Giving it away

Carbon News reports:

THEY’VE declared a climate emergency and now the government is taking steps to ensure we can continue to drink chilled Sauvignon Blanc in a warming world.
Agriculture minister Damien O’Connor has announced the government is investing in a seven-year programme led by Bragato Research Institute to help future-proof the sustainability of New Zealand’s Sauvignon Blanc grapevines.
“Sauvignon Blanc comprises 87% of our wine exports. This new $18.7 million grapevine improvement programme will introduce genetic diversity into our vines, and ensure they continue to thrive in New Zealand conditions,” O’Connor said.
…
“Many of our existing vines will need to be replaced in 10 to 15 years in order to avoid a loss in productivity.
“The new variants could also lead to new flavour and aroma profiles, resulting in exciting new styles of wine that will add further value to the sector.”

Seriously?

The government also ~~gifted~~ invested another $7.5 million through another MPI programme.

What is the problem the government thinks it is solving here? Does it think the horticulture sector has not heard of climate change? That growers could not possibly work out a way to cope with gradual changes in the distribution of temperatures, rain and humidity without someone to hold their hand?

“Anticipated climate change impacts require action now to ensure New Zealand continues to be considered the world’s Sauvignon Blanc capital.”

I’d guess there will be no shortage of action if the alternative is growers lose money or go out of business if they do not adapt to changing weather patterns.

If the standard for getting $26 million out of the government is that you might be affected by a changing climate – who does not qualify?

Of course, the problem the government is solving with its seemingly endless parade of nonsense on climate change is its own re-election in two years.

There is a fundamental problem across all of the government’s thinking on adaptation. The government is making no attempt to isolate the problems that property owners are not going to solve themselves.

Managed retreat from low lying land is a horribly exaggerated response to a problem that should mostly take care of itself. From the government’s perspective, 99% of the problem is going to be solved automatically by property owners responding to inundation risks. Nobody is better placed to weigh costs and benefits and tradeoffs between competing land uses than land owners.

The government’s magic bullet in all of this is finding a way to solve the commitment problem: the promise not to bailout wealthy landowners who suffer losses. Is there anybody in government thinking about adaptation in such gravy-free terms?

To Minister Shaw: Please explain

Yesterday, in the Herald ($), I challenged Climate Change Minister James Shaw to explain how his Emissions Reduction Plan lowers emissions.

In this post, I want to head off what he is going to say. His lines are, frankly, not right. So let’s get that on the table and go through the argument before he says it.

Shaw’s plan is vast. It covers every sector of the economy. The government could regulator, tax or subsidise anything or everything in the name of reducing emissions.

But Shaw’s plan is not going to reduce emissions.* The government has already placed a quantity cap, a sinking lid, on emissions with the ETS. Legislation passed in 2020. It is widely accepted that cap-and-trade schemes neutralise other emissions policies. If the cap determines total emissions, policies under the cap do not.

This neutralising effect of an emissions cap is called “the waterbed effect”.

Here is how a cap-and-trade scheme will neutralise an EV subsidy, for example:

Imagine an economy normally produces 100 tonnes of emissions. This year, the government decides to cap emissions at 80 tonnes. It issues 80 emissions permits and demands the surrender of one permit per tonne of CO2. Emissions fall to 80 tonnes.
Next year, the government issues another 80 permits and introduces a new EV subsidy. The subsidy successfully reduces transport emissions by five tonnes.
Total emissions remain at 80 tonnes. Why? Because there are still 80 emissions permits available. The five permits which transport no longer needs due to the subsidy will be used elsewhere. They will raise emissions (or postpone reductions) by exactly five tonnes somewhere else in the economy.

So, the EV subsidy reduces emissions from one sector. But overall emissions do not change. This is the waterbed effect.

Now, before I go any further, let me say that “The ETS Is Not Enough”™ is not an answer. That line is a mantra in Wellington. It is useless except for the fact it has fooled everybody who hears it.

Somehow, nobody has noticed “The ETS Is Not Enough”™ does not make any case for doing other policies if those policies are going to be neutralised by the cap.

Even if the ETS leaves you short of your emissions target (because it is Not Enough™), the waterbed effect is still in play.

So even if the “The ETS Is Not Enough,”™ complementary emissions policies don’t help. If they are neutralised by the cap, then those policies are going to leave you exactly as far short of your target as if you had not done them.

Every day, this advanced logic escapes hundreds of public servants who do nothing except think about climate change policy at your expense. You pay their salaries but I assure you they are not working for you.

Anyway, if Shaw’s Emissions Reduction Plan is to reduce emissions, it has to find a way around the waterbed effect.

Shaw has previously spoken about how to avoid the waterbed effect. His solution seems obvious: lower the cap as policies bring down emissions.

Here is Shaw speaking to Carbon News earlier this year:

[W]hat they’re talking about is something called the ‘waterbed effect’. If you cut emissions in one area and that takes things below the cap then it allows others to pollute more in the meantime.
But if you’re successfully lowering the cap every time then you minimise that effect because you’re saying, ‘Yes we’re taking emissions out here with the feebate and also with the ETS and then next time we set an emissions budget it will take account of the fact that emissions are lower.’
The way it works is you’ve got your 2050 target which is sort of long term. Then you’ve got your three five yearly budgets and each one is smaller than the one before. Every five years, at the start of each budget period, if circumstances dramatically change since you set the budget five years earlier, you can adjust at that time and say, ‘hey look things have moved far quicker or in unexpected ways we can adjust the budget to take account of that emissions budget.’

Shaw’s logic, as I understand it, is this: Ministers set the cap; Ministers can link the cap to complementary policies (EV subsidies, for example); complementary policies therefore lower emissions.

In the earlier example, emissions stayed at 80 tonnes after the EV subsidy had cut transport emissions. That is because there were still 80 emissions units in circulation. The intuitively obvious solution is to lower the emissions cap to 75 tonnes. Total emissions come down in line with the emissions benefits of the EV subsidy. Problem solved.

No. Problem not solved. That logic is not right.

Linking the cap to the policy does not make the policy lower emissions. It is the cap, not the policy, which lowers emissions. The policy is actually redundant. We explain why in our submission earlier this week on Shaw’s plan:

[Linking] the cap with complementary policies may imply the policies lowered emissions. However, this is an illusion. To see why consider this from the earlier example:

# If the government reduced the cap to 75 tonnes without the complementary policy, emissions would fall to 75 tonnes.
# If the government did the complementary policy but left the cap at 80 tonnes, emissions would remain at 80 tonnes.

The cap is doing all the work.
Accordingly, it is wrong to say that linking the cap to complementary policies means complementary policies reduce emissions. The connection is arbitrary. Ministers could link the cap to, say, cumulative rainfall, but nobody would suggest last week’s storm had lowered emissions. It is the cap, not the complementary policies, which lowers emissions. Complementary policies are still neutralised by the emissions cap. The waterbed effect is not avoided.

The cap is doing all the work. So long as the government has the option to reduce emissions simply by tightening the cap, other policies cannot cause emissions to come down (provided they are subject to the cap). The other policies are redundant.

The next obvious question is: what happens when the government does not have the option to simply tighten the cap? What if carbon prices rise to the point that voters or Parliament will not countenance any further tightening? Can complementary policies help further reduce emissions then?

This does open the door to complementary policies reducing emissions, but only by the smallest amount. Our submission walks through the weird permutations which are needed to get complementary policies to to cut emissions under an emissions cap. Short answer: we see no real way for complementary policies to cut more than a little extra emissions, at best.

If anything, complementary policies are more likely to raise emissions because of their lower economic efficiency and likely political inefficiency. The high cost of top-down emissions policies probably translates to a higher burn rate of political capital per tonne of emissions. That may seem like a fairly esoteric metric, but it matters in principle when the limiting factor on further reducing emissions is political feasibility.

Think about it this way: if the reason the ETS becomes politically constrained is because voters don’t like its cost of living effect, then how can policies which spend far more per tonne of abated emissions be any solution?

Complementary policies only have the opportunity to make any difference to emissions, up or down, if the ETS first becomes politically constrained.

It is hard to see any way the ETS is going to become politically constrained before 2050. New Zealand is already comfortably on track to achieve net zero emission in 2050 with existing policies. We include a list of reasons why in our submission. Nearly all of the evidence shows existing policies get us there.

I need to be clear about what “politically constrained” means. I mean it in the sense that a future government has no politically feasible way to net zero emissions.

Sure, the government could force the ETS price all the way to $500 if it stamps hard enough on trees and other removals technologies and rules out offshore mitigation entirely. That is what this government wants to do. And voters could well object to paying $500 per tonne of carbon.

But the ETS is not politically constrained if the government has the option to just stamp a bit less hard on trees or open the door slightly to offshore mitigation. Politically constrained is when the government cannot tighten the ETS any further, it cannot plant more trees, it cannot commission other removals technologies, and it cannot go offshore, and it is still short of net zero emissions.

Not going to happen. See the submission for why.

So, there is no question at all that right now we have legitimate, affordable, genuine pathways to net zero emissions, and we have options. We can plant a less trees and still get to net zero. We could plant no more trees and get to net zero. None.

Which means the government will always have the option to tighten the cap.

Which makes complementary policies under the cap redundant, including existing emissions policies.

Which means James Shaw’s vast plan is not going to reduce emissions. Not by one tonne.*

* For policies covered by the ETS cap, which is nearly everything except agriculture.

Why Reserve Bank independence matters

The case for Reserve Bank independence on monetary policy is obvious. If politicians have control of the money supply, they will use it to support their re-election.

But what is the case for Reserve Bank independence on financial regulation?*

The question arises because the Reserve Bank is looking at disclosure rules and possibly other regulations in response to climate change. The Bank can only consider these actions by maintaining climate change is a risk to financial stability. The Reserve Bank Act does not mention climate change but makes the Bank responsible for the stability of the financial system.

The Reserve Bank has not found any credible evidence that climate change threatens financial stability. Climate change is a big problem, to be sure, which demands a response. But its costs will be manageable and come with decades of warning. The idea that climate change is financial stability risk is absurd.

Accordingly, the Reserve Bank is outside its financial stability mandate by focusing on climate change. Its decision to target climate looks politically motivated.

John Cochrane explains why the combination of unlawful, politically-motivated actions by powerful financial regulators is toxic:

Of all the threats posed by a slowly warming climate, why is Ms. Yellen [the US Treasury Secretary] talking about financial stability? The answer is simple: Financial regulators are not supposed to implement each administration’s policies on non-financial matters. Financial regulators may only act if they think financial stability is at risk.
Why? Imagine that Trump returns. He declares, “Illegal immigration is an existential crisis. I can’t get Congress to do anything about it. Financial regulators: Tell banks to freeze the bank accounts of any customers who can’t prove legal status. Scour people’s accounts for payments to illegal employees. Freeze out any business that hires an illegal.” You would be shocked. The nation would be shocked. Ms. Yellen would be shocked. There is no financial risk here, we would all say. This is a vast abuse of power.

The Reserve Bank’s actions on climate change are not remotely in the same league of awfulness as this scenario. But it opens the door to that possibility in the future.

Climate risk to the financial system is a Big Lie. I don’t know how to put this politely. A little lie is a knowing untruth spouted by a devious individual. A Big Lie is a whopper, self-evidently false when parsed in standard English, passed around and around the bubbles of Davos, Glasgow, alphabet-soup financial agencies, philanthropies, and the narrative-endorsing media, until earnest do-gooders come to believe in its nonsense. Spouting it gains one the approval of the elite, and denying it quick expulsion and exclusion. A Big Lie justifies extraordinary grasps of political power.
…
Why repeat this Big Lie? Well, it’s obvious. Many people in our government and surrounding policy elites want to expand a particular kind of climate policy. That policy centers on stopping fossil-fuel development and use, before alternatives are available at scale, and subsidizing a particular kind of “green” projects. Windmills, solar panels, electric cars, rail, yes. Nuclear, carbon capture and storage — which would permit fossil-fuel burning — natural gas, hydrogen, geothermal, hydropower, innovation, zoning and land-use reform, adaptation, no.
…
Democratically elected legislatures and accountable administrations refuse to quickly implement this policy. Even the Biden administration, which on day one canceled the Keystone pipeline, quickly turned around to ask OPEC and the Russians to turn on the spigots when voters noticed gas prices rising.
…
What to do? Well, turn to financial regulation. What they can’t accomplish by accountable, democratic methods, they can accomplish by unleashing the awesome power of financial regulators to impose these policies, by denying funding to fossil-fuel companies and their customers, and freezing them out of the financial or payments system as we do to pot farmers, by demanding “disclosures.” The European Central Bank (ECB) is already printing money to buy “green” bonds, declaring them to be “undervalued.”
…
It is a particularly effective idea, because once thousands of pages of regulations are written, once the right people are appointed with all the protections of office, once the Twitter mob has silenced dissenters in the financial-regulatory community, once private businesses have gotten the message how to please regulators and hired hundreds of thousands of climate-disclosure compliance officers, the effort will be immune to the whims of pesky voters….
Most of all, it is blatantly illegal. In a democracy, independent agencies have broad but limited powers. Financial regulators are limited to financial risks. Securities regulators are supposed to enforce the “fiduciary rule” that asset managers must invest only on financial basis, not to please either the managers’ or politicians’ preferences. And there are great reasons for this limitation. If the Fed starts buying “green bonds,” the next Trump can force it to start buying “build the wall” bonds…

John Cochrane really is difficult to excerpt. Do read the whole thing.

In New Zealand, the order of events is slightly different. Climate change is more politically feasible here than in other countries, with the possible exception of agriculture. But it is the Governor driving the Bank’s focus on climate, rather than politicians forcing it onto the Bank. The end result is the same: an unelected body pushing a political agenda, compromising its independence, and opening the door to greater abuses in future. It is all fundamentally undemocratic.

Finally, a nice insight from Cochrane on the logic behind central banks’ focus on investment:

What they mean is not climate risk to the financial system, but the financial system’s risk to the climate, by financing the “wrong” investments. But they’re not allowed to regulate that. Hence the Big Lie: We looked for risks, and guess what, climate came out on top!

John Cochrane will deliver a public webinar for the New Zealand Initiative on Thursday 2 December at 11am. Sign up here.

Ian Harrison will deliver a public seminar on “Climate change and the risk to financial stability; Reality or overreaction?” next week on Friday 26 November at 11am Sign up here.

*To be clear, the independent application of financial regulation. Policy setting sits and should remain with the elected government.

Email to the Reserve Bank

The Reserve Bank says climate change is a risk to financial stability. It is proposing to regulate accordingly. A recent paper by the Federal Reserve Bank of New York finds weather disasters are profitable for large banks because they increase loans. In view of the apparent gulf in the two positions, and the lack of any credible evidence so far from the Reserve Bank for its position, the Bank needs to reconcile the gap between its position and the evidence.

Yesterday, I sent the following email to the Reserve Bank. It includes a promise to OIA the Bank at the end of February with a goal of finding out what the Bank has done with these papers:

From: Matt Burgess
Sent: Thursday, 18 November 2021 6:20 pm
To: xxxxxxxxxxxx@rbnz.govt.nz
Subject: Research on climate change and financial stability

Dear xxxxxxxx

In view the Reserve Bank’s interest in climate change, I attach a paper from the Federal Reserve Bank of New York titled “How Bad Are Weather Disasters for Banks?”

Here is the abstract:

Not very. We find that weather disasters over the last quarter century had insignificant or small effects on U.S. banks’ performance. This stability seems endogenous rather than a mere reflection of federal aid. Disasters increase loan demand, which offsets losses and actually boosts profits at larger banks. Local banks tend to avoid mortgage lending where floods are more common than official flood maps would predict, suggesting that local knowledge may also mitigate disaster impacts.[my emphasis]

The paper includes a literature review:

Our main findings are generally consistent with the few papers that study the bank stability effects of disaster. Looking across countries, Klomp (2014) finds that disasters do not effect default risk of banks in developed countries. Brei et al. (2019) find that hurricanes (the most destructive weather disaster) do not significantly weaken Caribbean banks. Koetter et al. (2019) finds increased lending and profits at German banks exposed to flooding along the Elbe River. The study closest to ours by Noth and Schuewer (2018) finds default risk increases at U.S. banks following disasters but the effects are small and short-lived. Barth et al. (2019) find higher profits and interest spreads at U.S. banks after disasters but did not look at bank risk. Based on four case studies of extreme disasters and small banks, FDIC (2005) concluded that …”historically, natural disasters did not appear to have a significant negative impact on bank performance.”

These findings appear to be directly relevant to and substantially at-odds with the Reserve Bank’s position on the financial stability effects of climate change. I have found no record of any of these papers on the Reserve Bank’s web site.

Here are the references to those cited papers with their abstracts:

Barth, J., Y. Sun, and S. Zhang (2019). Banks and natural disasters. SSRN Working Paper

Natural disasters are not rare and costless events. Indeed, the evidence indicates there has been an acceleration in the number of disasters and the associated costs over the past century. Such disasters can cause severe property damage in the communities affected. Typically, insurance policies and government disaster relief fail to cover the full amount of damages. In this case, banks can play an important supporting role in providing additional funding for the necessary reconstruction that takes place after disasters. We provide evidence that following natural disasters, banks with branches in the affected areas raise both deposit and loan rates, but the latter more than the former so that net interest margin increases. This, in turn, leads to an increase in return on assets for such banks, but not sufficiently large enough to indicate profiteering. At the same time, banks increase the use of brokered deposits after natural disasters to help fund the increased demand for loans by individuals and firms in affected communities. Thus banks located in the disaster-prone areas contribute to helping communities recover from natural disasters.

Brei, M., P. Mohan, and E. Strobl (2019). The impact of natural disasters on the banking sector: Evidence from hurricane strikes in the Caribbean. The Quarterly Review of Economics and Finance 72. https://ideas.repec.org/a/eee/quaeco/v72y2019icp232-239.html

While natural disasters cause considerable damage and a number of studies have attempted to investigate the nature and quantify the magnitude of these losses, there is a paucity of empirical evidence on the impact on the banking sector. In this paper we construct a panel of quarterly banking data and historical losses due to hurricane strikes for islands in the Eastern Caribbean to econometrically investigate the impact of these natural disasters on the banking industry. Our results suggest that, following a hurricane strike, banks face deposit withdrawals and experience a negative funding shock to which they respond by reducing the supply of lending and by drawing on liquid assets. There are no signs of deterioration in loan defaults and bank capital. Therefore, the withdrawal and use of deposits rather than an expansion in credit appears to play a significant role in funding post hurricane recovery in the region. This points to the importance of an active reserve requirement policy.

Klomp, J. (2014). Financial fragility and natural disasters: An empirical analysis. Journal of Financial Stability 13 https://doi.org/10.1016/j.jfs.2014.06.001

Using data for more than 160 countries in the period 1997 to 2010, we explore the impact of large-scale natural disasters on the distance-to-default of commercial banks. The financial consequences of natural catastrophes may stress and threaten the existence of a bank by adversely affecting their solvency. After extensive testing for the sensitivity of the results, our main findings suggest that natural disasters increase the likelihood of a banks’ default. More precisely, we conclude that geophysical and meteorological disasters reduce the distance-todefault the most due to their widespread damage caused. In addition, the impact of a natural disaster depends on the size and scope of the catastrophe, the rigorousness of financial regulation and supervision, and the level of financial and economic development of a particular country.

Koetter, M., F. Noth, and O. Rehbein (2019). Borrowers under water! Rare disasters, regional banks, and recovery lending. Journal of Financial Intermediation Forthcoming. https://libkey.io/10.1016/j.jfi.2019.01.003?utm_source=ideas

We show that local banks provide corporate recovery lending to firms affected by adverse regional macro shocks. Banks that reside in counties unaffected by the natural disaster that we specify as macro shock increase lending to firms inside affected counties by 3%. Firms domiciled in flooded counties, in turn, increase corporate borrowing by 16% if they are connected to banks in unaffected counties. We find no indication that recovery lending entails excessive risk-taking or rent-seeking. However, within the group of shock-exposed banks, those without access to geographically more diversified interbank markets exhibit more credit risk and less equity capital.

Noth, F. and U. Schuewer (2018). Natural disaster and bank stability: Evidence from the U.S. financial system. SAFE Working Paper 167.

Our analysis provides new evidence that weather-related disaster damages in the banks’ business regions indeed weaken bank stability and performance. This is reflected in significantly lower bank z-scores, higher probabilities of default, higher non-performing assets ratios, higher foreclosure ratios, lower return on assets and lower equity ratios in the two years following a natural disaster. For a relatively small number of (non-weather-related) geological disasters in the United States, such as earthquakes and tsunamis, we show that these disasters have even relatively stronger adverse effects on bank stability. Overall, the evidence reveals that natural disasters jeopardize borrowers’ financial solvency and decrease bank stability, despite potential insurance payments and public aid programs. On a more positive note, we find that banks generally manage to recover from the adverse shock from weather related disasters (but not from geological disasters) after some years, which is reflected in the bank stability and performance measures of affected banks that are not significantly worse than those of unaffected banks two or three years after a disaster.

Given the extent of the apparent gap between these research findings and the Reserve Bank’s position on the financial stability effects of climate change, I trust the Reserve Bank will consider this research seriously and be able to reconcile its position with these findings.

Given the public interest in this area and the significant steps the Reserve Bank is considering around disclosure and possibly other regulation, at the end of February 2022 we will submit a request to the Reserve Bank under the OIA for all documents and emails which refer to these articles.

I hope you will find this research interesting and useful.

Best regards,

Matt Burgess

—

And a reminder that none of those five papers appear anywhere on the Reserve Bank web site, according to Google on 17 November, despite their obvious relevance to the relationship between climate change and financial stability. #smh

Contrasting substance on climate

The Reserve Bank keeps saying climate change threatens financial stability. It has been saying that for three years. No previous Reserve Bank Governor agrees, judging by their silence on the matter. As I said in last week’s report on the Reserve Bank, after three years of looking the Reserve Bank has not been able to come up with any evidence for their theory. I’m sure it is due any minute now.

Via John Cochrane, the Federal Reserve Bank of New York has taken a different approach. It has actually looked at the evidence. Its paper, called “How Bad Are Weather Disasters for Banks?” includes this as its opening sentence in the abstract: “Not very.”

It goes on:

Disasters increase loan demand, which offsets losses and actually boosts profits at larger banks. Local banks tend to avoid mortgage lending where floods are more common than official flood maps would predict, suggesting that local knowledge may also mitigate disaster impacts.

Here is their literature review:

Our main findings are generally consistent with the few papers that study the bank stability effects of disaster. Looking across countries, Klomp (2014) finds that disasters do not effect default risk of banks in developed countries. Brei et al. (2019) find that hurricanes (the most destructive weather disaster) do not significantly weaken Caribbean banks. Koetter et al. (2019) finds increased lending and profits at German banks exposed to flooding along the Elbe River. The study closest to ours by Noth and Schuewer (2018) finds default risk increases at U.S. banks following disasters but the effects are small and short-lived. Barth et al. (2019) find higher profits and interest spreads at U.S. banks after disasters but did not look at bank risk. Based on four case studies of extreme disasters and small banks, FDIC (2005) concluded that …”historically, natural disasters did not appear to have a significant negative I impact on bank performance.”

So, a small, short lived increase in default (not stability) risk, followed by higher profits as a result of higher lending for the recovery. Larger banks see the greatest boost in profitability.

Oh.

There is more substance in that quote above than anything the Reserve Bank has written on climate change. Look at this tripe, from their the Reserve Bank’s Climate Changed report:

A key concern for us is the exposure of the financial sector, including banks and insurers, to climate-related risks… We take our role seriously, so in 2018 we launched our Climate Change Strategy to understand and manage our direct impacts on climate change, incorporate climate change into our core functions, and lead through collaboration… Without significant action there will be serious impacts on our economies.
There is more that we can collectively do to integrate climate considerations throughout the financial system. It is encouraging to see national and global progress – for example, progress in setting a framework to disclose climate-related risks and some firms beginning to disclose, the delivery of the Climate Change Commission’s first set of advice, and the launch of Toitū Tahua, the Centre for Sustainable Finance. Internationally we are heartened by collaboration in international groups such as the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) and the Sustainable Insurance Forum (SIF), and the focus on finance at this year’s United Nations Climate Change Conference (COP26).
A key challenge is that financial stability is best maintained when all relevant risks have been identified, priced and allocated to those best able to manage them. Work is underway to increase our global understanding of these risks.
Yet we need to be realistic in measuring our collective global progress against the scale of the risks before us and the transition required. While tools like disclosure and scenario analysis are critical in helping us understand and prepare for climate risks, we cannot let a desire to perfect such analysis paralyse us…

Etc. The Reserve Bank could have written that literature review quoted earlier. It decided not to. Instead, the Bank chose to pump out its risible agitprop which might as well have come from Greenpeace.

As Cochrane points out:

This is a courageous paper to write… “We looked and there is nothing here” is not going to go down well. It’s hard to publish papers and get jobs as climate and finance researchers these days if you come up with the “wrong” answers.

A reminder that John Cochrane is delivering a public seminar for the New Zealand Initiative on 2 December. You can sign up here.

—

Post script: The Fed’s literature review, the part that covers stability, has references to five academic papers. These papers have pertinent titles: “Financial fragility and natural disasters,” “The impact of natural disasters on the banking sector,” “Borrowers under water! rare disasters, regional banks, and recovery lending,” “Natural disaster and bank stability,” and “Banks and natural disasters.”

According to Google, none of those five papers are mentioned anywhere on the Reserve Bank’s web site. Quelle surprise.

Untrue statements as boilerplate

Stuff reports:

A group of more than 100 New Zealanders, including two former All Blacks and musician Neil Finn, has written an open letter to New Zealand Rugby saying it is going against its own leadership principles by making a major deal with an oil, gas and plastics company.

Good luck to those who have signed the open letter.

But where is the open letter that complains about all the emissions policies which the government says will cut emissions but don’t?

Just yesterday, for example, the government announced it will spend $13 million on a welter of new projects. Together these projects will reduce emissions by exactly zero tonnes because every one of them is in the ETS cap.

Thousands of officials continue not to understand that if an emissions cap decides total emissions then anything that is not an emissions cap does not affect total emissions. This advanced logic continues to elude public servants.

I’m sure former All Blacks are penning their outrage as you read this.

Stuff ends its article with this:

No, Stuff. The Earth is not basically on fire. It has warmed by 1 degree since 1850. The IPCC says so.

Untrue statements aren’t just in the news. They’re boilerplate.

The case for a carbon dividend in two charts

A carbon dividend takes the revenue from auctions of emissions units for the ETS and gives it back to households. This year, the sale of emissions units will raise around $1.3 billion.* That is around $750 per household.

The following two charts show a) low-income households spend more of their incomes on carbon than other households, but b) have a smaller carbon footprint.

Source: Figure 4.3, Report 2.

Source: Figure 4.2, Report 2.

The charts come from a UK analysis by the London School of Economics. I know of no equivalent analysis for New Zealand, although these findings from Infometrics appear consistent.

So what does this mean?

Carbon pricing is generally thought to be regressive because low-income households spend a higher share of their incomes on goods and services which produce or lead to emissions.

However, a carbon dividend reverses this, making carbon pricing progressive. Giving households the revenues from the sale of emissions units disproportionately benefits low-income households. This is because their absolute carbon footprint is smaller than other households, meaning less exposure to the carbon tax, but dividends are paid on (something like) a flat rate.

Studies find different carbon dividends are progressive under most allocation rules, including a simple flat payment per person. Here is a list of studies on the equity effects of carbon dividends.

Studies also find that carbon dividends mean carbon pricing overall is a net benefit for a majority of households. The mid-range estimate seems to be around 60% of households. Low-income households benefit the most from a dividend: one of the studies, from the US, estimates 84% of low-decile households would receive a net benefit from carbon pricing after a dividend payment.

So if you are worried about protecting the most vulnerable households from the costs of lowering emissions – and many who work on climate change say they do – then a carbon dividend should be attractive to you.

On the other hand, if you are concerned about whether it will be possible set a carbon price that is high enough to achieve emissions targets without compromising popular support, then a carbon dividend should be attractive to you. A carbon dividend allows governments to go faster and harder on raising the carbon price, since payments back to households are shelter from higher power bills and petrol prices that necessarily follow from pricing carbon. The fact that dividend means most households win from carbon pricing, with the largest proportionate benefits going to those on low incomes, should increase voters’ tolerance for aggressive efforts to lower emissions.

So, a carbon dividend ticks a lot of boxes.

Naturally, the government has all-but ruled out a dividend. One the few concrete new policies in last week’s Emissions Reduction Plan was to dismiss the dividend idea. Here is what the government said (pp. 34-35):

Given the breadth, scale and duration of the transition to low-emissions economy, we need to ensure adequate, durable and certain public funding for climate action. The Treasury and the Ministry for the Environment are currently considering how the public finance system can provide this, including:
…
4. how we can recycle revenue from the New Zealand Emissions Trading Scheme (NZ ETS) into climate spending.

I understand James Shaw has subsequently confirmed no dividend.

Next time you hear Shaw or the PM or any other minister talking about a “climate crisis” or “climate justice,” keep in mind that they have ruled out about the closest thing you can find to a magic bullet in climate change policy. The one thing, other than a carbon price, that could do more to cut emissions and protect the most vulnerable, simply and easily, than anything else.

That’s what they rule out first.

* Excluding revenue from the sale of 1.6 million “backed” units. These are additional units, issued and sold at the auction on 1 September to defend the ETS price cap. Backed units have to be offset by the government in some way such that they do not raise global emissions.

Not about emissions

With its Emissions Reduction Plan released last week, the government is promising unprecedented control over every aspect of your life.

How you move. What you eat. Where you live. How you heat your home.

It is little short of a revolution. Between its emissions plan and next year’s Budget, which will also be about climate change, future governments of this country will have more to say about everything.

The problem is that existing policies already have this country firmly on track to deliver emissions targets.

In both its draft and final reports, the Climate Change Commission said current policies and a $50 carbon price will be enough to deliver net zero emissions in 2050. Its analysis did not show undue reliance on removals by exotic trees, although Ministers and officials have repeatedly made misleading statements about the Commission’s findings.

Today’s carbon price is $65. So we are ahead of schedule.

Which makes the government’s Emissions Reduction Plan redundant. We get to our targets without the Plan. Emissions will come down about as quickly with the plan as without.

New Zealand should get more credit for its progress on emissions. On a per-capita basis, greenhouse gases have been falling since 2006. They are down 22% overall, and down 34% if agriculture is excluded.

Net emissions of long-lived greenhouse gases – relevant for the net zero target – are down 25% per person.

And it is not pine trees that are doing all the work. More than 100% of the fall in net emissions is due to lower gross emissions.

So current policies are already doing the business demanded by environmentalists. There is no need to add thousands of dollars to the cost of vehicle imports, or any of the many other impositions being looked at, since we are already on track to deliver the stated goal.

There should be no question existing policies will deliver all of our emissions targets if they are given the chance. That is because, apart from methane, New Zealand has set net emissions targets. Both domestic law and international agreements recognise three pathways to lower net emissions: lower gross emissions; removals by trees and other carbon capture technologies; and offshore mitigation.

Removals and offshore mitigation are each affordable and scalable enough on their own to deliver net zero emissions in 2050.

But voters prefer reductions. Fine.

So the task for emissions policies is to assemble a mix of reductions, removals and offshore mitigation which

delivers emissions targets; and
reflects the premium voters are willing to pay for more reductions, less removals and less offshore mitigation.

The government is not thinking about climate change this way. In fact, it does not seem to be thinking about emissions at all. It has published an Emissions Reduction Plan which will bring down emissions by about the same amount as existing policies to achieve the same emissions targets.

What, then, is the point of an Emissions Reduction Plan if it does not reduce emissions?

Judging from its effects, the point is control. The plan will have two clear effects. Ministers will decide how and where emissions come down, not you. Second, you will pay more – ten times more, on the government’s own analysis – for the benefit of their judgment.

What a terrible deal. For the environment. And for your back pocket.

And all based on the twin lies that reducing emissions requires central control, and that the government’s Emissions Reduction Plan reduces emissions.

A climate policy framework

John Cochrane has written a long essay in National Review called ‘Climate Policy Should Pay More Attention to Climate Economics’ with a subtitle of ‘Without numbers, we will follow fashion.’

The article is beautifully written, hardly a single one of the 3,500 words is wasted. In arguing for economics in climate policy, Cochrane covers many of the major ideas for thinking about how to reduce emissions. The article is comprehensive enough to be a framework.

In this post, I attempt to distil the main ideas in Cochrane’s article.

To avoid doubt, Cochrane (and I) believe climate change is real and is a problem which justifies a policy response. He disputes none of the climate science. He takes the findings from science as given and thinks about the consequences for climate policies. He highlights the harmful mismatch between scientific findings and popular rhetoric on climate.

Most of the following text is directly from Cochrane, with or without quotes. I have put my favourite soundbites in italics:

Climate science and climate policy are different. Climate science concerns the relationship between greenhouse gas emissions and climate. Climate policy is about reducing greenhouse gas emissions. Attacking policy is not attacking the science. “You don’t have to argue with one line of the IPCC scientific reports to disagree with climate policy that doesn’t make economic sense.”

Climate change is not that expensive. “The U.N.’s IPCC finds that a (large) temperature rise of 3.66°C by 2100 means a loss of 2.6 percent of global GDP. Even extreme assumptions about climate and lack of mitigation or adaptation strain to find a cost greater than 5 percent of GDP by the year 2100… Five percent of GDP is only two to three years of lost growth. Climate change means that in 2100, absent climate policy or much adaptation, we will live at what 2097 levels would be if climate change were to magically disappear. We will be only 380 percent better off [instead of 400%]. Or maybe only 950 percent better off [instead of 1,000%]… Northern Europe has per capita GDP about 40 percent lower than that of the U.S., eight times or more the potential damage of climate change. Europe is a nice place to live.”

The central uncomfortable fact is that the output of an advanced industrial economy like the U.S., moving headlong into services, is just not that sensitive to climate or weather. The worst heat waves, floods, and storms just do not move national GDP.

To be clear, a modest cost is no reason not to act on climate. But a modest cost places a modest cap on the benefits of emissions policies, so caution is necessary to avoid emissions policies doing more harm than good.

Growth risk is an order of magnitude larger than climate risk. “The cost of climate change to India is trivial compared with the benefits India could obtain by adopting economic institutions more like those of the U.S. — which themselves are far from perfect.”

If the question is, “What steps can we take, perhaps costly today, to improve GDP in the year 2100?” hurried decarbonization is not the answer. If the question is, “What steps can we take to improve the well-being of the world’s poor?” climate policy is not the answer, with many zeros before you get to the decimal point. Sturdy pro-growth policies, however unpopular to so many in today’s political class and incumbent businesses and labor organizations, are the answer.

GDP is imperfect, but if anything it understates the benefits of economic progress. “It leaves out a lot — the tremendous value of free or nearly free goods, the value of clean air and water, good health, long life, a free and egalitarian society, and so forth. But all of these things are better when GDP is better, and far worse where GDP is worse.”

If the question is how to blunt the economic impact of climate change, adaptation has to be a major part of the answer. There seems to be a great disdain for adaptation, clearing the brush, building dikes and dams, moving to higher land, installing air conditioners, moving or engineering crops and so forth. Spread over a hundred years, the costs of adaptation are not large. Perhaps climate-policy advocates dismiss talk of adaptation because, by reducing the damage that might be caused by greenhouse-gas emissions, it makes emissions less scary. Climate models are also short on adaptation and innovation, perhaps for the same reason.

Miami might be six feet underwater in 2100, but Amsterdam has been six feet underwater for centuries. They built dikes. By hand. Amsterdam is a very nice place, not a poster for dystopian end of civilization. Buildings decay and need to be rebuilt every 50 years or so. Just start building in drier places.

We need rigour in climate policy. “For a small donation, pictures of cuddly animals might do. For trillion-dollar costs and regulations, they do not. To justify such costs, we need some dollar value on specific environmental damage of climate change. Yes, the numbers are uncertain. But those numbers are the only sensible framework to discuss spending trillions of dollars on climate now.”

Cost-benefit analysis matters for making the best use of limited resources. “Naming costs and benefits is particularly useful to analyze whether some of those trillions are not better spent on other environmental issues. For example, species extinction is a real problem. We are in the middle of a mass extinction. But the elephants will die from lack of land and poaching long before they get too hot or dry. For a trillion dollars, how much land could we buy and turn over to complete wilderness? How many more species would we save that way, rather than spending similar amounts of money on high-speed trains and hurrying the adoption of electric cars? The oceans are in trouble. For a trillion dollars, how much over-fishing, chemical pollution, plastic garbage, or noise could we fix? Economics is about choice, and about budget constraints.”

Even though we don’t really know the economic or environmental cost of carbon, cost–benefit analysis is vital so that we do whatever we do efficiently. Avoid doing incredibly expensive things that save little carbon, and don’t ignore unfashionable things that might save a lot of carbon at lesser cost.

Without numbers, we will follow fashion. Today it’s windmills, solar panels, and electric cars. Yesterday it was high-speed trains. The day before it was corn ethanol and switchgrass. Actually addressing climate change in a sensible and effective way is likely to involve unfashionable technologies, and new technologies without political backers. A focus on cost–benefit, carbon per dollar, is vital to allow different technologies to compete, and new technologies to emerge. The alternative — and current predilection — is for different technologies to compete for political favor, a mechanism we all know well, along with its disastrous results, especially regarding innovation and cost reduction.

[MB: This is an important point. One of the costs of an ad hoc winner picking approach on climate is lower innovation. Subsidising EVs, for example, must reduce incentives for R&D in politically-disfavoured rival technologies, including technologies we do not yet know about.]

The policy prescription is simple: price + carbon dividend + R&D. “From an economic perspective, the ideal policy combines a carbon tax, whose revenues reduce other marginal tax rates, with strong support for basic R&D.”

Thus, if the question is how to reduce carbon as much as possible while damaging the economy as little as possible, an evenly applied carbon tax — even to the coal emissions used to create solar panels and car batteries — is the answer, in place of regulation and subsidies.

A carbon tax bakes in cost–benefit analysis, and otherwise incalculable carbon-reduction pledges. Just buy the cheapest option and you’re doing your bit.

Maybe rather than buying a Tesla, you should move closer to work — or carpool. Maybe cutting out one international trip does more than buying the Tesla. Maybe zoning and permitting reform will allow building houses so people don’t commute in the first place. Is it easier to decarbonize transport, home heating, cement, steel, or agriculture? Only by setting a price can we know the answers, and incent the millions of little daily decisions that go in to reducing carbon emissions efficiently.

A weak consumer response to a carbon tax argues for a carbon tax. “A carbon tax is a win-win. Many climate advocates disparage the carbon tax, on the view that people will not reduce energy consumption and carbon emissions when the price goes up. If so, great! A bankrupt government can raise a lot of money, and reduce other heavily damaging taxes. If people drastically reduce carbon emissions to avoid a small tax, the government doesn’t earn much money. Great! We save the planet at low cost.”

Carbon policy is full of economic fallacies. Mother Earth does not care if solar panels are made in the U.S. or China. She just wants them to be cheap. “Millions of green jobs” are a cost, not a benefit. Financial regulators are now taking on climate change, justifying this dramatic expansion beyond their legal authority by endlessly repeating a fantasy that “climate risk” imperils the financial system in the near future.

There is nothing in the science that justifies uniting “climate” with a left-wing political agenda. Yet even the IPCC mixes climate change with “sustainable development, poverty eradication and reducing inequalities.” Mixing anti-capitalist politics with climate change makes those skeptical of the rest of the agenda wonder about the objectivity of climate science, and whether the planet really is in such danger.

There is nothing in climate science to justify apocalyptic rhetoric. If the question is, “What threatens the collapse of civilization,” war, nuclear war, civil war, pandemic, crop pandemic, and social and political disintegration are far higher on the list. No healthy society fell apart over a slow and predictable change that came over a hundred years. There is nothing in climate science to say life on earth is threatened.

Climate advocates have done themselves and the planet a great disservice by wrapping climate policy in increasingly shrill, apocalyptic, partisan, and unscientific rhetoric. “Global warming” became “climate change,” reflecting in part effects on rainfall or different geographies, but also inviting media commentary on every weather event to become a sermon. In the Green New Deal and comparable movements, it became “climate justice,” wrapping climate inexorably in a far-left-wing politics of anti-capitalism. The required vocabulary moved on to “climate crisis.” Still not enough: In April the (formerly) Scientific American proclaimed that, in coordination “with major news outlets worldwide,” it would start using the term “climate emergency.” Will “climate catastrophe” be next?

Finally, here is what I think is Cochrane’s most important point:

Actually doing something about the climate will require decades of consistent policy. That will not happen by today’s elites crying wolf and cramming regulations down the throats of a disdained and temporarily distracted electorate. [MB: That will also not happen by seat-of-the-pants ad hoc policies, nor will name-and-shame work. Consistent policy means a system – consistent, clear, enduring rules to lower emissions. The ETS is a fine example of a rules-based approach. Policies like 100% renewable electricity are not.]

The ETS is extraordinary

Just a reminder of what an extraordinary achievement the New Zealand Emissions Trading Scheme (ETS) is. Introduced in 2008, the ETS covers around 96% of GDP. Apart from the carve-out of agriculture, the ETS has no domestic exceptions. Many offshore schemes exclude small businesses, and/or transport. Ours does not, making it probably the most comprehensive carbon price in the world. Agriculture, our main export earner, is on track to introduce some form of carbon price from 2025.

Look at how different things are in the United States, even under a Democratic White House. From John Cochrane:

[C]arbon taxes are right now a political nonstarter. You can see this most clearly in the hilarious plea from the White House for OPEC to increase production in order to keep gas prices down. This from the same administration that canceled Keystone, “suspended” the issue of new oil and gas leases on federal lands, and is spearheading a “whole of government” move to rapid elimination of fossil fuels before alternatives are in place, all of which must raise the price of gas. What’s going on? Well, clearly, governments find they must take underhanded, obscure regulatory steps to drive up the price of gas, with plausible deniability, rather than enact simple, transparent, much more effective and much less costly carbon taxes, which voters will notice.

The fact that we have an ETS which is comprehensive and puts a hefty $60 per tonne price on carbon, while remaining feasible, is exceptional.