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Minnesota raises the price of energy, relying on economic theory once more

Yesterday, Minnesota’s utility regulators voted to significantly increase the “social cost” of carbon. The current level is a range of 44 cents to $4.53 per ton. This will go up to a range of $9.05 to $43.06 per ton by 2020. According to Dan Lipshultz, the Public Utilities Commissioner who proposed the new range, energy consumers will “in all likelihood” see an increase in their bills.

What are social costs?

When an individual decides to act they do so based on the costs and benefits of the action; Do I want to listen to that Bob Dylan LP bad enough (the benefit) to get off the couch and dig it out of the chest (the cost)? But these are private costs and private benefits. Assuming that I’m home alone, it is only me who will receive the benefit from listening to the LP and only me who will bear the costs of finding it.

But what if I want to listen to the LP so loud that my neighbors can hear it. And what if they don’t like Bob Dylan (I’m told such people exist, even in Minnesota)? In this case the benefit is all private, felt by me, but the cost is felt by me and my neighbor. Me in the form of finding the LP, and my neighbor in the form of having to listen to it. The social cost (my effort + the neighbor’s discomfort) is greater than the private cost (my effort). I’m likely to listen to more loud music than I would if I had to take his discomfort into account.

As the economist A.C. Pigou wrote, where the social costs of an activity are greater than the private costs, more of that activity might be undertaken than ‘society’ actually desires. Music too loud in this case, more pollution in others. That is where Minnesota’s Public Utilities Commission comes in.

How do we deal with social costs? 

There is a long debate on whether social costs are a problem and what we do about them if they are. But assuming they are, one policy response is to try to raise the private cost to the level of the social cost. Pigou suggested that this could be done with a tax on the producer to the value of the difference between the two. The route taken by Minnesota’s PUC is to use regulation, and set a higher price for carbon.

Policymakers rely on supply and demand. Sometimes

Note the mechanism here. Policymakers see too much of something – pollution. They want to reduce the amount of it. To do this, they raise its price. They are theorizing, quite explicitly, that if you increase the price of something you decrease the quantity demanded. In other words, that the demand curve slopes down and to the right.

So what? Well, when applied to labor markets such logic is all too often thrown out of the window by policymakers. Here, they increase the price of labor and say with straight faces that the quantity of labor demanded will not fall.

I wrote yesterday about how policymakers apply economic logic in some cases but refuse to in others. The mismatch between public policy on minimum wages and carbon pricing is yet another example.

John Phelan is an economist at Center of the American Experiment.

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