Case Western law professor Jonathan Adler (someone to whom I link frequently here) is guest blogging for Megan McArdle at the Atlantic right now, and he’s sharing some valuable insights from his research in environmental and administrative law. His first post lays a foundation by summarizing and analyzing Garrett Hardin’s seminal “tragedy of the commons” work and the important relationship between property rights and the ability and incentive to overuse a common-pool resource. One thing that Jonathan’s analysis incorporates into Hardin’s is a recognition of the public choice/political economy dynamics that affect the incentives and ultimate outcomes in resource policy:

One thing that Hardin overlooked is that the political process often replicates the same economic dynamic that encourages the tragedy of the commons — a dynamic fostered by the ability to capture concentrated benefits while dispersing the costs. Like the herder who has an incentive to put out yet one more animal to graze, each interest group has every incentive to seek special benefits through the political process, while dispersing the costs of providing those benefits to the public at large. Just as no herder has adequate incentive to withhold from grazing one more animal, no interest group has adequate incentive to forego its turn to obtain concentrated benefits at public expense. No interest group has adequate incentive to put the interests of the whole ahead of the interests of the few. The logic of collective action discourages investments in sound public policy just as it discourages investments in sound ecological stewardship. This, in addition to the pervasiveness of special-interest rent seeking, explains many of the failings of centralized regulation. So despite the environmental gains of the past half-century, real challenges remain, and the tragedy of the commons is still with us.

This insight leads directly into his second post, which applies this foundation to fisheries. Many fisheries are in grave threat because of poor management and the failure of both governments and fishery trade associations to establish policies that define use rights within the common-pool resource; the impending collapse of the Atlantic bluefin tuna fishery is the appalling poster child for this problem.

It does not have to be this way. Even before Hardin wrote his essay fishery economists had diagnosed the problem and explained how property rights in fisheries could solve the problem. Specifically by recognizing property rights in a percentage of the catch for a given species (or, in some cases, by recognizing rights in fishing territories), the “race to catch” could be eliminated and fishing crews could be given an incentive to husband the resource. The creation of property rights in the underlying resource aligns the incentives of those who work in the fishery with the health of the fishery. As owners of a share in the catch year-after-year, the fishers have a stake in ensuring there are more fish tomorrow than there are today.

Jonathan’s two posts capture nicely the theoretical and practical issues in devising use rights to enable sustainability in a common-pool resource, and the extensive research that has been done on the effect of catch shares in various fisheries (his discussion of the Alaska crab fishery and the TV show The Deadliest Catch is illustrative).

Highly recommended reading, with a few more posts to come from him during his guest stint.

Loren Steffy, business columnist at the Houston Chronicle, is frequently a sensible guy. But his writing gig seems to require him to announce the sky is falling on a regular basis, so you have got to be a little careful when reading him. What else can you say about a column that cites a day (May 9, 2012) during which ERCOT wholesale power prices rose from $23 MWh around midnight to about $32 MWh as an omen of ill things to come? He says unnamed traders are “seeing suspicious activity in the spot markets.” Unnamed traders also “worry that the volatility will get worse.”

Really?

For just a little historical context, consider prices during May 2010: on average prices began about $26 MWh, dropped below $20 in the early going, but ran up to an average of $75 MWh during the afternoon peak.

Or how about May 2009? The first hour of the day the price averaged $35 MWh, dropped to $15 in the early morning hours and rose to $55 MWh at the afternoon peak.

These price patterns are even more extreme than the numbers Steffy is worried about. So maybe Steffy’s message is that the whole market has been tangled up in suspicious activity for years – why else would he say “we can only conclude that deregulation has become expensive nonsense.”

Only, if I want to buy into Steffy’s expensive nonsense story, I have got to ignore a bit of reality: average prices in ERCOT have been falling.  Prices in 2004 averaged about $45 MWh.  Power prices followed natural gas prices up in 2005, down a little for a few years then way up in 2008, down again in 2009, and back a little higher in 2010. In 2011 the average price in ERCOT was around $40 MWh.

Now here we are in 2012, years of “suspicious activity” later, and low natural gas prices continue to provide low electric power prices. By the way if you understand how the ERCOT market is supposed to work, and you realize the role natural gas-fired generation plays in Texas, then all of this makes a good deal of sense.

“Suspicious activity”? “Deregulation has become expensive nonsense”?

Before I buy Steffy’s conclusion that the sky is falling, I think I’ll get a second opinion from Henny Penny or maybe Goosey Loosey. I would ask the Unnamed Traders for a quote, but I don’t think those guys have done their homework.

NOTES: My beginning prices are an unweighted average of the four interval prices in the balancing energy market from midnight to 1 AM for each of the four geographic zones in ERCOT in 2009 and 2010. The other prices noted are similarly averages for all four zones over an hour. The market design has changed since May 2010 in ways that don’t much matter at the level of aggregation we’re talking about here, though it makes exact comparisons trickier.

I’m not quite sure how Steffy’s price numbers were calculated – he reports getting them from a trader. When I look at ERCOT real-time market settlement point prices from May 9, 2012  (http://www.ercot.com/content/cdr/html/20120509_real_time_spp) it looks like my May 2009 or 2010 numbers. Averaging the HB_HUB_AVG price for each hour: prices start the day about $16 MWh, peak at $55 MWh about 5 PM, and drop back to $18 MWh at the end of the day.

A crisis is coming for the New Jersey solar power installation industry. Stringent solar power purchase requirements imposed on electric utilities (i.e. on electric utility ratepayers) has turned the state into the nation’s second largest for solar power capacity installed, behind only sunny California.

But now that installed capacity is sufficient to meet current requirements, the installation business is expected to drop way off.  (The purchase requirements actually increase each year through 2021, but the rate of growth is slowing.) That expected drop off has lobbyists for both the solar power industry and unionized solar installers descending on the state capital, pleading for imposition of still higher purchase requirements on electric power consumers. The rallying cry has been to “save the jobs” created by the solar power purchase mandate.

Here is one report, “NJ looking to rescue ailing solar industry“:

New Jersey has long been known as the Garden State, but during the last five years, it could have easily been known as the Solar State from all the sunlight-absorbing panels that have cropped up nearly everywhere.

They’re on the roofs of schools, churches, municipal buildings and sewage treatment plants. They’re in farm fields and attached to utility poles. Even one of New Jersey’s trademark diners recently went green and installed panels.

But all is not well with New Jersey’s once-thriving solar industry, which has grown so big, so fast, that it’s now in danger of collapsing on top of itself.

The industry’s future could hinge on the work of the state Legislature during the next several months as lawmakers look to craft a bailout bill that rescues the solar market and the thousands of jobs it created.

A bailout bill was approved by the Senate Environment and Energy Committee on Thursday, but Bill S 1925’s chances of becoming law are far from certain as it relies largely on making power companies buy more electricity from solar generators.

Critics warn that doing so could mean higher bills for the state’s ratepayers. Supporters say without government help the entire industry will likely collapse.

“We have a crisis, and the crisis is this: If the market stays the way it is, there will be no new projects in the future, and the ones out there now will fail,” Sen. Robert Smith, D-17th of Piscataway, said Thursday at the onset of the lengthy hearing on the bill, which drew hundreds to the Statehouse, many of them union members who work in the industry.

At issue is the market for the electricity that solar panels produce, which has crashed during the last year because of an oversupply of solar development.

Under state law, utilities must obtain part of their electricity from solar generation. To do so, most must buy solar renewable energy credits, or SRECs, from solar panel owners.

The market for the credits originally boomed and helped New Jersey become the nation’s second-largest solar power producer behind California. All that development caused a glut in the market that has seen SREC prices decline from $650 or more in 2010 to less than $100 at times this year.

“We’ve become a victim of our own success,” Smith said. “We’ve had so much solar built in New Jersey that the market for SRECs has crashed.”

Historical SREC values are charted at the Flett Exchange.

The crash in the value of an SREC has cut into revenues projected for private businesses and public schools that have had solar panels installed. Banks have become less willing to loan for solar projects as subsidy revenues have dropped off.

A bill circulating to bail out the industry would both increase the mandated purchases, cap the size of solar projects built, and require projects gain approval from state regulators before they are built. The bill has failed, or at least stalled, on the issue of regulator review – the industry wants all existing projects exempted from regulatory review while the Governor’s office and some others insisted on no exemption.

All hope is not lost for the industry, even should the legislature fail to raise the cost imposed on ratepayers in order to bail out the New Jersey solar industry. The chairman of the New Jersey Board of Public Utilities has said if legislators don’t act then the BPU might simply impose a higher solar mandate on its own authority.

BACKGROUND: For an extended assessment of solar power incentives in state Renewable Portfolio Standards see Ryan Wiser, Galen Barbose, and Edward Holt, “Supporting Solar Power in Renewable Portfolio Standards: Experience from the United States,” Lawrence Berkeley National Laboratory, Berkeley CA, October 2010. LBNL-3984E.

I just heard a potential sign of the impending Greek exit from the Euro: this is the first time I can remember in 25 years of listening to NPR that they have included information in the news update about the day’s trading on the stock markets in France, Germany, and other European countries.

I’ve also learned in my morning reading that some are using the less-than-felicitous term “Grexit” as shorthand for the impending Greek exit from the Euro. Ugh.

Of course Greeks (and others, including British PM David Cameron) are making strong arguments about the large economic and social costs of Greece leaving the Euro. What are the costs of enabling them to stay? That’s the material question. If we have a flexible and adaptable and resilient global economy, we can digest the contagion. But some places are more brittle than others, due to rigidities such as labor market regulations (hello Spain!). I think contagion will be largest where those rigidities are highest, which means Europe. But are European countries willing to accept the costs of years of stagnation and debt load to avoid the disruption that will likely be sharp but briefer if Greece exits?

It’s a little disturbing how often I feel like Steve Horwitz has inhabited my brain and articulated my thoughts, and I am really glad that he does, because he is much more articulate in doing so than I am. His Freeman column today is an example, highlighting Hayek’s vision of a tolerant and pluralist society and the role of markets in such a society.

Here’s the important thing: Once we agree on the rules, we need not agree on the ends to live peacefully with one another. The liberal society is “means-connected” and not “ends-connected.” Markets enable us to disagree peacefully while each pursues his or her own way. …

Compare this to socialism or fascism. These systems require a single hierarchy of ends; according to the theory, the collective decides which ends will be pursued and which not. When resources are allocated centrally, pursuing our own individual ends is impossible. Our particular ends must be subordinated to the priorities of the State or collective. The result is not the peaceful disagreement and tolerance of the liberal order, but constant fighting over the reins of power in order to achieve one’s ends at the expense of others. We turn the positive-sum game of the market into the zero or negative-sum game of State power.

Exactly. Moreover, central determination of ends and allocation of resources stifles the innovation that is the manifestation of human creativity that makes the positive-sum game so positive, leaving a worse potential set of prospects for future generations.

I am attending an electricity markets workshop that we are holding here at Northwestern, about which I’ll have more to say later, but for now I wanted to capture a quotation of the day (apologies to Don Boudreaux for using his meme):

The difficulty lies, not in the new ideas, but in escaping from the old ones.

-John Maynard Keynes (1936)

Hung-po Chao from ISO New England used this quote in his talk, with reference to what I think of as the crucial need to clear the overgrowth in the regulatory underbrush, and the perverse incentives that underbrush creates (and the special interests that perpetuate it).

Some of the best environmental projects also save money. This post at The Atlantic’s Cities blog highlights urban green infrastructure such as permeable pavement projects, including a recent study finding that they can also be economical:

Looking at 479 case studies of green infrastructure projects around the U.S., the report finds that the majority of projects turned out to be just as affordable or even more so than traditional “grey” infrastructure. About a quarter of projects raised costs, 31 percent, kept costs the same and more than 44 percent actually brought costs down.

Here’s the logic: suppose you are, as Chicago is doing, using permeable concrete now when repaving alleys. Permeable concrete is more expensive than traditional concrete, but because it allows rainwater to return to groundwater, it reduces the water flow into storm drains, the sewer system, and wastewater treatment facilities. So you have to evaluate the higher construction costs versus the lower wastewater treatment cost and other reduced costs of storm runoff, including lower operating and maintenance costs. As reported in the post:

The costs of traditional infrastructure are especially pronounced in cities and regions with combined sewer systems that collect both sewage and stormwater. During heavy rainfall, these systems are often overwhelmed, pouring sewage-laden water into drinking water sources and greatly increasing water treatment costs.

Technologies like permeable pavements and rain gardens can capture, naturally treat and filter stormwater back into the ground, preventing overflows and reducing reliance on treatment centers. Chicago’s existing green infrastructure, including its green alleys, diverted about 70 million gallons of stormwater from treatment facilities in 2009, according to the report.

I can attest to the existing strains on the sewer/storm runoff system in Chicago; we live just off of a main north-south surface street, and after a heavy rain like last night’s there are substantial pools of water backed up onto the street around several of the storm drains (my neighborhood hasn’t had our alleys repaved yet). Moreover, this runoff frequently overflows from the sewer system into Lake Michigan, leading to beach closures on the days following rainstorms. I could channel my inner John Whitehead to do a travel-cost estimate of the value of the lost recreation, which reinforces the value of permeable concrete. One thing we don’t know yet, though, is if it’s as durable as traditional concrete, or if it depreciates more quickly.

All of this reminds me that I have to get the KP Spouse moving on that rain barrel …

Just a quick note to accompany the discussion in the comments on Mike’s post about Southwest Airlines, Delta Airlines, and fuel price hedging: a couple of weeks ago Virginia Postrel had a very good analysis of the reasons why the Delta-Conoco transaction is not a good idea, in her regular column at Bloomberg View. Virginia’s analysis emphasizes the extent to which vertical integration is only profitable when transaction costs make markets and contracting more expensive ways to accomplish the transaction. In this case, markets do not have substantial transaction costs.

But what about fuel price risk? Here Virginia quotes friend of Knowledge Problem Craig Pirrong:

The proposed purchase “doesn’t make a huge amount of economic sense — in fact quite the opposite,” says Craig Pirrong, a finance professor and director of the Global Energy Management Institute at the University of Houston’s Bauer College of Business.

You might think that owning a refinery would at least protect the airline from price fluctuations. But, Pirrong notes, crude oil prices affect the profits of airlines and oil refineries exactly the same way. When oil prices go up, their profits go down. Owning a refinery would simply magnify the effect. “If anything,” he says, “it increases the risk exposure that has bedeviled the airline industry for years.” …

Delta simply seems to be falling for the great fallacy of vertical integration: the belief that the inputs you get from an in-house supplier are cheaper than those you buy in the open market. There’s no markup. You’ve cut out the middle man!

But this story misses the real cost of those inputs.

Basically, if fuel prices are high, Delta will still not fly those costly half-full flights, but will instead sell their fuel in the low-transaction-cost markets. So what’s the point of owning the refinery when it’s not their comparative advantage and refining is such a low-margin business?

For the past year and a half a lot of my mental bandwidth has been dedicated to learning how to teach principles of macroeconomics. It’s harder than you think, and harder than I thought; yes, every academic economist should be able to teach it in terms of the knowing the material, but that’s only part of effective teaching of an introductory course. You have to make the ideas come alive, to be compelling and interesting and related to the real world that the students experience. In an introductory class you also have a group of students with backgrounds and interests ranging from the student who is afraid of math and only taking it for a prerequisite to the engineering student who may end up double-majoring in economics. That’s hard to balance, and it’s been humbling to see how much of a learning curve there is in it for me.

I’m using the Cowen & Tabarrok macro textbook, and one reason I’m using it is the material on which my students took an exam on Tuesday — the Solow growth model. Tyler and Alex prioritize growth in the material covered, including the Solow model and the role of new ideas and technological change. It’s a really rich way to communicate a lot of important economic ideas to principles students — the complementarity of labor and capital, the relationship among consumption, investment, and output, the balance between investment and depreciation, and the role of technological change and new ideas in changing the amount of output value we can create from our physical inputs.

Being economically aware of these relationships enables you to see them all around you in the world, even in philanthropic aid. Take, for example, one of my favorite charities: World Bicycle Relief. WBR builds on the bicycle design and engineering knowledge at SRAM, one of the top bicycle component manufacturers in the world (and located here in Chicago), to construct sturdy bicycles with standardized parts that are easy to repair. They distribute these bikes, mostly to schoolgirls in their teens, in African countries such as Zambia. Another group of people targeted for receiving bikes are home health caregivers, who travel among distant homes to tend to their patients.

What’s the Solow growth model connection? Teenage girls in Zambia are responsible for house chores before school, and then often have to walk up to two hours each way to school. Given these opportunity costs of their time and attention, school attendance rates are lower for girls and are more variable. Girls walking to school may also face personal safety risks. But with a bike, a girl can cover that two hours in less than an hour. She can also haul heavy items like water on the gear rack on the back of the bike, so she can be more productive in accomplishing her house chores because of the bike.

The WBR bike is a canonical example of the growth dynamic and how new ideas interact with other factors of production to increase productivity, and ultimately living standards, and WBR highlights that feature in their mission description:

Compared to walking, bicycles represent an enormous leap in productivity and access to healthcare, education and economic development opportunities. The simple, sustainable nature of bicycles empowers individuals, their families and their communities.

The bike combines with labor to provide more effective household chore completion per unit of labor. The bike increases the amount of schooling and the combination of education with labor, which creates human capital, ultimately increasing living standards. If you have a standard two-dimensional production function model in which output is a function of capital (with a given amount of labor, Y=f(K) given L), then introducing bikes increases K, which increases Y for a given production function. That can reflect the ability to perform more chores more efficiently. But there’s more — the bike increases school attendance, thus increasing human capital, which shifts the production function up. Better educated girls are more able to create output with a given amount of capital. Another aspect of human capital formation that WBR enables is through training mechanics in how to maintain and rebuild the bikes.

I said this was also a story about technological change. When WBR started, it was focused on increasing K, on getting bikes of whatever kind to these people in these communities. But they quickly found that some were not sturdy enough, and that broken bikes sat unused and unrepaired. This realization led the SRAM engineers to design a purpose-made bike that was sturdy, made with standard parts that were interchangeable, and easy to repair. That’s the combination of new ideas that constitutes technical knowledge, which also shifts the production function up and is the best source of continuing economic growth, because it arises from our boundless creativity.

This video does a great job of communicating the productivity-enhancing aspects of WBR’s programs (as they say, the power of bicycles). Note, in particular, the caregiver who says she used to only have time to visit two patients per day when walking, but can now visit 15 patients per day, and the dairy farmer who says that he can now carry all of his milk to market, whereas before he only had the capacity to carry some of his milk. That’s progress.

“We don’t know where the price of crude is going to be,” says [Southwest Airlines's Chris] Monroe. But, he adds, “I think we have to be generally bullish just because we’re trying to protect against an increase … So we have a little bit of a bias that prices may go higher.”

He chuckles that he and [former SW treasurer Scott] Topping, longtime colleagues and friends, used to describe themselves as the “most conflicted” managers in the building — although low fuel prices would benefit Southwest overall, it would mean their carefully crafted hedging strategy wouldn’t pay off as well….

Still, “In my heart, I would love lower prices,” says Monroe. “Lower prices are good for everybody in our country, and especially good for an airline.”

From, “The ‘Fixer’ at Southwest Airlines,” CNBC.

Notice that Southwest trades crude oil options and other derivatives even though they are not in the physical crude oil market. Proposals that aim to limit trading to parties with “true” commercial interests in the underlying commodity could inadvertently trip up quite reasonable hedging strategies such as pursued by Southwest. (Presumably they find the liquidity available in the much more heavily traded crude oil markets attractive compared to trading in the less liquid jet fuel markets even though the crude oil price is an inexact proxy for the price of jet fuel.)

In related news, Delta Air Lines is buying a refineryfrom the Phillips 66 unit being spun off of ConocoPhillips. According to Dana Blankenhorn at SeekingAlpha, “Delta Refinery Deal All About Southwest.”

(I’m still with the skeptics on this deal. Is is really going to be cheaper for Delta to own a refinery and make jet fuel than just buy jet fuel in a reasonably competitive market? Another way of asking the question, why does Delta think it can do a better job of running the refinery than ConocoPhillips did? Surely contract-based cost management as practiced by Southwest will be more flexible and adaptable to changing conditions than Delta’s ownership of an aging refinery near Philadelphia.)