Working papers: below is a summary of some recent papers that may be of interest to Regulation's readers.The Social Costs of Carbon Emissions
* "Estimates of the Social Cost of Carbon: Background and Results from the RICE-2011 Model," by William Nordhaus. October 2011. SSRN #1945844.
William Nordhaus estimates that the social cost for the emission of a ton of carbon dioxide in 2015 will be $11 in 2005 dollars, equal to about $12.50 in today's dollars. That amounts to about 12.5 cents of social cost per gallon of gasoline (which releases the equivalent of about 20 pounds of carbon dioxide) and 1 cent per kilowatt hour of non-baseload electricity (1.5 pounds) or 1.4 cents per kWh for coal-fired electricity (2.2 pounds). The variation we have experienced in gasoline and electricity prices in recent years dwarfs the increases from an optimal carbon tax. Thus incremental adjustments in behavior, rather than a radical alteration of energy infrastructure, would seem to be optimal in the near future.
This conclusion is reinforced by the introduction of equity considerations. The future generations who will be the beneficiaries of any investments we make now to reduce carbon emissions will be much richer than current generations. If current incomes were uniform, then the tax on today's "poor" to help tomorrow's "rich" should be lower than the $12.50 Nordhaus estimate. Tweaking this scenario to make it more realistic, assume the costs today are incurred by the richer countries like the United States, which are four times richer than other countries. The benefits will accrue to all countries 70 years from now. Further assume a 2 percent annual growth in consumption for all countries. The result of these assumptions is that consumption 70 years from now will be four times today's level. Under such assumptions there would be no equity adjustment to the optimal carbon tax because those taxed (the rich now) and those receiving the benefits (the future poor) would have the same income.
Should we weight the social cost of carbon results for those scenarios in which probabilistically the temperature change is high? Recent developments in insurance theory recommend that we take account of not just damages but also the relative income of the scenario in which the damages occur relative to the scenarios that would be charged a premium to prevent the damages. If the costs occur in the rich eras, then you would not want to "tax" the poor periods to smooth consumption. Nordhaus writes:
Suppose all the damages came because more intense hurricanes flooded the beach houses of very rich people in states of the world where incomes were very high. The logic of the result is that we should not pay an insurance premium today (paid for by non-rich people today) to insure against floods of rich people's houses in the future. (p. 21)
Sports Stadium Subsidies
* "League Structure and Stadium Rent Seeking: The Role of Antitrust Revisited," by David Haddock, Tonja Jacobi, and Matthew Sag. January 2012. SSRN #1983447.
Public subsidies for new professional sports stadiums in the United States are a large and growing problem (see "The Stadium Gambit and Local Economic Development," Summer 2000). They occur because sports teams credibly threaten to move from their current city to a city that will subsidize them. In contrast, English soccer stadiums are private, older, and frequently renovated rather than torn down and rebuilt with enormous infusions of public money.
According to the authors of this paper, there is an important difference between professional sports in the United States and England: the promotion and relegation system used in the latter. Top-finishing teams in a professional league are promoted to a more prestigious league the following year, while bottom-finishing teams are relegated to a lower league. Teams are geographically fixed but leagues, in effect, reform every year. So entry into the major leagues is much easier than in the United States and threats to move an English team to gain subsidies are not credible.
Shadow Banking and Bankruptcy
* "A Dialogue on the Costs and Benefits of Automatic Stays for Derivatives and Repurchase Agreements." by Darrell Duffie and David Skeel. January 2012. SSRN #1982095.
In previous columns I have described the development of the "shadow banking system," the replacement of the traditional deposit and loan system with an alternative in which overnight cash deposits were transformed into packages of securitized loans. By the mid 2000s this system accounted for two-thirds of lending in the United States, while traditional bank loans accounted for the other third. In the fall of 2008, because of the downturn in housing values and the resulting defaults on mortgage debt and mortgage securities packages, the cash depositors in this system lost confidence. They fled the entire securitized loan system and instead purchased safe Treasury debt.
An important policy change leading to the development of the shadow banking system was the exemption from the automatic stay in bankruptcy of Qualified Financial Contracts (QFCs), including derivative and asset repurchase agreements. Bankruptcy normally freezes all transactions until a judge determines the market value of assets and divides them equally among all creditors. QFCs have been exempt from the automatic freeze. Originally the exemption applied only to asset repurchase agreements ("repos") involving Treasury debt. In 2005 the safe harbor exemption was extended to repurchase agreements involving mortgage securities and other repurchase agreements that were the heart of the shadow banking system.
The bankruptcy exemption has five costs:
* The cash depositors have much less incentive to monitor the securities given to them as collateral because they can get their cash back just by giving back the collateral.
* A financial institution has incentive to have a very large repo "deposit" base so that it will be bailed out if it fails.
* Repos involve inefficient substitution away from traditional banking.
* The sale of illiquid repo assets to raise cash demanded by skittish depositors exacerbates the lack of confidence in the system by investors.
* Financial institutions financed by exempt repos have much less incentive to file for bankruptcy because bankruptcy would not prevent a run and demands for cash. For example, AIG spiraled down rather than file for bankruptcy because the Goldman margin calls could not be retrieved by AIG like all other unusual payments in normal bankruptcy proceedings.
The authors of this paper recommend a return to the pre-2005 rules in which only repos involving liquid Treasury securities are exempt from the bankruptcy automatic stay. No purpose is served by delaying access to liquid securities (like treasuries) because, by definition, they are easily converted to cash. The authors believe that the 2005 expansion of the safe harbor to include repos involving mortgage-related securities and other illiquid assets was a mistake.
Economic Consequences of Citizens United
* "Corporate Politics, Governance, and Value Before and After Citizens United," by John C. Coates, IV. December 2011. SSRN #1975421.
While the Citizens United Supreme Court decision has been good for free speech, has it been good for shareholder value? John Cotes examines data for the S&P S00 from 1998-2004, 2008, and 2010. He finds that corporate political activity is more frequent in those corporations that use corporate jets and whose chief executive officers later take political jobs. He finds that firms that were politically active in 2008 experienced a significant decline in shareholder value in 2010 relative to firms that were not politically active in 2008. In general, political engagement is negatively correlated with shareholder value. The exceptions include the most heavily regulated industries and the defense sector in which political activity helps shareholders.
These results remind me of Robert Sitkoff's ("Politics and the Business Corporation," Winter 2003-2004) revisionist description of the origins of the restriction on direct corporate donations to political campaigns, enacted in 1907. Corporations play a prisoners' dilemma game with respect to participating in the political system. All corporations collectively would be better off if none of them sought advantages from the public sector, but each of them individually has incentives to defect, particularly when politicians seek money from them and threaten them with adverse policy decisions unless they contribute. Sitkoff argued that the 1907 ban on corporate contributions was sought by corporations to prevent them from being "held up" by politicians.
Nuclear and Renewable Electricity Costs
* "The Private and Public Economics of Renewable Electricity Generation," by Severin Borenstein. December 2011. NBER #17695.
* "Prospects for Nuclear Power," by Lucas W. Davis. December 2011. NBER #17674.
These two papers provide readers with concise non-technical summaries of the costs of many of the non fossil fuel sources of electricity. The levelized cost of electricity is defined as the price of electricity that equates the present value of plant costs with the present value of its output over the lifetime of the plant. Plant costs are usually known. The unknowns are fuel costs, interest rates, and outage rates. Even though they are widely used, levelized costs are misleading because they ignore the time-varying value of electricity and do not distinguish between generation that is dispatchable and generation that is not. For example, solar is more valuable than wind because solar's peak output coincides with peak demand in the afternoon while wind's peak output is at night in the winter, a time of low demand.
Subsidies to fossil fuels are not really that distortionary because they amount to only 0.11 cents per kWh even if environmentalists' high estimates are used. The levelized cost of residential solar panels is about 24 cents per kwh while natural gas combined-cycle generation is below 8 cents per kWh. Even taking local pollution into account, natural gas-fired electricity is at least 15.8 cents less expensive per kWh. Thus the appropriate charge for the externalities from natural gas carbon emissions would have to be at least $316 a ton for solar to be competitive. And remember that Nordhaus, above, calculates that the optimal charge for the emission of one ton of carbon dioxide is only $12.50. Thus subsidies to renewable generation technologies are not a cost-effective substitute for optimal carbon taxes that are not politically acceptable.
Nuclear power's primary challenge is also its cost. The French have the most nuclear intensive electricity generation system in the world. If any country were to reduce costs because of learning-by-doing, it would be France. But French costs have escalated over time from $1,000 per kW of capacity in the 1970s to $2,300 per kWin the 1990s. The plants currently under construction in Finland and France have also experienced cost increases. A Finish plant, begun in 2005, was supposed to cost $2,800 per kW and be finished in 2009. It will now not come online before 2015 and cost $5,600 per kW. A French plant was supposed to cost $2,900 per kW and is now 50 percent over that and completion has been delayed by three years. The current best estimates of levelized costs are 10.5 cents per kWh for nuclear, 7.4 cents per kWh for coal, and 5.2 cents per kWh for natural gas.
PETER VAN DOREN is editor of Regulation and senior fellow at the Cato Institute.