Believe it or not, economists have been wrong before

PUBLISHED IN THE PUNCH:  In this country we are blessed with some outstanding economists. But can they be collectively wrong? The Gillard Government thinks not. They claim that no economist is backing the Coalition’s Direct Action Plan, which therefore proves that it is the wrong policy. Case closed.

Gillard’s claim is false: there are economists who back alternative approaches to her carbon tax including Nobel laureates and Reserve Bank board members. However, even when there is a massive consensus among economists, history shows that they can be wildly off the mark.

A prominent example of this was the letter that 364 economists signed against Margaret Thatcher’s Budget in 1981. Thatcher broke economic orthodoxy by cutting borrowings with aggressive fiscal measures in order to make it easier to control monetary policy and get inflation under control.

The entire economic establishment railed against the Budget signing an open letter that said there is “no basis in economic theory or supporting evidence” to back her approach and that it would “deepen the depression”. It was time to “reject monetarist policy”, they said. Thatcher was even asked by Labour Opposition Leader Michael Foot in Question Time whether she could name any economist who would agree with her approach. Sound familiar?

Thatcher was right and the economists wrong. Thatcher set the British economy on a course of recovery and set an economic template for other nations.

In the current context, Tony Abbott is right to feel confident of the Direct Action policy, despite many economists stating that a carbon tax or Emissions Trading Scheme is the most cost-effective approach for addressing climate change.

A weakness of these economists’ arguments is that they assume that reducing emissions is an end goal in itself. Curbing emissions, however, has no intrinsic value; it is only beneficial if it results in a more stable climate or has other direct environmental or productivity benefits for the nation.

In isolation, Australia’s reduction of emissions will provide few if any benefits to Australia. Even the Government finally admits this now.

In considering climate change policies, prominent economists such as Saul Eslake, Chris Caton, Bill Evans and Paul Brennan – who signed an open letter with nine others backing a carbon tax or ETS – have failed to apply their most fundamental tool: the cost-benefit analysis.

One of the very few economists in Australia to consider both costs and benefits of the carbon tax or ETS is ANU economist, Professor Jeff Bennett. He simply states that benefits are absent and therefore it is folly to take mitigating action: “You see, the policies that we put in place will not avoid global climate change. There may be some impact but even the world’s best climate scientists will agree that the sort of impact we will make by imposing these taxes or the cap and trades schemes is minimal.”

In this regard, carbon dioxide is different to apparent pollutants that have been limited by taxes or trading schemes in the past. In the United States, for example, an emissions trading scheme was used to cut sulphur dioxide (SO2) and hence reduce acid rain. But the benefit of reducing SO2 in America was clear and immediate: less acid rain in America and therefore less damage to property. The same cannot be said for carbon dioxide: Australia’s reduction of CO2 will have no perceptible impact.
The Coalition’s Direct Action plan aims to address this problem by promoting measures that both reduce atmospheric CO2 and produce immediate productivity or environmental gains.

Carbon capture in soil is the centrepiece of the Coalition’s Direct Action policy. Soil carbon capture would not only reduce atmospheric CO2, but would provide immediate productivity benefits by making soils more fertile. Similarly, planting trees would reduce CO2 but also immediately curb erosion, provide additional habitat to support biodiversity, and is generally considered to provide positive environmental value by most Australians.

Direct Action also has the benefit of flexibility, or option value, to use an economist’s jargon: it does not lock Australia into a single framework from which it is difficult to extricate. In an environment of uncertainty – over what technologies will be invented and what other countries will do – being flexible to adapt has value.
 
We should listen carefully to our economists – all of them including Professor Bennett who favours adaptation and Nobel laureates who favour technological investment. But no single economist has a crystal ball and a collective of economists can produce collective failure as the response to the Thatcherite reforms demonstrate.

Most importantly, economists should use the full suite of tools in their armoury – particularly the cost-benefit analysis. A sober approach from this perspective might convince more economists that a carbon tax where Australia acts in front of the world is simply a lot of cost with minimal gain.