Carbon courage, and for Gillard, no going back

Maybe Julia Gillard will make a good prime minister after all. Her decisions of late - culminating in her commitment to impose a price on carbon from July next year - suggest she has learnt from Labor's mistakes and understands what she must do to stay in office.

Kevin Rudd's biggest mistake was to abandon his carbon-pollution reduction scheme after the going got tough, rather than seeking to get it passed after a double dissolution election. Urged on by Gillard and Wayne Swan, he thought abandoning the threat of "a great big new tax on everything" would help preserve his popularity.

Instead, it convinced voters he was lacking in courage and conviction. That was when his sharp slide in the polls began. His funk over climate change contributed to the mishandling of the resource super profits tax, while emboldening BHP Billiton and the other big miners to attempt to knock off the tax by knocking off the government. It's clear that, when Gillard replaced Rudd and rushed to an early election, she had no idea why Labor was in trouble. Rather than taking a different tack on the emissions trading scheme, she made matters worse by promising not to impose a price on carbon during her next term.

The result was that Labor voters abandoned the party in droves, while few if any swinging voters were attracted to such a chameleon party. She'd tried to "govern from the centre" and been caught between two stools. At last, however, Gillard seems to have realised leaders have to stand for something if they're to retain the loyalty of their heartland and impress the rest of the electorate.

She's starting to show signs of courage in imposing the eminently avoidable flood levy, in attacking rather than aping Tony Abbott's latest attempt to capitalise on popular resentment of boat people, and in restating Labor's support for multiculturalism.

For weeks she's been making speeches about her belief in economic reform and now she's given that some substance by announcing a firm objective of introducing a price on carbon well before the next election, not after it. No going back now.

Not long after Rudd followed John Howard's example in committing to using an emissions trading scheme as the means of imposing a cost on emissions of carbon dioxide and other greenhouse gases, many economists decided they favoured using a carbon tax.

In theory, the two are mirror images of themselves. Trading schemes limit the quantity of emissions directly, in the process pushing up their cost. Carbon taxes raise the cost of emissions directly, in the process discouraging people from emitting them. In practice, the two approaches have differing practical and political pros and cons. And now Gillard's agreement with the Greens commits her to a hybrid of the two. An emissions trading scheme will be established, but for the first three to five years the price of permits will be fixed and no trading allowed. After that trading will be permitted and this will cause the price of permits to vary with the balance of supply and demand.

This idea was originally proposed by Professor Ross Garnaut and later taken up by the Greens. Of course, most of the details of how the scheme would work remain to be negotiated with the Greens and sufficient independents in the House of Representatives.

But in his review of Gillard's statement, Dr Richard Denniss, the director of the Australia Institute, says the initial price is unlikely to be lower than the $26 a tonne initially used by Treasury in its modelling of the carbon pollution reduction scheme. The annual increase in the price is likely to be the inflation rate plus a few percentage points. Denniss says that if the eventual move to a trading scheme led to a rapid fall in the carbon price this would harm many businesses. So he suggests setting a price floor to prevent that from happening (as it did happen in the European Union's trading scheme).

Perhaps the greatest area of political vulnerability is the scheme's addition to households' electricity bills, given these have already risen by 40 per cent or so in recent times for other reasons. Here Denniss has an unorthodox and second-best suggestion.

Since it's all higher prices rather than just higher carbon prices that are expected to change our habits in the use of power, why not shield consumers from any further price increases?

The power generators could be made to pay for their emissions, but the higher costs could be offset by direct payments to the retail distributors. This would leave the price incentive for generators to invest in less emissions-intensive production methods, while removing the need to raise household electricity costs but then compensate people for the rise in their cost of living.

As Denniss reminds us, behavioural economics explains why the punters hate being taxed with one hand and compensated with the other. Partly it's distrust - the pollies may welsh on the deal - but mainly it's because most people are "loss averse": they dislike losing money more than they enjoy receiving money.

The very use of the word "compensation" is a reminder to people there must be pain involved.

Because it's so hard to adequately compensate every last person with unusual circumstances, governments commonly end up overcompensating a lot of people. So if you sent the compensation direct to the electricity retailers you could avoid wasting the proceeds from the tax on overcompensation, leaving more available for subsidising research and development of alternative energy sources.

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A carbon price can't save the planet by itself

I have a love-hate relationship with economic rationalism. I have great respect for the power of market forces - individuals and firms do change their behaviour in response to changing prices - but I'm well aware of their limits.

To me the test of economic understanding is whether it's pragmatic and "evidence-based" or ideological and faith-based. Is the neo-classical model simply a tool of analysis, suited to some jobs better than others, or is it an infallible guide to the universe?

A good test for economists is their attitude to climate change. A few - particularly those associated with the Lavoisier Group and libertarian think tanks such as the Centre for Independent Studies and the Institute of Public Affairs - would prefer to deny the weight of scientific opinion rather than admit that global warming represents an instance of "market failure" needing to be corrected by government intervention.

I'm convinced the great majority of economists, however, accept the existence of global warming and the need for intervention. They argue the best way to tackle the problem is to use a carbon tax or emissions trading scheme to incorporate the cost of the damage done by greenhouse gas emissions into the prices faced by the producers and consumers of emissions-intensive goods and services, harnessing market forces in the service of the environment.

Agreed. But the next stage of the evidence-versus-faith test is whether an economist thinks "putting a price on carbon" is all we need to do the trick, or whether "complementary policies" are needed to bolster the pricing policy. Such complementary policies may involve government subsidies or tax concessions, or laws imposing certain requirements or prohibiting certain behaviour.

This issue arises because Julia Gillard is proposing to cover much of the cost of rebuilding Queensland's public infrastructure by ending or capping various government spending programs intended to reduce emissions. She's defended this by saying they'll no longer be needed once we get a price on carbon.

Actually, most of the programs she wants to chop would be no loss because they're far from cost-effective in reducing emissions. But should they be replaced by programs that are cost-effective or will the carbon price be sufficient, as Gillard implies?

The present secretary of the Department of Climate Change and soon-to-be secretary to the Treasury, Dr Martin Parkinson, is in no doubt that complementary measures are necessary.

He said in a speech last year that "the lack of a carbon price signal is fundamental, and no long-term policy solution is possible without the creation of [price] incentives to protect the integrity of our climate system and reduce the risks of dangerous climate change.

"But it needs to be complemented by other measures. These include support for the development of new low-emission energy technologies, integration of climate considerations into transport planning, provision of general energy efficiency information, and addressing split incentives in rental markets."

In a discussion paper issued this week by the Australia Institute, Dr Richard Denniss and Andrew Macintosh remind us that governments have a long history of using complementary policies to augment price-based measures in changing behaviours.

In their efforts to discourage smoking, for instance, governments used taxes to raise the price of cigarettes but also used subsidised access to quit treatment plus restrictions on advertising, sales to minors, who may sell cigarettes and where they may be smoked.

To encourage the use of unleaded fuel, governments cut the tax on unleaded but also required all cars sold after 1998 to run on unleaded petrol.

So when are complementary measures necessary and how should they be designed? Denniss and Macintosh set out six principles. First, measures should be cost-effective. The budgetary cost of measures to reduce emissions should be compared with the quantity of emissions likely to be prevented, thus expressing the cost as dollars per tonne of carbon dioxide. This can be compared with the price on carbon created by the tax or the trading scheme.

Second, measures must be in response to a clear case of market failure. It's because in practice markets sometimes fail to deliver the benefits the economists' model promises that putting a price on carbon isn't enough.

One example of market failure is "split incentives": if a tenant incurs the cost of installing insulation in a rental property, it's likely to be future tenants who capture most of the benefits. And if a landlord installs insulation it's the tenant who will benefit from better temperatures and lower electricity bills.

Another example is "public goods": sometimes people can't be excluded from benefiting from services they haven't helped to pay for, making it unprofitable for the market to provide these services in sufficient quantity. Research and development spending has this characteristic, meaning it should be subsidised by government in the public interest.

Third, complementary policies should work in conjunction with, not in opposition to, other policies aimed at reducing emissions.

For instance, the Rudd government's emissions trading scheme was designed in such a way that any reduction in emissions caused by its subsidies for households installing solar panels would simply reduce the effort required by other polluters, not add to the overall reduction.

Fourth, the complementary policies of the federal government should fit with the policies of state governments. Rudd's emissions trading scheme gave the feds all the responsibility for reducing emissions, while leaving with the states the responsibility for "adaptation" - coping with the effects of climate change - even though in some areas the states were better placed to reduce emissions.

Fifth, complementary policies should be equitable. While it's accepted that low-income earners should be compensated for the effects of a carbon price, much less attention is paid to the fairness of complementary policies.

For instance, only the well-off could afford to install photovoltaic solar panels but the cost of the generous feed-in tariffs they enjoy is borne by all electricity users, rich or poor.

Finally, complementary measures need to involve accountability. As we saw with the home insulation scheme, it's easy for such measures to be badly administered or for a lot of money to be spent without much effect, particularly where subsidies are involved.

So the objectives of complementary measures need to be spelt out clearly and the schemes need to be monitored regularly against those objectives.

It's no bad thing for Gillard to abandon those complementary measures that have proved wasteful. But the limitations of market forces mean doing no more than imposing a price on carbon emissions is unlikely to reduce emissions to the extent we need.

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Carbon price is no fix-all

Our wide brown land has always been subject to ''extreme weather events'' - droughts, floods, cyclones, bushfires and heatwaves. That's why no one can say the extreme events we've been suffering lately are a direct consequence of climate change.

But scientists have long predicted that one effect of global warming would be for extreme events to become more extreme, which is just what seems to be happening. So it would be a brave or foolhardy person who denied recent events had anything to do with climate change. And, certainly, the insurance industry, which keeps careful records of these events, is in no doubt that climate change is making things worse.

All this being so, you'd expect it to strengthen our determination to get on with doing our bit to reduce emissions of greenhouse gases. Yet cuts in spending on climate change programs are one of the main ways Prime Minister Julia Gillard proposes to cover the cost of rebuilding public infrastructure in Queensland. The cuts will save almost $1.7 billion over four years, compared with the $1.8 billion the temporary tax levy will raise.

So what on earth is Gillard on about?

She says the key to it is her determination to deliver a carbon price. ''There is complete consensus that the most efficient way to reduce carbon is to price carbon. Some of these policies are less efficient than a carbon price and will no longer be necessary - others will be better delayed until a carbon price's full effects are felt,'' she says.

She's right that there's strong agreement among economists and others that the most efficient - that is, the least costly in terms of economic activity discouraged - way to reduce our emissions of carbon dioxide is to build the cost of the damage done by the emissions into the prices of the emissions-intensive goods and services we produce.

This is the way to enlist market forces - our tendency to change our behaviour in response to changes in the prices we pay - in the service of the environment. It encourages us to find ways to reduce our emissions while giving us freedom to choose the ways that work best for us.

It also removes the price disadvantage suffered by the various forms of renewable energy because the prices of fossil fuels don't include the cost of the damage they're doing to the environment.

But, as the Australia Institute's Richard Denniss and Andrew Macintosh point out in a paper to be released today, imposing a price on carbon emissions won't solve the problems most of the affected climate programs were intended to tackle.

For instance, the cash-for-clunkers scheme and the Green Car Innovation Fund are designed to reduce emissions from cars. But the government's former emissions trading scheme specifically excluded petrol, and there's been no suggestion the new arrangements will include it.

The government plans to cut research into carbon capture and storage. But though raising the price of coal in Australia will provide some incentive for coal companies to continue pursuing clean-coal technology, they're unlikely to put in nearly as much money as the government was promising because the technology is not at all promising.

The government plans to cap or cancel various programs aimed at encouraging households to install solar panels. Again, it's doubtful whether raising the price of coal-based electricity will be sufficient to overcome the various impediments to better energy use in the home. So Gillard's claim that a price on carbon will remove the need for other measures to discourage emissions doesn't stand up.

But that's not to say she shouldn't be cutting back or getting rid of those particular measures. Most of them would be no loss. The cash-for-clunkers scheme is a hugely expensive way of encouraging a modest reduction in omissions. The green car fund is just a disguise for giving further help to car makers.

And the hope that the carbon dioxide emitted during the generation of electricity from coal could be captured and stored underground in a commercially viable way is probably a pipedream.

As for the schemes to encourage households to go solar, they've been far too generous, requiring the taxpayer to pay much too much for the reduction of emissions - up to $280 a tonne in the case of one scheme.

No, the disappearance of most of these programs will be no loss. But in claiming they will be made redundant by a carbon price, Gillard is trying to cover the government's embarrassment because most of them were introduced by Labor itself. And, as Denniss and Macintosh argue, she is inflating expectations about how much a carbon price could achieve. It may be the most important thing we need to do, but it's not the only thing.

Because market forces are powerful but far from perfect, the carbon price needs to be complemented by other measures. Getting rid of bad complementary measures is fine, but they need to be replaced by measures that are more cost effective.

And if Gillard is looking for cost savings to help pay for flood damage, she should start by getting rid of programs that actually subsidise the use of fossil fuels: the concessional taxation of company cars, the exemption from fuel excise for aircraft and natural gas and certain other tax concessions. Getting rid of those would not only help reduce emissions, it would save the budget more than $4 billion a year.

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Others doing more than us to cut emissions

To adapt an old saying, bad news is halfway round the world before good news has got its boot on. The media love bad news because they know their customers find it more interesting. But when the news is mixed, ignoring the good bits can leave you with a false impression of reality.

You already know the latest bad news on action to limit climate change: the loss of a Democrat majority in the House of Representatives has obliged Barack

Obama to abandon his efforts to get an emissions trading scheme through Congress.

Many have taken this as further evidence - on top of our own Senate's refusal to pass a trading scheme and the failure of countries at the Copenhagen conference to agree to binding emissions-reduction targets - that action on global warming is getting ever less likely.

The sceptics keep pointing out that, since greenhouse gas emissions are a global problem, if all the major countries can't agree on action it's pointless for any individual country to bother doing anything. That's true even for the United States or China, let alone a small country like Australia, which is responsible for just 1.2 per cent of the world's emissions.

To this we get the familiar refrain from the small-minded: why should we be the first to do the right thing? Why not let someone else make the sacrifice this time?

So what's the good news? There's a weakness in the logic that, unless we all agree, it's not worth anyone doing anything. We don't actually have to reach an explicit agreement.

There's nothing to stop each of the major emitting countries from acting unilaterally in the hope that, this way, a tacit agreement to act could be formalised later. Perhaps this was always the smartest way to achieve an agreement.

Wishful thinking? Don't be so sure. Contrary to popular impression, Copenhagen wasn't a total failure. The countries did reach an accord and one thing they agreed on was to each submit a pledge of the targets they were prepared to agree to.

Dr Frank Jotzo, director of the Centre for Climate Economics and Policy at the Australian National University, has studied those pledges and been encouraged by what he found.

He looked at 13 major countries that between them account for about two-thirds of global emissions. Among the developed countries he took the US (accounting for 14 per cent of global emissions), the European Union (11 per cent), Russia (4 per cent), Japan (3 per cent), Canada (2 per cent) and Australia.

Among the developing countries he looked at China (15 per cent), Brazil (6 per cent), Indonesia (4 per cent), India (4 per cent) and Mexico, South Korea and South Africa (each with 1 per cent).

All the targets to which the countries committed themselves were for their emissions in 2020. On the face of it, they varied greatly. The developed countries pledged to reduce their emissions by some absolute amount relative to their emissions in an earlier base year, whether 1990, 2000 or 2005.

China and India pledged to reduce their "emissions intensity" by a certain percentage - that is, the amount of emissions per dollar of their gross domestic product. The other developing countries pledged to reduce their emissions by a certain percentage below what they would otherwise have been in 2020.

What Jotzo did was to put all the targets onto various comparable bases, using certain assumptions. When compared in terms of absolute reductions in emissions the pledges varied widely, with emissions by China and India continuing to grow - but reductions in all other countries, developed and developing, bar Russia.

When compared on the basis of emissions intensity, however, remarkable similar percentage reductions were pledged, with the developing countries targeting bigger reductions than the rich countries. China, for instance, is targeting a reduction of 40 to 45 per cent over 15 years.

And when compared on the basis of reductions from what emissions would otherwise have been, the targets reveal a similar degree of effort.

Because we haven't done much - and because Obama's promise to continue working to achieve emissions reductions by other means received little attention - we happily assume other countries haven't done much.

Not true - especially not for China. It is actively pursuing the target it reported to Copenhagen. It has ordered the shutdown of inefficient and high-emitting coal-fired power stations and their replacement with high-efficiency coal-fired generators. It has imposed energy performance standards for emissions-intensive industries and vehicle emission standards, is offering various incentives for clean energy and is spending bucketloads on developing renewable energy.

You can use trading schemes or a carbon tax to impose an explicit price on emissions of carbon dioxide. That's the best way to do it. But government subsidies and other measures can do the same thing indirectly.

A study sponsored by Australia's Climate Institute has sought to measure the implicit carbon price in various countries. It's $29 a tonne in Britain because its participation in the European trading scheme is backed up by various domestic measures.

It's $14 a tonne in China thanks to the measures I've mentioned and it's even $5 a tonne in the US because of federal subsidies to clean energy sources and state renewable energy targets.

And what do our bits and pieces add up to? A princely $1.70 a tonne.

Two conclusions. All the key countries - even the US - have pledged their willingness to take significant action and some, including the biggest single emitter, China, are getting on with it. As other countries see this, they'll become more active themselves.

Far from being the country that's leading the way and making sacrifices while others hang back and marvel at our naivety, Australia - a country with more to lose than most - is dragging the chain.

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Economists waive any responsibility on climate

Julia Gillard's stop-gap substitutes for Labor's abandoned emissions trading scheme is unlikely to produce much reduction in emissions or be cost-effective. I reckon just about every economist would agree with that proposition, just as they'd agree with its corollary: the key to reducing emissions is to put a price on carbon.

Yet the nation's economists were neither unanimous nor active in supporting the Rudd government's carbon pollution reduction scheme.

Why weren't they? Why do so many economists behave in such an uninterested and even disinterested way on the subject?

Dr Martin Parkinson, the secretary of the Department of Climate Change, observed in a recent speech that, unlike with other, earlier economic reforms, ''there has not been a broad consensus within the economics profession on the merits of action to reduce Australia's greenhouse gas emissions, nor on the general approach to how it should be implemented''. With a few notable exceptions, he said, it had been surprising ''how little serious engagement we have seen from economists in the carbon pollution reduction scheme debate''.

Economists' preference for a carbon price signal was where agreement among economists ended. ''There is disagreement on the detail required for practical implementation, such as the timing, level and nature of the mechanisms that should be used to provide a carbon price signal, and in some cases disagreement on whether action should be taken at all,'' he said.

So why is there this lack of broad consensus and engagement by economists? Parko suggests four possible reasons.

First, some economists see climate change as an environmental problem rather than a multi-disciplinary problem. If it's an environmental issue, it's probably being dominated by environmentalists who are interventionist and anti-growth. In truth, the policy response to climate change is based on work coming from scientists, not greenies.

Note that Parkinson is a former deputy secretary of Treasury and has a quite a few ex-Treasury people around him. Emissions trading is an ''economic instrument'' and it was being designed and implemented by highly orthodox economists.

''When it comes to climate change science and projections, it is probably reasonable that economists without expertise in the relevant scientific disciplines should let scientists be the professional experts in this area,'' Parko said.

Even where some economists are genuinely sceptical of the scientific evidence, ''it has been surprising that some economists have resisted serious consideration of the professional application of the precautionary principle - that is, that taking action on climate change today is a form of insurance''.

Second, economists usually deal with marginal issues and have little experience with issues having potentially catastrophic outcomes. To a neo-classical economist trained in ''marginal analysis'', marginal doesn't mean of little importance, but quite the reverse. All the interesting things happen on the margin.

But climate change has the potential to involve a complete change in the state of the world, including the possibility of catastrophic outcomes. Economists have little experience in dealing with ''non-trivial'' (that is, worth taking seriously) probabilities of such outcomes occurring, or the related application of the precautionary principle and need for risk management.

This is the ''fat-tailed'' or ''black swan'' problem that's very difficult to assess using economists' conventional ''expected-value'' risk analysis: that is, a tiny probability of an unthinkable event.

The third reason economists have failed to provide strong support may be that, though they understand ''externalities'' in principle, in practice they have a strong preference for leaving things to the market.

The existence of market failure doesn't automatically justify government intervention in the market. You also have to be satisfied intervention will do more good than harm, otherwise all you end up with is ''government failure''.

This highlights the cost of inaction, which both Britain's Stern report and our own Garnaut report have shown is very high. This being so, the chances are high that, without guidance from economists, governments will pursue remedies involving high efficiency costs.

Parko's fourth possible explanation for economists' lack of support is that they prefer to be pure in their proposed solutions to problems and are suspicious of politically negotiated outcomes and transitional assistance.

Academic economists in particular love an ''elegant'' solution to a complex problem, but policy action is a messy, compromised business, that never starts with a clean slate and involves building coalitions around concrete policy proposals.

No sooner had the Rudd government fixed on an emissions trading scheme than economists came out of the woodwork arguing a carbon tax would be better. That trading schemes had long been the centre of international efforts to achieve a co-ordinated reduction in emissions troubled them not a bit.

''These proposals are generally put forward at a conceptual level, where they may be models of elegance and simplicity, untrammelled by questions of practical implementation or political reality,'' Parko said.

As for the objection to transitional assistance, ''no one ever suggested that tariff reform wasn't worth doing because it was implemented gradually and with generous transitional assistance packages - yet despite the careful attention paid to preserving the abatement incentives and ensuring that assistance is provided for a transitional period only, this is exactly what many are saying about the carbon pollution reduction scheme''.

Parkinson concludes that economists' lack of agreement on key implementation questions renders their preference for a carbon price signal largely meaningless in practice. In fact, it undermines public support for least-cost solutions. Well done.

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Show us your ticker, Gillard, before we vote

Excuse me, but what's the tearing hurry? We've had a new Prime Minister for five minutes, but we're being rushed off to an election before we can get her measure. Why? Is there a fear, if the election were delayed until October, the gloss would have worn off and we'd see Julia Gillard in a less hopeful and flattering light?

Is the new leader's fleeting honeymoon all that stands between Labor and electoral defeat? Is Labor's record in government that bad? Is Tony Abbott such a formidable opponent?

I'm not impressed by what we've seen of the Gillard government so far. We've seen the triumph of political expediency over good government. From her first day she's left little doubt three running political sores - the mining tax, resentment of boat people and the vacuum left by Labor's abandonment of its emissions trading scheme - needed to be staunched quick smart if the government's re-election were to be secured.

But what hasty, amateurish patch-up jobs we've seen. Wayne Swan has fudged up figures purporting to show the revenue cost of the deal done with the three biggest mining companies was minor, whereas sharemarket analysts are saying the extra tax to be paid by the companies will be minor. Then we had the fearful muddle over the Timor solution the Timorese hadn't agreed to, and now we're getting the climate change policy you have when you don't have a climate change policy.

The trouble with all this is it's terribly reminiscent of Kevin Rudd. Lacking in courage, not thought through and thrown together at the last moment. None of these stop-gap solutions will have been legislated before the election. So is that to be Gillard's agenda for Labor's second term: finishing off all the stuff not finished in the first term? Is that to be as inspiring as it gets? First re-elect my government and then I'll have time to think up my own agenda?

I'm sure the government has plenty of announcements up its sleeve to make between now and election day, but I'm not sure they'll add up to anything more than a grocery list. Bit of this, bit of that, tinker with this, fine-tune that. Nothing controversial, of course, and (given the budget deficit) nothing too expensive.

Before we vote on whether to retain Gillard we need to know a lot more about her and, more particularly, where she proposes to take us.

She tells us she believes in hard work, egalitarianism and the value of education, and she's proud of her mum and dad. I doubt if there are many who'd disagree, but if that's as big as her vision gets she's not ready to be our leader.

One of Rudd's biggest problems was he couldn't set priorities for himself. He took on too much, wanted the biggest and best in everything, and ended up not getting much achieved. He took on a couple of big economic reforms - the emissions trading scheme and the resource rent tax - but took them far too cheaply, underestimated the amount of explaining that needed to be done, then when the going got tough, turned turtle.

So what are Gillard's priorities? What does she plan to devote most of her attention to at the expense of all the other things she could focus on? Does she know but doesn't want to tell us, or hasn't she had time to think about it? Will she work it out as she goes along?

We know, despite her protestations, climate change won't be one of her second-term priorities. She says (correctly) we need to put a price on carbon, but then says she won't get ahead of public opinion and won't act on a carbon price until after 2012. Her next term will be spent doing the explaining that should have been done this term.

I fear most of what passes for economic debate in the election campaign will be of little consequence. Labor dumped its emissions trading scheme and emasculated its resource super profits tax for fear of being accused of introducing "a great big new tax", but that won't stop both sides accusing each other of planning to do just that.

Both sides will express their determination to get the budget into surplus as soon as possible and eliminate our (tiny) public debt post haste, while accusing the other of profligacy.

If there's one thing we don't need to worry about it's deficits and debt. Why not? Because we worry about it so much. The Libs make such a fuss about it it's a crime Labor wouldn't dare to commit.

The big economic issues facing us include how we'll make room for a greatly expanded mining sector in an economy already close to full employment, whether there's more tax reform in the Henry report we should be getting on with, and how we'll fix the ever-growing shortage of housing, including improving public transport to make homes in the outer suburbs more accessible.

Far from spending the next three years chatting about whether to get serious about combating climate change, we need to debate our unquestioned commitment to unlimited economic growth.

Does ever-rising affluence - much of it used to fuel an unending status competition - make us happier as both sides of politics assume? Are we paying a hidden price for it in damage to our family and social relationships? Is it really possible for the rich world to keep increasing its consumption of natural resources while the developing world - led by China and India - rapidly raises its standard of living towards Western levels without this irreparably damaging the ecosystem?

A bit too much for a prime minister from the left desperate to prove she's not left-wing? Far too threatening a subject for either of the political parties? I fear so. Much safer to have a furious argument about great big new taxes and the budget deficit.

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Green jobs just muddy the climate-change waters

A cartoon by Jon Kudelka shows Julia Gillard ticking off items on her to-do list: first, appease billionaires; second, appease xenophobes; third, appease climate sceptics. Too true ... although, actually, when she has finished appeasing those who live in fear of boat people her last bit of pre-election deck-clearing will be to appease those who regret the government's decision to walk away from its emissions trading scheme by announcing a program of government subsidies to induce people to reduce their emissions directly.

Amazing though it may seem, the climate-change-denying opposition has a post-trading scheme policy to encourage "direct action", whereas the government - which still protests its acceptance of human-caused climate change - doesn't.

It's a fair bet that when we see Gillard's direct-action policy it will come complete with boasts about how many "green jobs" it will create.

Creating green jobs is all the rage. About a year ago Kevin Rudd promised to create 50,000 of them. Tony Abbott has plans for a standing army of 15,000 green workers who could be deployed across the country. And every environmental group or renewable energy lobby group wants to tell us how many "green-collar jobs" could be generated if only we'd do as they say.

It seems the notion of green jobs arose as a response to the claims of the opponents of climate policy that moving to a low-carbon economy would destroy lots of jobs. No it wouldn't, environmentalists cried, it would create lots of jobs. What's more, they would be green jobs.

But as the Australia Institute warns in a policy brief to be released today, there's a lot of woolly thinking about green jobs. It seems to be little more than a propaganda tool.

For a start, there has been little attempt to define what constitutes a green job. If, for instance, a job maintaining a wind turbine is a green job, what about a job in the business that makes the turbines?

And if it's green to manufacture steel turbines, what about the jobs of the people who mine the iron ore and coking coal needed to make the steel? But if it's not green to be a miner, would it be better for us to import all the turbines we need so the sin of being non-green was on someone else's head?

Should people who work in industries with a low environmental impact be regarded as having green jobs? If so, a significant proportion of all our existing jobs - particularly those in health, education and community services - are green.

But what about jobs in industries that have reduced their ecological footprint, even though it remains substantial? Are these jobs more green or less green than jobs in industries whose footprint has always been small?

As a general rule, industries that are capital-intensive are likely to have a bigger footprint than industries that are labour-intensive, such as service industries. Does this mean we could make the economy greener by abandoning our age-old quest to use machines to replace workers wherever possible?

Do workers whose job is to return a mine site to nature after it has been worked out qualify as green-collar workers? If so, what about workers who clean up after oil spills?

And what about jobs that make the natural environment more accessible to people? If, for instance, you employ some young people to improve the signs on a bush-walking track (for which I'm always grateful) are these green jobs? The advocates of such projects seem to think so.

Visiting the great outdoors may make people more environmentally conscious. But what if the greater accessibility attracts more people and thus adds to the degradation of the area? Would the green jobs then turn brown?

If I were to drive all around the state - or fly all around the world - educating people about the damage the use of fossil fuels does to the climate, would that make me a green-collar worker?

Give up? I reckon it's virtually impossible to come up with a watertight definition of green jobs. But I don't think that matters. As the Australia Institute's report argues, focusing on green jobs is at best a distraction and at worse a snare and a delusion. The object of the climate change exercise is to move to an economy where little of our energy needs are met by burning fossil fuels, thereby making us a "low-carbon economy" and greatly reducing our emissions of greenhouse gases.

Focus on that and the jobs will look after themselves. What seems to be missing from the preoccupation with green jobs is an understanding that all economic activity creates jobs. Moving to a low-carbon economy may well involve reducing jobs in industries that produce fossil fuels, but it will also create them in renewable-energy industries. And even should producing a quantity of energy from solar, wind or whatever involve fewer jobs than producing the same quantity from coal, that's not a problem either. This greater productivity of labour would leave income to be spent elsewhere in the economy - probably the services sector - where it would create jobs.

Our businesses have been using "labour-saving equipment" to replace workers for 200 years and it hasn't cause mass unemployment yet. (It's true, however, that the workers displaced from fossil-fuel industries may not be well placed to take the jobs created in the renewable industries or elsewhere, but that problem - which does need to be dealt with - is common to all the changes in the structure of the economy that continuous technological advance has caused over the centuries.)

It's OK for governments to spend money for the dominant purpose of creating jobs when they're fighting to urgently reduce the impact of recession. Apart from that, however, the money they spend should be aimed at achieving its nominal purpose. The number of jobs this spending creates should be incidental.

If we continue our muddled thinking about green jobs, we risk having politicians trying to curry our favour by wasting money on schemes that will do little to combat climate change.

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Wanted: some belief in a leader

As I lay in bed one freezing morning lately I wished it would rain so I wouldn't have to get up and go jogging. But it's a free country - if I disliked the idea of going out into the cold so much, why didn't I just stay in bed? Because I knew if I wanted to be fit there was a small sacrifice involved. I also knew that when I make an effort I feel better than when I don't. All of us make similar decisions every day.

There's no law against wanting to have your cake and eat it - which is just as well because people do it all the time. This, I suspect, is a big part of Kevin Rudd's problem. When Tony Abbott began worrying people by branding the emissions trading scheme a great big new tax on everything and the public's enthusiasm for action on climate change began to slip, Rudd assumed we'd all be quietly relieved when he dropped the idea.

Instead, he's been amazed to discover that decision caused him to drop hugely in our esteem. Why? It's just a case of us wanting to have our cake and eat it. We wanted to worry about what the trading scheme might do to our cost of living but we also wanted action to reduce climate change.

Of course, we also wanted a leader who believed in things and would stick to his guns. A leader we could respect. A leader who, if he went on and on about something being really important, wouldn't just ditch it when the going got tough.

A big part of Rudd's problem is inexperience. As a result of that inexperience and bad advice he has seriously underestimated the electorate. He thought he could stay popular by appearing to pander to our whims.

Turns out we have no respect for a leader who merely gives us what we say we want. Somewhere inside us there is a semi-conscious understanding - probably born of our experience as children - that we need a leader who sometimes imposes on us things we don't fancy but he knows are for our own good.

The tyro politician's error is to assume success is simply about

never telling us anything we don't want to hear. That's the appearance but there's a deeper and more complex reality.

In the months before the 2007 election, Labor's focus groups detected public dissatisfaction over the rising cost of living. Rudd tried to capitalise on this disaffection by expressing great concern about the issue

and implying - without actually promising - there was something he could do about it.

This was the origin of two of the early setbacks in Rudd's term as Prime Minister, the failures of Fuel Watch and Grocery Watch, the first bits of evidence fostering the public's growing (if unfair) conviction that Rudd is all talk and no action.

Guess what? If you conduct focus groups today you'll find much dissatisfaction over the rising cost of living. It is, I suspect, an almost permanent state. The cost of living is always rising - but so too are wages and pensions. We have genuine cause for complaint only when the rise in prices is outstripping the rise in our incomes. And though that happens from time to time, over the past 10 or 15 years wages have grown a lot faster than prices.

So our unceasing complaint about the rising cost of living - always changing its focus, from the cost of petrol to interest rates to the price of electricity - is just another case of us wanting to have our cake and eat it. We wish we lived in a world where prices never rose but incomes rose as they do now. Dream on.

Our problem is not with the rising cost of living but with our efforts to keep up with the rising standard of living. We worry about every price rise because, in our unceasing attempt to keep up with the Joneses (who strive to keep up with us), we over-commit ourselves. When you spend all your income - perhaps more than your income - you always feel poor, always have trouble making ends meet, no matter how high your income.

Politicians who imagine this kind of foolish selfishness defines the electorate underrate us. We're looking for politicians who, in their concern to protect and advance our interests, demand more from us.

Rudd thinks we went cold on his emissions trading scheme because his opponents gave us an exaggerated opinion of what it would do to our cost of living. But Hugh Mackay, the noted social researcher, has a roughly opposite take: having been convinced by Rudd and others that our greenhouse gas emissions need to be reduced, we expected to be asked - even compelled - to change our behaviour.

When cities were running out of water, we had to stop using water in certain ways. Few resented this and almost all complied. The more we complied the more convinced we became of the seriousness of the problem and the need for strong action.

With climate change, however, no immediate demands were made on us. This was partly because of Rudd's misguided fear that making demands on us would make him unpopular.

Mackay makes the psychologist's point that our changes in attitude don't last unless they're quickly and strongly reinforced by a change in our actions (a truth that doesn't fit easily with economists' aversion to moralising, compulsion and even voluntary action, in favour of mere changes in prices).

Now, thanks to his great misstep in abandoning his trading scheme, Rudd lacks the moral authority to be believed even when he assures us the mining companies' claims that the resource tax would damage the economy are self-serving scaremongering.

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Prosperity cannot be paid forever by maxing out our green credit

The most thought-provoking comment I've seen on the budget came from Senator Christine Milne of the Greens. ''Every Australian knows,'' she said, ''that if you have two credit cards, it is very bad management to pay off your debt on one of them by racking it up on the other.'' The budget ''pulled down the national economic debt, but it continued the process of racking up our ecological debt''.

Sadly, it's true. The budget formally records Kevin Rudd's failure of leadership with his cowardly and illogical decision to shelve his emissions trading scheme.

It shows he took steps to avoid being accused of using the abandonment of the scheme to hasten the budget's return to surplus by using the net cash saving involved - $653 million - to increase spending on renewable energy.

The reversal did make it possible for the Government to meet its commitment to limit the real growth in its spending to 2 per cent a year.

And it did mean it was abandoning a ''great big new tax on everything'' in favour of a great big new tax on the mining companies, with the proceeds to be used to buy votes with a range of tax cuts and concessions - surely a net political gain.

Even so, if the government wants to insist it was motivated more by lack of political courage than by budgetary expediency, I accept its protestation.

No, that's not the point. It's that the budget continues our practice of worrying intensely about what we're doing to the economy while ignoring what we're doing to the environment. We just took a decision to take our chances on global warming - to do nothing to prepare for global action on climate change and nothing to set an example others might follow - but nowhere does that show up as a cost or liability.

It's not in the budget, nor in gross domestic product. It's invisible. We carefully measure and hugely publicise any increase in government debt or setback in economic growth, but what our actions and inactions are doing to the environment is largely out of sight.

When we run down our non-renewable resources (as we're hoping to do at a much faster rate with the return of the resources boom), nowhere does this show up as a cost or reduction of our assets. When we continue to deplete renewable resources at a rate much faster than they can renew themselves, nowhere does this show up as any kind of negative.

When we continue pumping our waste back into the environment - including greenhouse gases, but also other air and water pollution, garbage and human waste - at a faster rate than it can absorb, nowhere is this recorded as a cost.

GDP, our great de facto measure of progress, counts the short-term benefits from all this exploitation, but ignores its long-term costs. So Milne is right: we have been paying off our economic credit card by racking up debt on our environmental credit card.

But as the still-unfolding global financial crisis reminds us, you can get away with racking up debt only for so long. And with the environment the day of reckoning has already started to dawn. Lift your head from the economic statistics and you see rising average temperatures, the clearing of native forests, the destruction of habitat, the decline in fish stocks, the damage we've done to the Murray-Darling and other river systems and the degrading of our soil.

So far we've managed to keep the economy separate from the environment, but we won't get away with that much longer. Why not? Because, in the words of a former US senator, ''the economy is a wholly owned subsidiary of the environment''.

The economy exists within the natural environment and is dependent on it. Logically, you could have the natural world without an economy - that is, without human activity - but you couldn't have an economy without a natural world.

We can go for a period running our economy at the expense of the environment - plundering its natural resources on one hand, pumping out our waste on the other - but eventually we start to get feedback. The despoiled and depleted ecosystem begins to malfunction, with serious consequences for the continued functioning of our economy.

We get a lot more extreme (and thus expensive) weather events, a rising sea level forces us to move back from the coast, we start running out of native forests and some mineral resources and fossil fuels (making energy and fertiliser a lot dearer), we see the destruction of international tourist attractions such as the Great Barrier Reef,

we have to move agriculture north to where the rain is, but the elimination of fish stocks and degradation of soil makes food production a lot harder and more expensive the world over.

How did we get into the mindset that allowed us to take the environment for granted? Well, mainly it's because economic activity is simply more visible than the environment. And because, until relatively recently, we could plunder the natural world with impunity.

But also because we're wedded to a way of thinking about (and measuring) the economy that, because it has changed little in the past 150 years, simply ignores the environment. Because at the time global economic activity was so small relative to the huge natural world, it made sense for the early economists to treat the environment as a ''free good'' - something so plentiful it comes without cost.

But with the human population having more than trebled since 1927 and the global standard of living also having risen considerably, it's no longer sensible to treat the environment as an ''externality''.

We need a new economic model - and a new way of measuring progress - that recognises the centrality of the environment to our wellbeing and keeps recording and reminding us when we charge things up on our environmental credit card, as Rudd has just done.

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ENVIRONMENTAL ECONOMICS

July 24, 2007

The environment and economic activity

Mankind's economic activity - the production and consumption of goods and services - adversely affects the natural environment in many ways. It causes pollution, the using up of natural resources and the endangering of species. Linked with mankind's economic activity as a cause of environmental damage is the growth in the human population. More people mean more disturbance to the natural environment.

Economic activity will have a damaging effect on the environment no matter what system is used to organise that economic activity, whether it be a market system, command system or traditional system. However, since our economy is organised using the market system, we will focus on the way a market system affects the environment.

Economic arguments for preservation of the environment

There are four main economic arguments in favour of the preservation of the natural environment:
1) environmental assets. Environmental assets (such as clean air, clean water, attractive views, native species and fish in the sea) are just as much economic resources as the resources on which economics traditionally focuses: land, labour, capital and enterprise. Environmental assets are used in the process of production and consumption and are scarce (in limited supply). They are not 'free goods' because they can be used up. (Note: air can't be used up, but clean air can be.) If environmental resources can be used up, they should not be used wastefully, but used with economy ie allocated to their most efficient use. The main difference between traditional economic resources and environmental assets is that traditional economic resources have clearly defined private property rights, whereas environmental assets are common property. The price mechanism (and economic analysis) has difficulty coping with resources that are common property (ie market failure), but this isn't a reason to ignore environmental assets.

2) satisfaction of wants. The goal of economics is to maximise the satisfaction of the community's wants. It's clear that, as well as its material wants (more goods and services), the community has environmental wants (eg clean air and water, attractive views and the preservation of species). If economics ignores environmental wants because the market mechanism finds it hard to cope with them, it will not help maximise the community's satisfaction. It seems that, as the community's material standard of living rises, the value it places on environmental wants ('quality of life') increases.

3) environmental feedback. Much economic activity depends on the preservation of the environment eg effect of environmental damage on tourism; effect of land degradation on farming; effect of water quality on commercial fishing; over-harvesting of fish. As well, some environmental damage generates private costs eg double-glazing of windows to reduce noise pollution.

4) inter-generational equity. Much environmental damage is irreversible (eg clearing of land, building dams, destruction of native forests and extinction of species) and some resources are non-renewable. Current economic activity has implications for the environmental inheritance of future generations.

Economic arguments against preservation of the environment

There are three main economic arguments against preservation of the environment:
1) opportunity cost. Just as some material wants may only be satisfied at the expense of others, so some environmental wants may only be satisfied at the expense of some material wants. This is the correct way to express alleged economic arguments against environmental protection eg banning the logging of native forests will 'destroy jobs'; banning mining in national parks will 'harm the balance of payments'. A higher 'quality of life' may well involve a lower material standard of living. This is not a problem as long as the community understands the consequences of the choices it makes.

2) distributional implications. The costs and benefits of environmental protection may not be shared equally across the community. eg the people who gain most satisfaction from protecting native forests may not be the same people who lose their jobs.

3) the value of labour. Economists seek to make the most economical use of all resources, including man-made capital and labour. But environmentalists are concerned to make the most economical use (or even minimum use) of only natural resources, including energy. Implicitly, they attach little value to capital and labour. Because of the high cost of capital and labour, the market (and market-based intervention) will not produce as much recycling and avoidance of waste of raw materials as environmentalists desire.

Conflict between economic growth and environmental protection

The mainstream economists' view is that there is a conflict between man's desire to increase his material standard of living (ie produce more goods and services) and his desire to preserve the environment. The conflict arises because resources are scarce but wants are infinite. The opportunity cost of faster economic growth is more damage to the environment; the opportunity cost of less damage to the environment is slower economic growth.

There is, however, an exception to this general proposition: instances of government failure. Underpricing of publicly owned resources (eg forests, minerals) and underpricing of publicly provided services (eg electricity and water) can cause misallocation of resources and faster depletion of natural resources or unwarranted environmental damage (eg land degradation through irrigation; need to build more dams).

This is not to say that we face a mutually exclusive choice between either economic growth or environmental protection. It means the community must decide what trade-off it wants to make, what balance it wishes to strike, between these two valid, but conflicting, objectives. Economists are very familiar with trade-offs between conflicting objectives - which is why they developed the concept of opportunity cost.

Normally, the community determines the trade-off it desires between conflicting objectives in the market place via the price mechanism. It votes with its dollars. However, in the case of the conflict between economic growth and environmental protection, the market mechanism is not very effective in providing the community with the trade-off it desires. This is because environmental assets are common property rather than private property. Economic activity generates environmental externalities for third parties which those third parties lack the property rights to do anything about. This market failure means governments have to intervene in the market to ensure that the community's desired trade-off between economic growth and environmental protection is achieved. However, the political process by which governments seek to implement the community's preferences is an imperfect one where the true opportunity costs of choices may not be understood by the community.

Government policies to preserve the environment

Government policies to preserve the environment can be divided into two broad classes: command and control measures and economic instruments.

Command and control. In practice, most environmental intervention takes the form of legislation to prohibit or limit undesirable emissions and other activities. Local government zoning regulations limit polluting activities to certain areas, generally away from residential areas. State environment protection agencies set emission standards and rules for the disposal of waste and prosecute firms which fail to comply.

To the public, politicians and many environmentalists, regulation is the obvious way to respond to environmental problems. Regulation deals with the problem directly.
However, while economists accept that regulation and prohibition may be the only practical responses in some circumstances, they believe that, generally, regulation will not produce the best trade-off between SoL and environmental protection. This is because regulations impose costs without always creating incentives to find cheaper ways of reducing environmental damage.

Economic instruments. In our efforts to preserve the environment, economists favour the use of instruments which harness market forces to the service of the environment, believing that this will achieve the government's environmental objectives with minimum loss of economic growth. Economic instruments aim to 'internalise' externalities and, in the process, create incentives to meet environmental standards in ways that allocate resources efficiently.

Tradable permits. Governments may set an environmental standard which determines an acceptable level of emission, then award (or auction) permits to emit pollution up to the standard. Producers with low costs of controlling pollution have an incentive to do so, so they can sell part of their pollution rights to producers who face high costs of controlling pollution. The effect is to reduce the industry's overall cost of compliance with the standard. Tradable permits have an advantage over pollution taxes because the rate of emission is certain and the price of the permits uncertain, whereas with pollution taxes the rate of tax is certain and its effect on the level of emission is uncertain. Tradable permits can be used for other environmental protection, such as minimising the economic costs of limits on irrigation or fishing catches.

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