A Start on Some Fresh Thinking. Is there More?

Posted on 27 August 2009

A physicist, a chemist and an economist are stranded on a deserted island. A case of canned food washes ashore. The physicist says “I can open these cans by climbing that tree and dropping rocks on them!” The chemist says, “No, I can open these cans by creating a corrosive solution from salt water and immersing the can in that!” Then the economist speaks up and says, “Gentlemen! Why all the hard work? First we assume we have a can opener…”

“How to resolve the green paradox” by German economist Hans-Werner Sinn on the Comment page of the Financial Times today (8/27/09) is an interesting read for its theoretical implications but, like the joke, falls a bit short in practical advice.

His “green paradox” turns out to be the notion that current efforts to curb carbon emissions through alternative energy development and efficiency spending are having the unintended consequence of encouraging resource owners to accelerate the extraction of coal, gas, and oil – just the thing governments are trying to avoid.

The logic, though not very clear in this article, seems to be that by promoting the artificial and early substitution to alternative fuels through government policy destroys demand for fossil resources, pushing down their future value. In turn, the scarcity component of the Hotelling Rent equation (the technical concept) is altered such that prices fall closer to marginal cost, therefore increasing supply. The conclusion is that demand based efforts to curb carbon are ultimately counterproductive without a supply limitation.

He goes on to note the inherent difficulty, if not impossibility, of storing the carbon after the energy has been extracted from the resource. His solution is to focus more directly on encouraging the resource owners to leave the resource underground. How to do that?

The two options are a carbon tax or a cap-and-trade system. But like opening the can of soup, we are still left with the difficulty of not only reaching an agreement on how to curb emissions but how to enforce such an agreement. The article is timely given the approaching Copenhagen summit in four months, but it falls short of giving the parties solutions.

Nonetheless, Mr. Sinn’s article is one of the few we’ve seen in the mainstream press that hints at the underlying economics of exhaustible resource extraction – a topic that is worthy of further exploration.

For a recent example of one policy expert’s real world advice, see Michael Levi’s article in the latest issue of Foreign Affairs.