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MasterResource is a blog dedicated to analysis and commentary about energy markets and public policy.Precisely because energy is the lifeblood of the modern economy –…

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Why Krugman's Argument Against Fossil Fuels Fails Economics 101

Opponents of fossil fuels have long championed solar power and wind power as replacements. Unfortunately, there is no evidence that solar and wind can provide the cheap, plentiful, reliable energy that our standard of living requires. They have never come remotely close to competing economically on a free market. In fact, due to their low concentration and high intermittency, they have proven unable to provide substantial baseload power in any country, ever, even when exorbitantly subsidized.

When confronted with these facts, opponents of fossil fuels offer a seemingly scientific counterargument. Fossil fuels are only cheap, they say, because fossil fuel companies aren’t required to pay for the “hidden costs” or “negative externalities” of their product. These “hidden costs” are harms not reflected in the prices we pay–such as the presumed damage from future climate change. Companies should be required to pay these “hidden costs,” the argument goes, and if they were, solar and wind would actually be cheaper than fossil fuels.

In a recent column, “Here Comes the Sun,” Paul Krugman invokes this view to argue for major taxation on fracking (and, by implication, all other fossil fuel production). To believe otherwise, he says, is to be economically illiterate.

Fracking–injecting high-pressure fluid into rocks deep underground, inducing the release of fossil fuels–is an impressive technology. But it’s also a technology that imposes large costs on the public…Economics 101 tells us that an industry imposing large costs on third parties should be required to “internalize” those costs — that is, to pay for the damage it inflicts, treating that damage as a cost of production.

Unfortunately, this analysis fails both Political Philosophy 101 and, surprisingly given Krugman’s credentials, Economics 101.

It is true, as Krugman says, that the price of a product does not reflect all the negative effects that come with the product. For example, when the automobile industry overtook, the horse-and-buggy industry, there were many negative impacts on the workers and families of the latter industry, who had to suffer temporary unemployment, go through retraining, etc.

But Economics 101 does not tell us what to do about such effects. For example, it doesn’t say whether the automobile industry should have been forced to pay a tax for “imposing large costs on third parties” it drove out of business. Such questions are the province of political philosophy. Krugman is welcome to argue for his personal political philosophy, which, in my reading, is a hybrid of utilitarianism, egalitarianism, and economic authoritarianism. But he should not abuse his economic prestige to smuggle his political views under “Economics 101.” The idea of dealing with pollution issues via “externality” calculations rather than by proper definition of air and water rights, is highly dubious and anything but self-evident.

That said, it can be valuable in understanding the economic impact of an industry to analyze negative impacts that are not reflected in prices. But we must simultaneously analyze the positive impacts that are not reflected in the prices we pay. But Krugman and others steadfastly refuse to consider the “hidden benefits” of fossil fuels–even though they are massive.

A very clever video on YouTube illustrates the issue of hidden benefits with regard to the Internet. “How much money would someone have to pay you,” the host asks, “to give up the Internet for the rest of your life?” In other words, how much is the Internet really worth to you? The video’s featured economist, Professor Michael Cox, says his students mostly answer that no amount would be enough–and when they propose amounts, they are in the high milions or billions. Most of us would say the same, because the Internet is an indispensable value in our lives.

And yet how much do we actually pay for it? Less than a thousand dollars a year. “What the market has done,” observes Cox, “is create a tremendous gap between worth and cost.” This gap is a wonderful thing–so long as we don’t forget it when assessing the importance of indispensable values to our lives.

An equivalent gap between worth and cost exists between what we get and what we pay for indispensable sources of cheap, plentiful, reliable energy such as coal, oil, and natural gas–since energy is the resource that makes every other resource in our industrial economy possible.

Consider: If you were a factory owner, how much more would you be willing to pay for the coal-powered electricity that allows your business to exist? How much would you be willing to pay for the natural gas that keeps you from freezing in the winter? How much would you be willing to pay for the gasoline in the ambulance that saves your child’s life? A lot more than you do. The reason we get energy for such a bargain is because of the wondrous nature of the free market, including another part of Economics 101 Krugman conveniently omits: the marginal nature of prices. The price we all pay for a given good or service is set by the marginal buyer–the buyer who, among those having successfully bid for the good or service, was willing to bid the least for it.

This means that every other buyer valued the good more than the price paid. Thus, with every product or service, the total value consumers gain from buying it is necessarily higher than the total price they pay for it. And in the case of indispensable values, such as the Internet or cheap, plentiful, reliable energy, that value is incomparably higher. We should never confuse the price we pay for fossil fuels with the value we get from fossil fuels.

An honest attempt to guesstimate the full economic impact of fossil fuels would have to take into account, at the absolute minimum, the following:

• Cheap, plentiful, reliable energy adds dozens of years to life and makes those years incomparably more enjoyable.
• Given current technology and economics, including the desperate need for industrial-scale energy around the world, fossil fuels will be indispensable for decades to come. This is especially true because of the environmentalist assault on nuclear power, which has set back that technology decades.
• Industrial-scale energy has historically made us far less vulnerable to climate, not more–and would be essential to coping successfully with any serious climate change, natural or manmade.
• Solar and wind have never produced cheap, plentiful, reliable energy in any country, ever.

None of this enters into Krugman’s “scientific” evaluation. He treats the price of fossil fuels as fully reflective of their positives, and regards it as scientific to fixate on their negatives (real or fabricated) and demand that massive taxes be levied. What level of taxation? Krugman doesn’t say–but let’s explore the alternatives.

If the Left imposed a carbon tax that was large enough to force the entire economy to run on solar and wind, the entire economy would collapse. If the tax was large but not large enough to totally bankrupt the fossil fuel industry, it would do little to reduce greenhouse gasses but make us far poorer, including far more vulnerable to the climate–cheap energy being the key to making the climate livable. Any level of tax is pseudo-scientific and destructive, because it is based on an evasion of the indispensable, life-and-death positives of fossil fuels.

What should the government’s policy toward pollution be? This is a complex subject, but in my view the proper principle to guide policy is individual rights. The government should clearly define air and water rights, and enforce individual cases according to objective evidence of physical harm.

How such rights should be defined is in part an issue of the economic and technological context; since it is never possible to eliminate all waste, what amount of waste constitutes a rights violation must take into account the full context of what waste is preventable in a given economic and technological context and what isn’t. In today’s context, to call CO2 emissions “pollution” is to call human survival “pollution.” No view could be more damaging to our economy–or to the human environment.

By. Alex Epstein

This article was provided by MasterResource

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  • Anonymous on November 16 2011 said:
    What's the problem? In a 'debate' at the Singapore Energy Week, the environmentalist Jeremy Leggett insisted that it takes ten years to construct a nuclear facility, and as a result wind and solar should be the principle providers of electricity. That statement was absurd, but as I later found out, Leggett and others thought that I should have held my peace instead of referring to Mr Leggett as a fraud.Where fossil fuels are concerned, just look at the numbers. Nobody in their right mind can really and truly believe that it is possible to dispense with them...unfortunately.
  • Anonymous on November 17 2011 said:
    One barrel of 159 Liters costs 102 USD as of today. Theoretical energy value 1.590 kWh (approx.) in the barrel makes it 0,065 USD / kWh for crudeoil.Full electric car demands 20 kWh / 100 km Fossil small car 50 kWh / 100 km I calculate 0,065 USD x 2,5 to consider the better efficiency of the electric car. Those 0,16 USD / kWh are easily achievable by windpower and even photovoltaics should do the trick. Which 101 class would you send me to?
  • Anonymous on November 19 2011 said:
    Why do we have to encounter these misunderstandings about renewables and alternatives. Wind, photovoltaics and electric vehicles have a place in the overall energy picture. What does not have a place are crank calculations that are intended to turn the impossible into the possible where those items are concerned.What kind of teaching is taking place in the world's schools these days. I failed physics and math twice and was booted out of engineering school, but even in those days I probably knew enough arithmetic to know that wind and photovoltaics have at best modest prospects in the near future. As for electric vehicles, I want to believe in them but am too lazy these days to do the research necessary to give them a pass.
  • Anonymous on November 20 2011 said:
    Anybody's word, who is a Nobel Prize Winner this days, should be taken with a grain of salt. To say Krugman's Argument Against Fossil Fuels, Fails Economics 101, would be a drop in the bucket of any commonsense of economic facts this fraud and stooge to this administration, and the moronic NYT...But then, with the media we have today, it would be hard to even get the truth.
  • Anonymous on November 21 2011 said:
    ...so where do the fossil fuels come from 20, 30, 100 years from now? We've found ancient sunlight in gaseous, liquid and solid forms and are rapidly consuming them. Isn't it rather foolish to assume they'll always be around? It is equally foolish in my view to not go along the road of sustainable replacements ASAP. I am not opposed to nukes but the marketplace sure is! (I do hold out great hope for smaller, regional-sized machines though, which are factory-fueled and installed underground.)At this stage in mankind's development I consider fossil fuels as Capital in the bank. We can choose to live off the capital or we can use it wisely and try to live off the interest.
  • Anonymous on November 21 2011 said:
    There remains a vast amount of oil and natural gas for many generations still These offer the highest energy density of all options to date except for nuclear. Passive solar is an option but for heat only. Photovoltaics and wind power are next to useless (severely limited with no real solutions in sight). The longshot is fusion power via Tokamak ITER and DEMO projects but don't count on it..... We are stuck where we are. credentials: Electrical Engineer with 35+ years working with Nuclear, Solar, wind, biomass as well as Oil and Gas industries.
  • Anonymous on November 22 2011 said:
    Mr Lester, there is more oil and gas, but NOT enough for MANY generations. Hearing that is like hearing the environmentalist Jeremy Leggett making the crank contention at a recent energy meeting that it required ten years to construct a nuclear reactor because "they" said so. If people come to believe that there are many generations of oil and gas left in a world in which the global population increases by about a billion folks every decade, then somebody is going to be in deep trouble around mid-century. This is a serious problem, and it requires serious thought by serious people.

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