The Liberal Party and Neoclassical Economics

A quote from a recent Liberal Party report on the oil sands

Yet oil sands development is accelerating. It is as though the oil sands have been, and are being, developed within the confines of a neo-classical political and economic mindset that ignores externalities – in this case, the cost of economic development on the country’s valuable freshwater assets.

It appears the Liberal party is suggesting that neoclassical (or neo-classical) economics ignores the externality problem. The record, however, shows otherwise:

From one of my favourite journal articles - The core disagreement between Pigou, the profession, and Coase in the analyses of the externality question by Harold Demsetz:

Prior to Coase's article there was an unquestioning presumption [in the economics profession - Mike] as to where responsibility for externality costs (and benefits) should rest. This is true of Pigou's initial discussion of externalities and also of the profession's doctrine toward externalities at the time Coase wrote. The owner of the factory from which soot-filled smoke rises is held responsible, without question or analysis, for the increased cost of washing cloths in the neighboring laundry on which the soot falls. The owners of the ranch from which cattle stray to surrounding corn fields and of the railroad from which sparks fly are similarly held responsible for damage done to crops. This presumptive judgment made it difficult to recognize that the social value of the activities of the interacting parties might, in sum, be greater if the harmed party is left to bear the damages. If this possibility is not recognized, the inclination to take an analytical view toward the transaction cost variable is repressed, for the importance to be attached to transaction cost becomes apparent only on a genuine comparison of alternative assignments of responsibility.

The rationale for this asymmetrical approach is not in the neglect of transaction cost, but, rather, in a second implicit presumption made by Pigou and the profession - an omniscient and omnipotent government. The tax policy of an all-knowing, well-motivated state results in corrective adjustments for externalities that accord with the economist's prescription; this obviates the need for considering alternative assignments of responsibility. The problem is analyzed as if the state is a perfect agent through which the blackboard plans of economists can be brought to fruition. Ignoring State-associated costs of errors, implementation, and improper motivation, rather than ignoring the cost of using of markets, is the root cause of the asymmetrical approach brought to the assignment of responsibility...

Note that Coase's paper The problem of social cost was published in 1960.  Pigou's argument is from his 1920 book The economics of welfare, which was a sequel of sorts to his 1912 book Wealth and welfare.  Does this sound like a profession that was ignoring the externality problem?  I'm baffled why the Liberal Party would believe that taking a swipe at neoclassical economists and our mindset was a good idea.

Additional resources:

• The economics of welfare (1920) - full text.
• Wealth and welfare (1912) - full text.
• The Coase theorem is tautological, incoherent or wrong - not entirely relevant to this discussion, but one of my all-time favourite papers, by Queen's Dan Usher.

Comments

[Declan]

Meanwhile, back in the real world, the neoclassical political/economic mindset shows up on the pages of our national newspaper in quotes like this one,

"National vilification of world-class resources such as the oil sands over the accidental deaths of fewer ducks than die every minute of hunting season, urbane-elitists stuck in the old paradigm that denigrates resource developers as 'hewers of wood and drawers of water,' noisy non- governmental organizations that believe Canadians can thrive by changing the countryside into one vast national park and regulatory processes that turn development of new metal mines or hydro dams into a decade-long nightmare will need to give way to responsible and constructive engagement."

Gwyn Morgan, last Thursday in the Globe and Mail arguing that the only reason anyone opposes the Oil Sands is because of the ducks.

But I certainly appreciate that knocking down a straw man 'The Liberals said that there never any papers written on externalities by economists,' is easier than discussing the simplistic externality-free notions of invisible hands and free markets that drive right-wing policy decisions in this country.

[Mike Moffatt]

"But I certainly appreciate that knocking down a straw man 'The Liberals said that there never any papers written on externalities by economists,' is easier than discussing the simplistic externality-free notions of invisible hands and free markets that drive right-wing policy decisions in this country."

Because if WCI can be accused of anything, it's treating right-wing political parties with kid gloves.

[Stephen Gordon]

Wouldn't it be nice if both sides eschewed inanities?

[Mike Moffatt]

We'd be out of a job, though. I think I could live with that.

[Stephen Gordon]

Actually, it'd be nice if even just one side did.

[Mike Moffatt]

I'd even take a 5% reduction on one side.

We clearly need a Pigovian tax on inanities.

[Declan]

"Because if WCI can be accused of anything, it's treating right-wing political parties with kid gloves."

I wasn't accusing WCI of anything, just saying that you were taking a lazy approach in this post shooting down your interpretation of what someone said, when it seems clear they meant something else that would require a bit more work to tackle.

But maybe it is easier to knock down the straw man 'Declan says WCI treats right-wing parties with kid gloves' than discussing the simplistic externality-free notions of invisible hands and free markets that drive right-wing policy decisions in this country. :)

[Mike Moffatt]

Well, for one thing I disagree with your entire premise. It's not as if *any* political party does well on this front (see 'carbon tax' and 'B.C. NDP'). Unless you define politically right-wing as 'anyone to the right of Kim Jong-Il', I can't see how your statement applies to Canada.

[Mike Moffatt]

Also, I'd like to see anyone make the argument that neoclassical economists have ignored externalities more over the last, oh, 20 years, than the Liberal Party of Canada (glass houses and all that). It's an impossible argument to make.

[Stephen Gordon]

You know, this is just another example of how policy discussions get degraded once they become the object of partisan politics. A nuanced discussion of costs and benefits degenerates to "There are no benefits!" vs "There are no costs!". Loudest shouter wins.

[Just visiting from Macleans]

The pace of the oil sands development is largely Alberta provincial responsibility - they auction off the leases and issue development permits through the ERCB. Not sure what the point of the discussion might be at a national level.

Gwyn Morgan, btw, was the oil and gas industry's self appointed spokesperson against Kyoto, touting the still elusive "Made in Canada" solution to emissions reduction, while he was head of EnCana.

[Frances Woolley]

Surely Stephane Dion and the Liberal Party deserve some credit for advocating a carbon tax - the solution to the problem of externalities suggested by Pigou.

I'm not sure exactly the relevance of Coase when thinking about the tar sands. The truly staggering environmental costs of tar sands development will be borne by future generations - and they're not here at the bargaining table, which would seem to be a bit of an obstacle to achievement of efficiency through bargaining.

[Just visiting from Macleans]

Dunno about Dion credit. His execution/communications strategy and "tax shift" platform probably set the the carbon tax movement back a few years rather than advancing it. Certainly in the short and medium terms.

[Stephan Wehner]

I don't think it's fair to quote / mention articles that are 50 years old or older when you want
to reject what someone is saying today.

Stephan

[Mike Moffatt]

Agreed with JVfM (is that a first?) It also ignores the decade+ the Liberals were in power.

That being said, it's a bit of a digression to discuss. Larger point is ignorance of neoclassical economics.

[Stephan Wehner]

Instead of pointing to theory, could you give a more concrete example where policies
based on "neo-classical political and economic theories" have in fact dealt with externality
problems?

Stephan

[Mike Moffatt]

Stephan: Actual policies? How about the The Acid Rain program section of the Clean Air Act Amendments of 1990?

[Mike Moffatt]

I should create an entire blog post about it, but a decent backgrounder is here:

http://www.celsias.com/article/depth-look-emissions-trading/

[20th century workforce]

http://www.climatelaw.org/cases/country/canada/media/kpiadismiss

Why didn't Courts uphold KIA in 2007 other than "it will cause a recession"? Tar Sands's 135% or so (20% peat is my monopoly guess) emissions premium to oil will cause them to be shut down (lack of market when millions die somewhere), in 2020 or 2030. This "will cause a recession" because AB raids Heritage Fund ($14B vs Norway $400B). If our Courts prevent recessions as a goal why do our Judges allow Flaherty big-cap tax rates given petro price and export uncertainties? Finance too should legally institute P.Martin late-1990s no merger arguments. Ignoring boomer aging also induces recession. Running 14-figure deficits indefinitely to gut counter-cyclical safety net....

Just Visiting, isn't pollution a federal responsibility here like EPA in USA? Ont can't dump nuclear waste 10m metres upstream of Que.
Mining is provincial but can't mint coins.

[Stephan Wehner]

Thanks for the example!

I found a few other discussions in more recent literature:

1.

"Present-day neoclassical economic theory and its applications to development policy seriously overlook or undervalue major ecological concerns. The economic values of environmental services, while very real, are systematically underestimated in cost-benefit analysis because of measurement and valuation difficulties. ‘Intangible’ environmental benefits, such as those derived from the preservation of biological diversity, are recognized even less in economic analysis. The irreversible environmental effects of projects or policies are usually treated no differently from more reversible effects. The practice of discounting economic costs and benefits strongly favors projects with short-term benefits and long-term costs, often (though not always) with highly negative environmental effects."

Robert Goodland and George Ledec
Neoclassical economics and principles of sustainable development
Appeared in: Ecological Modelling
Volume 38, Issues 1-2, September 1987, Pages 19-46

2.

"The paper will argue that neoclassical thinking around markets makes key assumptions on efficiency, effectiveness and equity that are not suitable for emerging renewable electricity technologies. The workings of the RO and the planned addition of a feed-in tariff (FIT) will be critiqued using alternative assumptions of the market under a green economic framework (Kennet and Heinemann, 2006). The paper discusses what a green economics vision of the structure of renewable electricity in the UK could be."

Where neoclassical economics fails: impacts on renewable electricity in the UK
Sarah Skinner A1
International Journal of Green Economics
Volume 3, Number 3-4 / 2009
Pages: 402 - 413

3.

"When you buy those pants, neoclassical economists assume that you take into account not only the price, but the material the pants are made from, its scarcity, environmental damage, labor associated with its creation, et cetera when you decide to purchase them. In this way the market is perfect at managing scarcity. We all know that reality is far from this picture, however; consumers make decisions with limited information and often without consideration of the far-reaching effects and “externalities."

Externalities and Valuing Non-Market Goods
Joshua Nelson
http://steadystaterevolution.org/externalities-and-valuing-non-market-goods

Stephan

[20th century workforce]

EPA had the ability to regulate CO2 pollution under GWB; but can be ignored. Could a Liberal gov ask Courts to rule minus economic judgement? Kyoto has a late payment interest rate. Philippines stole their trading $10B, and "clean coal" funded. Leakage (paying for already planned) around 13%; acceptable given time-sensitive AGW fat-tails.
AB transfer payments are capped but fed deficits aren't. Ways to make public and private spending more efficient beyond N.Europe 2010 ratio. Without tax/cap/EPA-veto, oil inefficient. More profits can lead to inferior bank service. GST cut instead of indexing to debt or commodity/housing prices. Public spending historic low, census was efficient. CPC increases are GOP-failed war, prisons.

When feds inefficient to happiness, cap fed deficits, when provinces drunk, raise transfer payments (could offer prov bond subsidies and penalties). Pearson, Trudeau (Charter prevents USA corporatism), Chretein and NDP Tommy, reasons Canada so prosperous. Jean would've told 2007 Court where to stick their GDP. Majority not enclosed by Cranbrook to PlaP, or E.Quebec, want a Northern European country that seeks quality-of-living as a goal. Let the West separate and replay GOP mistakes eternally with resource windfall: Texas. Let Eastern Que separate economically inefficient, culturally inward and old, but with good safety net: Italy-Japan hybrid. The rest is a country capable of leading the world past novelties and learning from mistakes of others: Chretein Canada.

[rhaps]

Just Visiting, isn't pollution a federal responsibility here like EPA in USA? Ont can't dump nuclear waste 10m metres upstream of Que.
Mining is provincial but can't mint coins.

Yes, technically, the Feds could intervene on water (discharge rivers that transgress provincial/territorial boundaries); pipeline approvals across provincial/international boundaries by the NEB (National Energy Board); and perhaps air quality, though I'm not sure of that - I think it's largely provincial.

A carbon tax, applied universally by the Feds MAY slow down oil sands development (at worst make it slightly less economic) but that requires some insight/analysis before concluding one way or the other its impact on status quo development.

[Just visiting from Macleans]

I dunno how that happened - my last entry by "rhaps" was me. The perils of just visiting...

[Mike Moffatt]

Stephan: If you're interested in learning more about the intersection between neoclassical economics and environmental policy, there's an entire think tank devoted to it:

Property & Environment Research Center
http://www.perc.org/

[Mike Moffatt]

That being said, PERC, like any think tank often advocates policies that are out of the academic mainstream (see 'Fraser Institute' and 'census') because of political/ideological bias. That being said, they're often (but certainly not always) on the side of angels.

[Wonks Anonymous]

"When you buy those pants, neoclassical economists assume that you take into account not only the price, but the material the pants are made from, its scarcity, environmental damage, labor associated with its creation, et cetera when you decide to purchase them"
Have they ever heard of "I, Pencil"? The point, most extensively made by Friedrich Hayek, is that it is ridiculous to expect consumers to keep account of all those things in a complex economy. Rather, the price itself is supposed to aggregate information about scarcity etc. The neoclassical approach (following Pigou) is for the price to be raised through a tax in order to compensate for the associated environmental damage.

[20th century workforce]

Wonks, I like Tobin Tax and honey subsidy. Cotton appears to function as foreign aid.
Product labelling standards help. At +$6can now I'd only buy the rainforest coffee if middle class but if it comes down to +$2can I'd pay the premium even though I might have negative footprint.

perhaps, I guess Courts never ruled on CO2 yet. Judges need economics education or need new impartial judges appointed.
Dion $20/tonne a nice start but shift absurd in future peak oil era; might've stimulated oil. NDP cap shift to green R+D and Liberal Spring 2008 plan to shift cap revenue to green industry were superior. With a cap (which seems to go against the grain of *transitioning* energy by only considering existing players) at 2010 levels, tar sands claim are breakeven at $60 barrel at existing regulations. If 130% more CO2 intensive, that is $78/barrel. Assuming stronger CAD over lifetime (thx to Tommy and P.Martin no mergers), maybe $90/barrel for USD customer? Their consumption is going down 3% a year and are aging and greening (rate politically uncertain), maybe $100/barrel. Maybe $105/barrel to poison water less, IDK? $10 is peat emissions premium, maybe can disturb less but also be more fires with dried out peat, no? The way they claim are changing ways and shred a report...Fort Chipyewan has cancer and Mackenzie strategic aquifer polluted, so who would let a pipeline through BC or North? Are Thunder Bay or Churchill pipelines cost-effective? Again, a 40 or 50 year pipeline will be cut to pieces as soon as first AGW disaster.
Social Credit founded because of lack of response to Great Depression drought. Ironically causing global future droughts and no safety net, while big brothers try for another GD. Chip renders two regions irrelevant. But N.Europe invaded twice. I guess if feel you've been slighted, spoiled brat, but if actually slighted, appreciate value of life?

[Andrew F]

Not to be nit picky, but that last post is a bit incoherent. I'm guessing it's stream of consciousness, but if you're going to take the time to share your thoughts, why not invest a little more so people understand what you're saying.

[Nick Rowe]

What Pigou (certainly a mainstream neoclassical economist) wrote in 1920 is certainly relevant. But even more relevant is the fact that every first year economics text (to my knowledge) has a full discussion of externalities. Usually a whole chapter. And we teach it. We can't reasonably be accused of ignoring externalities.

[Patrick]

The report isn't available on the committee website. Based on the description in the Liberal party press release, they didn't actually make any policy recommendations. It's all pointless pseudo-intellectual posturing.

Why, oh why can't we have a better opposition?

[Stephan Wehner]

I looked at the first article on the front page of http://www.perc.org, which is at http://www.perc.org/articles/article1287.php

It has this rant towards the end, "Anyone who thinks the free market is to blame for such problems hasn't been paying attention to the last century of increasing government interference in every aspect of the economy, including business and other subsidies that discourage accountability."

I think that attitude is entirely consistent with a statement like "neo-classical political and economic mindset that ignores externalities".

I get the impression that neo-classical economists might talk about externalities, but they think of them simply as externalities, and not at the level of disasters.

It so occurs then, that you might benefit from a listening session, as opposed to going into explaining mode.

Stephan

[Patrick]

Stephan, I think you're assuming that 'neo-classical' economists is synonymous with the current dismal state of affairs. I don't think that's necessarily the case at all. I'll grant that I too find the PERC rhetoric distasteful and a little inaccurate, but they ain't entirely wrong.

Consider: in AB the government long ago changed tort law to make it virtually impossible for citizens to sue for damages and/or halt activities that wreck the environment and thus their private property in ways that would otherwise constitute trespass. Believe me, if farmers and land owners could sue oil and gas or mining companies for trespass when the companies wrecked that land, water or air, things would be very different.

This might interest you: Property Rights in the Defence of Nature

Also, the River Keepers used tort law to great effect. Their history might interest you.

[Just visiting from Macleans]

in AB the government long ago changed tort law to make it virtually impossible for citizens to sue for damages and/or halt activities that wreck the environment and thus their private property in ways that would otherwise constitute trespass.

Patrick, can you elaborate?

[Patrick]

IANAL. My understanding is that once projects get regulatory approval, you're done. No suing (barring negligence or fraud or something like that). During the approval process only people 'directly' affected can submit objections, and the who is considered to be 'directly' affected is left-up to the (captured) regulator to decide. Of course, the definition of 'directly' affected is pretty narrow. So once they approve a project that, for example, ends-up polluting the ground water (e.g. coal bed methane) or polluting the rivers (tar sands) or as part of it's normal operation then there isn't anything you can do.

Looking at it from another angle: if people can sue, then why haven't they? Surely a case could be made by the people of Fort Chip (for example) that tar sands operations polluting the Athabasca constitutes trespass, and thus the companies have to stop any further pollution and pay damages for past pollution? It's not criminal so the bar is much lower ('balance of probabilities' instead of 'beyond a reasonable doubt'), and trespass is quite broad (when not hamstrung).

Again, I'm not a lawyer, so I could be totally wrong. Maybe someone who knows more can clarify.

[Nick Rowe]

Stephan: "I get the impression that neo-classical economists might talk about externalities, but they think of them simply as externalities, and not at the level of disasters."

Nick in "explaining mode": some externalities are positive; some are negative; some are little; some are big; and some are big and negative and are disasters.

Nick in "listening mode": did you mean something different Stephan?

[Just visiting from Macleans]

Patrick - I think you're reading too much into it.

Yes, to get intervenor atatus in a regulatory hearing, you do need to be directly affected and represent a unique perspective. Members of the public are generally represented by, say, groups like the Public Interest Asdvocay Cenntre, Consumers Association of Canada, and in Alberta, often the Pembina Institute, Sierra Club, Green Peace etc.

Suncor and Syncrude have for years been creating massive tailings ponds to store waste water and all those nasty chemicals/heavy metals (because it costed too much to clean it up at the time). But, they are still required to maintain the integrity of the dykes, keep the wildlife off of/out of it. If one of the dyke walls failed, they'd still be liable for the environmental damage /clean up - similar to BP. In this case, the fault would be easily proven.

The problem with the situation at Fort Chip is proving cause and effect, and the expense of taking the big players to court - but the option is still open. It seems to me they would be required to prove negligence by one of the companies in not properly containing the tailings (in accordance with their license), and that this directly caused health related problems as a result - not an easy standard to meet.

Remember when Wiebo Ludwig was blowing up EnCana failities in the early 90s because he claimed sour gas flaring/fugitive gas venting was affecting his family's health? Some O&G companies, faced with similar concerns with farmers have compensated them for dead cattle etc. in the past. So, the liability doesn't end at regulatory approval phase. Ludwig's problem was that he went the criminal route/perhaps acting as his own lawyer in negotiations that eventually failed (with the aforementioned Gwyn Morgan btw while at AECL/EnCana). Perhaps not so coincidently, Alberta tightened up flaring/venting regulations a few years later.

[Patrick]

Perhaps.

I don't think one would need to prove cause and effect under trespass laws.

I think we probably need a real lawyer to clarify.

[20th century workforce]

Our federal offshore oil cleanup liability limit is $30M. I assume is same for tailings pond breach? Leakage over time would be just one $30M liability cap? The shredded report, if federal gov is captured, can't you just move the lawsuit from AB and oil sands companies to Canada or fed Parties that voted to shred document?

[Just visiting from Macleans]

I think we probably need a real lawyer to clarify.

Trespass? Perhaps I missed your point. Are you claiming the oil sands mining ops are trespassing on Fort Chip treaty lands (ie Alberta has no mining rights to these lands) or are you suggesting discharges from these industrial ops eventually enter waters where the Fort Chip people reside?

I don't think we need a lawyer here to dispute a very broad interpretation of trespass laws. Here's the Alberta Trespass To Premises Act. Even if the transgression qualified (can't see how) cost/benefit makes any legal effort grossly uneconomic:

Offences and penalties

3 A trespasser, whether or not any damage is caused by the trespass, is guilty of an offence and liable

(a)for a first offence, to a fine not exceeding $2000, and

(b)for a 2nd or subsequent offence in relation to the same premises, to a fine not exceeding $5000.