Monday, July 18, 2011

Decarbonising economy is not such a big deal

To a lot of thoughtful people, Julia Gillard's plan to virtually ''decarbonise'' our economy represents one of the most radical attempts at reform in our history.

It will present a profound challenge to the Australian way of life, we're told, requiring changes to our lifestyle, spending patterns, taxation burdens and possibly even people's chosen field of employment.

As well as changing our everyday practices, it will change the structure of the country's fiscal and industrial systems and the way we trade with the rest of the world.

Fortunately, however, the adjustment needed to achieve a low-carbon economy won't be nearly as drastic as the thoughtful observers expect.

The first point is that the very reason economists advocate the use of the price mechanism is their confidence this will be the least-cost way to bring about the desired changes. Least-cost primarily refers to least reduction in the rate of improvement in our material standard of living (which reduction Treasury's modelling estimates to be less than 0.1 percentage points

a year, totalling about 0.5 per cent by 2020).

Something that has such a modest effect on our standard of living is unlikely to have much effect on our way of life. If it doesn't, that will be by design.

Decarbonising the economy isn't as radical as it sounds. It's not too much of an oversimplification to say the main change we need to achieve is just in the means we use to generate electricity.

It's not likely to involve any reduction in our use of electricity, nor much reduction in the rate of growth in that use. That's true despite all the talk about the higher price of electricity encouraging householders and businesses to use it less wastefully. By definition, wasting electricity contributes nothing to our standard of living.

The majority of the economy will be largely unaffected by carbon pricing. Get this: Treasury estimates that industries employing more than 90 per cent of the workforce account for less than 10 per cent of emissions.

Note, too, that Treasury expects about half the eventual reduction in emissions achieved by our big polluting industries to be brought about in other countries, where reducing emissions is cheaper. This, too, is a design feature intended to minimise the cost and disruption to our economy.

Remember that the decarbonising of the economy won't happen overnight. It will be brought about over the next 40 years. And much of it will happen relatively smoothly as electricity producers install emissions-efficient generators when their old power stations come to the end of their useful lives.

This is why it's so important to leave those producers in no doubt that the cost of emissions will be high and rising. Paradoxically, the more they believe that, the more their actions will cause it to be less true.

Tony Abbott claims the scheme obviously involves the end of the coal industry because Treasury's projections envisage coal accounting for less than 10 per cent of electricity production in 2050.

This is dishonest for several reasons. It ignores the 15 per cent of production expected to come from coal that's been subject to carbon capture and storage. More significantly, it ignores the high proportion of coal produced for export, including coking coal for steel-making. (And this guy calls Gillard a liar.)

Decarbonisation should also involve a major reduction in our use of fossil fuels for transport, of course. But, if the world price of oil keeps rising, over time that change will come about regardless of Gillard's carbon pricing.

The assertion that decarbonisation will bring marked and disturbing changes in our way of life reveals a lack of appreciation of how much things are always changing - especially over a period as long as 40 years.

Our spending patterns change over the years as we buy proportionately fewer goods and more services, as new electronic gismos are invented, as more women leave the home to work and as enterprising businesses dream up new services to sell us. Do we notice? Not really.

It's funny to have some critics asking why they're levying a new tax then giving back most of the proceeds (including by reductions in income tax) and then have others talking about significant changes in the tax burden and the fiscal structure.

The beauty of taxes that are used to change the relative prices people and businesses face is that you can then use the proceeds to reduce other, ideally more inefficient, taxes. This, too, is a design feature.

John Howard used the surge in company tax revenue associated with the resources boom to cut personal income tax five years in a row then proposed increasing it to eight years (with the Rudd government obliging). This significant change in the mix of taxes was brought about without anyone much noticing.

It's true the carbon price will cause employment in the small proportion of the economy that's emissions-intensive to grow less quickly than otherwise, while employment in the small proportion of the economy producing renewable energy grows more quickly than otherwise.

While ever the overall economy is growing, such modest changes in employment shares won't cause much angst. And get this: each year about 2 million people change jobs, including about 500,000 who change industries.

The structural change the carbon price will bring isn't likely to be all that history-making. According to Treasury, ''the changes to the Australian economy from pricing carbon are [projected to be] small by historical standards and small compared to the changes we are already seeing in our economy as it adjusts to accommodate the pressures of mining boom mark II''.

A carbon tax is nothing compared with an exchange rate that stays above parity with the greenback.