Author Archives: James Broughel

“Regulatory Certainty” as a Justification for Regulating

A key principle of good policy making is that regulatory agencies should define the problem they are seeking to solve before finalizing a regulation. Thus, it is odd that in the economic analysis for a recent proposed rule related to greenhouse gas emissions from new power plants, the Environmental Protection Agency (EPA) cites “regulatory certainty” as a justification for regulating. It seems almost any regulation could be justified on these grounds.

The obvious justification for regulating carbon dioxide emissions would be to limit harmful effects of climate change. However, as the EPA’s own analysis states:

the EPA anticipates that the proposed Electric Generating Unit New Source Greenhouse Gas Standards will result in negligible CO2 emission changes, energy impacts, quantified benefits, costs, and economic impacts by 2022.

The reason the rule will result in no benefits or costs, according to the EPA, is because the agency anticipates:

even in the absence of this rule, existing and anticipated economic conditions will lead electricity generators to choose new generation technologies that meet the proposed standard without the need for additional controls.

So why issue a new regulation? If the EPA’s baseline assessment is correct (i.e. it is making an accurate prediction about what the world would look like in absence of the regulation), then the regulation provides no benefits since it causes no deviations from that baseline. If the EPA’s baseline turns out to be wrong, a “wait and see” approach likely makes more sense. This approach may be more sensible, especially given all the inherent uncertainties surrounding predicting future energy prices and all of the unintended consequences that often result from regulating.

Instead, the EPA cites “regulatory certainty” as a justification for regulating, presumably because businesses will now be able to anticipate what emission standards will be going forward, and they can now invest with confidence. But announcing there will be no new regulation for a period of time also provides certainty. Of course, any policy can always change, whether the agency decides to issue a regulation or not. That’s why having clearly-stated goals and clearly-understood factors that guide regulatory decisions is so important.

Additionally, there are still costs to regulating, even if the EPA has decided not to count these costs in its analysis. Just doing an economic analysis is a cost. So is using agency employees’ time to enforce a new regulation. News outlets suggest “industry-backed lawsuits are inevitable” in response to this regulation. This too is a cost. If costs exceed benefits, the rule is difficult to justify.

One might argue that because of the 2007 Supreme Court ruling finding that CO2 is covered under the Clean Air Act, and the EPA’s subsequent endangerment finding related to greenhouse gases, there is some basis for the argument that uncertainty is holding back investment in new power plants. However, if this is true then this policy uncertainty should be accounted for in the agency’s baseline. If the proposed regulation alleviates some of this uncertainty, and leads to additional power plant construction and energy creation, that change is a benefit of the regulation and should be identified in the agency’s analysis.

The EPA also states it “intends this rule to send a clear signal about the current and future status of carbon capture and storage technology” because the agency wants to create the “incentive for supporting research, development, and investment into technology to capture and store CO2.”

However, by identifying the EPA’s preferred method of reducing CO2 emissions from new power plants, the agency may discourage businesses from investing in other promising new technologies. Additionally, by setting different standards for new and existing power plants, the EPA is clearly favoring one set of companies at the expense of another. This is a form of cronyism.

The EPA needs to get back to policymaking 101. That means identifying a problem before regulating, and tailoring regulations to address the specific problem at hand.

Do Energy Efficiency Regulations Create Jobs?

Earlier this year, the Department of Energy (DOE) finalized a regulation setting energy efficiency standards for microwave ovens. At the time, Heather Zichal, the Deputy Assistant to the President for Energy and Climate Change, had this to say about the regulation:

…in his State of the Union Address this year, the President set a bold new goal: to cut in half the energy wasted in our homes and businesses over the next 20 years. Part of how we will achieve that goal is by making appliances more energy efficient. Not only will that help Americans keep more money in their pockets, it will also curb pollution and spark innovation that creates jobs and ultimately brings better products to the marketplace. That’s why we are proud to announce today that the Department of Energy has finalized new energy efficiency standards for microwaves… (emphasis added)

I’ve written elsewhere about why Americans should be skeptical of the environmental benefits from this regulation, as well as other energy efficiency regulations emanating from the Department of Energy. Putting that aside for a moment, I’d like to focus on the last part of Ms. Zichal’s comment, that energy efficiency regulations will create jobs.

As an example, let’s look at the microwave oven regulation that Ms. Zichal cites in her blog post. According to the Department of Energy’s own employment analysis, the employment effects of this regulation are negligible. Since American consumers import roughly 99% of microwaves purchased, the DOE expects that effects on domestic production jobs will be virtually zero.

In addition, DOE models indirect employment effects on other industries as a result of changes in consumer behavior and investment decisions resulting from the regulation. While these numbers are highly uncertain given the inherent difficulty in predicting these things, the DOE estimated the rule will probably eliminate jobs in the short term, estimating between 551 jobs destroyed and 17 jobs created by 2016. In the long run, employment effects may be positive, with the regulation potentially creating between 153 and 697 jobs by 2020. However, the DOE notes there are limitations inherent in its model when calculating these effects, especially when trying to predict jobs created years in the future. For example, the DOE states:

Because [the agency’s model] does not incorporate price changes, the employment impacts predicted by [the model] would over-estimate the magnitude of actual job impacts over the long run for this rule.

The DOE goes on:

…in long-run equilibrium there is no net effect on total employment since wages adjust to bring the labor market into equilibrium. Nonetheless, even to the extent that markets are slow to adjust, DOE anticipates that net labor market impacts will be negligible over time due to the small magnitude of the short-term effects.

Creating jobs should never be the primary reason for justifying a regulation.  In most cases, jobs created by regulations are compliance jobs, which constitute a cost of regulating, not a benefit. More importantly, these types of predictions about jobs created and destroyed ignore the true employment costs of regulation that occur when individuals lose their jobs because of a rule. These costs include things like lost earnings, loss of health insurance, stress, additional health effects, etc. Despite this, by the DOE’s own estimates job creation does not appear to be a solid justification for this particular energy efficiency standard.

Has the Sequester Hurt the Economy?

Several weeks ago, Steve Forbes argued that the federal government spending cuts known as the “sequester” are actually having beneficial effects on the US economy, and not slowing growth as many economists and pundits in the media have claimed. Forbes’s statement attracted critics, and many economists have expressed skepticism about the sequester too. One economist even went so far as to say, “The disjunction between textbook economics and the choices being made in Washington is larger than any I’ve seen in my lifetime.”

So have the sequester cuts hurt the economy? One possible answer comes from a new paper by Scott Sumner of Bentley University. Sumner argues that cuts to government spending don’t have serious deleterious macroeconomic effects when the Federal Reserve is targeting inflation. This is because the Fed ensures that prices stay stable under an inflation targeting regime, which keeps demand stable even in the face of government spending cuts. Similarly, when the Fed stabilizes the price level it also offsets any beneficial effects that fiscal stimulus might have, which helps explain the lackluster results from the 2009 American Recovery and Reinvestment Act (aka the “stimulus”).

Implicit in Sumner’s theory is that expansionary austerity, or the idea that the economy can grow even in the face of large government spending cuts, is indeed possible. Some of my colleagues at the Mercatus Center have described other ways in which expansionary austerity is possible.

Luckily, there are still things Congress can do to improve the economic outlook, even as spending cuts take hold. Lawmakers can enact policies that boost the performance of the real economy. By this I mean policies that increase the amount of real goods and services the economy produces, as opposed to policies that affect demand (i.e. spending).

One example is reforming the regulatory system, which discourages production of all sorts. With over 174,000 pages of federal regulations in place, there must be a few obsolete or duplicative rules that can be eliminated to relieve the burden on businesses and entrepreneurs. Congress could also reform the tax code, with its perverse incentives and countless carve outs for special interests.

Starting new government programs isn’t likely to do much to benefit growth. New projects take too long to implement, politicians waste too much money on silly boondoggles, and monetary policy will likely offset any beneficial effects anyway. If Congress wants to do something to improve growth, it should focus on creating a regulatory and tax environment that encourages investment and entrepreneurial risk taking.

Will The EPA’s Environmental Justice Agenda Backfire?

In May, the Environmental Protection Agency (EPA) proposed new guidelines for incorporating “environmental justice” into its rulemaking procedures. Environmental justice is the idea that all people, regardless of income or race, should be treated equally with respect to environmental laws, regulations and policies. Sounds pretty good, right? Unfortunately, it’s not quite as simple as waving a magic wand and making low income and minority communities cleaner and safer. Instead, EPA’s new guidelines may have unintended effects that harm the very people they are supposed to protect. Perversely, the poor may end up paying for a cleaner environment they won’t get to enjoy, while wealthier people enjoy it instead.

In the new guidelines, the EPA talks at length about how lower income and heavily minority areas are often correlated with environmental problems and a whole host of health risks. It may be that the poor are less politically organized than wealthier people and interest groups. Perhaps for this reason there are companies that purposefully pollute in poor and minority neighborhoods because the companies know they can get away with it. That seems plausible.

But there may be other reasons that poor people tend to live in more polluted areas. For example, the poor may move to polluted areas because those areas are less expensive to live in. I myself am a case in point.

When I was in my younger twenties, I tried to make a go at being a musician in New York City. I spent most of my time practicing with my band, so I generally worked odd jobs at off hours, living month to month and paycheck to paycheck. That way I could focus most of my time on music. When I first moved to New York, I lived in the Lower East Side of Manhattan. Then I moved to Harlem because it was cheaper. Finally, to save even more money, I moved to Greenpoint, a neighborhood in northern Brooklyn.

Most people don’t know this, but Greenpoint sits over one of the largest oil spills in North American history. In fact, there was a sign down the road from my house that signaled the end of my street was a “dumping station” where there was a physical pipe coming out of the ground dumping waste into a river, Newtown Creek. You could literally smell the oil in the air.

So why would I live like this? I paid $480 a month for a gigantic room with huge bay windows in a 3-bedroom apartment that was $1,300 a month in total, dirt cheap by NYC standards. My two roommates, also musicians, paid even less in rent than I did. We knew it wasn’t the best neighborhood; we weren’t stupid. We just thought the tradeoff was worth it.

So what does the EPA think will happen if it cleans up a neighborhood like Greenpoint? Would starving artists like myself and my old roommates benefit as we are finally freed from the exploitation of evil oil companies? Maybe, maybe not. The reasoning should be obvious to anyone who has ever lived in New York City.

Greenpoint is prime real estate situated extremely close to Manhattan. When the neighborhood gets cleaned up, real estate prices will rise as wealthier people, who previously wouldn’t tolerate the pollution, move in. Rents will go up as well. Those who own land will be better off, and some of them may currently be poor. But most low income people rent and don’t own property. Those people will have to move out as the area gets more expensive, or if they stay they will face a higher cost of living. Perhaps if they move, they will choose another polluted area to live in. Almost certainly, they will have a much longer commute if they work in Manhattan like I did.

The point of this story isn’t to say we should never clean up polluted areas. We should. But the EPA shouldn’t claim it is helping low income and minority populations when it is far from clear that they are the primary groups that will benefit from EPA rules. Regulations claiming to help the poor can be highly misleading if analysts don’t make an attempt to forecast (and analyze retroactively) adjustments in human behavior that result from regulatory changes.

There’s even more to the story. While the benefits to low income groups as a result of regulations justified on the basis of “environmental justice” can be highly uncertain, the costs are all too real. Costs of regulations are often spread evenly across everyone in society, much like the costs of regressive sales taxes are spread evenly across everyone who purchases a taxed product, and this includes the poor. We could end up in a perverse situation where the poor are actually paying to gentrify their own neighborhoods.

This is far from the only problem with the EPA’s new environmental justice guidelines, but it may be the most perverse. If the EPA really wants to help the poor, the agency should pay closer attention to changes in prices and human behavior that will result from its actions. The EPA should also seek feedback from, and provide detailed information on expected benefits and costs to, impacted communities before moving forward with a regulation. Otherwise, the EPA could be wasting a whole bunch of time with little to show for its efforts.

Delaying the Rearview Camera Rule is Good for the Poor

A few weeks ago, the Department of Transportation (DOT) announced it would delay implementation of a regulation requiring that rearview cameras be installed in new automobiles. The rule was designed to prevent backover accidents by increasing drivers’ fields of vision to include the area behind and underneath vehicles. The DOT said more research was needed before finalizing the regulation, but there is another, perhaps more important reason for delaying the rule. The costs of this rule, and many others like it, weigh most heavily on those with low incomes, while the benefits cater to the preferences of those who are better-off financially.

The rearview camera regulation was expected to increase the cost of an automobile by approximately $200. This may not seem like much money, but it means a person buying a new car will have less money on hand to spend on other items that improve quality of life. These items might include things like healthcare or healthier food. Those who already have access to quality healthcare services, or who shop regularly at high end supermarkets like Whole Foods, may prefer to have the risk of a backup accident reduced over the additional $200 spent on a new car. Alternatively, those who don’t have easy access to healthcare or healthy food, may well prefer the $200.

A lot of regulation is really about reducing risks. Some risks pose large dangers, like the risk of radiation exposure (or death) if you are within range of a nuclear blast. Some risks pose small dangers, like a mosquito bite. Some risks are very likely, like the risk of stubbing your toe at some point in your lifetime, while other risks are very remote, like the chance that the Earth will be hit by a gigantic asteroid next week.

Risks are everywhere and can never be eliminated entirely from life. If we tried to eliminate every risk we face, we’d all live like John Travolta in the movie The Boy in the Plastic Bubble (and of course, he could also be hit by an asteroid!). The question we need to ask ourselves is: how do we manage risks in a way that makes the most sense given limited resources in society? In addition to this important question, we may also want to ask ourselves to what degree distributional effects are important as we consider which risks to mitigate?

There are two main ways that society can manage risks. First, we can manage risks we face privately, say by choosing to eat vegetables often or to go to the gym. In this way, a person can reduce the risk of cardiovascular disease, a leading cause of death in the United States, as well as other health problems. We can also choose to manage risks publicly, say through regulation or other government action. For example, the government passes laws requiring everyone to get vaccinated against certain illnesses, and this reduces the risk of getting sick from those around us.

Not surprisingly, low income families spend less on private risk mitigation than high income families do. Similarly, those who live in lower income areas tend to face higher mortality risks from a whole host of factors (e.g. accidents, homicide, cancer), when compared to those who live in wealthier neighborhoods. People with higher incomes tend to demand more risk reduction, just as they demand more of other goods or services. Therefore, spending money to reduce very low probability risks, like the risk of being backed over by a car in reverse, is more in line with preferences of the wealthy, since the wealthy will demand more risk reduction of this sort than the poor will.

Such a rule may also result in unintended consequences.  Just as using seat belts has been shown to lead to people driving faster, relying on a rearview camera when driving in reverse may lead to people being less careful about backing up.  For example, someone could be running outside of the camera’s view, and only come into view just as he or she is hit by the car.  Relying on cameras entirely may increase the risk of some people getting hit.

When the government intervenes and reduces risks for us, it is making a choice for us about which risks are most important, and forcing everyone in society to pay to address these risks. But not all risks are the same. In the case of the rearview camera rule, everyone must pay the extra money for the new device in the car (unless they forgo buying a new car which also carries risks), yet the risk of accident in a backup crash is small relative to other risks. Simply moving out of a low income neighborhood can reduce a whole host of risks that low income families face. By forcing the poor to pay to reduce the likelihood of tiny probability events, DOT is essentially saying poor people shouldn’t have the option of reducing larger risks they face. Instead, the poor should share the burden of reducing risks that are more in line with the preferences of the wealthy, who have likely already paid to reduce the types of risks that low income families still face.

Politicians and regulators like to claim that they are saving lives with regulation and just leave it at that. But the reality is often much more complicated with unintended consequences and regressive effects. Regulations have costs and those costs often fall disproportionately on those with the least ability to pay. Regulations also involve tradeoffs that leave some groups better off, while making other groups worse off. When one of the groups made worse off is the poor, we should think very carefully before proceeding with a policy, no matter how well intentioned policymakers may be.

The DOT is delaying the rearview camera rule so it can conduct more research on the issue. This is a sensible decision. Everyone wants to reduce the prevalence of backover accidents, but we should be looking for ways to achieve this goal that don’t disadvantage the least well off in society.

Where Are The Benefits From Recent Energy Efficiency Regulations?

On Tuesday, President Obama gave a speech announcing his new agenda to combat climate change. As part of his efforts to curb greenhouse gas emissions, the President and his administration plan on releasing a series of energy efficiency regulations, supposedly with the intention of reducing carbon dioxide emissions. The problem is, the vast majority of the benefits from many energy efficiency rules have nothing to do with reducing carbon dioxide emissions, and this is according to the government’s own estimates. Instead, agencies like the Department of Energy (DOE) are eliminating options for consumers, and then counting the loss to consumers as a benefit of regulating.

How do they do this? It all has to do with a relatively new field of social science known as behavioral economics. You can think of behavioral economics as the intersection of psychology and economics. Behavioral economists believe that people exhibit many biases that cause them to systematically act in ways that are out of line with their true preferences. In a lab situation, there are many examples of such biases that have been demonstrated. For example, a person buying a home may bid one price, but if she is selling the same house, she may require a higher price, implying she values the same object differently depending on whether the object belongs to her or not. Or, people may value objects differently depending on time. For instance, a person might choose to receive $100 today over $110 tomorrow, yet at the same time pass on $100 a year from now in exchange for $110 in a year and one day, implying the person is more impatient today than he sees himself being in the future.

As the chart below demonstrates, the Department of Energy recently finalized a regulation related to microwave ovens, and nearly 80% of the benefits of the rule stemmed, not from protecting the environment or public health, but from saving consumers money by preventing them from buying the products they would choose otherwise. DOE does not seem to understand why consumers might choose to pay a relatively low price today for a product that is not very energy efficient, when this person could buy a more expensive energy efficient product that will save money over the life of the product through lower electricity bills. From an economics perspective, DOE does not believe this behavior is rational, hence it is like one of the behavioral biases described above, and in many cases DOE has decided to ban the products it doesn’t like in order to protect consumers from themselves.

Energy Efficiency Benefits from DOE Microwave Ovens Regulation*

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Federal agencies are ignoring the fact that consumers may value other attributes of products aside from energy and fuel efficiency. With automobiles, consumers may prefer larger and safer cars, to smaller more fuel efficient vehicles. Restaurants may prefer light bulbs that raise electric bills slightly every month, but whose warm glow creates an ambiance that customers enjoy. And in the case of microwaves and laundry machines, it may be that machines that use more energy simply work better at their stated purpose. And it’s not just microwave ovens. DOE, and other agencies like the Department of Transportation and the Environmental Protection Agency, make this same type of assumption with other regulations, like rules impacting commercial clothes washers, light bulbs, and fuel efficiency standards for vehicles. Agencies even assume businesses are behaving in this manner. Does anyone honestly believe that trucking companies aren’t taking fuel efficiency into account when buying new fleets? Or that laundromat owners don’t consider electricity costs when purchasing new equipment? It seems highly implausible, but agencies are assuming just that.

For decades, agencies have been required to identify a market failure or other systemic problem that exists before intervening in the marketplace with a regulation. Market failures include things like a lack of competition, a lack of consumer information, or costs that spill over onto the public as the result of a private transaction. Now, agencies like DOE have begun to expand the definition of market failure to include what they deem to be personal failures on the part of consumers.

So why are agencies doing this? One reason may be because the environmental benefits alone aren’t enough to justify the costs of some regulations. Claiming additional benefits helps agencies justify an inefficient policy, and keeps government programs continuing to employ regulators. Agencies have other ways to make the benefits of rules appear greater too. In the case of the microwave rule, of the small portion of benefits related to carbon dioxide reductions, most will be captured by citizens of foreign countries, with only a small fraction going to US citizens. Counting benefits to foreigners makes the benefits of rules appear greater, even though agencies are asked to only consider benefits to the United States in most cases.

Another reason we may be getting these types of rules is the rules may really be intended to benefit special interest groups more than consumers. A manufacturer that is already producing an energy efficient product may capture market share by getting the products of its competitors banned. Or manufacturers may simply want to force consumers to buy a more expensive product, or replace old products with new ones, while eliminating the possibility of a competitor undercutting them by selling a cheaper product in the marketplace.

Reducing Carbon Dioxide emissions in order to combat climate change may be a noble goal, but recent energy efficiency regulations are unlikely to get us there. Rather than overriding consumer choice, and counting this loss to consumers as a benefit, DOE and other agencies should give the American people a more honest assessment of the benefits of their rules.

* Source: Department of Energy, “Technical Support Document: Energy Efficiency Program for Consumer Products and Commercial and Industrial Equipment: Residential Microwave Ovens – Stand-By-Power,” (Table 1.2.1.), May 2013. Calculated using a 3 percent discount rate. Assumes 15 percent of reductions in CO2 emissions are attributed to the United States. This is the midpoint between 7 percent and 23 percent, the range estimated by the Interagency Working Group on Social Cost of Carbon, “Technical Support Document, Social Cost of Carbon for Regulatory Impact Analysis under Executive Order 12866,” February 2010.