FEDS 2021-055: What Can We Learn from Idiosyncratic Wage Changes?

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Andre Perry, senior fellow at the Brookings Institution and author of the book, Know Your Price: Valuing Black Lives and Propert…

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Economist Offers Stark Climate Reality Check. Plus a Bit of Science-Based Hope.

In a new book, Alligators in the Arctic and How To Avoid Them, Peter Dorman shows how flawed academic models, faulty assumptions and unrealistic schemes grossly underestimate what’s needed to stop catastrophic warming. He argues for a straightforward carbon emission budget – plus the active citizenship required to fight big businesses that want to keep doing business as usual. Lynn Parramore explores his findings and talks to the economist about the path forward.

All aboard! We’re hopping a time capsule to travel 56 million years back in Earth’s history. You are entering the time when dinosaurs have gone and curly-tailed early primates share the world with humongous flightless birds. The air is sultry, the landscape lush with feathery ferns and swaying palms. Alligators bask on rocks in the sun. It’s getting pretty steamy; you’re wishing you’d packed a swimsuit.

Surprise! You’re in the Arctic Circle.

You have landed in a period called the Paleocene–Eocene thermal maximum (PETM), a time when temperatures spiked for reasons that aren’t entirely clear. Somehow, a lot of stored carbon got pumped into the atmosphere, maybe in part from volcanic eruptions. Whatever the cause, the planet got super-hot. Alligators loved it, but a lot of other creatures, like deep marine life, couldn’t take the heat and went extinct.

Peter Dorman, professor emeritus of political economy at Evergreen State College, takes PETM alligators as the mascot for his new book, Alligators in the Arctic and How to Avoid Them: Science, Economics, and the Challenge of Catastrophic Climate Change (Cambridge: July 2022). Bringing together science and economics – two fields that butt heads in the climate debate – he argues that current discussions are not only based on dodgy assumptions and bad math, they may be leading us into risks we can’t even anticipate. Like Arctic alligators.

Dorman’s message is stark and simple: If we’re serious about climate change, we have to keep coal, oil and gas in the ground. Roger that? KEEP. IT. UNDERGROUND.

That message is at odds with much of what we hear in the news, in policy debates, and even in economics classrooms. Dorman takes aim at a range of popular approaches that in his view can distract us from the main goal, from the “ecotopian” dreams of Green New Dealers to the spurious claims of economic de-growthers. He challenges the promises of renewable energy enthusiasts who claim their programs automatically lower emissions (ask Germany; it’s not so easy) and points out the folly of market-based approaches, deceptive offset schemes, and individualist illusions.

He insists that while many of these projects, like renewable energy, have laudable aims, they are no substitute for phasing out fossil fuels. They don’t “balance things out” or really even buy us time.

Dorman doesn’t mince words: We’ve got to decarbonize a hell of a lot faster than most of us realize. It’s going to be hard and it’s going to hurt, but the situation is so dire that there’s no time for wishful thinking. He warns that until we face reality, we can’t get a handle on how to approach the economic, political and social disruptions that such a massive transformation of the way we live surely entail. He argues that while climate deniers are obviously a problem, environmentalists who promise a nearly painless transition from our fossil fuel habit aren’t doing us any favors.

So, how do we keep from frying ourselves into oblivion? Dorman wants us to quit putting our faith in vague, unenforceable pledges to cut back to certain emissions levels at some future date. The way to keep alligators in their place, he maintains, is a transparent carbon emissions budget that would steadily wean us off of fossil fuels for the rest of the twenty-first century. We make the budget and then we stick to it. Simple.

Dorman, a political economist, doesn’t downplay the fact that politics is a lot harder than math. Like John Dewey, he knows that the political sphere is pretty much the shadow cast on society by big business. But there’s no way around it: big business the challenge because the owners– and not just owners of fossil fuel firms, he shows, but companies in a wide range of industries -- know that pursuing a realistic climate agenda puts their wealth at risk. Since they have wrested control of our political system, they can easily block even the most urgent moves, like ending absurd fossil fuel subsidies. You can almost hear the alligator chuckling in the background every time a corporation touts its climate bona fides.

Hope lies in our ability to organize ourselves for the common good. Fortunately, we have a few things on our side that we didn’t have in other recent upheavals. With climate change, unlike the pandemic, for example, we can see a lot of what’s coming and plan accordingly. Dorman also reminds us that contrary to what most economists will tell you, economies can and do make a rapid shifts in production and consumption as the choices made by individuals and organizations react to one another. And some of the changes that a decarbonized world demands, like more leisure time and less work, along with better products that are crafted to last, may actually improve our lives.

But brace yourself. Dorman is clear that the most salient fact about the world’s response to climate is that it isn’t even out of the gate yet. In the following conversation, he discusses how economists have led us astray and how to get off the starting block so that we can keep alligators where they belong,

Lynn Parramore: You’re an economist. What motivated you to take a deep dive into climate change and climate policy?

Peter Dorman: As an undergraduate in the seventies, I had a professor who was an early scholar of climate change, so it was always on my radar. It became increasingly important to me around the beginning of the 2000s as it became clear that policy wasn’t moving the way it needed to. At the same time, as an economist, I thought I would have something to offer in the way of analyzing the options.

I got a consulting opportunity from an environmental group which resulted in my closely monitoring a regional climate change initiative. Listening in on meetings and webinars, it became obvious that this was a very sensitive issue in the political economy sense. I became interested in the mechanism of redistributing carbon revenues and that brought me in connection with Peter Barnes, an entrepreneur in that area. Through work I had done with him and others I met through him, I became interested in the various policy initiatives that were taking place. The final piece was teaching an interdisciplinary course at the graduate level on climate change with a climate scientist and a climate justice specialist. The course was structured not around academic disciplines but common questions about the nature of the problem and what we should do about it. I learned a lot about the global political context and also the science. That’s what all came together in the book.

LP: You’re critical in the book about the way economists have generally approached climate change and climate policy. You write that economics is “an indispensable tool for formulating and evaluating policies, yet also a primary source of misunderstanding.” Can you talk about where economics has gone wrong?

PD: The problem runs very, very deep. I think the source of it is in conventional welfare economics and the role it plays in the self-understanding economists have about their task and their position in the public sphere. Welfare economics evaluates economic outcomes in terms of some conception of social benefit. So economists feel that having analyzed economic data, they are in a position to pronounce on what is optimal for society.

Applied to climate change, that means that economists think they can decide what is the right level of climate mitigation and to override the judgments of natural scientists and others who have also studied this problem. The result, in my opinion, has been a dramatic misdirection of economic research effort. A huge amount of effort has gone into trying to estimate the potential damages of climate impacts in economic terms and estimating the social cost of carbon, which can then be compared to the costs of mitigation -- all with the idea of having an optimal response as economists see it. The problem is that this kind of approach does not apply to climate change.

Unfortunately, this is entirely in line with how economists have traditionally approached all sorts of policy questions. It’s a much broader problem and shows up in other areas, but certainly in climate change it’s highly problematic, and not only does it mean there’s been a lot of pressure coming from many economists for a moderation of effort on the climate front, but also that economic expertise has focused on the wrong areas. There are very important problems that need work in climate policy that economists are not working on.

LP: You noted in your book that the 2018 Nobel Prize in economics went to Yale economist William Nordhaus, whose work is at odds with the findings of the majority of global natural scientists. That must send quite a signal to the discipline that it’s ok to override scientific opinion.

PD: I’ve heard that the silences of dolphins are as important as the noises that they make. Certainly the silence of the Nobel Committee in not awarding a prize to [Harvard’s] Marty Weitzman for his work on climate policy spoke much more forcefully than the prize they did award to Bill Nordhaus.

LP: So how can the tools of economics be used more effectively for climate change and climate policy?

PD: The book takes as given the central logic of the mitigation reports of the IPCC [Intergovernmental Panel on Climate Change, the United Nations body on climate change science]. They have proposed a maximum target of 2°C for global warming limit and an aspirational target of 1.5°C. I begin with the accounting mechanism that comes out of climate science, which is centered on a budget for remaining carbon emissions.

LP: Let’s talk about the carbon budget idea. You point out that this approach is much simpler, transparent, and effective than the kind of mishmash of different future greenhouse gas reduction targets we have seen countries taking about, for example, in the Paris Agreement.

PD: With a carbon budget, the idea is that there’s a certain amount of carbon we can emit from now going forward. We can allocate that amount as we will, but it’s a hard budget constraint. Economics comes in when we talk about the various aspects of how we do that, like how to minimize costs. Here I think economists have really not given consideration to the problems of wealth and wealth write-down that will have to happen. We sort of have the wrong capital stock in our economic systems. We’ve inherited a capital stock from centuries of economic evolution which is not appropriate for a decarbonized economy. So that transition from the capital stock we have to the one we need ought to be a fundamental concern of economic analysis, but it’s not. The literature on stranded assets gets at a small piece of that problem, but it’s a much larger problem, I think.

LP: Let’s talk about stranded assets – the stuff that loses value or becomes obsolete as we decarbonize. You view them as a bigger economic problem that is widely understood. Can you explain why?

PD: About a decade ago, the organization Carbon Tracker came out with a report saying the amount of fossil fuel in the ground that was considered reserves -- and were tallied as assets by their owners -- in fact greatly exceeded the amount that could be dug up and burned if we were serious about the climate. As result, a lot of those fossil fuel assets would have to be stranded.

Then, a second generation of researchers looked at the next level of stranded assets, considering the companies that make equipment that specialize in fossil fuel extraction and combustion. They looked at industries that are highly intensive in the use of fossil fuels that might have difficulty in switching energy sources. These examinations then escalated to concern for the overall system stability at a market level – in other words, the amount of capitalization of those firms.

But what I am trying to argue in the book is that considering the pace of decarbonization which is needed in order to reach the IPCC targets, it isn’t just a question of fuel substitution. There will have to be substitution in end use of products in order to pull this off. That brings into play a much larger set of investments which are profitable if people have access to cheap energy -- but not if they don’t.

LP: Can you give an example of this end use problem? A product that won’t be profitable if energy isn’t cheap?

PD: Boeing and Airbus are not on anybody’s list of stranded assets because they’re not fossil fuel companies, they don’t make fossil fuel equipment and they’re not that energy intensive, actually, in their own operations (fuel is an important component, but so is labor, etc.) If fuel becomes very expensive, that impacts the demand side for airplanes. There won’t be re-orders. The companies that make airplanes will potentially have to write down a lot of value, particularly if they’re not able to easily repurpose the capital investments they’ve made.

Having toured the Boeing facilities, it’s hard for me to imagine a lot of non-airplane uses for that stuff! That’s a simple example and you can proceed from there. My guess is that a very substantial part of the capital stock that we have at the present time is potentially at risk. The origins of that insight came from the work I did as a consultant. When I was listening to what businesses were concerned about with potential carbon taxes and the effect that that would have on the demand for their product, it dawned on me that whether or not economists are looking at this, the businesses are. They have a very clear idea of what a rapid run-up in fossil fuel prices would mean for their particular products. The outcome of that is pressure from them on policy, which has been very effective and largely unopposed. To the extent that it’s possible I’ve tried to document the lobbying efforts of a variety of business sectors on carbon policy—not just the fossil fuel sector, not just the Koch brothers, but, in the case of Oregon where I live, for instance, the timber industry, the railroad industry, agriculture – it’s very widespread.

LP: Let’s look further into how corporations behave. A lot of firms -- Microsoft is an example you mention in the book – make a big public display of devotion to mitigating climate change, becoming more energy efficient, etc. But you point out that given the kinds of politicians these firms support with donations, those energy efficient offices might not mean very much. What’s going on here?

PD: I try not to be cynical. I know a lot of the people who do this work for corporations are very good, well-meaning people. I think I can understand where they’re coming from. We’ve had year after year, decade after decade, of not getting the policies we need. Under those circumstances, it’s understandable for people to say, ok, let’s see what I can do on my personal level, on a company level. So you get the carbon audits and the carbon footprints and all these little things that people are trying to tweak for themselves, hoping that somehow it will all add up to viable policy.

There are two things wrong with that. First of all, it doesn’t add up. You can’t really even say what your carbon footprint is, because you can’t know the effect of your actions on other people and how they will affect their carbon footprint, and therefore the footprint of society as a whole. It doesn’t reduce down to the individual level like that. The other problem is that by focusing so much attention on tweaks, we lose sight of the fact that it really still does come down to policy at a much larger level. In the case of Microsoft, ok, they pay an energy company in central Washington to say that they supply green energy to the company and all that, but on the other hand, they give large sums of money to extreme right-wing politicians who campaign on and govern on the principle that climate change is a hoax. So if you put those two things together, one is important and the other is not important.

LP: On the individual level, a lot of people want to do their part, but as your book points out, even figuring out what kind of shopping bag is environmentally friendly is actually a very difficult calculation. What’s an ordinary person to do? Are we spending too much time thinking about which kind of lightbulb to use and not enough time exerting pressure on the political front?

PD: Once more, I don’t want to be cynical. I do appreciate the good will that people bring to this, and no doubt it does make a difference whether you are ecologically conscious in your personal life. However, for climate change, where everything comes down to how much fossil fuel we can leave in the ground, in the end, what we need to do is recover our citizenship. We have to be active, organized citizens – and that’s difficult because we’ve lost the habit. We don’t have the kinds of membership parties or organizations on a large scale that mobilize people and exert political pressure for causes like this. But we need a counterforce to business. It’s sort of like the old countervailing interest idea of [John Kenneth] Galbraith. We need some kind of force in the public sphere that can stand up to the power of business and make serious climate policy happen.

LP: Let’s talk about the Inflation Reduction Act (IRA). What does it say about our political system and how we’re currently approaching climate change?

PD: I think the IRA is a fascinating episode. As the political system became apparently blocked and unable to act directly to reduce carbon emissions, there was a sideways movement where a lot of environmental people said, well, if we can’t get that, let’s at least get investments in green energy. That’s been a long-standing debate among environmentalists.

The original proposal for scrapping the science-based approach and moving to an investment-based approach was put forward twenty years ago by the Breakthrough Institute. They were saying, let’s not hear anymore doom and gloom. Let’s not try to meet scientifically defined goals, let’s just offer people jobs and good feelings and that’s how we’re going to win. I understand the motive. It’s a response to political blockage. The problem occurred when they moved the goalposts. They stopped saying that this was a compromise and instead said that this is actually what we wanted all along. Clearly we need these investments – I’m the last person to argue against them, but the fundamental problem is keeping carbon in the ground. If you pull carbon out of the ground in order to make investments which may or may not have a certain future effect in reducing demand for fossil fuel, that is truly a devil’s bargain. Even so, you might make that bargain, but you ought to be clear that it’s the bargain you just made. You’re pumping more fossil fuels into the atmosphere in the hope that maybe later you can go on a diet.

LP: So the IRA is really a devil’s bargain because it doesn’t do much for this central goal of keeping carbon in the ground?

PD: For the carbon part, yes, in a nutshell.

LP: You emphasize the importance of feedback effects in climate change, and how we have failed to take them into account. How might they impact global warming?

PD: We’re guessing as best we can with the data and models we have for how we think the Earth system works. The mechanisms of feedback have to do with mobilizing carbon that’s currently locked up, either on land or in the sea, which might be released with higher temperatures. We’re discovering that there are other feedback mechanisms that might have played a role in that earlier period of the hothouse Earth, the PETM that brought the alligators to the Arctic. For instance, different types of cloud formations seem to eventuate as the Earth warms, and those, in turn, increase the warming effect. Another feedback mechanism involves how much radiation reflects back into space as ice melts and you move from ice to water, which is known as the Albedo effect. We’re also learning about changes in the distribution of forest biomes as a resulting of warming. It’s pretty likely we’re going to lose at least some of our tropical and temperate forests and that, too, releases carbon into the atmosphere. These are the kinds of effects that occur as the temperatures rises, and we don’t know how big those effects are going to be.

LP: Is there any good news?

PD: I think the best single piece of news is that in certain ways the fix is clear. With some kinds of problems, we’re beset by enormous uncertainties and we’re stumbling in the dark when it comes to trying to deal with them. We saw this and we’re still seeing this with Covid. It’s difficult to chart a path when there’s so much you don’t know.

But in this case, while there’s a lot we don’t know, there’s a lot we do know. We certainly know enough to establish a carbon budget for ourselves, quotas for how much carbon we can emit. We can generally understand the mechanisms for economic hardship and we can work at stabilizing the macroeconomy and at an individual and household level to help folks maintain their living standards and finance the kinds of changes in their consumption that they’ll need to make. These things we know. I’m optimistic in the sense that I feel that if we could communicate this to enough people, we could somehow get them to organize themselves and become an effective force so that we can get these policies in place. We could do it. That’s the cause for optimism. Everything else is the cause for pessimism. I have to say though, that I’m less optimistic today than I was when I finished the book, because of the difficulty we’ve had with the pandemic. People may be less willing to make sacrifices for the common good than I had hoped.

LP: What advice would you give a young person studying economics who is interested in climate change and climate policy?

PD: With climate change, as in other areas, working respectfully in interdisciplinary teams, truly valuing their perspective, is critical. Recognize that climate scientists have understanding of the stability of the Earth system that economists don’t possess, and recognize the complexities of international politics and work with people in international relations and international political economy.

LP: How might economists benefit from other disciplines in dealing with ethical questions?

PD: I think the standard economic approach to ethics has been one of the negative consequences of welfare economics. That’s because it was a neatly packaged system that took the place of ethics, so economists didn’t think it was necessary. Once you recognize that welfare economics is not what it’s cracked up to be, you realize there’s an ethical hole. The economist has to recognize that hole and work with other people who are qualified to help fill it, including humanists, sociologists, and philosophers – a range of people who understand, substantively, different aspects of well-being and what makes a course of action better and worse. In the end, good polices come from broad perspectives that take into account many kinds of expertise, not just one.

LP: Final question: the title of your book references the alligators that once roamed the Arctic during a period of extreme climate change. What can we learn from these alligators?

PD: I used the alligator story in the book to illustrate the drastic consequences of interfering so profoundly in earth systems. But at the end I also pointed to another aspect of this remarkable species, how it is almost like two creatures in one. On land it almost appears sluggish, moving slowly and deliberately as if considering each step. (It can also lunge!) But in the water it moves more fluently, submerging and surfacing with a rippling splash. Humans who want to forestall the worst climate scenarios need to work in two environments as well. They need to be careful and precise in policy analysis, not settling for superficial slogans and pseudo-solutions. And they need to be bold and disruptive, making it clear to those in power that failing to realistically respond to the climate crisis will have political consequences they don’t want to face. Deliberate and radical.

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Development, Climate Change & Capitalism

Ying Chen discusses her work to better understand development, labor and environmental impact in the Global South, focusing in particular on the realities of Chinese economic policy as it has evolved.

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Symposium on the Inflation Reduction Act

Servaas Storm, Steven Fazzari, and Thomas Ferguson comment on the Inflation Reduction Act

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The Inflation Reduction Act (IRA): A Brief Assessment

Servaas Storm’s commentary for an INET symposium on the Inflation Reduction Act

The IRA has received mixed reviews, which is not surprising given the current polarised political, social, and economic conditions existing in the US. However, what strikes even more is that reactions by economic pundits, both from the center-left and the center-right, have been inflated, often relying on dramatic hyperbole and invoking sweeping vistas of (climate) disaster averted and ‘civilization saved’. The (sad) truth is that ‘serious’ establishment macroeconomists are once again having a breathless debate over very little. Let me quickly run through the debate.

Observers on the ‘liberal’ center-left, including Paul Krugman, Joseph Stiglitz, and the AFL-CIO, have hailed IRA as a ‘very big deal,’ ‘historic,’ and a ‘victory for working people’, because the Act will reduce CO₂ emissions (supposedly by 40% in 2030, compared to emissions in 2005), likely create more than 1 million green and relatively well-paying jobs per year over the next decade (according to the BlueGreen Alliance), and catalyse domestic production of batteries, electric vehicles (EVs), solar panels, and wind turbines, (finally) setting the US up to compete in the global renewable energy market. Using tax credits and direct consumer rebates for solar panels, EVs and heat pumps to speed up the clean-energy transition, IRA will lower energy costs for many US households by hundreds of dollars per year. IRA also offers an important ‘side helping’ of health-care reform which will benefit American working- and middle-class households by cutting the costs of prescription drugs and lowering health insurance premiums, while expanding health insurance coverage (White House 2022).

All this is done in a fiscally conservative way which should please all deficit hawks and balanced-budget fetishists—in fact, according to estimates by the Penn Wharton Budget Model (PWBM) and the Congressional Budget Office (CBO), IRA will lower accumulated fiscal deficits of the US government over the next 10 years by $248 billion and $305 billion, respectively. The lower deficit is also supposed to contribute to lower inflation: “126 leading economists—including 7 Nobel Laureates, 2 former Treasury Secretaries, 2 former Fed Vice Chairs and 2 former CEA Chairs—have said reducing the deficit will help fight inflation and support strong, stable economic growth” (White House 2022).

On the other side, observers on the centre-right are pointing out that IRA, despite its name, doesn’t do anything to reduce US inflation. This is confirmed by analysts using the Penn Wharton Budget Model, who conclude that the impact of IRA on inflation is statistically indistinguishable from zero, as well as by CBO Director Philip L. Swagel, who concludes that the bill will have a negligible impact on inflation in 2022 and 2023. This is not surprising. Any impact on US inflation of the average annual reduction in the fiscal deficit caused by IRA (which amounts to around 0.1 percentage point of US GDP) is simply too small to be detectable in the inflation estimates of the Bureau of Economic Analysis. In other words, the mentioned 126 leading economists—including 7 Nobel Laureates, 2 former Treasury Secretaries, 2 former Fed Vice Chairs and 2 former CEA Chairs—are wrong in believing that reducing the deficit does help fight inflation. (It is true, clearly, that some of the IRA measures will lower energy bills and healthcare costs for US households. But not aggregate inflation.)

Centre-right observers further worry that IRA will lead to an increase in tax rates for the US middle class, contrary to President Biden’s pledge to not raise taxes on households making $400,000 or less annually. Estimates by the Tax Policy Center (2022) show that this worry is evidently wrong: average taxes of middle-income households remain unaffected by IRA, while the after-tax incomes of low-income households may go up a bit and the average after-tax incomes of high-income people would decline somewhat. The point is, of course, that IRA is funded by highly targeted tax increases on highly profitable corporations: a minimum tax on the financial statement income of a few very large companies which currently pay little or no corporate income tax, and a tax on companies that buy back stock from their shareholders. Some centre-right and corporate observers (including the Business Roundtable) strongly oppose IRA, claiming that these extra corporate taxes will ultimately be paid by workers (whose wages will arguably rise less) and shareholders (robbed of the precious gains provided by their stock buybacks), also because they (mistakenly) argue that higher corporate taxes must hurt US economic growth. These pontifications about the impacts on growth of the proposed corporate tax increases make little empirical sense, however.

Estimates by the PWBM and CBO indicate that IRA will increase corporate taxes by around $30 billion per year in the next decade, or by just around 1% of corporate profits (in 2021); it must be further noted that corporate profits rose by around $120 billion on average per year during 2017-2021, and that there is ample evidence of corporate profiteering during 2021-22 (Storm 2022). Given the macroeconomically small hike in corporate taxation, it is unrealistic to expect any detectable effects on workers’ wages, business investment and growth. As Lance Taylor was wont to point out, policy changes involving billions of US dollars may look large from the point of view of an individual household or firm, but represent inconsequential droplets (‘peanuts’) at the macro level where variables are measured in trillions of dollars.

Cutting out the hyperbole and eschatological drama, both on the left and the right, what is the real significance of the IRA, if any? Clearly, IRA does nothing to bring down inflation (in the foreseeable future), but it does help lower-income US households to better manage price increases, especially as far as healthcare, medicines and energy are concerned. This is certainly important. However, IRA is best considered as a climate bill, meant to lower US CO₂ emissions, promote clean energy, and improve resilience to global warming and reduce the risk of ‘fossilflation’ (Storm 2022).

As such, IRA constitutes an important—albeit limited—step in the right direction. Using ‘pecuniary rewards’ (such as tax credits and rebates on renewable energy), funded by additional taxation of socially unproductive monopoly profits of corporations, IRA aims to provide a boost to the renewable energy transition—and thus help to cut US carbon emissions over time. Within the polarised stalemate of US (climate and energy) politics, IRA definitely constitutes a major break with the past—but, alas, one which falls rather short of ‘saving civilisation’, as Krugman is suggesting.

IRA falls short of what is needed because of two reasons: the fiscal stimulus to the renewable energy transition is far too small compared to what is needed in view of the steadily building climate crisis; and the positive price incentives, loved by establishment economists, will not work, failing to bring about the required structural transformation of the US economy, addicted to fossil fuels, to a net-zero-carbon system. Let me consider these two points in somewhat greater detail.

First, most climate macro-economists agree that a strategy to reduce carbon emissions so as to keep global warming below 1.5°C degrees (with a reasonable degree of probability) would require an annual increase (or reallocation) of investment by around 2 to 2.5% of GDP (for instance, see Taylor, Semieniuk, Foley and Rezai 2021). For the US, this would mean an increase in investment in renewable energy generation and infrastructure of around $500 billion per year. IRA is budgeting an annual increase in such investment of $37 billion, which is less than one-tenth of what is needed. It is difficult to see how the limited stimulus provided by IRA is going to lower US emissions by (the expected) forty per cent compared to levels in 2005.

I must add here, on this point, that per capita greenhouse gas emissions are much higher in the US than in the European Union (EU) or the United Kingdom (UK). In fact, in 2019, consumption-based CO₂ emissions are 17.1 tonnes per person in the US compared to 7.74 tonnes per capita in the EU-27 and 7.71 tonnes per person in the UK. This implies that even if IRA manages to lower per capita carbon emissions in the US by 40% over the next 10 years, CO₂ emissions by the average American continue to remain much higher than average per capita emissions in Western Europe. In other words, US climate action remains relatively unambitious. As Lance Taylor (2021) pointed out a year ago, “the USA is far behind the rest of the world in attacking global warming. A gallon of gasoline costs around $2.50 here vs. at least $7.00 in Western Europe.” It is important to keep sight of the relatively limited ambition level of US climate policy—especially in view of the political hyperbole and climate eschatology characterising US macroeconomic discussions on IRA.

Second, IRA wants to have the cake and eat it. It wants to promote clean energy using positive price incentives, but at the same time is protecting the vested interests of fossil fuel capital, allowing it to continue its stranglehold on the US political system. Gone are earlier ideas of taxing carbon or pricing carbon by setting up a CO₂ trading regime. Instead, IRA provides mainly positive pecuniary inducements, which (paraphrasing Martin Weitzman 2007) are meant to unleash the decentralised power of capitalist inventive genius on the problem of researching, developing, and finally investing in economically efficient carbon-avoiding alternative technologies. More specifically, as is lucidly explained by Jeff Goodell (2022), “In theory, it works like this: subsidies and rebates will give home heat pumps the little push they need to replace gas furnaces, which in turn will reduce demand for natural gas, which will close down the fracking operations that leak methane into the atmosphere. Subsidies and rebates will also give electric vehicles the extra shove they need to replace internal combustion engines, which will cut the demand for oil and that will in turn push companies like ExxonMobil and Shell and BP to accelerate their investments in clean energy. The faster this happens, the bigger it snowballs, and the faster the world is transformed.” I have put ‘in theory’ in italics because this is the crux: it won’t happen like this is reality. Sorry.

According to many energy modelers, the potential for CO₂ reductions from the IRA rebates and tax credits may be around 40% by 2030 (compared to 2005). But the assumptions concerning price-induced technological progress in energy and carbon efficiency on which most climate-economy models are built, are merely educated ‘guesses’—after all, data on past performance do not provide any guidance for the structural economic transformation and the required degree of decoupling of economic growth and CO₂ emissions that lies ahead (Storm 2009; Schröder and Storm 2020). Many modelers are techno-optimists, downplaying the stylized fact that labor and energy productivity levels have increased at close to equal rates for centuries (Semieniuk et. al., 2021). Rebates, subsidies, and tax credits falling within a politically acceptable range may be capable of inducing macroeconomically small changes in the structure of the economy and level of emissions. But given technical and structural constraints, the proposed incentives will not be effective, as Lance Taylor (2021) showed, in bringing about the structural change necessary to stabilize warming below 1.5°C. To argue otherwise is a conscious act of self-deception in the spirit of Wilkins Micawber's stubborn and unfounded optimism that, in the face of adversity, “something will turn up.” Meanwhile, the Keeling Curve (Figure 1), the chart of CO₂ concentration in the atmosphere (measured at Mauna Loa Observatory), continues to rise steadily and relentlessly.

A final reason why IRA will not achieve its ‘expected’ CO₂ reduction in the future is that it does almost nothing to reign in the fossil fuel industry. Could this be related to massive campaign contributions that the oil and gas industry routinely makes in elections? As argued by Aaron Regunberg (2022), by reframing the political discourse on climate around the additive potential of a green industrial policy and, at the same time, deprioritizing efforts to radically decarbonize the economy, the Biden administration succeeded in building a coalition (including senators Manchin and Sinema) in support of IRA. But IRA could turn into a Pyrrhic victory, coming at great costs, because, built into IRA, is a failure to do anything to directly and quickly scale back fossil fuels.

Even worse, in return for Manchin’s support, IRA comes with a side agreement, permitting changes that will help fast-track fossil fuel infrastructure—including a long-delayed pipeline in Manchin's home state of West Virginia. Concerned environmentalists warn that the bill contains two ‘poison pills’—in sections 50264 and 50265—which mandate oil and gas leasing in the Gulf of Mexico and Alaska and bar the federal government from authorizing new wind or solar energy development “unless an onshore [oil and gas] lease sale has been held during the 120-day period ending on the date of the issuance of the right-of-way for wind or solar” (Jake Johnson 2022). Tying renewable energy development in the US to massive new oil and gas extraction guarantees that IRA will not achieve its ‘expected’ CO₂ reduction in the future. Climate researchers rightly call it a climate suicide pact.

So, what is my bottom line? IRA is a first historic, but nevertheless modest step in the right direction of building a zero-carbon renewable energy US economy. Its impact in terms of reductions in CO₂ emissions will be considerably smaller than ‘predicted’, and its transformative power will be limited. Much more will be needed—both in terms of public investment in clean energy and sustainable technology and in terms of direct interventions to scale back fossil fuels. There is no getting around it: direct measures including phasing out coal (power plants), taking climate liability litigation seriously, public investment in renewable energy generation and RD&D, and banning drilling, fracking, and (oil and gas) pipeline provisions, will be needed.

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The IRA as a Climate Bill

Steven Fazzari’s commentary for an INET symposium on the Inflation Reduction Act

Recent headlines about year-over-year consumer prices sensationalize with phrases like “worst inflation in 40 years” and “out-of-control inflation.” The reality of high inflation, its real costs on many American households, and the extensive, sometimes excessive, media coverage has been a drag on Biden administration approval and is among the most prominent talking points in the Republican effort to take control of Congress in the November midterms.

In this environment, it is no surprise that Democrats labeled their hard-won and much watered-down legislative victory the “Inflation Reduction Act” (IRA, for short). Yes, the bill contains some pieces that reduce prices, including authorization for Medicare to negotiate prices of some widely used prescription drugs and initiatives to increase the supply of renewable energy over time. But in terms of the inflation data driving today’s news, the impact of the IRA on inflation will be minimal, as predicted by some model-based estimates.[1]

While one might criticize the act’s politically motivated name, it is important to recognize it is likely almost impossible to design an effective fiscal policy to address the recent inflation spike. The high inflation of 2021 and 2022 arose from the enormous economic disruptions caused by the pandemic and were magnified by the Ukraine war. Prior to the Covid-19 crisis, market-driven responses of supply chains to modest economic shocks prevented large shortages: supply almost always adjusted reasonably quickly to the changing composition of demand. But supply chains could not adjust quickly enough to the gut punch of the pandemic disruption. For example, the chart below shows the massive increase in volatility of components of real personal consumption, especially durable goods, that began with the pandemic.

The inability of supply chains to adjust to huge changes in the allocation of demand caused historic pressure on relative prices. A change in relative prices does not have to cause overall inflation, in principle. But the only way it would not cause higher inflation is if the prices of items less in demand fall to offset the increases in prices of items for which demand exceeds restricted supply.

The chart below shows this offset did not occur. As one would expect, durable and nondurable prices rose much faster when demand for these items increased rapidly as the economy bounced back from the initial pandemic lockdown. And the Ukraine war accelerated the price increases for nondurables, which include energy and food consumption. Did the price of services, which account for about two-thirds of personal consumption, fall to offset the rise in the prices of goods? The chart shows the answer is a strong no. Service prices largely followed their pre-pandemic trend. In fact, service price inflation rose somewhat as costs of some inputs into service production (energy, for example) rose quickly. If the prices of some things people buy rise a lot and the prices of others things remain on their long-term trend, the result has to be inflation.

The economy continues to adjust to these big shocks. Recent data shows some moderation in inflationary pressures. But the adjustment is taking a long time, longer than many analysts (myself included) expected a couple of years ago. But, in retrospect, considering the enormous size of the shocks, we should not be surprised.[2]

No political leader wants to say policy cannot do much in the short term to address problems that reduce economic well-being for many of their constituents, but that may be the unfortunate reality. The IRA has virtually nothing to do with the economic disruptions driving current inflation.

That said, there is a more subtle aspect of the IRA that may have a significant effect on long-term inflation over the coming decades. Servaas Storm (2022, section 11) argues persuasively that economic disruptions required to shift the world economy away from unsustainable production of greenhouse gas emissions will lead to higher long-term inflation. The logic of this argument is a slow-motion version of what I have described here for the pandemic and the Ukraine war. Fundamental restructuring of the sources of energy needed for production and consumption will put pressure on supply chains and possibly cause large shifts in relative prices, especially if these adjustments are induced by the chaos of climate catastrophes. And chaotic adjustments of relative prices will almost surely be inflationary. To the extent the IRA helps create a better, smoother path toward a climate-friendly economy, it could lead to lower long-term inflation through channels not included in conventional macroeconomic models.

Over the next few decades, perhaps the IRA really is an “inflation reduction act” because over shorter horizons it really is a climate bill.

Reference

Storm, Servaas (2022): “Inflation in the Time of Corona and War,” Institute for New Economic Thinking working paper 185, June 2022, https://www.ineteconomics.org/research/research-papers/inflation-in-the-time-of-corona-and-war

Notes

[1] Analysis from the Penn-Wharton model forecasts that the inflation impact of the IRA “is statistically indistinguishable from zero” (https://budgetmodel.wharton.upenn.edu/issues/2022/7/29/inflation-reduction-act-preliminary-estimates ). The Congressional Budget Office predicts “negligible” effects of the IRA on inflation in 2022 and 2023 (https://www.cbo.gov/system/files/2022-08/58357-Graham.pdf ).

[2] In a remarkable, extensive study, Storm (2022) analyzes the recent dynamics of U.S. inflation.

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How Inflation Reduction Became Export Promotion

Thomas Ferguson’s commentary for an INET symposium on the Inflation Reduction Act

Steve Fazzari and Servaas Storm’s breakdowns of the Biden administration’s Inflation Reduction Act are acute and persuasive. I think they point inescapably to a striking conclusion: That this flamboyantly contradictory production only looks like a piece of legislation. Really it is a new species of mythical beast – a twenty-first-century counterpart of the ancient Greeks’ fire-breathing Chimera, which notoriously joined the head of a lion with the torso of a goat and the tail of a serpent.

The crossbreeding on display in the Act is at least as eye-catching: Key parts were inspired by the Green New Deal and similar proposals pushed by advocates of strong action to limit climate change. As Storm and Fazzari lucidly explain, many of these provisions mark real advances, even if some, such as the tax credits for Carbon Capture and Storage, are unlikely to help much.

Even these features, though, betray unmistakable traces of more exotic fauna. The bill selectively reorients many progressive notions away from any hint of carbon pricing and avoids strong regulatory decrees. Instead, it emphasizes a dizzying array of investment incentives and tax credits as part of a (successful) strategy to enlist wider support not only from the usual suspects – alternative energy, Silicon Valley, and parts of finance – but also Ford Motor and other manufacturers, utilities, and electrical industry interests. Plus some previously skeptical unions. But the imprint of the Democratic Party’s progressive wing is plain enough.

The same holds for other provisos of the bill, including the corporate minimum tax and the very cautiously hedged opening to allow Medicare at last to bargain with pharmaceutical manufacturers over the prices of a few drugs, though this move likely drew support from some other elements of the medical-industrial complex. The tiny (1%) tax on stock buybacks, adopted at the last minute as a stopgap to plug revenue losses after Democrats close to private equity balked at raising taxes on the masters of the universe, is another instance where the influence of the Party’s progressive wing sticks out, though the rate is unlikely to deter any buybacks at all and signals which interests really won.

But what elevates the new beast to legendary status are the startling features Senators Manchin and Sinema insisted upon as the price for their votes.

As the bill hurtled toward final passage, Sinema held out for deletion of a revenue raising provision Manchin and Senate Majority Leader Schumer had agreed upon that would have slightly tightened up the famous “carried interest” tax loophole. By allowing private equity firms to treat income earned as capital gains instead of ordinary income this trick has long shielded the industry from billions of dollars in tax payments and has become something of a legend as an example of how big money corrupts politics.

Sinema’s brazen hold-up – she was awash in campaign contributions from the sector – can easily be over-interpreted and it was, as major media narratives rushed to portray Schumer as a populist hero challenging Wall Street.[1]

This was ridiculous: not in this Democratic Party. Schumer’s political career stretches through most of the era in which New York was the undisputed financial center of the world and he has long protected the financial industry and its lucrative tax breaks. As The Lever tartly observed, the tiny tax Schumer and Manchin proposed would not have applied to most of the industry’s earnings since firms typically hold investments well past the time cutoff the proposal stipulated for exemption. But the theater greatly enhanced Schumer’s and the Democrats' image as reformers. With Sinema and many other Democrats, including President Biden himself in the 2020 campaign, all benefitting from private equity largesse, the proposal was quickly and unceremoniously dropped.[2]

Which brings us to the real question about Inflation Reduction Act. The legislation had been lying fallow for the better part of a year. Manchin’s stonewalling had opened up a black hole that threatened to suck down the entire Biden agenda into it. The late July announcement that Manchin and Schumer had suddenly agreed to add a host of generous concessions to oil, gas, and mining interests to the bill and pass a separate measure shortening the time allowed for reviews of proposals for new pipelines and utility connections took everyone’s breath away. Not just the question of why the West Virginia Senator had suddenly relented, but why Schumer and the White House had agreed. Speculation about what changed has run rife ever since.

There is a plain answer: the war in Ukraine’s shattering impact on world energy markets. Few analysts expected a large-scale Russian invasion of Ukraine and almost nobody believed that Ukraine had much prospect of turning one back in the event it happened. When the guns kept booming in eastern Europe, the shock was profound. The threat to Europe’s cheap energy supply was obvious.

Germany, along with most of the rest of Europe, accepted in principle the need to cut back its dependency on Russian energy and started laying plans to find new energy sources over time. It has also reversed long-standing policy by committing to substantial rises in its military budget. Initially, the German government and most of industry and labor insisted that a quick end to all Russian gas imports would be too much of a shock. The consequence would be prolonged stagflation and strong pressures for even more production outsourcing to less expensive countries, including China.

The argument resonated widely in other parts of Europe, including Austria and Italy. In the wake of the spring IMF meetings, where attendees wrung their hands at the challenges posed by inflation for the global economy, especially skyrocketing food and energy prices, along with rising US interest rates, even some American officials signaled that they understood the transition required time.

That was then. Now in the short run, the issue is moot unless the fighting suddenly stops. Russia has reduced the flow of energy to Europe to a trickle. The European hunt for new sources has kicked into high gear. How much and how rapidly liquid natural gas from the United States and Middle Eastern gulf states can really flow into Germany and the rest of Europe is currently the subject of furious speculation and desperate diplomatic maneuvering. Practical questions about ship chartering, export platform availability, and storage possibilities are all involved, but vast issues of geopolitics are front and center.

Joe Manchin and many oil patch spokespersons recognized this virtually from the beginning. They realized that the shocking turn of events offered the United States a rare chance to go back to the future -- that is, to recreate a twenty-first-century version of the post-World War II order in which America actively guaranteed energy security in Europe.

As Manchin explained: “Putin’s war in Ukraine must serve as a permanent wake-up call to the international community that we cannot rely upon hostile nations for the free world's energy security. The only way we'll be able to guarantee it is to rely on ourselves and our proven partners around the globe.”

Hammering away at the Biden administration for its efforts to rein in new pipeline construction and oil drilling, the Senator contended “that building up domestic natural gas infrastructure would reduce costs, create jobs, and give the U.S. geopolitical power at a crucial time.”[3]

Giving up on the Democrats, Manchin for a while entertained hopes of finding common ground with Republicans, whose attachment to oil ran far deeper than that of most members of his own party.[4] As one news report summarized his thinking at that point: “Manchin, who killed Biden’s more ambitious, $1.75 trillion bill last December, has been privately hinting he prefers to pass any legislation outside of the partisan budget reconciliation process. That means it had to clear a higher bar: 60 votes — with at least 10 coming from the Republicans.”

But that path faced obstacles besides Republican unwillingness to give President Biden anything that looked like a policy success: “Some of his preferred policy prescriptions for energy independence, like approving the Mountain Valley Pipeline, were always in danger of being washed out of a reconciliation bill by a so-called Byrd Bath.” This referred to a quirk of Senate procedures that “allows the Senate parliamentarian to rule if a specific piece of legislation can be considered via the process reserved for budget reconciliation.”

The Republicans proved unyielding. With American oil producers pressing for long-term contracts to protect the gigantic investments that would be required, Germany and other major European countries went shopping for reliable long-term energy sources.[5] Though details are murky, long-term futures prices of natural gas have stayed way up. An authoritative German study of the long-term natural gas market recently leaked in the Frankfurter Allgemeine indicated that by 2030, the United States was expected to fill most of the shortfall created by the Russian gas withdrawal, since only the United States is actually in a position to step up exports of liquid natural gas on the vast scale required.

Eventually, Manchin gave up on bipartisanship. Avoiding threats from the Senate Parliamentarian, he, along with Schumer and the White House, agreed not to discriminate against fossil fuels in the Inflation Reduction Act and to reform the permit process through a separate measure.

A Congressional vote on that measure is imminent. The issues raise a host of urgent public policy questions since it is hard to believe that a vast expansion of fossil fuel production will not have major effects on American efforts to counter climate change. But the short-run needs of Europe and the rest of the world are also very great. That is why a mythical beast as strange as anything the Greeks ever imagined has suddenly materialized at the heart of American politics. It is how the White House and the Democratic Party reorganize to guarantee that the United States remains a dominant exporter of energy from fossil fuels in the midst of the ever-deepening peril from climate change.

Notes

[1] The Arizona Senator’s opposition-led also to the removal of another tax on Wall Street from the bill. See the discussion by the Associated Press, “Kyrsten Sinema’s Donations From Investors Surged to Nearly $1 Million in the Year Before She Killed a Huge New Tax on Private Equity and Hedge Funds,” in Fortune.com, August 12, 2022.

[2] Estimates of how much money from private equity flow to Democratic Party candidates in recent elections differ widely in articles discussing Sinema and her colleagues. The subject needs a careful assessment. Virtually all numbers are likely way low. For now, see Thomas Ferguson, Paul Jorgensen, and Jie Chen, “The Knife Edge Election of 2020: American Politics Between Washington, Kabul, and Weimar,” Institute for New Economic Thinking Working Paper No. 169, especially Appendix 5. This presents a very careful estimate for the presidential campaign of 2020. The industry is also heavily represented in the Biden White House, but the topic is too far afield to discuss here as are some important shifts within Democratic primary campaigns in 2022.

[3] The passage is a quotation from a Fox News summary of Manchin’s views, not a direct quotation from the Senator himself.

[4] See, e.g., Ferguson, Jorgensen, and Chen, “The Knife Edge Election of 2020.”

[5] This point is fundamental to understanding the changed international energy environment. See Thomas Ferguson, “An Acutely Fragile World,” The International Economy Magazine, Spring 2022, pp. 36-39

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Michael Grubb on BBC Panorama

Michael Grubb appears on BBC Panorama to discuss his INET research on European energy markets

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Navigating the Crises in European Energy

Price Inflation, Marginal Cost Pricing, and Principles for Electricity Market Redesign in an Era of Low-Carbon Transition

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Electricity Markets, Climate Change, and the European Energy Crisis

Price inflation, marginal cost pricing, and principles for electricity market redesign in an era of low-carbon transition

Economies across Europe face unprecedented challenges arising from the soaring cost of energy which holds the prospect of turning into major social and political crises. In the UK, without any intervention, total household consumer expenditure on energy is set to rise from £64bn in 2021 to around £200bn – an increase exceeding defense and education expenditures combined. The rise is dominated by expenditure on electricity and gas, split (on average) roughly equally between the two. Energy costs are a prime factor driving general inflation in the UK to at least 10%, whilst poor households face cost-of-living increases of almost 20%.

The proximate causes – a Covid-recovery surge of global demand relative to supply in global gas markets, followed by the Russian invasion of Ukraine - are well known. In addition, the unprecedented heatwaves and drought across Europe – in line with the expected foothills of accelerating climate change - have curtailed output from nuclear and hydro sources, adding further pressure to electricity prices even aside from other more direct impacts of the extreme weather.

However, underlying these proximate causes is the generalized application in energy of an economic principle of marginal cost pricing far beyond its appropriate limits. This principle - which in energy markets could be more precisely termed short-run-marginal-cost-on-all pricing - means that fossil fuels still predominantly set the wholesale price of electricity, which over the past eighteen months, has risen from around £50/MWh to around £200/MWh. The result is that as the price of the marginal energy supply rises, the gains accrue to all producers regardless of their average prices. In an added twist of irony, though, European electricity systems are in the midst of a transition from the internationally traded commodity of fossil fuels to mainly domestic assets – notably, renewable energy sources.

Aside from the cost and distributional consequences, such an approach to pricing is also demonstrably inappropriate for driving investment in non-fossil fuel assets; indeed, it is obscuring the growing success of a transition which has seen rapidly rising volumes of increasingly cheap renewable energy.

The result is a striking paradox of ‘cost inversion.’ New renewable sources, based on contracts outside the market, offer power at under a quarter of current and projected wholesale electricity prices. They presage a future of predominantly non-fossil, asset-based electricity with entirely different economic (as well as environmental) characteristics. Aside from the proximate causes, navigating the crisis by exploiting this transition is the fundamental task facing policymakers.

This new working paper, jointly published by INET and the Institute of Sustainable Resources at University College London, examines how the cost of gas-powered generation feeds through to electricity bills, on the principle of marginal cost pricing, setting the price for most of the time though it accounts for only about 40% of GB generation. We offer estimates of the increase of revenues across the wholesale market and outline five principles for reform for addressing the combined challenges of energy costs while accelerating low-carbon transition.

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Your Summer Holiday Spot Needs Climate Action Now

Because global warming doesn’t take a holiday

At summer’s end, if we’re lucky, we may find ourselves with bare feet and sun-kissed skin; our senses soothed, our bodies attuned to nature’s rhythms. A recent study found that more than half of American adults are traveling for Labor Day this year, leaving the hustle behind to squeeze the last golden drops of summer in beach and lake, park and mountain; savoring deep memories and anticipating future joys. This time of year reminds us of so much to be grateful for in the natural world.

We need this interlude. New research shows that the health of Americans is deteriorating, but at the same time, a growing body of studies validates what we know intuitively: being in nature heals us. Spending just two hours a week in green spaces enhances our health and well-being.

There is something infinitely restorative in the cyclical refrains of nature—the promise that the seasons will roll on as they always have – until they don’t.

News of relentless heat waves, flooding, and fires testify that climate change doesn’t take a holiday. Earlier in the summer, Yellowstone National Park was ravaged by flooding. In recent weeks, swimmers in drought-ridden Cape Cod have been frolicking in waters laden with feces. Right now, high temperatures are scorching the country, putting over 55 million Californians under heat alerts as the state braces for record-breaking temperatures over Labor Day weekend. Instead of enjoying cookouts, many may face rolling blackouts. Hikers on the Pacific Crest Trail are panting in meager shade and trekking through burned-out forests.

Meanwhile, North Carolina’s Outer Banks, with their wild horses and magnificent beaches, are slipping into the sea; acidic seawater and warming temps are killing reefs in the Florida Keys; and glaciers are melting in Montana’s Glacier National Park. Many of the summer destinations we love will not look the same in five years, ten years, or even next year. Napa Valley may be unable to produce the grapes for your favorite vintages due to hotter temperatures. In Colorado’s Mesa Verde National Park, precious Pueblo cliff dwellings are breaking into pieces from extreme temperature swings. Rising sea levels are narrowing beaches in Hawaii at a frightening clip: this year’s condo may have toppled into the sea by the time you start planning next year’s visit.

Summer is becoming a bummer.

Even along Maine's cool and craggy coastline, long known as "America's vacationland," the signs are scary. Lobsters are swimming away from warming waters and erosion is swallowing parts of popular beaches.

Pete Nichols, a Maine native who leads the Midcoast Conservancy, warns that time is short to take action. “The 50-year climate horizon that has been the conventional wisdom for some time has recently been accelerated to a time frame that is within reach in the next 5 to 10 years,” he told me. “People visiting Maine are already experiencing the impacts of climate change through the warming waters of the Gulf of Maine, historically rich with cold water seafood all visitors enjoy.” That water, he says, is warming faster than 96% of the world's oceans due to many factors, including shifts in the dynamics of the Gulf Stream due to glacial melt. Nichols anticipates other changes visitors to Maine can expect, from extended drought, and warming lakes to algal blooms and wildfires.

Yet this conservationist insists that this is no time to throw up our hands. As we witness the glaring red flags of changing weather patterns, vanishing marine life, and warming water, we can choose to commit to making changes in ourselves, our neighborhoods, and our communities. This requires the development of a global network of consciousness around climate change: “If we stop and think about it, nature has all the solutions we need for climate resilience,” he observes. We can take a cue from mycorrhizal fungi, he says, referring to that champion of the microbiome that feeds and connects trees and plants in a network that supports the local ecosystem. “We need to create a network that spreads climate consciousness through stewarding our immediate surroundings,” he says.

Even on a summer weekend holiday, we can be mindful stewards -- limiting air travel, eating locally, and avoiding plastic bags and containers. We can consider our connection to the outdoor workers, the communities of color, and the women who bear the brunt of climate change. Rather than resigning ourselves to a scorched Earth, we begin the process of what author Jeremy Lent calls “Deep Transformation,” moving away from the idea of humans as atomistic, selfish individuals to a rediscovery of our profound interconnectedness.

Polls show that Americans want to take climate action, and finally, there are signs that our government, pushed by social movements, is beginning to respond. Everyone is still poring over the details of the 750-page Inflation Reduction Act, but the experts I’ve spoken to at the Institute for New Economic Thinking agree that the newly-passed bill takes small but meaningful steps to put in place programs that might help preserve the places we cherish, aiming to boost renewable energy while slashing greenhouse gas emissions, and providing environmental protections including funds for wildfire risk reduction, forest management, wetland conservation, wildlife habitat protection, coastal restoration, and staffing for the National Park Service. These urgently needed investments can potentially mean resilience rather than destruction for park, beach, or forest so they can survive to be treasured for many summers to come.

What we have is a moment in which the momentum to tackle climate change is building. Let’s seize it.

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Beware of Toxic Innovation

How big tech barons crush innovation—and how to fight back

In late 2017, the European Commission asked us to research innovation in the digital economy. Our earlier work, including Virtual Competition, raised the concern of policymakers around the world as we uncovered several significant risks of the digital economy including algorithmic collusion. But on innovation, we, like many others, were optimistic and trusted in the market’s ability to deliver. As we dug into the data over the next few years, however, we found multiple fallacies about innovation in the digital economy. Our counterintuitive findings were unsettling.

After submitting our report to European policymakers, we began getting calls from other policymakers who had seen our report, and they too had similar concerns. That led to further research and more unsettling truths, and our latest book, How Big-Tech Barons Smash Innovation—And How to Strike Back.

Intuitively we know something is amiss. Lots of us, as surveys reveal, are concerned about corporate power in many markets, including in the digital economy. But seemingly, people still believe, as we initially did, that innovation has been unaffected. It remains synonymous with the digital economy. Innovation and creativity, we are told, are the keys to success. And the underlying assumption is that the digital economy is contestable: If you are good at what you do and are willing to experiment and quickly learn from your customers’ behavior, you could make it! The prevailing message is that while many innovators might fail, some that quickly identify and exploit opportunities will succeed.

But the reality is more complex and far less promising.

While the innovation gospel might have been valid in the 1990s, that is not true today. A few powerful firms (whom we call the “Tech Barons”) are now the critical gatekeepers in their vast ecosystems, where contestability is carefully orchestrated. Think, for example, of Alphabet (Google), Apple, Meta (Facebook), Amazon, and Microsoft (GAFAM for short). These Tech Barons not only govern the competition within their tightly controlled ecosystems, but they also affect the nature of innovation that makes it to the market. And to protect their interest, they make sure to only advance and allow innovation that does not disrupt their business models and profits. As their ecosystems expand to the health industries, the metaverse, and beyond, so too will the Tech Barons’ power.

As we increasingly go online to socialize or shop, we instinctively understand that many innovations coming from the Tech Barons’ ecosystems have a dark side—whether to our privacy, well-being, or autonomy. The heady tech utopia of the 1990s now seems like a dystopia. Based on our research and discussions with market participants, several things become clear:

• How the Tech Barons differ from powerful platforms and apps. If apps are worth millions, and platforms are worth billions, then Tech Barons, in controlling the ecosystems, are worth more than billions. They are quasi-sovereigns. While the Tech Barons tolerate innovations that do not threaten their ecosystems, they will smash companies with disruptive technologies that add significant value, whom we call the Tech Pirates. Our book explores the fate of several Tech Pirates, including the privacy app Disconnect (which Google kicked out of its ecosystem), the search engine DuckDuckGo (which promotes privacy, but many have never heard of because of Apple’s revenue-sharing agreement with Google); Aptoide (which was subject to Google’s dark patterns); Sonos (which was forced to limit its innovations of speakers with multiple digital assistants), and WhatsApp and Waze (who were acquired by the Tech Barons).
• How the Tech Barons, unlike past monopolies, have multiple weapons to kill or marginalize these innovation pirates and influence the scope and nature of innovation that reaches the market. Tech Barons can distort the supply of innovation (for example, by excluding disruptors from the ecosystem or reducing interoperability), and the demand for innovation (for example, by controlling the interface, and using dark patterns and friction to affect our choices). Their strategies also affect and distort the paths of innovation outside their ecosystems. As a result, the market delivers fewer disruptive innovations that add significant value, more innovations that sustain the Tech Barons’ power, and more innovations that extract or destroy value.
• How the innovations have become toxic. Under the guise of personalization, the Tech Barons and those within their ecosystem innovate in finding better ways to harvest data and predict and manipulate our behavior. Among the many patents and innovations to implement these strategies, you could find, for example:
  • Technologies that scan your private communications to learn more about you, your interests, and your needs;
  • Mechanisms that enable third parties to access your correspondence;
  • Technologies that use available microphones, including on your smartwatch, to listen to your environment; and
  • “Sniffer” algorithms that listen to background conversations (at times, without requiring a “wake word”).
• How toxic innovation will increase. The Tech Barons design their ecosystems to favor their interests (at the cost of crushing beneficial innovations). As a result, the Tech Barons’ value chain will often dictate the type and scope of innovation that one will find, and in looking at the value chains, we can predict that innovations will become even scarier. As a result, potentially beneficial innovations that offer value will likely be deployed in a manner that extracts or destroys value. For example, in July 2021, an algorithm successfully decoded for the first time speech from brain activity. When the study’s participant, who, because of paralysis, could not speak, was asked, “How are you today?” AI was able to decode from the participant’s brain activity his response: “I am very good.” No doubt, these innovations can create significant value, particularly for those with speech paralysis. The critical point is that with market power, control over the ecosystem, and existing value chains, these technologies will likely be implemented in ways that do not necessarily serve our interests. In an environment where the Tech Barons eliminated disruption and potential competition, they will likely drive the innovation to deliver the ultimate goal—profits. With power comes the ability and incentive to implement innovations to exploit us. As more participants’ internal thoughts are converted into code, algorithms will more accurately decipher what we are thinking. Just as our DNA has been mapped out, so too will our emotions, thoughts, and thought processes. So, who is sponsoring this “speech neuroprosthesis” AI? Facebook. This research aligns with the company’s goal of transitioning from a social media company to a metaverse company, where AI, in decoding our thoughts, will redefine the virtual reality experience. Facebook can’t protect us currently from the sex traffickers and drug cartels on its platforms. So, expect the same groups that currently promote on Facebook’s platforms violence, exacerbate ethnic divides, and delegitimize social institutions to also be in Facebook’s metaverse. And expect Facebook to be deciphering our thoughts while we experience this discord in the metaverse.
• How one cannot easily avoid the ripple effects of the toxic innovations flowing from the Tech Barons’ ecosystems. After seeing the inflow of toxic innovations, your reaction might be to avoid the Tech Barons’ ecosystems. Some of you might already have deleted your Facebook and Instagram accounts, switched to DuckDuckGo or another private search engine, and canceled Amazon Prime. But one cannot easily escape the ripple effects of the toxic innovations. Our book examines how these innovations are harming our children, ripping apart our social fabric, and undermining political stability and democracy. And the Tech Barons know this. This is problematic, especially as the Tech Barons’ ecosystems expand.
• Why the “ideological buffet” which calls for limited intervention, is so alluring. Some of you might still hesitate. Consider some of the policymakers who responded along these lines: Granted these companies wield a lot of power, but we don’t want to chill innovation. Why is it that some policymakers are adamant that we should simply keep calm and allow the market to work its magic (never mind that these Tech Barons have remained dominant despite their abuses)? The answer is found in the ideological buffet served up by the Tech Barons and interest groups on their payroll. The ideology is so alluring precisely because we have heard it so often, and it often contains kernels of truth. Google, Apple, Facebook, and Amazon and their third-party interest groups reportedly spend millions of dollars in lobbying, and with the pending antitrust legislation in Congress, expect the lobbying and the “chilling innovation” claims to intensify.
• Why the legislative proposals to rein in the Tech Barons won’t necessarily stem toxic innovation. While the Tech Barons are in the news for their mounting antitrust attacks, the likely relief including Europe’s Digital Markets Act, Digital Services Act, and Data Act, will not fix the underlying problems. As our book explores, toxic innovation remains a significant blind spot for policymakers, enforcers, and courts. Even if all the legislation in the US passes, even if the competition agencies around the world win all their lawsuits against the Tech Barons, and even if some of the Tech Barons are broken up, it won’t necessarily end toxic innovation. Part of the answer lies in duck hunting. One doesn’t aim where the duck is, but where it is heading. One problem is that the enforcers are aiming at the Tech Barons’ past anticompetitive practices, which the Tech Barons may not need to rely upon going forward. Another problem is their focus. The agencies typically focus on the impact of the Tech Barons’ behavior in narrowly defined markets. But the power that the Tech Barons wield does not come from their control over particular markets, but their control over ecosystems. Moreover, rather than simply asking whether the behavior is anti-competitive, policymakers should also ask why the Tech Barons behave the way they do. They need to inquire how the ecosystem’s value chain affects incentives and innovation paths.

As we continue along the current policy path, valuable innovations will be increasingly stifled and toxic innovations (which primarily extract or destroy value) will flourish. The digital platforms are often analogized to a coral reef, where various app developers and technologies ultimately contribute to the platform’s structural complexities. Instead, we’ll see putrid red algae that attack these coral reefs—where the Tech Barons kill off healthy innovators by depriving them of the “oxygen” needed to survive.

Should we care?

Yes—whether you are a company seeking to exploit an opportunity online, a parent concerned about the effect these technologies have on you and your children’s mental health, or a policymaker seeking to restore competition online and make these markets more contestable.

Companies that seek to innovate and expand in the digital economy are directly affected by these dynamics. They will need to know what drives the Tech Barons’ strategies and how the Tech Barons will likely perceive them and react to their innovation efforts. While the Tech Barons may change over time, the underlying forces of the digital economy will not. So, companies need to understand how their innovations will affect the prevailing Tech Barons’ value chain, where they can safely disrupt, and what opportunities exist for disruption as the Tech Barons’ ecosystems expand.

Consumers need to understand what innovations to expect and how they’ll likely affect their well-being, privacy, and autonomy. While no one can predict the exact form of these innovations, we can get a glimpse by better understanding the Tech Barons’ incentives. Indeed, based on the patents we’ve reviewed, we’ll likely continue to see some truly toxic innovations.

Policymakers should be rightfully concerned since innovation is necessary for economic growth and addressing global warming, wealth inequality, social unrest, growing population, and the present threats to democracy. To address these pressing needs, we need disruptive innovations, and we need them sooner rather than later. Leaving the Tech Barons to determine the scope and trajectory of digital innovation will undoubtedly leave us worse off.

Of course, the Tech Barons prefer that we stick with the current policies, which were designed many years ago and are ill-suited to deter their power over the supply and demand of innovation across their vast ecosystems. Although nearly all the Tech Barons are being sued across several jurisdictions, they have little to fear. This is especially the case when antitrust reforms have stalled in Congress, and when some elected officials, like Senator Rand Paul (R., Ky.), opine: “Rather than pursue even stronger antitrust laws, Congress should allow the free market to thrive where consumers, not the government, decide how big a company should be.” That ideology, as we explore, is wrong on several fundamental levels, including that this vision of a “free market” does not reflect the reality of the many captured markets dominated by a handful of Tech Barons.

But the scary part is that even if the antitrust enforcers prevail over this “free-market” rhetoric and win every case, the relief will likely be too little and too late. And even if all the recent policy proposals, including the multiple bills pending in Congress, were all enacted, they will unlikely prevent the toxic innovations. The current Tech Barons and their successors will continue to distort the path of digital innovation absent corrective policies. The costs of going off course are huge—to our well-being, autonomy, and democracy.

Why it’s not hopeless.

There are many reasons to be gloomy: high inflation eating into our earnings; Congressional leadership unresponsive to the bipartisan concerns over the Tech Barons’ power, and a digital economy careening off course. Our democracies are in peril. The Tech Barons always seem to be several steps ahead of the policymakers. And while companies must compete and disrupt online, their journey is more perilous than what the business literature depicts.

Our children already stand less of a chance of a better life than ours. Are they doomed to the precariat worker class?

The upside is that we can restore contestability and fairness in the digital economy. Toward that end, our book offers three fundamental principles for policymakers:

• Our First Principle is Value -- Consider the type of innovation and ask whether it creates, destroys, or extracts value. As we explore, innovation is neither inevitable nor invariably desirable. Since not all innovation increases value, policymakers and enforcers must inquire about the type of innovation (sustaining or disruptive) and whether it increases or reduces our well-being (that is, whether it destroys, extracts, or increases value).
• Our Second Principle involves Incentives -- Ask who's designing the ecosystem and influencing the innovation paths, what is the ecosystem's value chain, and what incentives it fosters. What's good for the Tech Baron is not necessarily what's good for us. And so, one must understand the incentives at play (that flow from the value chain) and ensure these incentives align with our interests. Every ecosystem is regulated--whether by Tech Barons, informal norms, or laws, rules, and regulations. If policymakers assume that the marketplace is naturally self-regulating and that the market participants' incentives will always align with our interests, they are ill-informed.
• Our Third Principle promotes Diversity – We need to foster an effective competitive process that enables disruption and innovation plurality and offers Tech Pirates a viable opportunity to prosper. The diversity of innovation paths is crucial for future prosperity. We cannot predict who will emerge as the next Tech Pirate, given their high rate of failure and the evolutionary selection on which we rely to ensure that the right innovations prosper. But we can hedge our bets by fostering a plurality of innovators and the ensuing collision of ideas from different fields.

We also offer two ways to operationalize these principles. If betting on the Tech Barons and their ecosystems for the disruptive innovations to solve today’s problems is such a terrible bet, where should policymakers place their bets? One startling insight, at least for us, is cities. Consequently, we explore why need to fundamentally overhaul our policies, and invest in general research (which will benefit the Tech Pirates), cities, regional innovation clusters, and more generally, in diversity. If we do so, then the digital economy will more likely help us address today’s critical challenges, rather than contributing to them.

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