The fallacy of external costs

The International Monetary Fund released a new report on fossil fuel subsidies. They say that the world spent 5.200 billion USD on them in 2017. According to this report, the US alone spent a whopping 649 billion USD. More than the already quite gigantic defense budget.

The US is not the worst subsidizer in this report, that distinction would go to China. But China is not considered to be a developed economy yet and hence is a bad example of what comes next.

What does the IMF put into the subsidy group bracket then?

It is natural to assume that those are direct payments towards producers. Or consumers of fossil energy. But how much of those subsidies originate in OECD countries? 

The IMF report identifies 3 kinds of subsidies:

1. Direct payments to either consumers or producers or both;
2. Undercharging for consumption taxes. This also covers lenient tax treatment for the cost of business (foregone taxes);
3. Not charging a price for local air pollution, climate change, and environmental costs. Those are also called “negative externalities”;

And it’s this 3rd group of negative externalities that generates the big numbers.

An externality is an unintended consequence of human action.

An example

Railway stations allow travelers to board and un-board trains. Those trains bring them to the intended destination. They also provide shelter to the homeless when the weather is bad. Furthermore, they also constitute a rallying point for those homeless. There are lots of passersby they can try to get some money from.

Railway stations are not destined to help homeless people in mind. Besides, some countries impose tight curbs on begging.

From the vantage point of a vagrant, this is a positive externality of the railway station. I am sure many others would not see it that way. 

Where there are homeless itinerants, better security becomes more important. Users of the railway station may also find the extra smell and trash inconvenient. This causes extra expenditure for cleanup. And also more frequent patrols by private security or police. All this adds to the operational cost to the operator of the railway station. From their point of view, this is a negative externality.

Let’s apply the general concept to fossil energy now.

Producing and burning coal, oil, and gas produces the effects we search for.  We can move ourselves and stuff cost-effectively. We get heating and electrical power when and where we need it. Today’s level of comfort and civilization would not be possible without fossil fuels. Our very standard of life depends on them. 

According to the World Bank, global GDP was a sliver of more than 80 trillion USD in 2017. This figure would likely be in the single digits without the use of fossil energy.

Yet, fossil fuels also produce unwanted byproducts.

The byproducts of fossil fuel combustion pollute the air, water, and soil. This makes us sick and also die or die sooner from it. Also, the quality of life goes down and the environment gets harmed. This becomes plain in cities such as Bejing, Dheli, and Lagos to name but a few. On certain days, simple breathing there becomes hard.

Cities in developed countries are much less affected by this. There are strict air pollution laws in place. But when Paris experiences the “Canicule” you can see the negative side effects of fossil fuel. And you can smell them.

This pollution is local as it does not travel very far. So, in a sense, a country that allows this to happen saves on filtering but pays through the health care system. In developed economies, those pollutants have not disappeared altogether. But they are very low, hence their negative externalities are few and weak as well.

That said, those consequences are real and thus are subject to precise measurement. Still, the method in every single case often merits further discussion.

The above is also true for noise.

Then there are the so-called climate gases – CO2 and methane emissions. And here it gets all woo-woo.

The IMF has resorted to phantasy numbers when pricing those externalities. And to be sure, they also make up the bulk of this more than 5 Trillion USD figure.

Let’s come back to the US example. What they have done is take the assumed carbon emissions of the US in 2015 (5,4 billion tons). They then multiplied by a 36.- USD per ton price has pulled out of thin air.

No mention of positive externalities derived from the use of fossil fuels. They too should enter the calculation for fairness’ sake.

But wait, we have seen above that the world generates more than 80 Trillion USD in GDP each year. It’s hard to assume that fossil fuels are not at least responsible for 3 quarters of this GDP. This means 60 Trillion USD of GDP would not be possible without fossil fuels. Let’s subtract those 60 trillion from those around 5 trillion in negative externalities. Now we have 55 trillion in positive externalities from fossil fuels. I am being generous with the non-fossil fuel economy here.

We would be back at muscle power and unreliable renewables. This means we would go back to where we were 400 years ago. Whatever renewable energy there is would be only for a slim caste of very rich persons. This condemns the rest of humanity to subsistence levels. Greetings from the Panem franchise. Is this what the IMF folks want for us?

The positive externalities dwarf the alleged cost of carbon emissions. They do so by more than an order of magnitude.

Also, a higher CO2 concentration favors plant growth. Huge agronomic benefits need factoring into the overall calculation.

The plot thickens.

And here we are still in the realm of “CO2 is bad and causes global warming”. This is far from being a proven fact but still, a fancy theory that unravels with every model that runs awry.

Anything humans do on this planet produces negative externalities. And a lot of positive ones. Windmills are monstrous contraptions that spoil huge swathes of land. They devalue this land through the hideous looks and their infrasound emissions. But also through their shredding of birds, insects, and other airborne lifeforms. Does anyone put a price on those effects? There is a price for CO2 emissions from fossil fuels. That same practice should also apply to the production of windmills and solar arrays.

Their production has released CO2 into the air. This CO2 backpack is a subsidy if we apply the IMF logic. The madness never ends.

Let’s keep things straight. We must dismiss those unfit attempts by the IMF. And also those of the European Commission. Their study on the internalization of transport externalities prepared by the CE Delft tries the same trick. 

We ought to stick with the classical definition of a subsidy. Or we go for a more global calculation method altogether.

A political act to make a tangible allowance to someone to foster a practice or relieve a burden. It must change the profit and loss situation of the recipient as it must be tangible. And the public purse must fund it which means the tax or ratepayer. It’s a market-distorting measure that needs justification.

By that count, the subsidy for solar energy alone is about 1/3 higher per MMBtu than the total wellhead price for Natural gas in the US.

Image by Ben Kerckx from Pixabay