The oil industry is attacking the proposed climate change legislation that has passed the House and is on its way to the Senate.  Here is a summary of the arguments from the American Petroleum Institute:

“The House climate change bill will increase costs of gasoline, diesel and aviation fuel, and drive jobs and production overseas, increasing greenhouse gas emissions (GHGs) in foreign countries that will have a new competitive advantage. Under the so-called ‘American Clean Energy and Security Act’, U.S. refiners will have to buy allowances, increasing their costs and giving a competitive advantage to non-US refiners. U.S. jobs will be lost and contrary to the bill’s intention, America will be less energy secure and more reliant on imports of gasoline and other refined products."

Wow.  That’s a lot to swallow.  Let’s take it step-by-step.

First, the proposed climate bill “will increase costs of gasoline, diesel and aviation fuel.”

Yes!  Absolutely!  Totally true!  That is the entire point of the legislation!  And it is a good thing!

Now before you think I am some kind of tree-hugging, left-leaning radical, let me tell you what the most famous conservative and libertarian economists say about the subject.
Alan Greenspan – the former Federal Reserve Chairman, acolyte of Ayn Rand, and self-described Libertarian – favors a hefty gasoline tax of at least $3 or more per gallon because, he says, we “need significantly higher gasoline prices to wean us off gasoline-powered motor vehicles.”

Milton Friedman agrees.  Remember him?  He was the Nobel-prize-winning economist from the University of Chicago who provided much of the intellectual firepower behind Reaganomics.

Why do these intellectual giants of conservative and libertarian economics favor taxes on gasoline?  Simple.  It has to do with something economists call “externalities.”

To understand externalities, consider a chemical company that offered to create more jobs and lower prices.  There is just one catch.  They will save the money to make this possible by dumping their toxic wastes into the pond in your backyard instead of disposing of the waste properly.  In other words, they will make the cost of avoiding or cleaning up pollution “external” to the price of their product.

Obviously, that is not acceptable.  Proper disposal of toxic waste is a cost of doing business and it should be factored into the price of the product – even if that means higher prices and/or fewer jobs.

The costs of avoiding or cleaning up pollution, however, are not always incurred by the producer or passed on to its customers.  For example, coal-fired power plants have delivered relatively low-priced electricity for more than 100 years, but have also been dumping carbon dioxide and other greenhouse gases into the atmosphere.  The same with petroleum products like gasoline and diesel fuel.

That is why Greenspan, Friedman, and many other conservative and libertarian economists have favored taxes on gasoline and other substances that cause pollution.  Because the failure to account for the cost of pollution tends to distort many basic economic decisions such as pricing and competition.  People think they are getting a good deal because their gasoline and electricity are relatively cheap.  But they are really only imposing the cost of pollution on the environment.

By imposing a tax equal to the cost of avoiding or cleaning up the pollution, the market will make rational choices based on the real cost of the polluting product.  And – this is very important – inventors and investors will have an incentive to develop cleaner alternatives that can be sold at a competitive price without the pollution tax.

So, the oil industry does not get any points for arguing that the climate change legislation will increase the price of gasoline, diesel fuel, and aviation fuel.  That is what it is supposed to do.

BUT!  The oil industry has a very legitimate point when it argues that the proposed legislation will “drive jobs and production overseas, increasing greenhouse gas emissions (GHGs) in foreign countries that will have a new competitive advantage.”

Anyone who has seen horrific pollution in developing countries knows what will happen to our environment if we simply drive up costs in the more developed economies.  Without a comprehensive, global approach to pollution and climate change, we will just shift the externalities (costs of pollution) from our own backyards to backyards of very poor and politically less influential people in developing countries.  And we will not be able to fence in the adverse effects.

Which leads to questions that have more to do with politics than economics.  How do we get to a global solution on climate change?  To what extent must we, in the more economically developed world, take the first step and make the first sacrifices?  And to what extent should we refuse to budge until the rest of the world agrees to follow?  And you thought economics was the dismal science.  More on the politics and diplomacy of a global climate change agreement in later posts.

John Howley
Tokyo, Japan
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