Wednesday, June 30, 2021
Tuesday, June 29, 2021
FEDS 2021-040: Nonlinear Unemployment Effects of the Inflation Tax
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Monday, June 28, 2021
IFDP 2021-1320: The Economic Effects of Firm-Level Uncertainty: Evidence Using Subjective Expectations
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Carbon Taxes: A Good Idea But Can They Be Effective?
The arguments in favor of all the nations in the world implementing a uniform (or near-uniform) carbon tax are both old and, under some very restrictive circumstances, valid. Strong support for carbon taxes, especially among economists, continues to this day, as global carbon dioxide emissions continue to increase, reaching about 40 billion tons per year in 2019. For example, recently a High-Level Commission on Carbon Prices (2017), consisting of many very prominent researchers of the mitigation of climate change chaired by Joseph Stiglitz and Nicolas Stern, recommended that a global carbon tax of about $50 per ton of CO2 be initiated very soon, rising to $100 per ton by 2030.[i]
The Commission realizes that for many reasons individual countries might want their country-specific carbon tax to be somewhat lower or higher than this global average. Implicit in this recommendation is, certainly, the assumption that a carbon tax at these levels will be sufficiently adequate to help the world achieve zero carbon emissions within a reasonable period of time, for example, by 2040-2050, in order to keep the global average temperature increase due to climate change to under 2.0 degrees Celsius. Yet, this assumption that carbon taxes in this range will provide significant help in achieving the goals of the Paris Treaty is rarely supported by real world analysis of the actual impacts of carbon taxes on specific energy end-uses, as opposed to attempts to support this claim using un-documented integrated assessment models and out of date economy-wide price elasticity estimates.
One reason for the lack of historical analysis of actual carbon tax impacts is that according to the World Bank’s Carbon Pricing Dashboard, the estimated average carbon price for the almost 20% of worldwide carbon dioxide emissions that occurred within carbon pricing schemes in 2018 is only about $7.43 per ton of CO2, hardly enough for any consumer of fossil fuels, even businesses, to notice such a small price increase in the actual energy products they purchase. This very low average carbon price is certainly not high enough to get many people or businesses to significantly reduce their carbon emissions, or even to react at all. Thus, the world has insufficient relevant experience with carbon taxes to know what their impact on carbon emissions would likely be, in spite of a couple of studies that claim to be able to measure some effect, however small.[ii]
One major practical problem with the concept of a uniform global carbon tax is that the same tax level (e.g. $100 per ton of CO2) would have a very different macroeconomic impact in a rich country versus a poor country. In a rich country, a ton of CO2 emissions might cost only two hours of a worker’s wage, whereas in a poor country this could easily represent two weeks' wages or more. Thus, the incentive to use less fossil fuels would be far stronger in poor countries, so much so that even a moderate carbon tax such as $100 per ton might cause major disruptions to their economies and family livelihoods even though the per capita consumption of fossil fuels in poor countries is much lower than in rich countries. Thus, in poor countries, not much carbon emissions could be reduced per person in spite of the stronger financial incentive to do so. One issue, then, that must be discussed when discussing the possible merits of carbon taxes, is to what extent can poor countries seriously consider implementing a carbon tax anywhere near the higher level of a carbon tax that might be established in rich countries. And if doing this would be impossible, would this allow global corporations to escape paying much of a carbon tax by moving production from rich to poor countries, even more than they have done already, among other unintended consequences?
Of course, the High-Level Commission noted that a carbon tax is only part of the policy solution for sufficiently mitigating climate change and that such a tax would likely need to be implemented in conjunction with other mitigation policies in order to reduce carbon emissions to near zero. It is also well known that most people and businesses do not react to prices and price changes in fossil fuels in a simple, rational way, i.e. to invest in energy-consuming equipment that will most likely minimize the present value of their total costs over the lifetime of the equipment. They usually have many other priorities other than present value cost minimization, and most consumers do not even know what this means. This fact about human beings tends to undermine the likely effectiveness of carbon taxes in the future relative to what economists typically predict.
In addition, when fossil fuel prices rise for any reason, most individual consumers of fuels and businesses first simply use a little less of the fuel when they can after the price rise begins to bother them, such as by driving their cars a little less, or by turning down their heating thermostats a degree or two. It takes a fairly big rise in fuel prices, which seems fairly permanent, to convince consumers to purchase more energy-efficient equipment, or to switch fuels to a cheaper one, which also typically requires a capital investment. Thus, in theory, what we might call the short-run price elasticity corresponding to just using a little less fuel, as we have observed periodically in the past, is just the first stage in modeling increasing carbon price impacts. Economists often do not explicitly distinguish this first phase of a response from the second stage response, which is when significant investment occurs to make the energy-consuming equipment more efficient or able to burn lower cost fuels. Because econometric analysis of the impacts of fossil fuel increases in the past can not distinguish between these two phases of individual and business responses, they cannot determine an aggregate price elasticity for each particular type of energy-consuming equipment in different sectors of the economy that might occur over a period of many years following an increase in fossil fuel prices.
In addition, this High-Level Commission, and most other analysts, neglect to discuss specifically which other mitigation policies should be implemented to complement carbon taxes, and by when, so that total carbon emissions could plausibly be reduced to zero in a reasonable time frame. Thus, there is often little discussion in academic economics articles on carbon taxes of such alternative policies such as resource portfolio standards (RPSs) for electricity supplies, much stronger CAFÉ efficiency standards for vehicles, requirements to phase-in an increasing fraction of new vehicles as electric vehicles, requiring all new buildings to be electrically heated (or net-zero carbon), or for industry to be required to ratchet down their carbon emissions over time per dollar of value added or per some other unit of output. Because of this major omission, most academic papers discussing the pros and cons of carbon taxes do not carefully analyze the extent to which these other policy options should complement carbon taxes in each major sector of the economy, by when, and what would their impact be on carbon emissions if carbon taxes were not also included in the policy mix. In particular, what is usually never discussed is to what degree monetary or other incentives would be required to implement these other policies to complement carbon price levels, and how should they be phased into practice in various sectors of the economy and regions throughout the world over the next ten years, or more.
The first analytical question that I will attempt to answer in this paper is, what impact would a $50-100 per ton carbon tax over the period 2020-2050 likely have on the world’s energy system by itself, without considering supplementary policies? How close would such a tax, by itself, get us to zero carbon emissions in each major sector of the economy by, for example, 2050? However, as we will see, answering this question will not prove to be very useful since without complementary mitigation policies, total carbon emissions would probably be affected quite little by a carbon tax under $100 per ton alone, perhaps reducing total emissions averaged over all sectors of the economy by only 10%, or so, by 2050, or substantially less than 1% per year. In contrast, if a region like California wants to reduce its carbon emissions to zero by 2045, as the state has recently committed to doing, it will need to reduce its carbon emissions by about 4 percentage points per year, on a linear basis, over the next 25 years. What does California need to do, then, to get the other approximately 90 percentage points of reductions in carbon emissions that carbon taxes alone will not likely achieve, if I am right?[1]
In fact, if I am right, then it must be the case that the complementary policies need to be structured so that in the worst case, if carbon taxes are not very effective at all, carbon emissions could still be reduced to zero in each sector of the economy even without carbon taxes. Thus, it seems that a better approach to analyzing the likely usefulness of carbon taxes is to describe to what extent carbon taxes might make it easier to achieve zero carbon emissions once the other relevant and desirable mitigation policies have been implemented, and not the other way around. But to take this approach, we need to turn our attention to the various major sectors of the economy that use energy, which means buildings, industry, agriculture, and transportation. This is because it is likely that each of these demand sectors requires very different complementary mitigation policies to be implemented whether or not a carbon tax is also implemented.
The Building Sector
Obviously, at the present time, almost all the buildings in the world use a lot of fossil fuels either directly, or indirectly via their electricity consumption. Natural gas, biomass, and heating oil are the primary fuels used directly. Causing the building sector’s energy consumption we find primarily the need for heating, cooling, hot water, cooking, and electricity for appliances. Of course, some of the energy for heating, cooling, cooking, and hot water is also currently supplied by electricity, but relatively little is, except for cooling. Most of the heating, cooking, and hot water is currently supplied by burning either natural gas, biomass, or oil on the premises of the buildings. Thus, to get to zero carbon emissions, we cannot just make building shells more energy efficient via the use of better insulating materials and multi-pane windows, although this is very important to do for older buildings. We also must phase out all natural gas, biomass, and oil-burning heating equipment and replace it with technologies run on renewable (zero carbon) electricity. This new equipment would mostly be heat pumps of various sorts, which take heat from the outdoor air, or for a limited number of buildings, from the ground (geothermal energy). Most heat pumps have the added benefit of also being able to be used for air-conditioning in the summer, thus reducing their effective capital cost for heating only. Of course, much of the renewable energy needed could be provided from onsite solar energy technologies, either roof-top solar hot water or photovoltaic cells, and not only from the electricity grid.
Prior to making major changes in building technology for enhanced efficiency and to run energy end-uses off of electricity, we can ask what impact a carbon tax in the range of $50-100 per ton of CO2 might have had independently of any other regulations and laws that would require such changes. Since such carbon taxes in this range would increase the variable cost of heating a building and providing hot water by only about 30-60%, without including equipment costs, they are not likely to have much impact in either causing building owners to enhance the energy efficiency of their building shells or in causing them to buy electricity-based heating and cooling technologies to replace their current gas-fired equipment prior to the end of its functional life. This is particularly true for the owners of residential real estate, who are not typically very reactive to these levels of price changes, especially when rental real estate is concerned. In fact, increases (and decreases) in heating fuel costs in the range of 30-60% have occurred over the last few decades as the market prices for natural gas and oil fluctuate from month to month, and year to year, without leading to long-term investments in increased energy efficiency.
Yet, even when fuel prices have gone up in the past, we have seen very little activity on the part of building owners to better insulate their buildings, and even less of a move towards purchasing electricity-driven heat pumps for heating, given the significant capital costs of doing so and the higher variable costs of electricity when compared to oil and natural gas. (Note that air conditioning has always been electricity-driven because it always depends on heat pumps.) One reason for such inaction is that most older people have typically experienced fuel prices going back down fairly soon after they have gone up (in inflation-corrected dollars), therefore they do not believe that most energy price increase will persist in the long run.
The other major component of building energy consumption is the use of electricity for a wide range of appliances, as noted above, in addition to its use for cooling. It is important to note that the major trend in electricity consumption for each individual appliance has been downwards over the last few decades, primarily due to appliance efficiency standards established by many governments in developed countries. But the number and size of many appliances have also increased rapidly, so much of the benefit of more efficient appliances such as refrigerators has been canceled out by bigger TVs and more computers, for example. However, overall, light bulbs have become much more efficient over the last few decades and will continue to do so, as new technologies such as LEDs come into the market to replace all kinds of light bulbs. But whatever efficiency electrically driven appliances operate at, they can all easily become “carbon-free” if the electricity supplied to them becomes all renewable.
Thus, the key issue for appliance-related carbon emissions is to get the electricity supplying them to be 100% renewable. This can usually be achieved much more readily by government regulation than by market forces or carbon taxes, i.e. by governments requiring the electricity supply to become more and more renewables-based each year. The approach often used is the implementation of resource portfolio standards (RPSs) which mandate that the percentage of the electricity supply being renewables should increase at a designated percentage each year, such as 4 percentage points per year which would achieve 100% renewables by 2045. Many states in the US have adopted RPSs, though currently they increase the percentage of renewables too slowly to mitigate climate change quickly enough.
Once a resource portfolio standard, or a feed-in tariff that subsidizes renewable electricity, is established, as in Germany, what incremental impact would a carbon tax in the $50-100 per ton range likely have? Again, the impact is likely to be very small, since the change it would cause to electricity bills would be very small given that much of the price of electricity is the recovery by utilities of fixed investment costs and not fuel costs, even when that electricity is produced by burning fossil fuels. In fact, it is usually the case that less than half of the cost of electricity produced by fossil fuel plants is the fossil fuel costs themselves. Furthermore, as the percentage of electricity coming from renewables increases over time due to other mitigation policies, the percentage impact of an increase in the price of electricity due to a carbon tax will decrease, since less and less fossil fuel on a percentage basis will be burned to generate that electricity. Thus, a carbon tax of any given dollar level will have a steadily decreasing impact on electricity consumers in all sectors of the economy, as the renewable component of electricity approaches 100%. And since the main thrust of mitigating climate change is to convert all end-uses of fossil fuels to electricity, the overall impact of a carbon tax on the entire economy will rapidly diminish over time.
At best, then, a carbon tax would have diminishing returns for all electricity consumers and diminishing impacts on the use and type of electricity consuming equipment over time unless the level of the tax is continuously increased far above $100 per ton of CO2, perhaps necessitating taxes in the $1000 per ton range for fossil fuels burned to produce the last amounts of non-renewable electricity in order to have any effect at all. This obvious fact of diminishing returns seems to be neglected in most if not all discussions of the desirability of implementing carbon taxes. Analysts seem to forget that in the long run, almost all energy consumption will have to come from 100% renewable electricity in order to get to zero carbon emissions. This implies that the major effect that relatively low carbon taxes, such as those in the $50-100 per ton range, are likely to have, will come only in the short to medium term if there is any effect at all. Carbon taxes will, then, not likely be very useful to drive the percentage of renewable electricity anywhere close to 100%. Again, complementary laws and regulations will be essential to accomplish that goal. This makes it clear why any real-world price elasticity that accurately quantifies the impact of carbon taxes on total energy use will rapidly decrease over time. In fact, since some countries are planning to convert most of their electricity supply to all renewables by as early as 2035, since this sector is the easiest to de-carbonize, price elasticities for electricity may hit zero soon after many economists want carbon taxes to only hit $100 per ton.
The Transportation Sector
As is the case for the buildings sector, eventually all fossil-fuel vehicles, trains, ships, and airplanes will also have to be replaced by vehicles that consume, in most cases, renewable electricity. For ships and airplanes, at least, synthetic liquid fuels made from sustainable biomass and renewable electricity will probably be necessary. Some vehicles or ships might also burn hydrogen in fuel cells, when that is convenient, but that hydrogen would also have to made from renewable electricity by electrolysis. All cars, buses, and most trucks and trains will likely consume electricity directly. Obviously, trains and buses are the easiest and cheapest to electrify since overhead power lines can often be easily installed as has been done in the past so that they do not need to depend on more expensive battery technologies.
Again, this implies that in the long run, a carbon tax will have to be increased well above $100 ton of CO2 in order to have any significant effect at all on the declining fossil fuel consumption in the transportation sector. This is because while in the short run a carbon tax might cause drivers of gasoline and diesel-fueled vehicles to drive slightly less, but since a $100 per ton carbon tax translates into only about a $1.00 increase per gallon of gasoline, such increases have happened many times in the past with very limited reductions in the miles driven by vehicles, and very limited changes in the types of vehicles purchased. These small changes are due, in part, to the fact that many people need to drive their vehicles to work or for other purposes no matter what the price of gasoline or diesel fuel is. And buying a more efficient vehicle is typically very expensive relative to the value of the saved fossil fuels unless the vehicle is driven many miles per year. Furthermore, the range of available efficiency improvements for similar vehicles has often been small in the past. While more high-efficiency fossil-fueled vehicles such as hybrids and electric vehicles are rapidly becoming available, once someone buys such a more energy-efficient vehicle, the incremental incentive of carbon taxes to get an even higher efficient vehicle is greatly reduced.
Of course, the higher renewable electricity prices might cause electric vehicles to become slightly more energy-efficient, but electric vehicles are inherently much more efficient than fossil-fueled vehicles to begin with, and there is a strict limit on how much more efficient they can become for any given weight and size of any vehicle. The efficiency of the batteries in electric vehicles is also important, and it should be assumed that battery efficiency will increase but very slowly, given how much research has already gone into improving this technology. All these factors imply that carbon taxes under $100 per ton will have little impact on the transportation sector in the future as the total consumption of fossil fuels in this sector declines, especially in rich countries. In poor countries, again, the consumption of fossil fuels per capita is already far lower than in rich countries, and the vehicles are already far more energy-efficient, so there is also low potential there for significant impacts of carbon taxes on fuel consumption.
Again, regarding trains, both for freight and passengers, it is very easy to convert all trains to electricity, and many already run on electricity. All railroads have to do to make this conversion is to string all of their rail lines with electric wires, which is relatively cheap, and which will not likely be significantly influenced or accelerated by the implementation of a carbon tax, unless it is far above $100 per ton. Then they have to buy electric locomotives as the older diesel ones retire. The rate of continued electrification of all rail lines is likely to be more dependent on the price of electricity that the railroads must pay when compared to diesel fuels, than any small increase in electricity and diesel prices that result if a carbon tax was charged to both electric utilities and diesel refineries.
With regard to the potential use of advanced liquid biofuels for long-distance trucks and airplanes, as advertised recently by Exxon Mobil and other oil companies, there are several key issues to consider. The first is that no matter how efficient new processes are for converting biomass to synthetic biofuels, this must be done without the use of any fossil fuels as input to these processes. This implies that renewable biomass and renewable electricity must provide all the energy inputs required by such processes. This fact is often not discussed in the context of the future production of synthetic biofuels, including hydrogen. This implies that synthetic liquid biofuels will continue to be so much more expensive than liquid fossil fuels are today that relatively low carbon taxes applied to fossil fuels will not be sufficient to induce a change to consuming more synthetic biofuels. Strict regulations requiring such a transition will probably be necessary.
Secondly, many analysts have raised justifiable doubts as to how much tonnage of sustainable biofuels can be produced on an annual basis, given the need to preserve most of the earth’s land area for agricultural use, and for forests and other ecosystems to sustain the earth’s atmosphere and water. Of course, forests are also needed to produce wood and paper products, many of which are better for the environment than the products made from plastics or metals today. Thus, we may need to use more wood and other biomass per capita in the future for these kinds of products, rather than less. This may include the greater use of wood to replace concrete and steel beams for new buildings, except for very tall buildings, and to replace pedestrian walkways.
Similarly, as sanitary standards in developing nations improve, more biomass may even be needed for products like toilet paper and cleaning products. It is probably best, then, to assume that biomass use should be reserved for only the highest value-added products, implying that alternatives to biofuels such as renewable electricity and its possible energy derivatives such as hydrogen should be used whenever possible. Obviously, to the extent that airplane travel is still allowed and affordable, synthetic kerosene for aircraft may become one of the best uses of synthetic biofuels given the lack of technological alternatives. One key question usually not discussed is whether or not the combustion of synthetic biofuels should be subject to carbon taxes, at least in the long run, if questions arise about their sustainability given society’s other needs for biomass. In addition, we must remember that the combustion of biomass in any form creates immediate carbon emissions, whereas the process of new biomass growth reabsorbing the carbon back from the atmosphere takes time, at least a year for crop biomass, and many decades for forests.
The Industrial Sector
The major costs to industry of mitigating climate change will be the costs to convert all of their fossil fuel using equipment to electricity or synthetic renewable fuels, including hydrogen, and the incremental cost of these zero-carbon energy sources themselves, since they are generally more expensive per unit of energy than energy from fossil fuels. (Fortunately, this is starting to change in many parts of the world for new renewable electricity technologies.) This implies that yet again a small carbon tax of $100 or under will have little or no influence in getting industry to also convert to the use of 100% renewable energy resources, especially electricity, as it will be required to do to allow society as a whole to get to zero carbon emissions. While the easiest renewable energy resource to convert to will be electricity, some industrial processes may not be amenable to being converted to electricity use, in which case gaseous or liquid energy forms such as hydrogen or synthetic biofuels, would be needed to eliminate CO2 emissions, if they are produced by 100% renewable electricity.
Of course, one implication of a transition to 100% zero-carbon energy is that the need for oil and gas refineries, pipelines, and pumping stations will decline rapidly, implying that certain industries may almost completely disappear. The same might be true of much for the plastics industry, if the world returns to the use of biomass for many final products, as it survived doing for thousands of years, including as recently as the 1950s when the manufacture of plastics first began to skyrocket. Plastics may also begin to disappear since they often create very nasty types of pollution and have very limited recycling potential, contrary to common belief. Other types of industries that will begin to disappear will include gasoline stations, natural gas utilities, the manufacture of fossil-fueled power plants, and other industries that use and make very energy-intensive products. On the other hand, some new industries will spring to greater life such as the commercial-sized battery industry, which will require intensive and thorough recycling of its input materials to become sustainable, if it can be made sustainable.
A Global Carbon Tax?
While a carbon tax in the $50-100 per ton range in a rich country might have little effect on the economy, and on the mix of energy products purchased, it might have disastrous consequences for poor countries, as noted above. Thus, it seems obvious that any proposal for a global carbon tax would have to specify carbon prices that scale, to some extent, with the average per capita income of each country.
The best thing about implementing a carbon tax, even if it is fairly small such as $100 per ton, is that governments will acquire a very large but declining revenue stream that can be used to subsidize further climate change mitigation. For example, even at the very low carbon tax of $50 per ton, the US government will receive a revenue stream of about $50 (per ton of CO2) x 330,000,000 (people) x 20 (tons of CO2 emissions per capita), or about $330 billion per year to spend on mitigation, before the revenues start to decline as carbon emissions decline. While this will not be nearly enough money to completely fund the incremental capital costs of climate change mitigation and adaptation, it will go a long way towards reimbursing and subsidizing its citizens who do not have the financial resources to take adequate mitigation actions themselves, such as buying electric vehicles and converting their homes and apartments to electric space heat, which, again, would have to be supplied by somewhat more expensive renewable electricity. Note that one reason why the retail price of renewable electricity is likely to rise to levels higher than the current mix of sources of electricity is that there will be substantial investments needed to expand the electricity distribution and transmission grid to accommodate the much higher new demand, even if the unit price of new electric generation does not change.
One question which has also received a fair amount of attention in debates about carbon pricing is whether or not some or all of the revenues collected by governments from taxing carbon emissions should go directly back to consumers in some way, in addition to subsidizing climate change mitigation costs. In general, the direct refund of carbon tax money to consumers or taxpayers seems like a very bad idea, since such refunds would tend to substantially undermine the goal of such taxes, which is for people to consume fewer fossil fuels. One argument in favor of refunding such carbon taxes is, of course, that doing so would enhance the political feasibility of getting such a carbon tax program established in the first place. But the main problem with this argument is that no one has yet demonstrated that if carbon taxpayers get these refunds that they will still buy significantly less or any less carbon, in comparison to the level of reductions in carbon emissions that would follow from investing most of the carbon tax revenues in technologies which mitigate climate change. Again, many groups of voters in many rich countries are incredibly sensitive to raising certain types of fuel such as gasoline prices via carbon taxes, which are posted daily on every gasoline station and thus highly visible. In contrast, rising electricity prices are much more likely not to be noticed by the public who rarely read the prices in their monthly electricity bills.
Either way, it is my “educated guess” that carbon taxes at the $100 per ton of CO2 or lower level will only likely cause CO2 emissions to drop by about 10% when averaged over all end-use sectors of the economy in countries where there is only limited use of coal today, and even that will likely take many years to occur. Thus, the first priority for governments to accomplish the other 90% or so of CO2 emissions reductions needed is to develop a comprehensive set of regulatory and legal mandates that cover the need for changes in energy-consuming technologies in all sectors of the economy, and a timetable for their implementation.
Conclusions and Implications
So how should a carbon tax be structured so that it might have a significant positive effect in driving the economy to completely eliminate the consumption of fossil fuels by 2050, or sooner? Could this happen only if other powerful policies are adopted very soon to require the reduction of carbon emissions in each sector of the economy? It is easy, but glib, to think that any increase in the price of fossil fuels, such as an increase caused by a relatively low carbon tax of $100 per ton of CO2, would cause some people and businesses to use less fossil fuel. However, this simple economic hypothesis does not take into account how people and businesses react to the actual complex mix of energy end-use technologies that exist in a modern economy, and the fact that many other policies will need to do the major part of the work to drive all fossil-fuel consumption to 100% zero-carbon energy, especially renewable electricity.[iii] And, of course, the faster that society decides to achieve zero carbon emissions, the less likely it is that society will be able to depend on a carbon tax playing any significant role at all in achieving this goal, given the inherent diminishing effect that carbon taxes can play as carbon emissions fall.
Thus, while there may be some political reasons, especially those involving social justice impacts, for opposing high carbon taxes, a carbon tax in the $50-100 range as recommended by the High-Level Commission on Carbon Prices seems likely to be fairly innocuous, but also fairly ineffective. However, given social justice concerns a carbon tax in the range of $50-100 per ton of CO2 would only be reasonable to implement in rich countries, with some compensation required for the poor even in such countries. In poor countries, a carbon tax at that level would be far too disruptive to the economy compared to simply regulating the carbon emissions from each energy end-use or supply technology. Yet, such a low carbon tax in rich countries might at least provide some psychological context to motivate other much stronger mitigation policies such as phasing out/banning gasoline cars, but it will probably not do much more than that. Thus, I am all for rapidly phasing in a low carbon tax at the $50 to $100 per ton level for CO2 in rich countries in order to raise awareness of the broader need to invest large sums of money to mitigate climate change.
Of course, the impact of a much higher carbon tax in the $500 per ton of CO2 range would have a much more dramatic impact on the economies and energy technology mixes of rich countries, probably far too dramatic for a capitalist market global economy to cope with, but that is altogether another story. Yet, such potentially disruptive economic impacts of very high carbon taxes are almost certainly not properly modeled in the IAMs used in IPCC and related studies over the long run, since those models seem to be incapable of producing financial crises and economic disruption generally. Finally, we must remember that even with a reasonably slow phase-in rate to a high carbon tax in rich countries so that the economy could cope without crisis, as typically modeled by IAMs, even a high carbon tax will still have rapidly diminishing returns in reducing carbon emissions as the supply of electricity approaches 100% renewables, with little to no carbon left to be taxed.
Notes:
[1] Of course, taxes on CO2 emissions at a level well above $100 per ton would likely yield greater reductions than 10%, but that is another important but very different possible scenario, with serious likely disruptions to many economies.
[i] Stiglitz, J. and Stern, N. (Co-Chairs), Report of the High-Level Commission on Carbon Prices, World Bank, Washington, D.C., 2017.
[ii] Rafaty, R., Dolphin, G., and Pretis, F., Carbon Pricing and the Elasticity of CO2 Emissions, Institute for New Economic Thinking Working Paper No. 140; https://www.ineteconomics.org/research/research-papers/carbon-pricing-and-the-elasticity-of-co2-emissions; Taylor, L., Carbon Pricing Isn’t Effective at Reducing CO2 Emissions, Institute for New Economic Thinking, May 10, 2021, https://www.ineteconomics.org/perspectives/blog/carbon-pricing-isnt-effective-at-reducing-co2-emissions.
[iii] Even the High-Level Commission on Carbon Pricing Report stated that “Carbon pricing by itself may not be sufficient to induce change at the pace and on the scale required for the Paris target to be met and may need to be complemented by other well-designed policies tackling various market and government failures, as well as other imperfections.”
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Thursday, June 24, 2021
FEDS 2021-039: Lending Standards and Borrowing Premia in Unsecured Credit Markets
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FEDS 2021-038: Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID-19 Crisis
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Wednesday, June 23, 2021
China and the Supply Chain: A Comment on the June 2021 White House Review
In January 2013, the Obama White House released a White Paper on “National Strategy for Global Supply Chain Security: Implementation Update.” It was a short document, only 22 pages, almost wholly focused on the security of transport – of ships, air freight, the mails – against terrorism and other threats. What traveled through the supply chain, and from where, does not appear to have been a major concern.
In June 2021, the Biden White House published a “100-day review” entitled “Building Resilient Supply Chains, Revitalizing American Manufacturing and Fostering Broad-based Growth.” It is focused on a very different concept of what the “supply chain” is; the term now encompasses the entire spectrum of upstream production. The Biden review takes these up in four areas: semiconductors, high-capacity batteries, critical minerals, and pharmaceuticals.
One might ask, why these four areas and not others? There is no clear answer, and it may be that choice was mainly bureaucratic. The review was compiled from separate reports by four cabinet departments: Commerce, Energy, Defense, and Health and Human Services. Had the Department of Agriculture been asked, or the Department of Transportation, one might have gotten different choices. Petroleum comes to mind. Or natural rubber – the linchpin of World War II in the Pacific.
If there is an Ariadne's thread to these four areas, it is the trading and competitive relationship with China. The reports do not focus solely on China and give what is largely a fair-minded and wide-ranging assessment of vulnerabilities in each sector. For the reader not previously immersed in the structures of semiconductor production or the technology of electrical storage, this document, at 250 pages, is a mine of information. But China lurks in each section, sometimes looming large, in other places only in the background.
The global semiconductor industry is here described in fascinating detail. It is a paragon of extreme specialization, relentless technological improvement, economies of scale, and global division of labor. US firms dominate in semiconductor design and integrated production; Japan produces the wafers; Taiwan and (to a much smaller degree) South Korea do high-end fabrication in “contract foundries,” while China handles a substantial share of low-end chips and of “packaging” – a term that covers the placing of chips into circuit boards including, of course, the assembly of smartphones. American-based production is only 12 percent of the world's capacity, roughly a third of what it was in the 1990s.
To characterize broadly, the semiconductor supply chain is a network of unique nodes, in which a given firm has one upstream supplier for many major components and perhaps just one downstream customer, creating a web of bilateral monopolies operating in extreme interdependence. Thus a breakdown anywhere along the line can disrupt the entire system. This is, by the way, very much the classic problem of Soviet-style industrial structure, designed to maximize efficiency at each node (in the Soviet case, a matter of scale), but fragile as events in the early 1990s showed.
The review calls attention to several specific events that have led to recent and ongoing shortages in semiconductor supply. These include a fire in March at a facility in Japan and the freeze in February in Texas which took a trio of Austin facilities off-line for up to a month. But the most important was not itself a natural event but rather the reaction to one. As Covid-19 took hold, key figures in the industry shifted capacity to household applications. They failed to anticipate how quickly demand for vehicles would recover as the pandemic waned.
The problem is that chip production takes a lot of time; it is characterized to an extreme degree by what economists of the Austrian school call “roundaboutness.” The multiple steps (etching, doping, and so forth) are repeated “hundreds of times”; producing a single chip “can take up to 26 weeks.” So once locked into a program, the industry has the margin of maneuver, roughly, of the Ever Given in the Suez Canal. Meanwhile, the automakers who have designed a hundred or more distinct chips into their new cars must sit and wait. This accounts, no doubt, in part for the surging prices of used vehicles and the current scarcity of rental cars.
What then is the “China threat” to the semiconductor supply chain? The most important one is stated very plainly. China is the world's largest semiconductor market, both for home use and for incorporation into products sold elsewhere. The single biggest risk from China is not some nefarious disruption of components or materials. It is rather, a possible fall in the final demand. The review is clear and unambiguous on this point:
“US semiconductor companies... thus have the potential to be significantly impacted by trade restrictions between the United States and China, with major potions of their revenue at risk of long-term disruption. Based on the Chinese government's ambitions in regard to the semiconductor industry, these revenue sources may be at risk regardless, but given that their ability to reinvest is immediately dependent on sales to China, their long-term viability is immediately affected by actions that decrease sales.” (p. 57.)
The review goes on to note that since much of the industry operates on the two banks of the Taiwan Strait, “Even a minor conflict or embargo could have immediate major disruptions to the United States and long-term implications for US supply chain resilience” (p. 57). In a White House document, at this moment of heated China-bashing, this is a welcome realism.
With large-capacity batteries, the principal supply-chain issue is not so much a science-driven matter of design and engineering as it is access to key materials, most notably nickel, graphite, cobalt, and lithium. With these materials, it appears reserves are not particularly scarce, although in the case of cobalt they are concentrated in the Democratic Republic of Congo, where mining conditions are tactfully described as being “outside of international practice.” The review notes that China's advantage in materials supply results, mainly, from having invested in finding reserves on its own territory.
But, it turns out, industrial dominance in this area does not rest on the supply side. It lies rather in the development of the industry itself, driven by demand for electrical storage, which is overwhelmingly in the automotive sector. China is the low-cost producer because it is the world's largest user, consuming 40 percent of global large-capacity battery output. Europe accounts for another 40 percent, and the United States for just 13 percent. Consider this: there are 425,000 electrically-powered buses in the world today. Of these, 300 are in the United States; 421,000 are in China. Perhaps oddly for a report on the supply chain, but not unreasonably under the circumstances, the recommendations in this section are relentless: the United States should work to bolster demand.
In the report on critical materials, prepared by the Pentagon, thirty-eight minerals are listed for which US direct import dependence is above 75 percent. Of these, China is a top supplier in eighteen cases. And why is that? Largely, as the report states, because the growth in China's own demand for these materials has made it profitable for China to invest in the supply chain, hence to become the high-volume, low-cost producer, to whom the world turns.
The Defense Department is naturally concerned with the possible consequences of conflict, and so with the possibility that access to materials might be lost, especially where there is only one source of supply. This is particularly true in the case of “rare earths” – a grab-bag of exotic minerals – where China had 85 percent of the global market as of 2014 – even though the entire Chinese workforce in the mining of rare earths consists of only 4,000 souls, with an additional 40,000 in smelting. Perhaps understandably, not even the Pentagon has a good answer to this problem, apart from conservation, recycling, stockpiling, and being prepared to divert from routine to essential uses in an emergency. The review laments the decline of mining expertise emerging from US university systems, where educational programs have folded as mines have disappeared. But it is hard to see why students would pursue degrees, or universities provide them, in fields for which jobs no longer exist.
With pharmaceuticals, the problem is not of scarcity but of basic economics. The supply chain moved to India because costs are low as befits the low-price, low-margin, high-volume business of generic drug manufacture. Supply chain resilience would thus be a matter of maintaining a “virtual” stockpile, consisting of manufacturing equipment and precursor chemicals, to be held in reserve in case of emergencies. It is important to note that to be useful, the reserve capacity would have to be kept idle – otherwise it adds no layer of safety in the event of a disruption. The review is realistic about the prospects for this: the scale and complexity of the sector, together with the unpredictability of future biological threats, makes it impractical to maintain large reserves in all areas. In an open global market economy, drugs will be bought from where they are cheapest to produce.
In each area, the Review is critical of Chinese practices, which are said to consist of large-scale, “top-down,” “market-distorting,” public investments, subsidies to Chinese companies, state-sponsored industrial rationalization, and in the case of electric vehicles, large subsidies to consumers to spur demand. Thus we read: “The Chinese Government has focused on capturing discrete strategic and critical material markets as a matter of state policy.” (p. 174). Examples given are that in 2002 China “prohibited foreign investors from establishing rare earth mining enterprises in China” and in 2014 consolidated the business in the hands of a “handful of national champions.” Also, back in 1985, China had established a VAT rebate for rare-earth exports, “which contributed to the erosion and the elimination of US production in the global market.”
In this and other instances throughout the Review, the deplorable practices of state planning and national development strategies undertaken by China are, within a few pages, pretty much exactly what the authors recommend for the United States. (The DoD recommendations on critical materials are an exception here, addressing among other things recycling, human rights issues, and environmental concerns, even though these are perhaps somewhat tangential to supply-chain issues per se.) Thus on lithium-ion batteries, we read: “As part of the American Jobs Plan, President Joe Biden has called for transformative investments to spur this demand, including $100 billion in incentives to encourage US consumers to transition to EVs” (p. 134). Similarly on semiconductors: “Consistent with the American Jobs Plan proposals, federal incentives to build or expand semiconductor facilities are necessary to counter the significant subsidies provided by foreign allies and competitors.” (p. 76). How an “incentive” differs from the Chinese practice of “subsidies” is not clearly explained. Nor does the review admit that export rebates on VAT are standard practice everywhere.
Still, from a broad reading and fair appraisal of this genuinely excellent document, two major conclusions may be drawn. The first is that the Chinese advantage – which is by no means absolute in all areas – stems from a pragmatic program of economic development, including infrastructure and human resources, in a vast country able to take advantage of a scale of production and internal market impossible anywhere else. This leads to lower costs across a wide range of industrial and engineering capacities, bolstered by being embedded (as the Review does not point out) in a system oriented toward social stability and steady growth rather than short-term profitability and financial contracts. The Chinese edge – similar to India's in pharmaceuticals but much more broadly based – is the product of the success of China's development approach, especially in the post-Mao era, but with roots that go back to the 1949 revolution, to the creation of the People's Republic and to the restoration of a unitary Chinese state with full control over the nation's land and resources. This is a fact of life and not an artifact of ruses or dirty dealing.
The second key conclusion is that in critical sectors, in the world we inhabit and from which we cannot escape, US-China interdependence is indefeasible. Rare earths are a minor example, barring new discoveries in other places. Semiconductors are a major one: without the Chinese market, the American firms that presently dominate the high-end design processes would collapse. Bringing manufacturing back to the US, we learn, would come primarily at the expense of allies, including Japan and South Korea as well as, especially, Taiwan. It is hard to see why even the most aggressive China hawk would favor stripping Taiwan of its chip foundries – but even doing that would hardly lessen the dependence of the semiconductor ecosystem on the Chinese market.
So we come to a truly remarkable third conclusion, no less powerful for having been left unstated. It builds on the fact that the integration of the global economy cannot be undone. The division of labor – hence productivity, living standards, and the advance of technologies – is limited by the extent of the market, as Adam Smith wrote in The Wealth of Nations back in 1776. China is a now-developed country with about twenty percent of the human population; its advantages are stability and scale, almost exactly as was true in the 18th century. These advantages cannot now be taken away without destroying the world as it is.
To be sure, the Chinese still, in many important advanced areas, draw from and depend on the United States. Certainly, the US can slow the inroads of Chinese firms in some cases, and certainly the US can foster, as this report recommends, its own advantages in new sectors by maintaining and expanding its research and development base. Certainly, there are many things to be done in the United States to meet urgent environmental, public health, and critical social goals.
But the US position, as an economy with only one-fourth the population, equally now depends on the Chinese market, and on downstream Chinese firms supplying applications to the world. While precautions against natural disasters and pandemics can be taken – up to a point – the central unstated message of this 100-day Review is that the greatest risk to the supply chain, in each of the four areas, is disruption of normal trade relations with China. In short, as an objective economic matter, we learn here, the United States has an overwhelming interest in peace.
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FEDS 2021-037: Open Source Cross-Sectional Asset Pricing
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Tuesday, June 22, 2021
Kandeh Yumkella: COVID-19 Has Helped People Understand the Vital Connection Between Energy and Health.
As you are the member of Parliament for Kambia in the northwest of Sierra Leone, tell us how this part of the country has been hit by the COVID pandemic and how it has managed to cope over the last 12 months.
When COVID started we were really scared in the northwest, in Kambia and its region. The fact is that our neighbour, Guinea, and its capital Conakry had large COVID numbers even before we had the first case in Sierra Leone. We were concerned for two reasons. Kambia is one of the closest points to Guinea and is only 2-3 hours from Conakry. It’s the main crossing point between Sierra Leone and Guinea. So, our proximity to Guinea scared the hell out of us. Second, we remembered our bad Ebola experience which we inherited from Guinea, which made us panic further.
As Member of Parliament for the Kambia region, I and my MP colleagues started quickly with a programme of sensitization, even before the first case was logged in Sierra Leone. My constituency, in particular, is very porous. We have over 40 crossing points into Guinea and a lot of them are no more than bush paths. We had to set up youth groups to help control the crossing points and, despite the worry, we did not actually get large numbers of infections. Somehow those initial measures counted, helped by the fact that Sierra Leone closed the borders.
To deal with the large number of illegal crossing points, we mobilised quickly the military and police, and organised trips with them to go to the different crossing points. I sensitised villages and chiefs along the length of the border, so they became aware of the problem. And the military on both sides were very vigilant. In spite of those scares, our numbers stayed relatively low, and they remain low. We don’t know how to explain this - perhaps that early sensitization work, the handwashing, plus the social distancing. The Ebola experience probably made people a little bit more compliant with instructions and regulations from government. Kambia had a curfew imposed long before any other place in the country, from 6pm in the evening till 7am in the morning. This stayed in place for quite a long time, so much so that some of my constituents were complaining and asking for it to be lifted. But we didn’t allow it because we were watching the numbers in Conakry, which were really high in comparison with Sierra Leone.
On the health front we have fared relatively well so far, but the economic impacts have been more serious because of the lockdown. Farming was affected and we will have to wait to see the survey numbers to see how badly farming has been hit. There is no doubt the lockdown brought hard times. We have the largest international market in the country in Kambia, which attracts traders from Guinea, Senegal, Mali, Burkina Faso, and Liberia. This market which they call Barmoi Luma. Luma means “community market” in my home language. On a good day we estimate more than 20,000 people come and mingle. There are huge trucks from Mali and Senegal buying our produce. People still do barter trade of commodities. Shutting the border and restrictions on movement badly affected people there in terms of jobs and incomes.
It is mainly an agricultural area growing rice and because there is a very long coastline, there is a lot of fishing too. My constituency has 67,000 people and Kambia District as a whole 350,000 residents. While we rely a lot on fish for food and proteins, there are also groundnuts, maize, cashew, cassava - the second main staple - and palm oil. Vegetables matter too, and we grow a lot of peppers and aubergine. These vegetables find their way to Conakry, which some people estimate may have as many as 3.5 or 4 million people, so it’s a really big market, almost 50% of Sierra Leone’s total population and we’re close by. As a result, a lot of what we grow, most of all our rice, fish and palm oil goes to Conakry.
What is the situation in Sierra Leone with vaccine availability? And are people willing to be vaccinated or it there a lot of hesitancy?
There is both hesitancy and denial as regards COVID and the vaccine, because our numbers are so low. A recent US travel advisory note put us amongst the four lowest worldwide in terms of prevalence. A lot of people in my constituency don’t believe COVID is real. They also joke that it is a “white man’s problem” and it cannot affect them. So there is denial that COVID even exists. I myself also wanted to wait a few months until the vaccines were proven. I finally got my first vaccine this week. Rollout started three months ago, and it is only now I have chosen to have the vaccination. Look at me - I am well-educated, well-aware of the trade-offs and have good information. I was certainly a bit hesitant. I am not sure about the absolute numbers but all of the vaccine we have here came in through COVAX, the initiative of the World Health Organisation. We got AstraZeneca through this channel, then the Chinese brought their own vaccine in, and we then got a second lot of AstraZeneca from COVAX. The President and the Ministers did well to take it at State House, in a televised ceremony. Some of us sceptics did not show up. The rollout has been smooth because the numbers of people volunteering for injections are few so far. They have done a reasonably good job in putting supplies in each of the main district headquarters. Even Kambia has its share. While it has been a small amount to start with, we’ll need a lot more now.
Part of what pushed me to take mine, as a member of the elite, is because people like me have now become scared of the Indian (or Delta) variant. They had been saying our hot climate protects us from COVID. But the experience of India and Brazil kills the myth about hot weather. It has been fear of the Indian variant that scared us to go and get it done. Second, is the worry that we will be faced with the need to get a vaccine passport for travel, and this made some of us realise we need to get vaccinated now. I have friends who say “hey, if I don’t get it now, I may not be able to travel for business or other reasons to Europe, US or Asia”. The roll out is going well but we need a lot more. We’ve had a miniscule supply, and there are also concerns about cold-storage. When I took mine, I had two days of fever but nothing really serious, and the third day, it cleared, and I now feel fine and well. But there has been fear about proper storage. And that links to the energy system, as we have power outages for as many as 6 hours a day. There is a big worry about efficacy of the vaccine if the storage system is not good.
You mention energy which has been at the centre of your work over the last 15 years. Has the COVID crisis made you re-think your focus on energy?
The COVID crisis has given even more impetus to all of the energy-related issues that I have been advocating over the last nearly two decades. Fifteen years ago, we had one of the highest maternal mortality rates in the world, and the highest infant mortality rate in the world. My cousin who was doing a survey for DFID ten years ago showed that much of this was due to lack of electric power in some of the clinics, while a lot of deliveries were done at night without electric light - they use candlelight. When COVID hit, you could immediately see the potential link between sickness and vaccine cold-chains, powered by grid electricity or renewable energy, to keep temperatures sub-zero. We’ve been telling the world for the last two decades that energy is critical to achieving all the other SDGs, especially health service delivery. The COVID pandemic has, if anything, inspired me further. I did an article in February arguing that effective vaccine delivery was closely tied to the availability of renewable energy, because I cannot see how they will store the vaccines in my village without solar power. And because it came out just after the US President’s inauguration, I said “President Biden, this could be your new foreign policy. If you want to democratise vaccine distribution, you also need to drive the spread of renewable energy to all corners, all communities.”
How has the rollout of investment in energy been affected by the COVID crisis and associated economic downturn?
The COVID pandemic has had several impacts on the energy sector. The first impact, even before any cases actually hit Africa, was an immediate drop in demand for oil and gas. So those countries, like Nigeria, Angola and others, were immediately hit, in the first few weeks of COVID appearing in Asia, Europe and America. Demand immediately dropped which also then affected related investments in prospecting and expansion of the oil and gas industry. Second was lowering of the demand for electricity, especially in the more industrialised African countries. Factories shut when there is a lock down. Third was the inability of consumers to pay their bills. In neighbouring Guinea, the president offered to pay people’s utility bills because lockdown meant people did not have any money. We did not do that in Sierra Leone, but a number of other countries considered that measure. Lockdown has badly hit utility companies. Investments have also not been coming in. The International Energy Agency estimated already by January or February this year that there had been a 30% drop in energy investments in Africa, and this is for a continent with the lowest rate of access to energy already in the world. As a result, you can imagine how these multiple factors have impacted the energy sector. We hope things may improve in the post-COVID period. We hope that governments in Africa and elsewhere can understand the critical nexus between access to energy and social service delivery - clean water and health services – as well as food and agriculture. We hope it has made them understand the connections. But there is another bigger problem. 85% of people in sub-Saharan Africa (outside South Africa) rely on charcoal and fuelwood for cooking, which is causing household air pollution and pulmonary problems. We worry that underlying pulmonary problems for women, children and men as well could make them more vulnerable to another wave of COVID. The WHO has been doing studies in India and elsewhere to see if there is any correlation between air pollution in general and COVID susceptibility. We’ll see what comes out in the next few months and from household studies in Africa.
How might you get more investment, both domestic and foreign, coming into energy generation and distribution?
In my own country, and others I know well, corruption is very high. Energy sector governance has to be re-vamped. That’s a big catch-all phrase which covers many things, like honesty around running the power utility well. This includes revenue collection, billing processes, and pay as you go - digitalisation could help all of these as it did for mobile phones. Regulations and public policy all have to be consistent, predictable and long term. The government has to have commitment to longer term solutions, instead of relying on a “fire-brigade quick fix”. My country is so guilty of quick fixes - we’re still relying on emergency power provided by Turkey’s Karpowership. which the government party criticised when in opposition, but they’ve done just the same. They’ve extended the contract. As a result, we’re going to have emergency power supply in Freetown for ten years. But if you look at those last ten years, Rwanda more than doubled access to electricity in that time, because they were focused on long term solutions. The energy sector is so corrupt, you need to go in for brutal governance reforms to bring effectiveness and transparency into the sector. Successive governments want to do quick fixes and make money under the table. We must have sector governance reform - if you fix it, there is predictability and maybe some companies will come and partner with you.
Second, we need to get the utilities to perform. They are such big gatekeepers in the system that when they are corrupt and inefficient, they mess up everything else in the energy sector. Third, we must find ways to support the regulators, many of whom are new in sub-Saharan Africa. Many have been operating for less than ten years, so they’re still trying to learn their role as regulators. The “unbundling process” for energy supply is recent and not complete in a number of African counties. Another critical factor is proper planning. A number of us are advocating for an integrated energy planning framework. This is an idea we have been pursuing in the Global Commission to End Energy Poverty launched by the Rockefeller Foundation, African Development Bank and MIT. A number of us from Africa are part of this Commission and promoting the idea of a good energy framework for planning the integration of energy systems across several dimensions. For example, make sure that when you plan for on-grid, you plan for off-grid too, including mini-grids. Good geo-spatial mapping is a big help, so that potential investors can come in and see, for example, that they can deliver to the whole northern region. Population densities are known, and income levels are known, so the investor would not need to do detailed background research himself.
Integration is also critical for developing other sectors properly. If we’re going to do sector-coupling, which is so essential for a country like mine which relies on minerals. When we design mining policy for a country like mine, let the Energy Minister be part of the negotiations and consider how those mining companies can become anchored centres for energy demand, or potential private sector power producers. Because every mining company which comes to Sierra Leone also builds their own power-generating plant. But with good planning, they could be part of a private company’s energy supply under a guaranteed Power Purchase Agreement (PPA), and meanwhile they can also supply the community. Maybe out of corporate social responsibility they could even cross-subsidise energy access for the communities around the mining site. So, we need integrated public policy for energy and mines, energy and health which we were discussing earlier, and strategic planning for energy utilities so that they think about the likely future demand from using electricity for cooking, as an additional demand centre.
Finally, one of the neglected areas which we have tried to document in the Global Commission to End Energy Poverty and the work I did two years ago for the European Commission is the lack of investment in distribution systems. We have that situation here in Sierra Leone. The president made a speech a few weeks ago in which he stated that, under his administration, over the last three years he has increased significantly the availability of electricity in the capital. Even in the well of parliament, we all started laughing. Why? We have more power outages today than we had a month ago, or 6 months ago. He went on to explain that the reason there have been problems is that we inherited an antiquated distribution network. In the reports we have been doing, we say let’s find ways to bring investment into independent power producers, and its probably also time we develop business models for independent distribution providers. Some countries are making big investments in power generation, but the transformers and the power lines are not there. The interconnections between our cities do not exist. In Sierra Leone we have one of the worst inter-district connections – in fact we only have 3 lines - in a country where you have 14 districts, each of which has its own independent connection. Distribution has been a neglected area for a long time. And of course, finally, finance matters. Getting more investment in, de-risking these investments using ODA, all of that depends on good sector governance.
Foreign direct investment is one obvious source of capital for energy. But what about domestic sources of capital? How can you tap into these?
We need to strengthen the capacity of local banks to invest in the energy sector. I can speak for my own country - we don’t have banks able to support energy investment, whether its renewables, mini-grids or whatever. Maybe its different in some of the biggest economies like Nigeria. Capacity building and seed financing are needed. Let’s put this in context. When the Iron Curtain fell, the European Investment Bank had to train bankers in eastern Europe how to structure deals and energy efficiency projects. That’s how they grew that market. When I was leading SE4ALL, I was with EBRD and they would tell stories about the first few banks they were training in eastern Europe to retrofit people’s apartments, and also start financing industrial energy efficiency measures. After a few years other banks came into the market. And it’s a $40b market now. A group of funders had to invest in capacity building - KFW, EBRD and EIB - it took time to help make those markets grow. It’s the same in Africa. We need to help build capital markets with deep pockets that are able to take the risks to expand power production, and power trade.
One issue which I need to mention is encouraging power trade. Some of our countries are too small to bring in big investments in power generation. Twelve years ago, I was talking to a rich European investor, who had major assets in North Africa and Asia. We met at an event and I said “hey my president is looking for people to invest in 50MW of energy generation”. And he said “Mr Yumkella, 50MW may be big for your country and your president but that’s not big enough for me to open an office.” He was thinking 500MW or even 1GW – that scale would give him grounds to open an office. And preferably in a place like Cote d’Ivoire with good internet and power connections which allow you to trade power, as also happens a lot in Europe. A number of us are advocating for power trade, and my country is building its first interconnection backbone due to be operational at the end of this year. But that deal took seven years to negotiate. It took another 3 years to set up the company that will run it and provide power between Sierra Leone, Guinea, Liberia and Cote d’Ivoire. But with this kind of experience, we now believe we can negotiate these deals in 3 years not 7. And companies then know that instead of supplying Sierra Leone, you’ll be supplying 45 million people. The AfCFTA would certainly help with this. There is also a recent study by the Tony Blair Institute and PowerAfrica which shows how much money each country could save if they had good interconnections and energy trading through the power pool. The AfCFTA would certainly make the trade easier and we’re advocating for this with Power Africa.
You were formerly DG at UNIDO before SE4ALL, with a particular focus on industrialisation. How does the industrialisation debate look for Africa today? Has the COVID pandemic changed the strategy?
I have made the case for 25 years that Africa has no choice but to industrialise otherwise we’re doomed to be poor for another 50 or 100 years. This is a major reason why I went into the energy space. We were on a call with Secretary Ernest Moniz – Obama’s secretary for Energy - with the Global Commission and he made the case for why there is a strong nexus between energy and industrialisation in Africa. We cannot talk about energy transition in a utopian sense as if Africans will suddenly jump into solar. Many people don’t want to talk about using gas for power, but it’s an injustice for Africa. Moniz and I were on the same page as we both argue that gas is an important transition fuel to enable Africa’s industrialisation ambitions but also enable greater deployment of renewables. In many cases, it’s not just about energy transition, it’s about energy access. My country has 15-20% energy access, so we should certainly look for gas to power solutions. The government here is looking at gas – both liquid natural gas, and liquid petroleum gas - how can anyone tell us not to do that? The bigger context is that Africa’s emissions represent 2% of the global total so if you start to talk about carbon budgets, as will be the discussion at COP26, let’s remember in Africa we’re only using 4% of the global total. So this means that Africa should have some degrees of freedom to use fossil fuel technologies to save lives and power our economy. We’ll make very little impact even if we do use gas. Industrialisation is key. COVID has made us realise even more the importance of this. It has also made us think about the manufacturing of drugs. In our parliament debate is going on about a convention we’re supposed to ratify about harmonising standards across Africa for drugs. As leader of UNIDO, I certainly invested a lot of time on this topic, supported by the Germans above all. At that time, we were supporting generic drugs production for HIV medicines. Industrialisation is a must. The context is even more difficult now – some estimate Africa must generate 20 million jobs per year, in my country youth unemployment is 60%, which everywhere is a very big timebomb, which will hit and destabilise us. John Kerry used to talk about this a few years ago, when he was secretary of state. The youth bulge in Africa is scary. And unless we focus on industrialisation, diversification and digitalisation, I see instability accelerating across a lot of countries. And when you look at more and more draconian governance systems across Africa, I think part of it is fear of the youth. The youth will revolt. I just pray that some of us don’t become collateral damage. I spoke about this back in 2008 at the African Union. I told them then that youth are angry, in a very angry undiplomatic speech. Kenya had just had the post-election riots in which they’d massacred almost 1,000 people. That day Ghaddafi had moved to suspend discussion of industrialisation, despite the fact that we had prepared for months. Luckily, other African leaders backed the industrialisation debate.
How do you see the role of countries outside Africa in this industrialisation process? Some people say China is the best model, others go for the US, or for Europe? Who can be the best partner?
Africa needs all partners. We need to be smart and eclectic, picking what works for us depending on time and context. We need all markets – Chinese, European, American. We want to sell and be part of global value chains, picking our niches of course. One of my friends is Paul Collier and together we have been advising the Lagos Business School Forum. We went back to look at some of the work Paul did for me when I was at UNIDO. The industrialisation we need now is not to produce entire products but to be part of a value chain where you do one bit of a larger chain. There was a big splash when we launched that study. Paul had just produced the book “The Bottom Billion” and we produced some case studies which included one village in China that produces 75% of the buttons that they use in garments in the rest of the world. So don’t think you have to produce the whole jacket, just buttons and labels. They were so good at it, Italians started dismantling their own factories and bringing them to that one location. Africans should look at niche markets producing specialised components that others will buy. Rather than just selling commodities. Our industrialisation has to be by making ourselves relevant in certain value chains and this will vary by geography. It depends on which country, on your human capital, on your natural resources.
If we go back to energy now, Africans should ride the green wave and become producers of components within some technology value chains. We’re sitting on 40-50% of the world’s cobalt plus manganese, both of which are needed for batteries. South Africa has 70% of the world’s platinum group of metals which are needed for fuel cells. All of these metals plus rare earths are critical for the world’s transition to clean energy. In short, some of the key metals we need for driving a clean energy revolution, say in hydrogen, are sitting in Africa. If we’re talking about a just and fair transition as is being proposed for COP26, it has to consider Africa’s ability to supply many of the key metals needed for the green energy revolution. Whether it is battery storage systems, solar panels, wind turbines or other components. We need to be part of the first and second stage in refining and processing metals, such as coltan, zircon and tantalum. It would be unjust if, with this new green revolution, Africa is left out, or used merely as a source of raw materials. It’s not a conspiracy to leave us out but more a question of whether we Africans are ambitious enough to ride this green wave and capture market share. We don’t want to be left behind.
About the COVID-19 and Africa series: a series of conversations conducted by Dr. Folashadé Soulé and Dr. Camilla Toulmin with African/Africa-based economists and experts about their perspectives on economic transformation and how the COVID situation re-shapes the options and pathways for Africa’s development - in support of INET’s Commission on Global Economic Transformation (CGET)
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Monday, June 21, 2021
Saturday, June 19, 2021
Friday, June 18, 2021
Thursday, June 17, 2021
The State Has Failed to Protect Black Wealth in Tulsa and Across America
One of the most critical indicators of your economic well-being is wealth. That’s the difference between your assets and what you owe. Once you have it, you’ve got a resource even more precious than a steady paycheck. You have something to turn to when hard times come, like a job loss or health crisis. Wealth helps you get an education, purchase a home, and start a business. It enables you to take risks and maximize life’s wonderful possibilities.
Wealth, whether in the form of a home, a retirement account, an emergency fund, or a stock portfolio, pays forward into the future, generating security and opportunity along the way for you and your children, and your children’s children.
After decades of rising inequality, most everyone below the 1% has problems accumulating wealth. But a mountain of evidence continues to demonstrate in America, people who aren’t born White face especially daunting obstacles. Economist Darrick Hamilton, director of the New School’s Institute on Race and Political Economy, studies how economic injustice reflects the forces of capitalism and systemic racism. His research poses challenging questions: Why do Black people accumulate so extraordinarily less compared to other groups? When they get it, why is it so hard for them to keep it?
Recently, Hamilton and his colleagues looked at wealth and income across various racial and ethnic groups in Tulsa, Oklahoma. Tulsa, as you’ve been hearing in the news, is the site of the horrific event in 1921 that left as many as 300 people dead and a prosperous Black community in ashes. At the time, Oklahoma's Greenwood District was a place where Black people were managing to flourish even under the harsh conditions of Jim Crow segregation. Greenwood had made amazing economic strides – growing so affluent it got the nickname “Black Wall Street.” At the time of the massacre, six Black families in the area owned their own planes.
But none of this protected them from bombs, beatings, seizure of property, arrest without due process, squalid detention camps, and murder. None of it protected them from terrorism.
A century later, Tulsa offered the researchers a chance to trace the impact of the destruction on generational wealth and look at how losses continue to haunt the present.
The forthcoming report, timed for the 100-year anniversary of the Tulsa Race Massacre, also investigates the wealth experience of other racial and ethnic groups living in Tulsa, such as Native Americans, also the targets of systemic violence and oppression. The researchers were able to break down groups into more refined categories than usual, like individual Native tribes and immigrant and non-immigrant Mexican households, giving them a better picture of how people accumulate wealth according to their circumstances.
Let’s take a tour of some staggering items revealed in the report.
The researchers show that as of 2014, Black households in the metropolitan area of Tulsa had a median household wealth of only $8,000. White households, in contrast, boasted a median total of $145,000.
When it came to homeownership, Black Americans came out last of all the groups studied. Only 40% of Black households owned their homes compared to 85% of White households. And even though Black households showed the lowest rate of homeownership, they had the highest amount of debt -- 75% carried a mortgage.
As for liquid assets, the kind that can get you through emergencies, Black households in Tulsa had a median number of exactly zero -- less than any other group. White households, on the other hand, had a median liquid asset number of $12,000. Cherokee households were not far behind at $10,000.
What about stocks, another key component of wealth? Again Black households were far behind. Just 5% owned this type of wealth, compared to 37% of White households. The only group with a lower rate of stock ownership than Black households was Mexican households, at 3%.
Black households also had the highest rate of student loans and the second-highest rate of payday loans – the type of debt most poisonous to economic wellbeing.
The numbers add up to an undeniable – and indefensible -- picture of White economic advantage. “This racialized nature of wealth in Tulsa is not surprising,” state the researchers, “given the country’s racist and violent past.”
Hamilton and his colleagues also found that the wealth gap between White households and non-White households was bigger than the gap in income. That finding suggests that even when the incomes of people of color were closer to that of White people, they still had a harder time accumulating wealth.
Remember, these appalling statistics come from a city that once had one of the most prosperous Black communities in the nation.
The Massacre was fomented by tales that a Black man had raped a White woman. The violence was eerily similar to what had occurred two decades earlier in Wilmington, North Carolina, where another prosperous Black community was devastated by White violence and a multi-race municipal government overthrown. There, too, the excuse for the bloody rampage was the defense of White female virtue.
But the underlying motivation, says Hamilton, was actually envy. Just as it happened in Wilmington, White envy of Black success caused hell to break loose. The resentment of poor White people could be leveraged by the more affluent White capitalists to seize Black wealth when the ashes settled. These capitalists weren’t about to let their economic dominance was become threatened. The bone they threw to the poor White people was the reward of becoming at least better off than Black Tulsans. Fake news fanned the flames of White envy, just like in Wilmington. The result was carnage and pain that echoes through generations.
Hamilton argues that calling Tulsa’s Greenwood District “Black Wall Street” is not quite accurate. “Greenwood was about more than finance -- its prosperity was grounded in diverse businesses, in relationships in the community,” he explains. “Focusing on Wall Street centers on capitalism as the image and mechanism of success at the exclusion of the other organizations and work that make for a thriving, self-sufficient community.”
In fact, as Hamilton explains, it was the financiers who descended like capitalism’s vultures to pick the bones of Greenwood after the destruction, scheming – with the help of the state -- to deny insurance claims filed by Black people by classifying the Massacre as a riot.
Of all the urban areas Hamilton has studied, Tulsa provides a unique case to examine wealth not just because of its racial history, but its geographical location and the fact that outside of Alaska, it has the largest urban U.S. population of Native Americans (it was Indian Territory until 1907). It also has a substantial Mexican population.
The story of Tulsa and wealth, Hamilton explains, is about more than just government policy. It’s about what he calls “political codification” -- the ways in which the state fails to protect the property rights of people in communities like Greenwood. “And it’s not just about protecting them from vigilantes,” he adds. “It’s about protecting them from what can only accurately be called terrorism – the taking of property through terrorist acts.”
Hamilton points out that over and over in America, the state has interpreted and enforced laws in ways that preserved economic White advantage. “Black people have always been vulnerable to state-sanctioned terror,” he says. “Not just their property, but their personhood. That has been the American story. There are laws to protect property rights, laws against fraud, but not only have these laws not been enforced to protect Black people, they’ve been used against them.”
Hamilton describes what happens in places like Tulsa and Wilmington as the opposite of the Homestead Acts of the 19th century. “In that case, government policy gives you a nest egg of property so that you can accumulate assets,” he says. “Well, Black people were denied access to that and many other similar policies. Even when they did manage to accumulate capital in various pockets of communities that were poised for growth and had some viability, they would be exposed to forces of terror to property and person. And the state itself was involved in the plunder.”
So why does it still remain so hard, even after Jim Crow has ended, even after the Civil Rights Movement, for people who aren’t White to amass and hold onto wealth? Why is it that Hamilton’s research shows again and again that in American cities – and not just Tulsa -- White people are always either at the top or close to it in terms of wealth?
Hamilton explains that history, geography, and circumstances all play a role for specific groups. Immigrant Mexican households in Tulsa, for example, are impacted by the need to send remittances home. Certain Native American groups in Tulsa appear to be relatively better off than other groups, but their rural counterparts may have a totally different experience.
“Wealth is grounded in capital, but it’s also grounded in politics,” says Hamilton. “In certain cases of Native American tribal membership, such as the Cherokee, political infrastructure can pave the way to some wealth and capital accumulation. Tribal sovereignty brings communal mechanisms and structures for individual accumulation. But it’s important to emphasize that all Native American cases are by no means the same.”
For Black people in Tulsa, the legacy of the Massacre plays a detrimental role in trying to secure wealth. Hamilton explains that part of this is because acts of terrorism like Tulsa destroy vital infrastructure. As he and his colleagues state in their report, Black Tulsans today face “shocking disparities” in everything from employment and educational opportunities to safe and affordable housing to a healthy environment and access to primary healthcare. “These disparities are fueled by racist underfunding of public structures and deliberate and ongoing structural violence enacted by government entities whose choices impoverish the chances of Greenwood’s descendants into 2021,” they note.
An example of this structural oppression is mass incarceration. Oklahoma, the researchers point out, has the highest rate of incarceration in the U.S. – perhaps in the world. And Black people are disproportionately sent to prison.
Hamilton observes that the state never repaired the damage done in 1921, leaving the decedents of the Massacre with diminished possibilities. To hear the testimony of survivors like Viola Fletcher, a 107-year-old whose family was driven out of the city, is to feel hardships of lack of education and job opportunities come alive.
But it’s not just a problem Tulsa, Hamilton observes. “Black people are consistently at the bottom in terms of wealth in cities across the country, and not only in places with an especially violent racial past. They have been vulnerable in terms of policy and the protection of their wealth throughout the country.”
So how can the damage be repaired? Both in Tulsa and in the rest of America?
Hamilton sees two parts to this question. One is a psychic reckoning: “People need to know that it will never happen again, that the state will not turn a blind eye or worse, that it won’t be complicit in terror against them.” The second is a material reckoning: “There’s a material trauma that gets passed down from one generation to the next,” says Hamilton. “It’s not just about wealth generation, it’s wealth stability.”
The economist says that in Tulsa there is an urgent need for restitution “in the sense of a full-throated acknowledgment” of what happened. In addition, he calls for “compensatory measures” to redress the harm that was done. If those two things happened, he says, Tulsa could become a model for the rest of America.
“The ultimate national redress,” says Hamilton, “is reparations, which would be an act of the federal government to acknowledge that these scenarios of Tulsa, Wilmington, and elsewhere were not isolated spatially or in time. That beginning with slavery, the original sin, and well beyond slavery, elements of these failures to protect the rights of Black people manifest. Even today, we see the ways in which the state and the court system interact with Black people as it relates to their property.”
Finally, Hamilton argues that in the broadest sense, we need an “economically just perspective” in America – a vision that ensures that people will always have access to capital and one in which the state ensures that there are “no material consequences associated with something as cursory as ones race of gender identity.”
Only then, he says, will America truly be on a path of justice.
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