Many problems in public policy are government-created, and the best solution is not more government. Unfortunately and predictably, solutions involving more government will be supported by groups that are short-sighted and will benefit directly from them.

As the latest illustration of this, biodiesel producers in Missouri are calling for extending the $1-per-gallon biodiesel blender’s federal tax credit. In its Friday issue, the St. Louis Business Journal published two articles that profile a struggling biodiesel plant as it waits for extended handouts from the government.

Meanwhile, there exists a lack of demand for biodiesel in the market, and the government has responded by setting a mandate to create an artificial level of demand. From one article:

Environmental mandates that require oil companies to blend petroleum-based diesel with minimum levels of biodiesel [...] have increased demand, and therefore prices, for biodiesel and helped offset the loss of the expired tax credit.

The problem with mandates and production subsidies like those for biodiesel is that the government is encouraging energy producers to invest in an infrastructure that is neither efficient nor cost effective. Residents of Missouri and other states could achieve higher levels of utility if government stayed out of the market and allowed the profit-and-loss system to allocate resources. As another positive consequence of eliminating handouts to biodiesel producers, fewer resources would be distracted from the development of other alternative energies that are perhaps more viable.

Last week, MissouriNet reported on the president’s speech in Kansas City, in which he talked about clean energy:

President [Barack] Obama said in his speech that just a few years ago, the U-S accounted for 25% of the world’s economy, but was only making 2% of the world’s advanced batteries for hybrid and electric vehicles.

“But thanks to our new focus on clean energy and the work that’s taking place in plants like this one, we could have as much as 40% of the world’s market by 2014,” Obama said.

It is true that if we devote a large amount of our resources to clean energy, we could expand our share of the world’s market. If we wanted to, in fact, I’m sure we could devote exorbitant sums to clean energy and capture 80 percent of the world’s market.

Does that mean that it would be a good investment for the U.S. government? When someone invests her own money, she has a stake in that investment working out. Investors who make wise investments have more money to make additional wise investments. No matter how vital government officials think it is to invest in clean energy, they do not have that feedback; whether they invest wisely or not, their cash inflow is not affected. The government does not have the right competitive mechanisms in place, and thus may create more problems for clean energy than they solve.

Why is that? When the government favors certain types of clean energy over others (perhaps yet undiscovered) energy sources, they change the dynamic. As a result, those energy producers make money not because they efficiently produce energy, but because they have curried political favor. Energy producers who receive government monies are also restrained by government regulation and procedure, which stifles innovation.

From the aforementioned speech (emphasis added):

“[...] But my answer to those who don’t have confidence in our future, who want to stop, my answer is come right here to Kansas City see what’s going on at Smith Electric. I think they’re gonna be hard pressed to tell you that you’re not better off than you would be if we hadn’t made the investments in this plant,” Obama said.

I beg to differ. In the cases where clean energy is as good an investment as some proponents claim, private individuals will be willing to put money toward the venture. Many companies want to use efficient, environmentally friendly energy because consumers appreciate that. Clean energy, at its best, will lower costs, a condition necessary for it to become a primary energy source. Cutting the tax rate for all businesses would better promote the move toward clean energy sources than targeting incentives toward specific clean energy plants. If clean energy production is to become sustainable, it needs further exposure to market forces so that the most efficient product can succeed.

In the free market, supply and demand intersect at the point of equilibrium. At this point, the amount that individuals pay for an appliance equals its value. If more individuals were willing to buy an energy-efficient appliance but the suppliers were producing at full capacity, then the price would increase. For some individuals, the higher price will exceed the amount that they value the appliance, and they will not buy one. Additionally, the higher price will incite more firms to enter the market and manufacture energy-efficient appliances, which will push the price back to its equilibrium level.

By offering a rebate, the government distorts the market for energy-efficient appliances, resulting in a loss to the economy. I made the following graph to demonstrate how this happens. (Please keep in mind that I was an economics major, not an art major!) The critical error that many make when evaluating this policy is ignoring this loss.

Graph of Supply and Demand for Energy-Efficient Appliances

Let’s assume that the price of an energy-efficient appliance is $500. At this price, a certain number of people will buy one. For the sake of this example, lets assume that 1,000 individuals will buy one appliance at $500. Next, the government provides a rebate of $175 to incite additional people to buy them. At this lower price, a greater number of people will buy one.

Let’s say that 1,200 people are willing to buy them at this price. Now, these individuals consume a product that the economy-wide equilibrium values at $500, but which the individual values at $325. This means that there is a cost to the economy of $175 (the amount of the rebate) for each appliance sold under the new program. This number, multiplied by the number of additional of appliances sold, roughly equals the dead-weight loss to the economy. In this example, the dead-weight loss equals $175 * 200 = $35,000. In this simplified example, this represents the goods and services that would have been bought in the absence of the rebate, which constitutes destroyed wealth.

Another factor that contributes to the economic loss is the amount of the old appliances that are destroyed despite still being operable. This, too, is represented in the graph.

What’s more, this distortion does not increase the number of energy-efficient appliances sold in the long run. This is because the rebate incites transactions that would have occurred anyway in the future. As old appliances break down, individuals will replace them with new appliances that use improved technology.

Ultimately, the rebate program will destroy wealth and fail to hold down energy prices in the long term. Missourians would be better off if the state and federal governments considered the long-term negative consequences of this policy and let the price system work its magic without this kind of short-sighted intervention.

I guess the news has finally reached Washington. In a recent post on the Political Fix blog, Bill Lambrecht pointed out that the political heat around subsidies is increasing, and this time it is fueled by ethanol. Almost two years to the date after the Show-Me Institute’s release of its case study of the E-10 ethanol mandate in Missouri, another nonprofit research organization has published a study about the inefficiencies of federal ethanol subsidies. The Environmental Working Group’s analysis of the ethanol subsidies concluded:

Americans have spent $17 billion since 2005 to achieve reductions in gasoline consumption that could have been achieved for free.

Today, proponents of ethanol are attempting to piggyback on the recent oil crisis in the Gulf of Mexico in order to gain support for their most recent push to increase the amount of ethanol in the U.S. gasoline supply and keep their subsidies. In a Post-Dispatch article yesterday, Jeffrey Tomich pointed out:

The ethanol industry is also lobbying Congress to extend a tax credit for blending ethanol with gasoline and maintain a tariff on imported ethanol — measures implemented years ago to help a fledgling industry grow. Both the tax credit and tariff are set to expire at the end of the year.

Letting the tax credits and tariffs expire wouldn’t be such a bad thing. Who knows, besides saving the American taxpayers $17 billion dollars, we might actually come up with an alternative energy idea that works.

The State of Missouri recently announced that it would offer an extra $50 in rebates to consumers who participate in the Energize Missouri Appliance Rebate Program. The additional money comes as an incentive to help participants in paying the cost of recycling their old appliances.

But just what are the costs of recycling these appliances? Missouri’s State Energy Efficient Appliance Rebate program (SEEARP) is explicitly restricted to the replacement of existing appliances. Further, there are essentially no qualifications on eligibility for replacing older appliances.

Thus, a couple looking to buy necessary appliances for their new home are not given the government incentive to purchase energy efficient appliances, but homeowners with already functioning appliances are.

What happens to the old appliances? In order to qualify for the rebate, consumers must show proof that the appliance was “properly recycled.” Recycling appliances, however, is tricky business. Most of the materials aren’t biodegradable, so the appliances have to be broken down into their parts and either sold as scrap or, in the case of metals, reprocessed altogether. How much more earth-friendly could this process be compared to simply repairing and using an existing appliance for as long as possible? Further, for the appliance to be recycled, its parts need to be in a minimally workable condition in order to be repurposed. Otherwise, the scrap ends up in a landfill. On the other hand, if the appliance could be repaired, why would anyone replace it? Answer: because you can get a government discount on a new one.

Not only does the SEEARP program then distort the market, it incentivizes consumers, who by and large have no real need for new appliances, to wastefully and expensively toss workable ones. Supporters of initiatives like the rebate initiative may argue that the continued use of such appliances generates a negative environmental impact. While that might perhaps be marginally true, there remain serious environmental, and economic, problems with this argument. For one, the process of recycling old, functioning appliances itself requires a great deal of energy. Further, energy-efficient appliances may even encourage individuals to consume more energy overall. Incentivizing the disposal of viable machinery also misallocates resources that could have been spent on encouraging growth in other areas of the economy. Remember: The rebate program does not simply encourage people to buy energy-efficient appliances, but to replace their old — functioning or not — appliances.

Additionally, in order to qualify for the rebate, consumers are limited to select Missouri retailers. This might not be cost effective for the consumer, who, for instance, could potentially find a better deal online — and it’s certainly not cost effective for Missouri.

Because the rebate program only applies to recycling an appliance, consumers are further disincentivized from selling, or donating, these appliances to others who might need them. Those who actually need to purchase appliances, either new or used, are therefore harmed by the program, both because workable, used appliances would need to be recycled, rather than sold or donated, by owners replacing them with energy efficient appliances, and because those who want to purchase a new appliance do not qualify for the rebate.

The truly green solution is to let consumers decide without government prodding when, and how, to replace their appliances.

Photo from the Kansas City Star.

Sing along:

Go ahead and hate your gasoline,

Go ahead and scam a friend.

Do it in the name of subsidies,

You can justify it with an E-10 blend.

There won’t be any markets working,

Come the judgment day,

On the inefficient morning after …

One free marketer rides away.

(continue singing)

And, I should add, rides away with 3 percent less gas mileage.

Thanks to Billy Jack Combest for the KC Star link.

The St. Louis Post-Dispatch editorial board wrote a piece yesterday about a number of bills in the legislature that would allow utility companies to request rate hikes every six months, as opposed to the current policy that limits a change to every 11 months. The Public Service Commission regulates the rates of investor-owned utilities, like Ameren electric and Laclede gas.

From the article:

Under the proposed new law, rate hike cases could last no more than six months, meaning utilities could file two requests each year.

That’s not just two rate hike cases for each electric company, including AmerenUE. It also means extra rate cases for water companies, including Missouri American Water, which is seeking a 21 percent rate hike, and for gas companies, including Laclede Gas, which has a $52.6 million rate hike request before utility regulators.

Last year, when AmerenUE raised its rates by 8 percent after a 12.1-percent increase the previous year, the utility’s president justified it in order to continue “maintaining reliable electric service.” He also said:

“Much of the increase covers the costs of projects initiated to improve the reliability of our electric system, the costs of environmental and efficiency improvements at our generating plants, and the costs of fuel for those plants.”

It is hard to evaluate the validity of these claims without a field of competitors providing greater incentives for efficiency and cost reduction. That competition doesn’t exist, though, because utilities are generally viewed as a natural monopoly, an industry that requires economies of scale so large that it is most efficient to have a single supplier. As a result, municipalities generally restrict entry into utility markets. In The Concise Encyclopedia of Economics, economist David Henderson pointed out that this restriction is probably unnecessary:

Economists tend to oppose regulating entry. The reason is as follows: If the industry really is a natural monopoly, then preventing new competitors from entering is unnecessary because no competitor would want to enter anyway. If, on the other hand, the industry is not a natural monopoly, then preventing competition is undesirable. Either way, preventing entry does not make sense.

In “The Myth of the Natural Monopoly,” Loyola University economics professor Thomas J. DiLorenzo cited economist Walter J. Primeaux’s findings from more than 20 years of studying electrical utilities and competition:

• Contrary to natural monopoly theory, costs are actually lower where there are two firms operating;
• Contrary to natural monopoly theory, there is no more excess capacity under competition than under monopoly in the electric utility industry;
• The theory of natural monopoly fails on every count: competition exists, price wars are not “serious,” there is better consumer service and lower prices with competition, competition persists for very long periods of time, and consumers themselves prefer competition to regulated monopoly;

If a utility is providing the lowest price, a competitor’s challenge will not be a serious threat. Competition itself — or the potential for competition — can keep prices low. Regulatory boards, on the other hand, historically have not been successful in lowering prices, as DiLorenzo noted:

In one of the first statistical studies of the effects of rate regulation in the electric utilities industry, published in 1962, George Stigler and Claire Friedland found no significant differences in prices and profits of utilities with and without regulatory commissions from 1917 to 1932. Early rate regulators did not benefit the consumer, but were rather “captured” by the industry, as happened in so many other industries, from trucking to airlines to cable television.

If barriers to entry are low enough, the potential for competition can increase efficiency and cost reduction in existing utilities. Instead of a focus on how often a utility company can change its rates, Missouri residents would benefit more from lowered regulatory barriers to entry in utility markets. In that case, future rate increases — like the recent decision to increase rates by 3 percent in order to promote energy efficiency — will be weighed against the possibility of a competitor attracting market share through lower prices.

Writing in the St. Louis Beacon, Washington University professor of Earth and planetary sciences Bob Criss argues that raising the Missouri gas tax could solve a number of environmental and social ills. Although I’m opposed to pretty much all taxes, I’m somewhat amenable to Criss’ argument. If we have to tax something, it is far better to tax something no one wants, like pollution, than to tax something everyone wants, like income (or general consumption, for that matter).

However, the Missouri Constitution makes implementing Criss’ proposal somewhat problematic. The state Constitution requires that funds generated by the gas tax be dedicated to building and repairing roads, bridges, and highways. The goal of a higher gas tax for Criss is that people would use less gasoline by driving less or using more fuel-efficient vehicles, but more and better roads will at least marginally increase people’s incentive to drive by allowing them to reach more destinations more quickly and comfortably. Increased roadwork would also generate a fair amount of air pollution. Those effects probably would not completely eliminate the environmental gains of a higher gas tax, but they are worth considering.

Furthermore, if people drive less but there are more gas tax revenues to spend, we will end up wasting that money on underused roads and highways. In short, while Criss’ proposal is not without merit, implementing it properly would involve a much greater challenge than simply raising the gas tax.

The big news in Missouri today is President Barack Obama’s visit to an ethanol plant in Macon, so I thought it would be worth briefly rehashing the airtight case against ethanol subsidies, as we have done here so many times in the past.

Most obviously, ethanol costs more than gasoline, so consumers have to pay more for energy to run their vehicles. However, because ethanol diverts foods like corn from their more traditional use as energy for humans and farm animals, food prices are driven up by greater ethanol use. Ethanol backers like to claim that such costs are justified by the environmental benefits of ethanol, but those benefits appear to be completely illusory. From the abstract of a 2008 study on biofuels:

Most prior studies have found that substituting biofuels for gasoline will reduce greenhouse gases because biofuels sequester carbon through the growth of the feedstock. These analyses have failed to count the carbon emissions that occur as farmers worldwide respond to higher prices and convert forest and grassland to new cropland to replace the grain (or cropland) diverted to biofuels. By using a worldwide agricultural model to estimate emissions from land-use change, we found that corn-based ethanol, instead of producing a 20% savings, nearly doubles greenhouse emissions over 30 years and increases greenhouse gases for 167 years.

Research has repeatedly confirmed that ethanol subsidies only drive price inflation for both energy and food without cutting greenhouse gas emissions, and it is long past time for politicians to admit that such programs are nothing more than a means for buying favor with voters in agricultural states.

I’ll be appearing on the Mike Ferguson Show on The Eagle, 93.9 FM in Columbia, this afternoon to discuss ethanol. Everyone can listen live online, and I hope you will tune in.

A blogger, commenting on my recent editorial about the wasteful nature of Missouri’s green tax rebate program, recently expressed skepticism that promoting the purchase of energy-efficient appliances may also encourage individuals to consume more energy.

In the second part of his post, he links to an article on Slate that cites a study analyzing electricity consumption patterns in the wake of government policy intended to “nudge” consumers into using less energy. First and foremost, this study is not relevant to my argument. In the case of Missouri’s green rebate program, which is what I discussed in my commentary, individuals receive a cash rebate when they buy energy-efficient appliances. The study cited in the Slate article looks at a case in which the electricity company simply sent its customers a home energy report that included charts and a list of tips on how to improve energy efficiency. The program considered by this study included neither a financial incentive, nor an upgraded appliance. The only conclusion that I would feel comfortable making from the study is that pamphlets do little to influence individual behavior. The study suffers from additional shortcomings, as well. For example, I disagree that a change of 1 percent or 3 percent is significant. This variation could be attributable to multiple other variables, such as a change in the price of energy or a seasonal change in the weather. The study also did not prove that the customers it identified as “liberals” reduced their energy consumption as a result of the home energy reports. Again, this reduction could have stemmed from any variety of other factors. Furthermore, because the percentage change and the sample size are both so small, a completely different result could conceivably be selected from the raw data.

According to a report published by Peter Huber and Mark Mills at the Manhattan Institute, the claim that we can meet future energy demand through conservation and efficiency is a myth. They provide evidence that, despite dramatic gains in energy-efficiency, aggregate energy consumption has increased over history:

The American economy has experienced massive efficiency gains: for each unit of energy, we produce more than twice as much GDP today than we did in 1950. Yet during that period of time, our national total energy consumption has tripled. Paradoxically, when it comes to energy, the more we save, the more we consume. [...]

“Efficiency fails to curb demand because it lets more people do more, and do it faster—and more/more/faster invariably swamps all the efficiency gains,” Peter Huber and Mark Mills state in The Bottomless Well. Or, as Huber characterized this “efficiency paradox” in a 2001 Forbes column: “More efficient jet engines … cheaper tickets … more passengers … more jets in the air.” The same holds true for cars, lightbulbs, power plants, and everything else that uses energy.

Furthermore, an economic moral hazard problem is often associated with buying green products. Energy-efficient appliances make doing dishes and laundry cheaper, which subsequently encourages individuals to use these appliances more frequently than they had before. Increases in energy efficiency mean that there is a decreased need for the existing energy supply, which leads to a reduction in the cost of energy, consequently shifting the demand curve for energy to the right. Similarly, there is evidence that owning a fuel-efficient car encourages people to drive more. A person could become less inclined to turn off light bulbs when they are more efficient, just as a person could be more inclined to run his washing machine or his dishwasher when it is not full.

Today, I spoke with Maria Keena of KMOX about my editorial, published today, arguing that Missouri’s green tax rebates are a wasteful use of state funds. The interview is scheduled to air on KMOX radio in St. Louis around 6:00 p.m. and tomorrow during the morning drive-time show. I encourage our blog readers to tune in!