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Why the lack of labor mobility in the U.S. is a problem and how we can fix it

Many researchers have found evidence that mobility in the U.S. is declining. More specifically, it doesn’t appear that people move from places with weaker economies to places with stronger economies as consistently as they did in the past. Two sets of figures from a paper by Peter Ganong and Daniel Shoag succinctly show this decline over time.

The first, shown below, has log income per capita by state on the x-axis for two different years, 1940 (left) and 1990 (right). On the vertical axis of each graph is the annual population growth rate by state for two periods, 1940 – 1960 (left) and 1990 – 2010 (right).

directed migration ganong, shoag

In the 1940 – 1960 period, the graph depicts a strong positive relationship: States with higher per capita incomes in 1940 experienced more population growth over the next 20 years than states with lower per capita incomes. This relationship disappears and actually reverses in the 1990 – 2010 period: States with higher per capita incomes actually grew slower on average. So in general people became less likely to move to states with higher incomes between the middle and end of the 20th century. Other researchers have also found that people are not moving to areas with better economies.

This had an effect on income convergence, as shown in the next set of figures. In the 1940 – 1960 period (left), states with higher per capita incomes experienced less income growth than states with lower per capita incomes, as shown by the negative relationship. This negative relationship existed in the 1990 – 2010 period as well, but it was much weaker.

income convergence ganong, shoag

We would expect income convergence when workers leave low income states for high income states, since that increases the labor supply in high-income states and pushes down wages. Meanwhile, the labor supply decreases in low-income states which increases wages. Overall, this leads to per capita incomes converging across states.

Why labor mobility matters

As law professor David Schleicher points out in a recent paper, the current lack of labor mobility can reduce the ability of the federal government to manage the U.S. economy. In the U.S. we have a common currency—every state uses the U.S. dollar. This means that if a state is hit by an economic shock, e.g. low energy prices harm Texas, Alaska and North Dakota but help other states, that state’s currency cannot adjust to cushion the blow.

For example, if the UK goes into a recession, the Bank of England can print more money so that the pound will depreciate relative to other currencies, making goods produced in the UK relatively cheap. This will decrease the UK’s imports and increase economic activity and exports, which will help it emerge from the recession. If the U.S. as a whole suffered a negative economic shock, a similar process would take place.

However, within a country this adjustment mechanism is unavailable: Texas can’t devalue its dollar relative to Ohio’s dollar. There is no within-country monetary policy that can help particular states or regions. Instead, the movement of capital and labor from weak areas to strong areas is the primary mechanism available for restoring full employment within the U.S. If capital and labor mobility are low it will take longer for the U.S. to recover from area-specific negative economic shocks.

State or area-specific economic shocks are more likely in large countries like the U.S. that have very diverse local economies. This makes labor and capital mobility more important in the U.S. than in smaller, less economically diverse countries such as Denmark or Switzerland, since those countries are less susceptible to area-specific economic shocks.

Why labor mobility is low

There is some consensus about policies that can increase labor mobility. Many people, including former President Barack Obama, my colleagues at the Mercatus Center and others, have pointed out that state occupational licensing makes it harder for workers in licensed professions to move across state borders. There is similar agreement that land-use regulations increase housing prices which makes it harder for people to move to areas with the strongest economies.

Reducing occupational licensing and land-use regulations would increase labor mobility, but actually doing these things is not easy. Occupational licensing and land-use regulations are controlled at the state and local level, so currently there is little that the federal government can do.

Moreover, as Mr. Schleicher points out in his paper, state and local governments created these regulations for a reason and it’s not clear that they have any incentive to change them. Like all politicians, state and local ones care about being re-elected and that means, at least to some extent, listening to their constituents. These residents usually value stability, so politicians who advocate too strongly for growth may find themselves out of office. Mr. Schleicher also notes that incumbent politicians often prefer a stable, immobile electorate because it means that the voters who elected them in the first place will be there next election cycle.

Occupational licensing and land-use regulations make it harder for people to enter thriving local economies, but other policies make it harder to leave areas with poor economies. Nearly 13% of Americans work for state and local governments and 92% of them have a defined-benefit pension plan. Defined-benefit plans have long vesting periods and benefits can be significantly smaller if employees split their career between multiple employers rather than remain at one employer. Thus over 10% of the workforce has a strong retirement-based incentive to stay where they are.

Eligibility standards for public benefits and their amounts also vary by state, and this discourages people who receive benefits such as Temporary Assistance for Needy Families (TANF) from moving to states that may have a stronger economy but less benefits. Even when eligibility standards and benefits are similar, the paperwork and time burden of enrolling in a new state can discourage mobility.

The federal government subsidizes home ownership as well, and homeownership is correlated with less labor mobility over time. Place-based subsidies to declining cities also artificially support areas that should have less people. As long as state and federal governments subsidize government services in cities like Atlantic City and Detroit people will be less inclined to leave them. People-based subsidies that incentivize people to move to thriving areas are an alternative that is likely better for the taxpayer, the recipient and the country in the long run.

How to increase labor mobility

Since state and local governments are unlikely to directly address the impediments to labor mobility that they have created, Mr. Schleicher argues for more federal involvement. Some of his suggestions don’t interfere with local control, such as a federal clearinghouse for coordinated occupational-licensing rules across states. This is not a bad idea but I am not sure how effective it would be.

Other suggestions are more intrusive and range from complete federal preemption of state and local rules to federal grants that encourage more housing construction or suspension of the mortgage-interest deduction in places that restrict housing construction.

Local control is important due to the presence of local knowledge and the beneficial effects that arise from interjurisdictional competition, so I don’t support complete federal preemption of local rules. Economist William Fischel also thinks the mortgage interest deduction is largely responsible for excessive local land-use regulation, so eliminating it altogether or suspending it in places that don’t allow enough new housing seems like a good idea.

I also support more people-based subsidies that incentivize moving to areas with better economies and less place-based subsidies. These subsidies could target people living in specific places and the amounts could be based on the economic characteristics of the destination, with larger amounts given to people who are willing to move to areas with the most employment opportunities and/or highest wages.

Making it easier for people to retain any state-based government benefits across state lines would also help improve labor mobility. I support reforms that reduce the paperwork and time requirements for transferring benefits or for simply understanding what steps need to be taken to do so.

Several policy changes will need to occur before we can expect to see significant changes in labor mobility. There is broad agreement around some of them, such as occupational licensing and land-use regulation reform, but bringing them to fruition will take time. As for the less popular ideas, it will be interesting to see which, if any, are tried.

More labor market freedom means more labor force participation

The U.S. labor force participation (LFP) rate has yet to bounce back to its pre-recession level. Some of the decline is due to retiring baby-boomers but even the prime-age LFP rate, which only counts people age 25 – 54 and thus less affected by retirement, has not recovered.

Economists and government officials are concerned about the weak recovery in labor force participation. A high LFP rate is usually a sign of a strong economy—people are either working or optimistic about their chances of finding a job. A low LFP rate is often a sign of little economic opportunity or disappointment with the employment options available.

The U.S. is a large, diverse country so the national LFP rate obscures substantial state variation in LFP rates. The figure below shows the age 16 and up LFP rates for the 50 states and the U.S. as a whole (black bar) in 2014. (data)

2014-state-lfp-rates

The rates range from a high of 72.6% in North Dakota to a low of 53.1% in West Virginia. The U.S. rate was 62.9%. Several of the states with relatively low rates are in the south, including Mississippi, Alabama and Arkansas. Florida and Arizona also had relatively low labor force participation, which is not surprising considering their reputations as retirement destinations.

There are several reasons why some states have more labor force participation than others. Demographics is one: states with a higher percentage of people over age 65 and between 16 and 22 will have lower rates on average since people in these age groups are often retired or in school full time. States also have different economies made up of different industries and at any given time some industries are thriving while others are struggling.

Federal and state regulation also play a role. Federal regulation disparately impacts different states because of the different industrial compositions of state economies. For example, states with large energy industries tend to be more affected by federal regulation than other states.

States also tax and regulate their labor markets differently. States have different occupational licensing standards, different minimum wages and different levels of payroll and income taxes among other things. Each of these things alters the incentive for businesses to hire or for people to join the labor market and thus affects states’ LFP rates.

We can see the relationship between labor market freedom and labor force participation in the figure below. The figure shows the relationship between the Economic Freedom of North America’s 2013 labor market freedom score (x-axis) and the 2014 labor force participation rate for each state (y-axis).

lab-mkt-freed-and-lfp-rate

As shown in the figure there is a positive relationship—more labor market freedom is associated with a higher LFP rate on average. States with lower freedom scores such as Mississippi, Kentucky and Alabama also had low LFP rates while states with higher freedom scores such as North Dakota, South Dakota and Virginia had higher LFP rates.

This is not an all-else-equal analysis and other variables—such as demographics and industry composition which I mentioned earlier—also play a role. That being said, state officials concerned about their state’s labor market should think about what they can do to increase labor market freedom—and economic freedom more broadly—in their state.

New York’s Buffalo Billion initiative has been underwhelming

New York’s Buffalo Billion plan has come under fire amidst an ongoing corruption probe looking into whether some contracts were inappropriately awarded to political donors. The investigation has led to funding delays and there are reports of some contractors and companies rethinking their investments. But even without these legal problems, it is unlikely that the Buffalo Billion initiative will remake Buffalo’s economy.

Buffalo, NY has been one of America’s struggling cities since the 1950s, but before then it had a long history of growth. After it became the terminal point of the Erie Canal in 1825 it grew rapidly; over the next 100 years the city’s population went from just under 9,000 to over 570,000. Growth slowed down from 1930 to 1950, and between 1950 and 1960 the city lost nearly 50,000 people. It has been losing population ever since. The Metropolitan Area (MSA), which is the economic city, continued to grow until the 1970s as people left the central city for the surrounding suburbs, but it has also been losing population since then. (click to enlarge figure)

buffalo-population

Buffalo’s population decline has not escaped the notice of local, state and federal officials, and billions of dollars in government aid have been given to the area in an effort to halt or reverse its population and economic slide. The newest attempt is Governor Andrew Cuomo’s Buffalo Billion, which promises to give $1 billion of state funds to the region. The investment began in 2013 and as of January 2016, $870.5 million worth of projects have been announced. The table below lists some of the projects, the amount of the investment, and the number of jobs each investment is supposed to create, retain, or induce (includes indirect jobs due to construction and jobs created by subsequent private investment). This information is from the Buffalo Billion Process and Implementation plan (henceforth Buffalo Billion Plan).

buffalo-billion-projects

The projects listed have been awarded $727 million in direct investment, $150 million in tax breaks and $250 million in other state funds. The total number of jobs related to these investments is 9,900 according to the documentation, for an average cost of $113,859 per job (last column).

However, these jobs numbers are projections, not actual counts. This is one of the main criticisms of investment efforts like Buffalo Billion—a lot of money is spent and a lot of jobs are promised, but rarely does anyone follow up to see if the jobs were actually created. In this case it remains to be seen whether reality will match the promises, but the early signs are not encouraging.

Executives of the first project, SolarCity, which received $750 million of benefits and promised 5,000 jobs in western New York, appear to have already scaled back their promise. One company official recently said that 1,460 jobs will be created in Buffalo, including 500 manufacturing jobs. This is down from 2,000 in the Buffalo Billion Plan, a 27% decrease.

The SolarCity factory is not scheduled to open until June 2017 so there is still time for hiring plans to change. But even if the company eventually creates 5,000 jobs in the area, it is hard to see how that will drastically improve the economy of an MSA of over 1.1 million people. Moreover, page eight of the Buffalo Billion Plan reports that the entire $1 billion is only projected to create 14,000 jobs over the course of 5 years, which is again a relatively small amount for such a large area.

Contrary to the local anecdotes that say otherwise, so far there is little evidence that Buffalo Billion has significantly impacted the local economy. Since the recession, employment in Buffalo and its MSA has barely improved, as shown below (data are from the BLS). There has also been little improvement since 2013 when the Buffalo Billion development plan was released. (City data plotted on the right axis, MSA on the left axis.)

buffalo-employment

Real wages in both Erie and Niagara County, the two counties that make up the Buffalo MSA, have also been fairly stagnant since the recession, though there is evidence of some improvement since 2013, particularly in Erie County (data are from the BLS). Still, it is hard to separate these small increases in employment and wages from the general recovery that typically occurs after a deep recession.

buffalo-county-wages

The goal of the Buffalo Billion is to create a “Big Push” that leads to new industry clusters, such as a green energy cluster anchored by SolarCity and an advanced manufacturing cluster. Unfortunately, grandiose plans to artificially create clusters in older manufacturing cities rarely succeed.

As economist Enrico Moretti notes in his book, The New Geography of Jobs, in order for Big Push policies to succeed they need to attract both workers and firms at the same time. This is hard to do since either workers or firms need to be convinced that the other group will eventually arrive if they make the first move.

If firms relocate but high-skill workers stay away, then the firm has spent scarce resources locating in an area that doesn’t have the workforce it needs. If workers move but firms stay away, then the high-skill workers are left with few employment opportunities. Neither situation is sustainable in the long-run.

The use of targeted incentives to attract firms, as in the aforementioned SolarCity project, has been shown to be an ineffective way to grow a regional economy. While such incentives often help some firms at the expense of others, they do not provide broader benefits to the economy as a whole. The mobile firms attracted by such incentives, called footloose firms, are also likely to leave once the incentives expire, meaning that even if there is a short term boost it will be expensive to maintain since the incentives will have to be renewed.

Also, in order for any business to succeed state and local policies need to support, rather than inhibit, economic growth. New York has one of the worst economic environments according to several different measures: It’s 50th in overall state freedom, 50th in economic freedom, and 49th in state business tax climate. New York does well on some other measures, such as Kauffman’s entrepreneurship rankings, but such results are usually driven by the New York City area, which is an economically vibrant area largely due to historical path dependencies and agglomeration economies. Buffalo, and western New York in general, lacks the same innate and historical advantages and thus has a harder time overcoming the burdensome tax and regulatory policies of state government, which are particularly harmful to the local economies located near state borders.

Buffalo officials can control some things at the local level that will improve their economic environment, such as zoning, business licensing, and local taxes, but in order to achieve robust economic growth the city will likely need better cooperation from state officials.

State and local policy makers often refuse to acknowledge the harm that relatively high-tax, high-regulation environments have on economic growth, and this prevents them from making policy changes that would foster more economic activity. Instead, politicians invest billions of dollars of taxpayer money, often in the form of ineffective targeted incentives to favored firms or industries, with the hope that this time will be different.

Discovering an areas comparative advantage and creating a sustainable industry cluster or clusters requires experimentation, which will likely result in some failures. Local and state governments should create an environment that encourages entrepreneurs to experiment with new products and services in their region, but they shouldn’t be risking taxpayer money picking winners and losers. Creating a low-tax, low-regulation environment that treats all businesses—established and start-up, large and small—the same is a better way to grow an economy than government subsidies to favored firms. Unfortunately the Buffalo Billion project looks like another example of the latter futile strategy.

Does Tax Increment Financing (TIF) generate economic development?

Tax increment financing, or TIF, is a method of financing economic development projects first used in California in 1952. Since then, 48 other states have enacted TIF legislation with Arizona being the lone holdout. It was originally conceived as a method for combating urban blight, but over time it has become the go-to tool for local politicians pushing economic development in general. For example, Baltimore is considering using TIF to raise $535 million to help Under Armor founder Kevin Plank develop Port Covington.

So how does TIF work? Though the particulars can vary by state, the basic mechanism is usually similar. First, an area is designated as a TIF district. TIF districts are mostly industrial or commercial areas rather than residential areas since the goal is to encourage economic development.

Usually, in an effort to ensure that TIF is used appropriately, the municipal government that designates the area as a TIF has to assert that economic development would not take place absent the TIF designation and subsequent investment. This is known as the ‘but-for’ test, since the argument is that development would not occur but for the TIF. Though the ‘but-for’ test is still applied, some argue that it is largely pro forma.

Once an area has been designated as a TIF district, the property values in the area are assessed in order to create a baseline value. The current property tax rate is applied to the baseline assessed value to determine the amount of revenue that is used for the provision of local government goods and services (roads, police, fire, water etc.). This value will then be frozen for a set period of time (e.g. up to 30 years in North Carolina), and any increase in assessed property values that occurs after this time and the subsequent revenue generated will be used to pay for the economic development project(s) in the TIF district.

The key idea is that municipalities can borrow against the projected property value increases in order to pay for current economic development projects. A simple numerical example will help clarify how TIF works.

In the table below there are five years. In year 1 the assessed value of the property in the TIF district is $20 million and it is determined that it takes $1 million per year to provide the government goods and services needed in the area (road maintenance, sewage lines, police/fire protection, etc.). A tax rate of 5% is applied to the $20 million of assessed value to raise the necessary $1 million (Tax revenue column).

TIF example table

The municipality issues bonds totaling $1 million to invest in an economic development project in the TIF district. As an example, let’s say the project is renovating an old business park in order to make it more attractive to 21st century startups. The plan is that improving the business park will make the area more desirable and increase the property values in the TIF district. As the assessed value increases the extra tax revenue raised by applying the 5% rate to the incremental value of the property will be used to pay off the bonds (incremental revenue column).

Meanwhile, the $1 million required for providing the government goods and services will remain intact, since only the incremental increase in assessed value is used to pay for the business park improvements. Hence the term Tax Increment Financing.

As shown in the table, if the assessed value of the property increases by $2 million per year for 4 years the municipality will recoup the $1 million required to amortize the bond (I’m omitting interest to keep it simple). Each $1 million dollars of increased value increase tax revenue by $50,000 without increasing the tax rate, which is what allows the municipality to pay for the economic development without raising property tax rates. For many city officials this is an attractive feature since property owners usually don’t like tax rate increases.

City officials may also prefer TIF to the issuance of general obligation bonds since the latter often require voter approval while TIF does not. This is the case in North Carolina. TIF supporters claim that this gives city officials more flexibility in dealing with the particular needs of development projects. However, it also allows influential individuals to push TIF through for projects that a majority of voters may not support.

While TIF can be used for traditional government goods like roads, sewer systems, water systems, and public transportation, it can also be used for private goods like business parks and sports facilities. The former arguably provide direct benefits to all firms in the TIF district since better roads, streetscapes and water systems can be used by any firm in the area. The latter projects, though they may provide indirect benefits to nearby firms in the form of more attractive surroundings and increased property values, mostly benefit the owners of entity receiving the development funding. Like other development incentives, TIF can be used to subsidize private businesses with taxpayer dollars.

Projects that use TIF are often described as ‘self-financing’ since the project itself is supposedly what creates the higher property values that pay for it. Additionally, TIF is often sold to voters as a way to create jobs or spur additional private investment in blighted areas. But there is no guarantee that the development project will lead to increased private sector investment, more jobs or higher property values. Researchers at the UNC School of Government explain the risks of TIF in a 2008 Economic Bulletin:

“Tax increment financing is not a silver bullet solution to development problems. There is no guarantee that the initial public investment will spur sufficient private investment, over time, that creates enough increment to pay back the bonds. Moreover, even if the investment succeeds on paper, it may do so by “capturing” growth that would have occurred even without the investment. Successful TIF districts can place an additional strain on existing public resources like schools and parks, whose funding is frozen at base valuation levels while growth in the district increases demand for their services.”

The researchers also note that it’s often larger corporations that municipalities are trying to attract with TIF dollars, and any subsidies via TIF that the municipality provides to the larger firm gives it an advantage over its already-established, local competitors. This is even more unfair when the local competitor is a small, mom-and-pop business that already faces a difficult challenge due to economies of scale.

There is also little evidence that TIF regularly provides the job or private sector investment that its supporters promise. Chicago is one of the largest users of TIF for economic development and its program has been one of the most widely studied. Research on Chicago’s TIF program found that “Overall, TIF failed to produce the promise of jobs, business development or real estate activity at the neighborhood level beyond what would have occurred without TIF.”

If economic development projects that rely on TIF do not generate additional development above and beyond what would have occurred anyway, then the additional tax revenue due to the higher assessed values is used to pay for an economic development project that didn’t really add anything. Without TIF, that revenue could have been used for providing other government goods and services such as infrastructure or better police and fire protection. Once TIF is used, the additional revenue must be used to pay for the economic development project: it cannot be spent on other services that residents might prefer.

Another study, also looking at the Chicago metro area, found that cities that adopt TIF experience slower property value growth than those that do not. The authors suggest that this is due to a reallocation of resources to TIF districts from other areas of the city. The result is that the TIF districts grow at the expense of the municipality as a whole. This is an example of the TIF working on paper, but only because it is pilfering growth that would have occurred in other areas of the city.

Local politicians often like tax increment financing because it is relatively flexible and enables them to be entrepreneurial in some sense: local officials as venture capitalists. It’s also an easier sell than a tax rate increase or general obligation bonds that require a voter referendum.

But politicians tend to make bad venture capitalists for several reasons. First, it’s usually not their area of expertise and it’s hard: even the professionals occasionally lose money. Second, as Milton Friedman pointed out, people tend to be more careless when spending other people’s money. Local officials aren’t investing their own money in these projects, and when people invest or spend other people’s money they tend to emphasize the positive outcomes and downplay the negative ones since they aren’t directly affected. Third, pecuniary factors don’t always drive the decision. Different politicians like different industries and businesses – green energy, biotech, advanced manufacturing, etc. – for various reasons and their subjective, non-pecuniary preferences may cause them to ignore the underlying financials of a project and support a bad investment.

If TIF is going to be used it should be used on things like public infrastructure – roads, sewer/water lines, sidewalks – rather than specific private businesses. This makes it harder to get distracted by non-pecuniary factors and does a better – though not perfect – job of directly helping development in general rather than a specific company or private developer. But taxpayers should be aware of the dangers of TIF and politicians and developers should not tout it as a panacea for jump-starting an area’s economy.

When Regulatory Agencies Ignore Comments from the Public

A few days ago, the Department of Energy (DOE) finalized a rule setting energy efficiency standards for metal halide lamp fixtures. Last October I wrote a public interest comment to the DOE to point out several problems with the agency’s preliminary economic analysis for the rule. As part of the Administrative Procedure Act, agencies are required to solicit, and respond to, comments from the public before finalizing regulations. Unfortunately, the DOE failed to even acknowledge many of the points I made in my submission.

As evidence, here are some of the main takeaways from my comment:

1)      The DOE claims consumers and businesses are acting in an irrational manner when purchasing metal halide lamp fixtures because they forgo modest long term energy savings in order to pay a low upfront price for lamp fixtures. Yet the agency offers no convincing evidence to support the theory that consumers act irrationally when purchasing metal halide lamp fixtures. At the same time, roughly 70% of the estimated benefits of the rule are the supposed benefits bestowed upon the public when products people would purchase otherwise are removed from the market.

2)      The DOE is currently adding together costs and benefits that occur in the future but that are discounted to present value using different discount rates. It makes no sense to add together costs and benefits calculated in this manner.

3)      The DOE is using a new value of the Social Cost of Carbon (SCC), a way to measure benefits from reducing carbon dioxide emissions, that may be of questionable validity since the analysts who arrived at the estimate ignored recent scientific evidence. Additionally, the DOE is using the new SCC in its analysis before the public has even had a chance to comment on the validity of the new number.

4)      In its analysis, the DOE is including benefits to foreign countries as a result of reduced carbon dioxide emissions, even while the costs of the metal halide lamp fixture regulation will be borne largely by Americans.

Regarding #1 above, the DOE provided no direct response to my comment in the preamble to its final rule. This even though #1 puts in doubt roughly 70% of the estimated benefits of the rule.

The DOE also failed to respond to #2 above, even though I cited as support a very recent and relevant paper on the subject that appeared in a reputable journal and was coauthored by Nobel laureate Kenneth Arrow.

Regarding #3 and #4, the DOE had this to say:

On November 26, 2013, the Office of Management and Budget (OMB) announced minor technical corrections to the 2013 SCC values and a new opportunity for public comment on the revised Technical Support Document underlying the SCC estimates. Comments regarding the underlying science and potential precedential effect of the SCC estimates resulting from the interagency process should be directed to that process. See 78 FR 70586. Additionally, several current rulemakings also use the 2013 SCC values and the public is welcome to comment on the values as applied in those rulemakings just as the public was welcome to comment on the use and application of the 2010 SCC values in the many rules that were published using those values in the past three years.

In other words, the DOE is committed to continuing to use a value of the SCC that may be flawed since the public has the opportunity to complain to the Office of Management and Budget. At the same time, the DOE tells us we can comment on other regulations that use the new SCC value, so that should reassure anyone whose comment the DOE ignored related to this regulation!

All of this is especially troubling since the DOE is required by statute to ensure its energy efficiency rules are “economically justifiable.” It is hard to argue this rule is economically justifiable when roughly 94% of the rule’s benefits are in doubt. This is the proportion of benefits justified on the basis of consumer irrationality and on the basis that Americans should be paying for benefits that will be captured by citizens in other countries. Without these benefits, the rule fails a benefit-cost test according to the DOE’s own estimates.

The requirement that agencies respond to public comments is designed to ensure a level of democratic accountability from regulators, who are tasked with serving the American public. A vast amount of power is vested in these agencies, who are largely insulated from Congressional oversight. As evidence, Congress has only used its Congressional Review Act authority to overrule major regulations once in its history. If agencies ignore the public, and face little oversight from Congress, what faith can we have that regulators will be held accountable for any harms that inevitably arise from poorly designed regulations?

A New Year’s Gift from the Department of Energy

On New Year’s Eve, the Department of Energy (DOE) announced it will be denying a petition brought to the agency by the Landmark Legal Foundation. The petition had requested the DOE reconsider a regulation related to energy efficiency standards for microwave ovens on the grounds that the Energy Department used a new, much higher, estimate of the social cost of carbon (SCC) in the final analysis of the regulation than had been used in the proposed version of the rule. The SCC is a number the Department uses to estimate benefits to society from reductions in greenhouse gas emissions. The public was denied the opportunity to comment on the higher estimate of the SCC since the new estimate was not used until after the time the public was allowed to comment on the regulation.

Here’s some of the DOE’s reasoning for denying the petition:

In the microwave oven rule, the SCC analysis did not affect DOE’s decision regarding the standards that were published in the Federal Register at either the proposed rule or final rule stage because the estimated benefits to consumers of the standard exceeded the costs of the standard, even without considering the SCC values. [emphasis added]

However, as I and others have stated before, these “benefits to consumers” are not benefits at all, and should be excluded from consideration when determining whether the DOE’s energy efficiency standards produce benefits in excess of costs. In a comment I wrote to the DOE as the agency considered this petition, I said:

The preponderance of the rule’s benefits, nearly 80 percent, are not related to reductions in carbon emissions, or even to any environmental effects at all. Instead, these benefits are based on the assumption that consumers behave in an irrational manner when purchasing microwave ovens and that the Department will be able to “fix” this behavior by issuing a regulation, thereby resulting in benefits to consumers. These “savings” should be excluded from the agency’s final analysis of benefits resulting from the regulation.

So the DOE is partly right. The new SCC really doesn’t make a difference in this particular case. However, this is because the regulation produces net costs to society with or without the higher estimate of the social cost of carbon. Thus, the rule can’t be justified on a cost-benefit basis even with the new social cost of carbon number the DOE uses. As I explained in my comment:

Given that the primary estimate of the total benefits resulting from this regulation is estimated at $294 million per year (2011$), and total costs are estimated at $66.4 million per year, subtracting the consumer “irrationality” benefits of $234 million produces net costs to society of $6.4 million per year (2011$).12 If DOE used a lower value of the SCC, like the estimate used in the proposed version of this regulation, that net cost figure would be even higher. The problem is further compounded if benefits to other countries are excluded from the estimates.

The DOE made no effort to respond to this particular critique in its response to the Landmark Legal Foundation petition. The agency does not view the questionable nature of its estimated benefits to consumers as within the scope of the issue it sought comment on. Perhaps this is so. However, there will be more such regulations in the future where this controversial technique is employed by the DOE. Indeed, at Mercatus we have already commented on such regulations. Additionally, the agency’s decision to slip this notice out on New Year’s Eve leads one to question the degree to which the agency is committed to transparent practices. As a result, an inefficient regulation will be implemented and Americans will be made worse off.

 

Energy Efficiency as Foreign Aid?

A recent suite of energy efficiency regulations issued by the Department of Energy (DOE) have been criticized due to the DOE’s claim that consumers and businesses are behaving irrationally when purchasing appliances and other energy using devises. The Department believes it is bestowing benefits on society by “correcting” these faulty decisions. Mercatus Center scholars have written about this extensively here, here, and here.

However, even if we set aside the Department’s claims of consumer and business “irrationality,” a separate rationale for these regulations is also very problematic. The vast majority of the environmental benefits of these rules stem from reductions in CO2 emissions due to lower emissions from power plants. However, in a 2010 report, the US government estimated only 7 to 23 percent of these benefits will be captured by Americans. The rest will go to people in other countries.

Here’s a recent example. In August, the DOE proposed a rule setting energy efficiency standards for metal halide lamp fixtures. In the agency’s analysis, it estimated total benefits from CO2 emission reductions at $1,532 million. Using the more optimistic estimate of the percentage of CO2 related benefits going to the US citizens (23%), Americans should capture about $450 million in environmental benefits from the rule (once we include benefits from reductions in NOx emissions as well). At the same time, the DOE estimates the rule will cost $1,294 million, much of which will be paid by American consumers and businesses. How can the DOE, which is tasked with serving the American public, support such a policy?

One might argue America is imposing costs on the rest of the world with its carbon emissions, and therefore should pay a type of tax to internalize this external cost we impose on others. However, the rest of the world is also imposing costs on us. In fact, US emissions are actually in decline, while global emissions are on the rise.

Even if we assume it is a sensible policy for Americans to compensate other countries for our carbon emissions, is paying for more expensive products like household appliances the best way to accomplish this goal? Given that no amount of carbon dioxide emission reductions in the US will do much of anything to reduce anticipated global warming, wouldn’t the rest of the world be better off with resources to adapt to climate change, instead of (at best) the warm feeling they might get from knowing Americans are buying more expensive microwave ovens? A more efficient policy would be a cash transfer to other countries, or the US could create a fund the purpose of which would be to help other countries adapt to climate change.

Energy efficiency regulations from the DOE are already difficult enough to justify. Knowing they are really just a roundabout form of foreign aid makes these rules look even less sensible.

“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.

The Precautionary Principle vs. Glow in the Dark Plants

http://www.thecroodsmovie.com

In “The Croods,” a box office hit cartoon showing a family of cavemen, the father issues daily warnings to his family that everything new is bad. He explains to his inquisitive daughter that they have survived for so long in their dangerous world by doing exactly the same thing every day and eschewing innovation. In our times, we would call his approach “the precautionary principle.”

The precautionary principle was on display when environmental activists petitioned a startup fundraiser Kickstarter to shut down the Glowing Plant Project, calling it “a new biotech threat coming from Silicon Valley.”  As its name suggests, the project aims to create plants that will glow in the dark using synthetic biology. And while the idea may sound like a fad, it may have practical applications, e.g. living streetlights that would use their own energy to illuminate our cities.

Under pressure, Kickstarter amended its rules to ban startups from rewarding their donors with genetically modified products. The environmental activists further called on the regulators to subject similar projects to independent risk assessments. So far various agencies claimed that the issue is outside their jurisdiction.

The idea of making organisms glow is not new. A few years ago, FDA certified that there was no evidence that the Glofish, produced using similar technology, “pose any more threat to the environment than their unmodified counterparts.” But this will hardly satisfy the environmental groups who believe synthetic biology poses a major threat to conservation and sustainability of biological diversity.

There is logic to the precautionary principle. Innovation can and often does bring new risks. There were no driving related fatalities before the invention of cars and certainly fewer greenhouse gas emissions. And it would take a lightening strike to get a fatal electric shock before the invention of powerful electricity generators. Cars, electricity, vaccines and many other innovations came with substantial risks. But just imagine how riskier and poorer the world would be if we had used a precautionary principle to stifle innovation in those technologies.

My colleague Adam Thierer writes in his recent law review article:

New technologies help society address problems that are associated with older technologies and practices, but also carry risks of their own. A new drug, for example, might cure an old malady while also having side effects. We accept such risks because they typically pale in comparison with the diseases new medicines help to cure. While every technology, new or old, has some risks associated with it, new technologies almost always make us safer, healthier, and smarter, because through constant experimentation we discover better ways of doing things.

He further notes:

The precautionary principle destroys social and economic dynamism. It stifles experimentation and the resulting opportunities for learning and innovation. While some steps to anticipate or to control unforeseen circumstances and “to plan for the worse” are sensible, going overboard with precaution forecloses opportunities and experiences that offer valuable lessons for individuals and society.

So take it from the Croods – if we didn’t take risks and innovate, we’d still be living in caves.

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.