’ll explore topics such as power accounting, the role of political institutions, and the lessons history has for the current American institutional model.” Should be a good read; added to my RSS reader!

One of my favorite political philosophers, Jason Brennan, writes a very clear argument for why Paul Ryan should not be considered, as I saw in the comment thread on a CNN post earlier today “an Ayn Rand fanboy”. Jason argues that despite Ryan’s rhetorical posturing and invocation of minimal-state arguments from Rand, or Hayek, or others in the umbrella of small-state small-l-liberalism, his actions show him to be a much more standard neoconservative: “Rand would regard our current government as an unjust, rights-violating, bloated monstrosity. It is a monster Paul Ryan helped create. Ryan may admire Ayn Rand. He may quote F. A. Hayek in interviews. Yet his voting record is right out of the neocon playbook.” On the same topic and theme earlier this week, Conor Friedersdorf says that we should “stop calling Paul Ryan a Randian“. The other good thing about both of these arguments is that their authors represent Rand’s ideas in an informed manner, unlike many other arguments I’ve read since Ryan’s selection.

I don’t link to Conor Friedersdorf nearly as much as would reflect my appreciation and respect for his writing. (I attribute that to my attempt to minimize discussion of politics here, but if politicians insist on intruding even further into economic activity, well, …) On Wednesday he wrote a good argument for why liberals need to start holding Obama responsible for his policies, particularly his acceleration of the Bush-era subversion of civil liberties and increase in executive power. From the progressive portion of the political spectrum, Glenn Greenwald has been making this argument for some time, most recently with reference to the U.S. government’s lethal drone strikes in Pakistan and the refusal of those in the west to condemn these strikes. Just today comes news of a drone strike last night in Pakistan, the fifth this week, that killed 18 people, some of whom are likely to be innocent “non-combatants”. Another worthwhile read on this issue is an essay from actor John Cusack that was published this week, and is a thoughtful piece of writing. The link also includes notes from a conversation between Cusack and constitutional law professor Jonathan Turley, and shows concern from a progressive perspective about the “gutting of the Constitution”. This is a conversation that I think we have to have, if we are going to move beyond the fear-based policies that are eroding the social institutions in which we, as individuals and in our voluntary community associations, are trying to thrive. And that’s the connection back to economics; as I’ve argued before, the erosion of civil liberties has moral and economic consequences, and makes us less well off … which circles us back to the Acemoglu and Robinson point at the top of this post.

Did China cause North Dakota’s oil boom?

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Michael Giberson

News about the Chinese economy has become a bit worrisome, for instance from the New York Times earlier this week, “China Confronts Mounting Piles of Unsold Goods“:

After three decades of torrid growth, China is encountering an unfamiliar problem with its newly struggling economy: a huge buildup of unsold goods that is cluttering shop floors, clogging car dealerships and filling factory warehouses.

The glut of everything from steel and household appliances to cars and apartments is hampering China’s efforts to emerge from a sharp economic slowdown. It has also produced a series of price wars and has led manufacturers to redouble efforts to export what they cannot sell at home.

The severity of China’s inventory overhang has been carefully masked by the blocking or adjusting of economic data by the Chinese government — all part of an effort to prop up confidence in the economy among business managers and investors.

Now looking backward at oil prices over the last decade, how much of growing demand for oil has come from China?

According to IEA data, China consumed about 4.7 million barrels a day in 2000 and will consume about 9.7 million barrels a day in 2012. That growth has been among the factors pushing world oil prices from near $30/barrel in 2000 to this year’s prices ranging between $80 and $110.

High prices and technological improvements, particularly since about 2007, have also motivated the addition of new supply capability which is just recently coming to market.

So here is an idea: if Chinese demand growth was a significant boost to oil prices, then maybe without that boost fewer folks would have been so excited about drilling in the farther reaches of the Bakken Shale (and the Eagle Ford in Texas, and the Marcellus and Utica shales in Pennsylvania, West Virginia, and Ohio). So what happens if demand from China doesn’t reach over 10 million barrels a day, as the IEA is predicting, and instead falls to 7 or 6 or 5 — just as new supplies are coming to market? Where will oil prices be a year from now?

RELATED: “Forget the past: Gas is expensive and staying that way, experts say.”

“I don’t think we’re going back to the 1990s. It’s a different world,” said James Hamilton, an economist at the University of California San Diego…

If I disagree with James Hamilton on oil markets, he is probably right and I am probably wrong. And yet, I still disagree.

Obsolete boutique fuels and failure to arbitrage

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Lynne Kiesling

Andy Morriss (Univ. of Alabama Law School) and Don Boudreaux (George Mason University) have an excellent op-ed in today’s Wall Street Journal, A Coca-Cola Solution to High Gas Prices. The punch line: environmental fuel formulation regulations balkanize wholesale fuel markets and make prices more volatile as a consequence.

This is not a new phenomenon; indeed, in the mid-2000s the boutique fuel problem was the focus of a lot of attention, as well as a lot of my posts here at KP. But it’s a problem that has persisted as the regulations have persisted, despite the fact that modern pollution control technology makes fuel formulation regulations obsolete. As Jonathan Adler notes in remarking on Andy’s and Don’s op-ed,

While most of the fuel standards were adopted in the name of the environmental protection, many are actually the result of special interest pleading. Producers of various products, ethanol in particular, sought fuel content mandates or performance requirements that would benefit their particular product. (I detailed part of this history in “Clean Fuels, Dirty Air,” in Environmental Politics: Public Costs, Private Rewards (Greve & Smith eds. 1992).) Worse, some of the content requirements are irrelevant for new cars due to modern pollution control equipment. Federally imposed boutique fuel requirements have outlived whatever usefulness they ever had.

Similarly, Andy and Don point out that

By the 1920s and early 1930s, oil companies were engaged in a vigorous “octane war” to improve quality and reduce price. This competition helped transform 100-octane fuel from a chemical that sold for $25 per gallon in the early 1930s to a mass-produced commodity selling for about 25 cents per gallon a decade later. That improvement helped win the Battle of Britain by giving the Royal Air Force a performance edge over the Luftwaffe. By 1944, Standard of Indiana alone could refine 1.15 million gallons of 100-octane aviation gasoline per day, a production rate surpassing that of the entire industry before the war.

After the war, prices continued to fall as competition drove producers to improve their fuels and expand their pipeline networks. With the gasoline market becoming national, refiners gained the scale to innovate in ways that further boosted quality and cut prices. …

From the 1920s to the 1950s, competitive markets successfully drove improvements in transportation fuels while reducing prices. We need to unleash those forces again. A good place to start is by undoing the anticompetitive regulations that keep our fuel markets small and fragmented—and making the sale of gasoline once more like selling Coca-Cola.

This is a really important point. In a very important sense, fuel performance and emissions reduction objectives are aligned — the better the fuel at delivering performance and the better the engine and the exhaust system at minimizing fuel waste, the lower the emissions per mile driven and per gallon of fuel. That also lowers the overall cost of driving, which gets us back to the Jevons effect discussion of yesterday and before.

See also David Henderson’s comments on the topic at Econlog. He accurately connects the regulation-induced price volatility to a failure to arbitrage across markets, which would happen naturally if not outlawed.

Bastiat, Hayek, Eurozone

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Lynne Kiesling

Steve Horwitz has a great post at the LSE blog that provides an introduction to and summary of the Austrian economic theory that’s relevant to macro policy questions, including the current Eurozone crisis. Most people know that Austrian economics provides a critique of the Keynesian policies emphasizing government stimulus spending, but what’s the underlying logic of the critique?

The key to their view is their understanding that economic resources, whether capital or labour, are not fungible. That is, capital goods and human beings have a multiple, though not infinite, number of ways they can contribute productively to the value creation process.

The productive structure of an economy is like a jigsaw puzzle where the pieces of capital and labour must fit together in particular combinations. Only specific pieces can be linked with others. However, unlike real jigsaw puzzles, we don’t have a picture of the pattern we are creating. Instead, we have prices, profits, and losses to inform us when pieces do or do not fit together appropriately. If those signals are working well, we will have success at fitting pieces together in ways that are orderly. The interesting thing about that orderly use of the jigsaw puzzle pieces is that we might not need to use all the pieces at any one time to generate a recognisable and desirable pattern.

Note two important points in that brief excerpt: (1) heterogeneity of labor and capital, and specific patterns of how they combine to produce value; (2) no teleology — there is no way of knowing what the actual possible outcomes are of those various combinations, and the economy is not a closed or deterministic system. Steve continues the metaphor to illustrate the flaw in the stimulus argument:

What advocates of stimulus are arguing is that we need spending, just any old spending, to jump start struggling economies. But this argument must assume that it does not matter which capital and which labour are brought out of idleness and into what sorts of activities. They must of necessity ignore the specificity of resources and their limited complementarity. It does us no good to try to force pieces together that don’t fit, as that’s what got us in trouble in the first place. And the point of doing a jigsaw puzzle of this sort is to get the pieces to fit in a way that forms an orderly pattern, not to simply use them all up.

This argument reminds me of the debate over the past few days between Bryan Caplan and Matt Yglesias over the relevance of Bastiat. Bryan kicked it off last week by saying that Bastiat is very good at exposing the bad logic underlying the naive reasons why people support interventionist ideas:

Take the minimum wage.  Normal people like it because the government waves a magic wand and makes mean employers give helpless workers extra money, with zero blowback.  So inane, yet so convincing to a psychologically normal human.  An intellectually serious argument, in contrast, begins by conceding the theoretical possibility of a disemployment effect, then defends low estimates of labor demand elasticity.  This is a huge improvement in intellectual substance, yet persuades only wonks.

This is the real root of Bastiat’s differential ideological appeal.  Friends of the free market love him because Bastiat destroys the inane arguments that make the modern welfare state popular.  Once you deprive the median voter of these inane arguments, friends of the modern welfare state have to resort to intellectually serious arguments to make their case.  Alas, these arguments are utterly beyond the median voter’s comprehension.  Most college students can’t even grasp them.

Matt responded, with the crux of his argument being that Bastiat assumes what he’s trying to argue:

Similarly, Bastiat’s alleged broken windows fallacy involves simply assuming that there’s no such thing as genuinely idle resources or an “output gap.” In that context, yes, it’s a vibrant intuitive depiction of crowding out. But this doesn’t counter any Keynesian or monetarist points about the viability of stimulus during a recession induced by nominal shocks, it involves assuming that no such recessions can occur even though they plainly do.

Here’s where I think Steve’s essay above helps illuminate why I think Matt is mistaken about Bastiat. In order for Keynesian stimulus arguments to hold, you have to assume (1) input heterogeneity and complementarity doesn’t matter and (2) that we know the desired outcomes and “right” combinations well enough to know what’s excess capacity and what’s not, as well as how to use that capacity correctly. A simpler version of that way of thinking is, at least in part, what Bastiat is trying to mock (to use Bryan’s word).

I interpret Bastiat’s model as being entirely consistent with what Steve said about the heterogeneity of labor and capital and the non-deterministic and non-teleological nature of open economic systems. Neither Bastiat in the broken windows fallacy nor Hayek in Austrian capital theory assume that there are known combinations and outcomes that external intervention can achieve, even in situations where it appears like there is underemployment/excess capacity. As Jonathan Pearce said at Samizdata about the debate between Bryan and Matt:

The point is that the issue of “idle resources” or an “output gap” only makes sense if you start from the position of assuming that there is an optimum amount of economic activity to be had, and that supposedly clever central bankers (try not to laugh please) know what this “gap” is and have the skills to fill it. Given the manifest failings of Keynesianism – and arguably also some of the cruder forms of monetarism – it seems those who want to push this approach are under an onus of proof.

Bastiat continues to be relevant to the extent that his arguments (and Smith’s, and other classical liberal economists, as Bryan notes) expose some of these essential assumptions that are really not borne out upon reflection. Yes, his examples may be dated and his arguments and examples are simplified, but isn’t simplification necessary for any kind of model of complex phenomena? If we are going to critique simplification, we have to critique all of analytical narrative and all of science while we’re at it. Simplification does not necessarily disqualify an argument; remember statistician George Box’s observation that “all models are wrong, but some are useful”. The useful ones make simplifying assumptions that abstract from less important details. This observation ties back around to the Austrian critique of Keynesian stimulus models, which rely on the assumptions that input heterogeneity and complementarity are unimportant and that desired macroeconomic outcomes are knowable.

Yesterday Bryan characterized Bastiat’s subtle value added as

Bastiat’s value-added: He elegantly exposes popular arguments’ absurdity, then reminds us that public policies are based on popularity, not truth.

My value-added: Building on Bastiat’s giant shoulders, I point out that most wonks used to be normal people.  They initially embraced popular policies for absurd reasons.  It is remarkable, then, that wonks continue to largely support the same policies as normal people.

This exchange has clarified my thinking about both Bastiat and critiques of Keynesian models and policies.

To return to Steve’s initial post, I have not done it justice in my excerpts. In particular, he elaborates on the political economy of how the limited knowledge of politicians about how best to do stimulus leads them to make government spending decisions through a lobbying-influenced political process more than they would if they did have better knowledge.

More on rebound, backlash, and the Jevons effect

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Lynne Kiesling

Back in July and also a couple of other times over the past two years, Mike has written here about the Jevons effect — when an increase in energy efficiency reduces the per-unit cost to the consumer of doing the energy-consuming action, moving her down along her energy demand curve and increasing her quantity consumed. This fascinating and nuanced issue, like so many things in energy policy, is a real phenomenon, but a very dynamic one. How big is the Jevons effect; how much of a rebound will there be from a given increase in energy efficiency? Paraphrasing Jevons’ neoclassical successor Alfred Marshall, answering that question starts from a comparative statics-partial equilibrium analysis, but ceteris is never paribus, so the model you use is likely to be wrong, and you’ll have a hard time capturing the actual dynamics accurately because the underlying system you are trying to model is not just complicated, but also complex (i.e., non-linear and non-deterministic).

The size of the rebound depends, among other things, on the price elasticity of demand for the energy (typically thought to be pretty inelastic), but the demand for energy is always a derived demand, so it depends on the demand for the goods and services into which the energy is an input. So, say, if I’m going to drive 10 miles a week no matter how much I spend per week on gasoline, an increase in energy efficiency will not have a rebound effect from my behavior because it’s not going to change. To complicate matters further, though, my demand for those goods and services is a function of both substitutes and complements, and is a function also of the context in which I am making my consumption choices. So at the margin the reduction in the per-mile cost of driving may, at the margin, induce me to drive slightly more because then I can group my errands more efficiently, weighed against the other alternative ways that I might be able to achieve what I want to achieve (in the case of transportation, alternatives like bus, train, bike, walking, scooter, etc.). Those preferences are sure to be quite heterogeneous across a diverse population, as are time preferences and discount rates, which can also change in a highly distributed way as people change their behavior based on their expectations of future environmental harm from current energy consumption. Plus, ceteris is never paribus in the sense that other technological and energy efficiency changes are likely to be occurring simultaneously with the one you are trying to isolate, which will confound the analysis.

But I digress (sorry). Like Mike, I’ve been thinking about the Jevons effect and have read Jevons, although I have not yet read The Myth of Resource Efficiency: The Jevons Paradox yet. A couple of weeks ago I also discussed the new Gayer and Viscusi paper from Mercatus on the consumer irrationality hypothesis and whether energy efficiency regulations actually do benefit consumers. Mike and I aren’t the only ones; Ken Green at AEI also took note of some Jevons effect work (referencing the Breakthrough Institute work that Mike mentioned in his most recent post on this) and the Gayer and Viscusi work on consumer irrationality, thinking of those two issues as pervasive fallacies in energy policy.

And then in this morning’s Wall Street Journal, Robert Michaels takes on the rebound effect in a short opinion piece, The Hidden Flaw of ‘Energy Efficiency’. In this piece, which draws on his recently-released Instituted for Energy Research study, The Rebound Dilemma, Michaels analyzes the direct and the indirect effects of energy efficiency mandates:

Higher efficiency reduces the cost of cooling. A family that once had only a single air-conditioned bedroom may now choose to install a central unit, and one that suffered in the heat may purchase its first one. Direct rebounds like these, however, are only the start of the story.

Technology that improves energy efficiency and reduces its cost means people can consume more goods and services that use energy—home electronics, appliances and the like. And of course, businesses will use additional energy making them.

One reason why I think research and debates are important on complex effects like the Jevons effect is that too often, energy efficiency mandates are naively offered up as a cost-effective way to reduce energy use, and therefore to reduce greenhouse gas emissions. We’re fooling ourselves (or, as Ken notes in his post, suffused with fatal conceit) if we think that such effects and relationships are going to be so straightforward and yield the desired outcomes predictably and reliably.

In the context of Mike’s earlier posts, I think Bob’s conclusion fits right in:

Rebound gives critics of regulation both philosophical and practical rationales for their views: Some object to efficiency standards on libertarian grounds and rebound research now tells us that many standards will fall short of their initial promise. But for the Breakthrough Institute in Berkeley, Calif., which gives primacy to climate change, rebound increases the urgency of introducing large-scale governmental management of both markets and technologies.

The growing body of research on rebounds means that both the left and the right must rethink their stances on energy policy. Some efficiency regulations may be worth their costs, but the existence of rebound means that the nation can no longer accept legislation to improve efficiency without further thought.

To that I would add another recommended reading: Richard Epstein’s Simple Rules for a Complex World.