Afternoon roundup

The tabs. There are too many.

• Dan Brunskill asks 20 economists how they'd define recession. A bunch of us pointed to how NBER does things. 
• Believing that recycling does much of anything to reduce GHG emissions is wrong and gets you laughed at. Believing that reducing your consumption of things covered by the ETS will reduce GHG emissions is also wrong, but generally gets you plaudits. 
• A paranoid person might start to think that government-funded media goes on crusades to name and pillory pseudonymous critics of the government who do not share their cultural views. 
• The last $5b of the Covid fund was blown on a bunch of populist vote-buying exercises. Good luck getting cross-party consensus to take on just-in-case debt in the next crisis. Labour has really poisoned this well. It is very bad if you think that future governments need to be able to do this. 
• Harvard should protect whistleblowers.
• Michael Gordon has a substack. And he provides a helpful reminder about SNZ's work trying to figure out why the jobseeker numbers are so out of whack when compared to the unemployment figures. 
• Susan Edmunds checks on CTU Craig Renney's claims that the economy's doing great. I pointed to a couple cautions, but also one area where he might have understated things: employment rates were at or near historic highs before Covid hit. 
• Oliver Lewis points to the ways that National's housing policies will likely fail. I still wish National and Labour could have maintained consensus on MDRS by setting a price target for exemptions. 
• There were a lot of appropriate condemnations of poor forestry practice leading to bad outcomes during the recent floods. And a lot of that turned into the usual "it's all neoliberalism's fault" nonsense. Anyway, here's Queenstown Council doing exactly the same thing, causing similar problems.
• I still think the funniest chaos outcome for the election would be Labour winning, but only because it loses enough party votes to the Greens that it gets a substantial overhang from its electorate seats. One can engineer scenarios where National and ACT get 51% of the vote and still lose. It's not entirely plausible, but it would make for a chaotic election night. Here's Greg O'Connor stumping for the electorate vote.
• Remember how I wanted a public health agency laser-focused on contagious disease so it wouldn't just shift back to its usual BS? Pandemic's still going, and they're already back on their usual nonsense. 
• Ngāi Te Rangi is importing houses from the US to build here. I still think that iwi should declare themselves to be their own consenting authorities and tell naysayers to sue them if they don't like it. If council makes it tough for iwi to build houses on their own land...
• BusinessDesk has a series on cost blowouts on infrastructure. On average infrastructure costs have been 23% over their initial budgets. The paper's really worth the sub. 

Forestry and the ETS

I got our submission in on the ETS review and forestry just under the wire last Friday. 

For those interested, it's here.

I really hate the precedent that the government is setting here. 

Farmers are mad about afforestation, and afforestation can have adverse consequences that have nothing to do with net emissions. But those can and should be dealt with by the parts of government best suited to dealing with each of them as they arise.

The alternative to sound Tinbergen-style policy is that we wind up in consultations about different ways of breaking the ETS every time changing carbon prices lead to changes in activities that have their own potential externalities. 

I go through a few examples:

2.12 Consider the perils of the alternative approach, which would require the ETS to reconsider which forms of carbon sequestration or gross emission reduction it might recognise or to what extent – because carbon prices encourage ‘too much’ of the activity resulting in other ancillary problems. A few simple hypothetical examples follow: 

2.12..1 Carbon sequestration through olivine transformation proves highly cost-effective, but olivine mining causes changes in land use and community concerns about heavy truck traffic. Rather than use consenting processes to mitigate externalities from mining or appropriate road-user charging and roading upgrades to deal with truck traffic, the Climate Commission is asked to pretend that this form of direct-air capture carbon sequestration does not sequester carbon – to reduce the incentive to engage in olivine mining. 

2.12..1.1 A new methane inhibitor for livestock proves highly cost-effective in reducing biogenic methane emissions. For sake of argument, let us imagine that this happens after biogenic methane emissions are brought fully into the ETS as CO2-e and are subject to the ETS cap – or are subject to their own methane trading system. The new methane inhibitor unfortunately increases nitrogen concentration in cattle urine. And because dairy farmers face lower methane charges with lower emissions, dairy farming becomes more profitable and there is an increase in dairy conversions. All of it puts increased pressure on overburdened water catchments. Rather than appropriately regulate water quality, the government asks the Climate Commission to put a thumb on the scales to discourage use of the methane inhibitor. 

2.12..1.2 A new type of cement is developed that produces vastly fewer emissions. The technology for producing the cement powder is owned by an overseas company who can easily deliver the powder to New Zealand; when used here, emissions from cement are trivially low. But because the overseas company will not licence the powder to large domestic incumbent cement producers and because it will outcompete domestically produced cement, the incumbent faces difficulty. The Climate Commission is asked to level the playing field by requiring surrender of NZU for use of the new cement as though it had the same emissions profile as existing cement – to avoid unemployment at community cement plants. A ‘just transition’ path is suggested that would allow the new cement to be treated fairly in twenty years’ time. 

2.12..1.3 A new direct-air carbon capture technology is developed. It can sequester carbon at a cost of $50/tonne and can scale infinitely. It could not only offset the entirety of New Zealand’s gross emissions, but also prior emissions if allowed to run at scale. The Climate Commission is asked not to recognise this new technology because, if it were allowed to generate NZU at $50/tonne, there would be weaker incentive to reduce gross emissions and New Zealand would not achieve the wholescale industrial, social, and economic transformation that some might otherwise desire. 

2.12..1.4 A high carbon price makes people wish to avoid housing that has high carbon cost and prefer apartments and townhouses near the city centre. However, cultural concerns are raised about the shift away from suburban living, with commensurate concern about potential reductions in family size and an aging population. A conservative government encourages the Commission to consider a higher NZU surrender requirement for electricity used in apartments as compared to electricity used in detached suburban homes to avoid this undesirable change in housing use. 

2.12..1.5 A rising price on biogenic methane emissions in agriculture, when those emissions finally face an emission price, results in reduced herd sizes and changes in rural land use. The Commission is asked to redo methane accounting to reduce the likelihood that emission pricing results in land use change, because of a view that emissions prices were not intended to result in land use changes. 

It is also interesting that the agricultural sector, which has been able to successfully evade pricing on biogenic methane for ages, is also lobbying for changes to the ETS that would sharply increase the marginal cost of reducing net emissions within the covered sector.

Forests and intertemporal equilibrium

I'm a bit of an ETS-absolutist. Or at least a carbon-pricing absolutist, in a place the size of NZ. I think the Weitzman reasons for preferring a carbon tax to an ETS are second-order relative to political economy considerations, and any weight at all put on switching costs makes it ludicrous to want NZ to flip from an ETS to a carbon tax. 

But if a carbon tax were already in place, I'd be an absolutist about supporting the carbon tax.

There are fun and interesting arguments around tech-forcing, but NZ's not at the scale where that even really comes into play except maybe around ag biotech. So, prices are the way to go. 

One of the big things I hear from non-economists pushing back on it is around future generations. 

Here's my version of what I get a lot on Twitter, and as pushback from others. I hope I'm not providing a strawman treatment of it here. 

The ETS is fine in principle, but it is inequitable. In particular, it does not consider the interests of future generations. If we allowed the ETS to do its work without hindrance, a lot of the countryside would be planted in pine trees. Let's leave aside all of the biodiversity issues with that for now and just focus on one additional problem: intergenerational equity. If you plant trees now, that's a one-off. The land you've planted in trees has to stay in those trees forever as a carbon sink. If you harvest the trees, you have to re-plant them if you don't want to have the carbon released. That locks the land into forestry, unless some future person buys the ETS credits necessary as part of surrender obligations if they take the land out of forestry. So you're locking a future generation out of other uses of that land. Worse, you're only offsetting some current emissions. If gross emissions do not come down, then future generations either have to do more to reduce their gross emissions, or come up with new carbon sinks that could be even more difficult than forestry. This is intergenerationally inequitable. 

I hope that's an accurate representation of that particular concern.

I used to cover something similar in my 200-level policy course at Canterbury on intertemporal equilibrium. I don't think that this is at all commonly appreciated outside of economics, although the core paper establishing it is almost a century old.  

Imagine that you own a piece of land that's currently a sheep paddock but could be turned into a forestry block. There are only so many of these in New Zealand; it's a big country, but it is finite. When should you run a forestry conversion? 

Let's think through the owner's incentives and decision, and then relate it back to the equity issue that non-economists like to beat me up about. It isn't that economists haven't thought about it, it's rather that it's already kinda taken care of by the system.

If I keep the land as a paddock, I can keep earning paddock-related income from it. I can maintain that as long as I like. Carbon prices in the ETS are increasing over time. If I keep the land in sheep, eventually I'll be facing a carbon price for emissions from those sheep. That cost will be increasing, but is reasonably predictable. The current carbon price is about $38/tonne and is capped at $50/tonne plus 2% per year after that. Some price will attach to methane, but that's yet in flux. 

If I flip the land to forestry, I face a one-off conversion cost that won't change a lot over time, unless somebody figures out far less costly ways of planting forests. I will get a one-off set of ETS credits for converting the land. I can hold onto those credits, or sell them into the system. I can sell them into the system now, or I can sell them into the system at some later date. 

From now until time t when I convert, I get paddock net earnings per year. From time t onward, I get some lumber earnings as forests mature and get replanted, but I have to keep the land in forest. As soon as I fail to replant, I have to surrender credits comparable to the bundle of credits that I got when I planted. I have a bundle of ETS credits when I flip; if I sell them, I get the interest rate as return on that investment. If I hold them, ETS prices could rise or fall; I take on that risk and potential return. 

How should I decide when to flip to trees? What sorts of things will matter? This is a rather standard application of the old Hotelling problem. 

Howard Hotelling wanted to figure out time paths for prices for non-renewable resources. He showed that those futures prices should be coordinated through the interest rate. How? Let's take a simple example.

You own a paddock that's currently in sheep. You can keep running it in sheep, but methane prices will eventually hit your returns. If you flip it to forestry, you'll get a wad of ETS credits for the forestry conversion, and thereafter you get forestry returns from the land. If you ever flip out of forestry, you have to redeem a pile of ETS credits to do so.

Suppose you think that carbon prices are going to be far higher in future than they are now. If you believe that, you do not want to flip to forestry today, unless the returns from running a forestry block are comparable to the returns in sheep, leaving aside the ETS credits. Why leave aside the ETS credits? You can get those anytime. The opportunity to flip from sheep to forest will be there as long as you own the land. Once you convert, you get that bundle of credits. The credits don't do you any good, really, until you sell them. And, once you sell them, you can earn the interest rate on the money you get from selling them. 

Suppose that the returns in sheep are the same as the returns in forestry. The only reason to flip to forestry now, instead of later, would be if you figured that you could earn more by banking interest on your ETS credits than by holding the option until later. And that will only be the case if you're expecting the value of ETS credits to rise more slowly than the interest rate. 

And that's an equilibrating process. 

Whenever it seems like carbon prices will rise more rapidly than the interest rate, people will want to hold off on forestry conversions until later. If you wait until later, you get a more valuable bundle of ETS credits for the conversion. Fewer forestry conversions now means fewer ETS credits now, which pushes up current ETS prices relative to future ETS prices, which pushes that time path to look more like the interest rate.  

Whenever it seems like carbon prices will rise more slowly than the interest rate, people will want to flip to forestry now so they can sell the credits, invest the money, and earn interest. That process means you get more ETS credits now, which pushes down the ETS price now relative to later, which again makes the time path look more like the interest rate. 

Interest rates provide intertemporal coordination. They're a law-of-one-price for the future, holding constant riskiness and other stuff. 

Expectations about technological change will also matter. If you think new equipment will make future forestry conversions more cost effective than they are now, that will have you leaning against current conversions. If you think regulatory changes will make future conversions more difficult, you'll want to bring those conversions forward before councils ban them or before the Climate Commission mandates something weird about what kinds of trees you're allowed to plant. 

So back to our opening worry about relying on tree conversions. The underlying premise there is not just that a lot of land will be flipped to forests as a way of generating ETS credits, but that doing so imposes an uncounted cost on future generations. But if people expect carbon prices, and consequently the value of ETS credits, to be a lot higher in the future, they'll want to wait to exercise that option. They only will want to bring forward that option if current ETS prices seem high relative to futures prices, given interest rates. So the equilibrating process encourages preserving the option to plant later in scenarios when future scarcity in carbon permits seems high, but exercising the option to plant now in scenarios when future scarcity in carbon permits doesn't seem high. And that's exactly the set of incentives that you want, right?

Now there are ways that that can all blow up. If you expect that somebody's going to ban forestry conversions, then you can distort that intertemporal decision. That will make you want to convert sooner rather than later, because later might not be allowed. If you expect that the government will blow up the ETS in future, then you'll want to plant now, sell the credits, and hope that whatever mess of a policy we have in future doesn't hold you to the surrender obligations if you flip out of forestry. Both of those point to the importance of credible reliance on the ETS, and of not continually making noises about future bans on forestry conversions. Talking up future bans brings forward forestry conversions. 

If your objection is that investors can err about whether to make the conversion, because they're underestimating future ETS prices, the solution to that isn't banning conversions, it's making sure that the binding cap tightening over time is credible and advertising likely price paths consequent to those conversions. 

The usual critique is that people don't think enough about the future because they're too selfish, so they don't think about the opportunities they take away from future generations. But every agent in the Hotelling setup is a pure profit maximiser. They only care about making money. And holding the option to convert later can be better than converting now, if you think that ETS prices in future will be a lot higher, and depending on the interest rate. 

And if you think that everybody else is wrong about the likely price path for NZU and that ETS credits are going to be way more expensive in future, you could go and trade in ETS credits to make a lot of money out of it. 

I worry a lot about policy initiatives where the underlying problem definition requires that markets somehow can't handle long term investment decisions. It winds up with an arbitrariness - it gets rolled out whenever a market outcome doesn't correspond to some bureaucrat or politician's vision of the good.

Anyway, bottom lines: 

• intertemporal prices already provide incentive to consider the value of maintaining the option to convert to forestry later; 
• these decisions wind up being guided by and coordinated by overall interest rates;
• expectations about tech and cost paths can also matter, but all else equal it's going to be expectations around future ETS prices and interest rates;
• you can break a lot of that setup by threatening to abolish the option to convert in future, as that will have folks rush to convert earlier. And if you're threatening to abolish that option, it's probably because you don't want them to be converting now, right? 

Reader Mailbag: the proposed forestry legislation

Back in April, BusinessDesk warned about some pending legislation around logging; I went through some of it then at Newsroom:

BusinessDesk last week reported that Jones is considering levies on log exports to fund some kind of “re-setting” of local industry, or a variety of regulations to ensure domestic lumber processors have their needs met before logs are exported.

The story noted how local lumber processors are struggling to compete with processors elsewhere when international prices for logs are high. Jones viewed protections were necessary to ensure a viable domestic log processing sector in New Zealand.

But it’s worth explicitly stating what that means. Jones, as Minister, would effectively be setting a price cap on logs, restricting exports whenever international demand is high. This would be a transfer of money from timber farms, which would otherwise profit from higher prices, to sawmills.

It would also mean a substantial shift in New Zealand trade policy. If another country banned the export of raw materials to New Zealand to subsidise its own processors, New Zealand’s processors might see that as basis for a complaint about unfair trade practices. New Zealand’s trade negotiators can boast about New Zealand’s clean record in following trade rules. If Jones has his way, those negotiators will have New Zealand’s trade restrictions in lumber thrown at them any time they object to trade practices which disadvantage Kiwi companies.

So it is misguided on pragmatic grounds that it will disadvantage New Zealand as the world leans toward greater protectionism – New Zealand has more to lose than most from a weakened rule-based international trading system. Wellington should be working to support that system rather than help tear it down.

The legislation is working its way through now. And it looks to be a complete disaster. BusinessDesk again had some excellent reporting from the Select Committee hearings, and on consequences like cancelled plans for lumbermill expansions.  

Stephen Layburn emails me today with more on the legislation:

Here’s one live example – the Forests (Regulation of Log Traders and Forestry Advisers) Amendment Bill

The submissions on the Bill are illuminating. Sadly, they are much more illuminating than officials’ reports.

IMHO, this has to be amongst the leading contenders for the worst piece of emergency legislation promulgated by the Government.

A glance at the regulatory impact statement elicits some truly worrying signs, in terms of both:

• strained application (or disregard – depending on your point of view) of the most basic of economic concepts; and
• a fundamental misunderstanding of the economics of domestic wood processing – and the nature of the NZ wood resource and its uses. 

Where, for example, is the comparative analysis of the over-arching policy espoused in support of the Bill - and the investment policies of the Provincial Growth Fund? Both are overseen by the same Departments.

From where I sit, the much-needed restructuring of domestic processing must be part of a much wider analysis of the wood resource, its uses and the new technologies coming on stream. To take just one example, surely, a key part of that study must include what New Zealand is going to do about important issues such as social housing. On the latter score, the appalling spectacle of clusters of campervans being used, during the COVID-19 lockdown, to house families in rural Northland – because they provided a better solution to the leaky, cold, houses available to those affected families must be a wake up call that technology such as prefabricated housing (using available domestic timber resource) needs to be applied urgently to address a problem that most New Zealanders would (if asked) agree needs to be addressed – right now.

Instead, we have another go at occupational licensing and more regulatory hurdles - that will hobble an industry and stifle innovation.

What next, legislate to require the coarse wool industry to prop up ailing carpet mills? Or force fine wool growers to supply the local craft industry rather than pathfinders like Icebreaker?

This is just a subsidy disguised as public good legislation and should be confined to the dustbin.

I am sure that it was Bernie Galvin who said (30 years) that past Presidents of the Manufacturers Association were buried 3ft under – so they could still get the next hand out.

I am not an economist or an industry expert, I have just spent a lot of time saving or closing down processing facilities. One issue that simply isn’t mentioned is that one of the reasons I am advised the economics of LVL plants are “challenging” – is that the resource isn’t stiff enough.

So you have the PGF, Scion and NZTE putting a huge amount of $$ into new technology (which will fix the stiffness issue) – and then the (same) Govt implementing a protection racket for old world technologies. Just terrible.

Could the government perhaps consider, well, not doing this?