In today’s Australian, Danny Price, MD of Frontier Economics, has attempted to clarify what became obscured about their argument on the ETS last week. First, he argues that there has been little acknowledgement by the Government of the economic cost of an ETS. Part of this is a claimed enormous error in the Government’s modeling. But the other part is surely the usual political issue of how policies are sold. In my mind, those economic costs have hardly been hidden and in economics circles they have been all the discussion.
Second, he argues that the shielding in electricity price signals the Frontier report advocates is not about households but about small to medium enterprise. I must admit that I missed this in the Frontier report and didn’t see the reference to the evidence on this. Like the whole notion of gradualism — that has a legitimate basis in economics (unlike so-called ‘churn’ which was not called that in the Australian piece) — what is disappointing is that Frontier provided a theoretical argument but no evidence to push-back on the Government’s more, big bang like approach. Recall, however, that the Government has adopted some shielding too with a carbon tax being favoured for the first year of the CPRS. To me, it seems very important the SMEs see the energy costs they face with carbon prices embedded so that we have a flow-on effect to less energy intensive production. How often are computers replaced? To wait 3-5 years seems silly. But then again, I agree that we need evidence to sort these competing theories out. Where is it?
Finally, the piece talks about a problem with churn (that is, making generator’s pay for permits and making it up at the household end with tax cuts). It was not (again I might have missed it) mentioned in the Frontier report but it has to do with political economy:
The government plans to charge the same carbon price to all generators whether they are high or low emitters. This will make all emitters, good and bad, more expensive and drive up the cost of electricity across the board. But this is one aspect to the scheme the government seems to like. Over the years the government’s coffers will swell from an additional $4 billion a year to $20bn in the sale of permits. This will give it a lot of discretionary expenditure, and the political power that comes with it.
So when it comes down to it, the reason to go with the Frontier scheme rather than the Governments is that we don’t trust the Government to not divert the money in ways that destroy the economy. Again, I’m not sure about that but in the end the Frontier scheme and the Government’s are legislated outcomes. The Government could legislate more commitment — maybe it already has — that prevents this, somewhat speculative, dire consequence. But even if they legislated the Frontier plan, it would be subject to the same political risk.
I agree with the piece that there is lots still to debate on the details of the ETS. What I am not sure about is whether theoretical discussions are contributing to that debate. Evidence is still lacking.
Core Economics 
On climate change there is a world solution or there is no solution for Australia.
If our carbon emissions went to zero tomorrow, we would still suffer the consequences of continuing world emissions. And as a 1% emitter, our reduction would be meaningless.
So an Australian-only ETS will export jobs and emissions, to the detriment of the Australian economy, without achieving a solution. I am not keen to pay more for food, knowing that it will hurt Australian farmers, and benefit the exporters of other nations not concerned about carbon emisions.
The key players in an effective ETS would be the US, China and India. Until we have an emissions reduction strategy that includes those nations, we are deluding and disadvtaging Australians and Australian jobs for no outcome gain.
Beyond the comfort it gives generation Y, an Australian-only ETS simply does not make sense.
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Danny seems to be talking about the macroeconomic effect of increased taxes:
“Adding a cost to householders and businesses for their impact on the environment will also impact on the economy. Householders respond by spending less. This reduces demand, and job growth slows. Businesses also respond by cutting costs, which will mean less demand for suppliers, and in some areas this will also mean cutting jobs. Less people with jobs will mean less demand, and so the cycle slows even further.”
But is this effect not easily counteracted with conventional fiscal and monetary tools? And isn’t this what Rudd is proposing anyway?
Danny also argues that:
“The government’s scheme will leave the small-to-medium enterprises exposed to much higher energy bills. Damage this heartland of Australian business and you can’t avoid significantly damaging the economy.”
I suspect that electricity is such a small part of most SMEs’ cost base that even a doubling of prices will have little effect on output or employment. In any case, where SMEs are not trade-exposed, they can largely pass the costs on to customers (so this microeconomic effect becomes macroeconomic and can be dealt with accordingly).
So, the only impact I can see is on SMEs who are (a) electricity-intensive (b) trade-exposed and (c) not already protected by the Rudd scheme. Who are these SMEs and how can they create such a major impact on the economy?
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