By Jason Krupp*
As a researcher at a public policy think tank with a strong focus on economics, it is sometimes easy to take prices, and the influence they have on behaviour and innovation, for granted. Two recent incidents highlighted how powerful this mechanism can be.
The first happened at a dinner party, where the conversation had strayed to the taboos of religion and politics. Well, anthropomorphic climate change, but it could be argued that the topic fits into either or both categories, depending on who you talk to.
The focus of the conversation was not on whether humans are warming the planet, but rather what needs to be done about it. The loudest voices at the table argued that governments must heavily invest in renewable energy like wind turbines and ban the use of fossil fuels such as oil and coal in order to decarbonise the economy.
Pointing out that you cannot build a wind turbine without coal was quickly tutted away, but it remains a point of fact.
Robert Wilson, a student completing a PhD in mathematical ecology, expounds on the point here. In brief, he quotes US Geological Survey figures that state it takes 103 tonnes of stainless steel, 402 tonnes of concrete, seven tonnes of fibreglass and 20 tonnes of cast iron to produce a single megawatt of wind capacity.
Some of this could be produced by greener methods than are currently employed, such as using recycled metal instead of coking coal to turn iron into steel. But these production techniques are only viable at the margin, and would require several decades of investment before green steel could be produced in significant quantities. Other parts of a wind turbine cannot be produced without fossil fuels, such as the fibreglass blades. In addition, the concrete used to make the base that a turbine stands on is produced in giant kilns that rely on coal or natural gas for heat.
Even if there were viable alternatives, Wilson notes that fossil fuels are used at every single point in the production process, and there are no viable substitutes. For example, the trucks and giant diggers that extract iron ore from mines are fuelled by diesel. Similarly, the ships that transport the ore to the smelters run on crude oil, and are huge steel creations in their own right.
Although Wilson has made some assumptions and taken some necessary shortcuts to build his argument, his conclusion that you cannot build wind turbines in large quantities without fossil fuels is sound. A ban on fossil fuel is self-defeating if your goal is to encourage energy production from renewable sources.
Constraining carbon emissions by prices is a much smarter way to achieve the same outcome, either through cap-and-trade or an outright carbon tax. Those firms that want to avoid this constraint will look for ways around it, such as through innovation.
This is already happening in the wind turbine space, with manufacturers steadily scaling back on the amount of materials required to produce a megawatt of power. Wind and solar desperately need these kinds of advances to lift their efficiency. A recent paper analysed how much energy goes into making a power source versus how much it puts out, and found that nuclear, hydro, coal, and natural gas are more effective than photovoltaics and wind power by an order of magnitude.
Importantly, prices do not shut down potential innovation that a ban would otherwise stifle. If fossil fuel use were forbidden why would anyone continue to invest in developing carbon capture schemes or storage technologies?
The second recent incident that underscored the power of prices, or the potential thereof, was a recent story about a US biotech firm called Pembient. The San Francisco-based firm has developed a method of manufacturing rhinoceros horns that not only look like the real thing, but are genetically identical too.
The aim is to flood illegal wildlife markets in Asian with these bio-horns, thereby collapsing prices and wiping out any profits poachers may hope to make from killing these animals in the wild. If it works, prices could end up saving the remaining rhino species from extinction where an international ban, armed park rangers and tough criminal sentences have so far failed.
Even if Pembient’s aim were not as noble as described, but simply to make a profit (rhino horn allegedly sells for US$65,000 a kilogram), prices are likely to fall further as other suppliers enter the market. And provided the costs of production are lower than what it costs to illegally harvest a horn from an animal, poaching will also decline.
The point of these two examples is to hopefully introduce an alternative remedy to the popular problems that are discussed at dinner tables. All too often the go-to response is “the government needs to ban X, or ban Y”. It would be a welcome change to hear someone who is not an economist say “why not let prices do the work?”
There may be cases where a ban is justified, such as where you cannot put a price constraint on a behaviour that society wants to prevent. Or because it may take too long for prices to take effect, and the harm needs a remedy now. However, the use of bans should be saved as a last resort, and even then sparingly and with extreme caution for fear of unintended consequences.
We know prices work because we see them in action every day. The upshot in trusting in prices and the market is that it could lead to a world where more electricity is produced from renewable resources and rhinos thrive in the wild, and that sounds like a fine place to live.
*Jason Krupp is a research fellow at the New Zealand Initiative. This is this week's NZ Initiative weekly column for interest.co.nz.