14 February 2012

Natural Monopolies and Cap and Trade

Note: this post is intended as discussion of economic theory.  The use of certain analytical tools should not be construed as approval or said tools, nor should assertions and arguments be construed as advocacy.  This is simply an exercise in economic analysis.

Taking the mainstream definition of natural monopolies, and assuming that the human-produced carbon dioxide that inevitably results when producing electricity does contribute to global warming, I think it’s safe to say that cap-and-trade schemes are superfluous.

In the first place, note that natural monopolies are generally defined are  markets that have high entrance costs with minimal variation in products.  Landline telephone service would be an example of this, as the infrastructure necessary for building a market is extremely expensive, while the product available generally doesn’t vary (i.e. you get to call people).  In contrast, mass-market retail (think: Walmart or Meijer) is not a natural monopoly because the costs of market entry are not necessarily high—insofar as they can be localized—and there can be quite a variation in products available.   For purposes of analysis, electricity is considered a natural monopoly since market entrance costs are high and the product is uniform.

In the second place, note that one common assertion made by mainstream economists is that natural monopolies are anti-market (or, more accurately, anti-consumer) because they impose what is assumed to be artificially high prices on consumers, which in turn requires consumers to lower electricity usage or reduce other forms of spending to afford their electrical bills.  As such, the argument is that the government needs to interfere in this market so as to make sure that consumers do not have to make difficult decisions about economic tradeoffs.  In doing so, the government lowers the price of electricity, and increases the amount of electricity consumed.

In the third place, producing electricity exacerbates global warming.  Most electricity in the US is produced from fossil fuels (i.e. coal, crude oil, and natural gas).  Fossil fuel refinement and usage releases carbon dioxide into the atmosphere, which traps heat.

In the fourth place, there is a proposed solution for carbon-dioxide-based global warming:  cap-and-trade.  This seeks to discourage the use and refinement of fossil fuels by imposing a tax on carbon usage and production.

Now, here’s where things get confounding: if natural monopolies could simply exist and charge consumers higher prices for electricity, then there would be no need for cap-and-trade since the market would solve that problem naturally by the price mechanism.  Not only that, this would also help to ensure the long-term stability of carbon-based energy prices, as this would further ensure that demand is not pulled too far forward (which is what happens when the government artificially lowers prices).  Of course, allowing natural monopolies to do this means that money goes to businessmen instead of politicians, so the real reason for cap-and-trade is to a) correct for a government-caused market inefficiency and b) enrich politicians.  Isn’t it amazing how all that works out?


  1. My take on the idea of "natural monopolies can be found here.

  2. Do not also forget the aesthetic value of cap-and-trade schemes when it comes to marketing them to the general public. This stuff looks very good to people who have a passing concern about environmental matters but know very little about the details of economics and theories on global warming.

    Back in my liberal days, I was a person who might have supported such an idea, had it been floated at the time. The clamor for ever greater regulation reveals Occam's razor to be correct yet again. No solutions are really needed because systems find equilibrium on their own. Simplicity need not be complex!

    BTW, I was saved in my junior year by a student who gave me a copy of Hayek's "The Use of Knowledge In Society" which confirmed the niggling feelings I had always had but thought were wrong. If you have not yet read it, please do. Of course I am not aligned with many libertarians lately either, because the position on open borders and abortion is destructive and immoral, and attitudes towards those who want to "eat local" and live in the country only reveal the commentariat to be as intolerant as the libcons they claim to be above.

  3. Cap and trade is and always was a scam. It was created to enricha few people at the expense of everyone else. The natural monopoly was not to be fuels, but the trade certificates. The carbon credits could be manufactured from thin air and sold to the highest bidder. Bidders would be required to buy them by force of law even though they didn't need or want them. politicians benefit throught henormal means (campaign contributions) and through the extra-normal means of directly owningthe companies that would issue and handle the trade transactions (Al Gore).

    It was sold as a "market-based" solution, but there is nothing "market-based" about having the govenment create an artificial market for a product no one needs or wants.

    The world trade in carbon credits collapsed a few years ago when it became apparent that the USA wasn't going to participate. They were intended to be the principle buyer of all the imaginary carbon credits the rest of the world was going to produce. The Russians especially were going to make a killing.

  4. @Cranberry- I think what makes cap and trade so appealing is the shallowness of the analysis. We have an obvious problem (global warming) with an obvious cause (man made CO2 emissions) and an obvious solution (cap and trade). Reality is more complex than that, but people don't like complexity or inaction, so any proposal that wants political support is going to have to be simple and active so it looks like we're "doing something."

    I think I have a copy of Hayek's book somewhere, but I've not yet gotten around to reading it. I assume the conclusion is along the lines of "central planning fails because it doesn't have access to enough knowledge, and systemic knowledge is reflected in the price mechanism."

    I also have some disagreements with libertarians about abortion (which I completely and totally oppose), open borders, and free trade. I have no feelings on the "eat local" movement, FWIW.

  5. @PRof. Hale- there's no doubt about it being a scam. What I was trying to point out is that most mainstream economists are nothing more than statist apologists. Using their own assumptions and methodologies, I made an argument for using deregulation to prevent global warming in the exact same way that cap and trade is supposed to. It is indeed amazing the sheer amount of statist policies that are proposed and enacted under the guise of being "market-based." We are truly living in the era of Newspeak.

  6. Many libertarians do oppose abortion, including myself.

    From wikipedia:
    "Many supporters and opponents of abortion rights justify their position on NAP grounds. The central question to determine whether or not abortion is consistent with NAP is at what stage of development a fertilized human egg cell can be considered a human being with the status and rights attributed to personhood. Some supporters of NAP argue this occurs at the moment of conception. Others argue that since the fetus lacks sentience until a certain stage of development, it doesn't qualify as a human being, and as such may be considered property of the mother. Opponents of abortion, on the other hand, state sentience is not a qualifying factor. They refer to the animal rights discussion and point out the Argument from Marginal Cases that concludes NAP also applies to non-sentient (i.e. mentally handicapped) humans.

    Objectivist philosopher Leonard Peikoff has argued that a fetus has no rights over its host because it is a parasite. Pro-choice libertarian Murray Rothbard has the same stance. Other pro-choice supporters base their argument on criminal trespass. In that case, they claim, NAP is not violated when the unborn child is forcibly removed, with deadly force if need be, from the mother’s body, just as NAP is not violated when an owner removes from the owner’s property an unwanted visitor who is not willing to leave voluntarily. Libertarian Walter Block follows this line of argument but makes a distinction between evicting the fetus and killing it (see Libertarian perspectives on abortion).

    Pro-life libertarians, however, argue that because the parents were actively involved in giving life to another human being, and the unborn child was brought inside the mother’s body by both parents’ action and without the child’s consent, no parasitism or trespassing is involved. They state that as the parents are responsible for the position the child is in, NAP would be violated when the child is killed with abortive techniques."

    I've heard estimates that approximately half of libertarians are pro-life.

  7. @Robert- the abortion issue is pretty simple for libertarians, but its predicated on how one views a fetus. Basically, if its a human, it has rights; if it's not, it doesn't. The 50/50 split seems like a reasonable estimate to me.