Fukushima Fallout

I said a few months ago that the Fukushima disaster might be the best thing to happen to renewable energy in quite some time.  Not only will it, hopefully, raise some serious questions about the economics of nuclear and thus redirect some of the money that has been subsidizing nuclear power into renewable investment, but if Japan gets serious about kicking nuclear power and using renewables instead they're going to have to address the major problem facing a 100% renewable future: intermittentcy.  

Well, it looks like the first of those two things is happening.  Various segments within the Japanese business and government spheres have announced in the last few days that Japan is quite serious about becoming renewable, with the PM going so far as to say they will be generating twenty percent of their power from renewables by the 2020s.  Perhaps more importantly, they want to reduce the cost of solar power (what type is left unclear) to one sixth of what it is today by 2030.  Doing so would make PV very cost competitive with fossil fuels. 

Most importantly though, Japan getting serious about renewables means that one of the most technologically innovative countries in the world will now, almost assuredly, have to put a lot of thought towards solving the intermittentcy problem of renewable generation and, this likely means, putting a lot of thought towards new, large-scale battery storage.  Advances in this area would do wonders for the wide-spread implementation of renewable power.  That Japan is now getting into this game in a big way has dramatically accelerated the time-table for potential business feasibility of these technologies. 

Fun with Graphs pt II

So here is another entry based mostly on some graphs I put together - or borrowed from the St. Louis Fed - based on BLS data and OECD statistics data.  Inspired by a comment my macroecon professor made in class the other day I decided to compare four things: (1) the decline in output in the U.S. during the recession in 2008, (2) the decline in output in Germany at the same time, (3) the increase in unemployment in the U.S. during and after the recession, and (4) the increase in unemployment in Germany at the same time.  The graphs of each of these four things are below (I used GDP as a proxy for output since it was easier to find that data) and the grey boxes in each graph correspond roughly to the period that the U.S. economy was technically in recession. 

 

A couple of things should be obvious from these graphs.  First, and most surprising to me, there is almost no increase in German unemployment associated with the recession.  I hadn't expected there to be a U.S. sized increase in unemployment (that expectation was what prompted the whole exercise) but I had thought it would be larger than the roughly half a percent increase that that the graph shows.   

That half a percent increase corresponds to roughly a ten percent increase in the overall level of unemployment.  Contrast that to the five percent increase in the U.S. unemployment.  As you can see from the graph, that's a drastic increase in the level of unemployment in the U.S.  Roughly, 100% in fact.  

Now look at the declines in output in each country around the same time, and would have, to some degree, caused the increases in unemployment.  In the U.S. GDP dropped roughly 550 billion from it's peak in late 2007 to the low point in mid 2009.  That's a decline of a little less than five percent.  In Germany, by contrast, GDP peaked in mid to late 2008 and bottomed out around the same time in 2009 after a fall of about 2.2 billion or a little more than six percent.  

What's remarkable to me about this is that a slightly smaller decline in GDP in the U.S. led to a massive increase in unemployment relative to the increase in Germany.  Not only that, but in the U.S. the unemployment rate has remained high since the recession whereas in Germany it jumped up and then has resumed the steady decline seen since 2006.  

Here is where the comment by my professor comes in.  He suggested that the reason that the Germany unemployment rate didn't respond to the recession is that as the recession hit Germany paid out subsidies to companies to retain employees.  So although German productivity dropped sharply in the recession (as compared to a smaller drop in the U.S., neither is shown here) that productivity drop meant that unemployment stayed low.  In turn, this meant that once companies came out of the recession employees already had jobs and were not waiting for companies to return to hiring as they are in the U.S.  How accurate this is I'm not sure but it seems reasonable.  To my mind it also argues for a slightly more interventionist state when it comes to responding to recessions.  Sure the government can stimulate demand by direct spending but it seems that if people where still employed they be more willing to go spend money and thus stimulate demand themselves and so a subsidy that encouraged companies to retain employees during a downturn might have been a more effective recovery package.  

A final note about the U.S. GDP data.  For all the talk of a gradual "U" shaped recovery the GDP data seems to suggest a fairly straightforward "V" recovery in output.  So it isn't the economy that still needs to recover but the jobs market.  However,  this doesn't seem too likely in the near future.  Someone is capturing that increase in output and it isn't workers.  That leaves companies and executives and they aren't known to willingly give up profits. 

Engineering vs. Adaptation

Those few of you out there who are loyal readers know that I oscillate between being a cheerleader for economics and economic/market solutions to problems, and criticizing the tendency of economics to reduce everything to models and dollars. I find myself squarely in the middle of these to poles after reading Nick Kristoff’s most recent editorial on aid. Kristof is clearly infatuated with economics in a way only a non-economist could be. To quote at length, we apparently possess:

“…a rigor that other fields in the social sciences don’t – and often greater relevance as well. That’s why [we’re] shaping national debates about everything from health care to poverty, while political scientists often seem increasingly theoretical and irrelevant. Economics are successful imperialists of other disciplines because they have better tools.”

While I’m flattered that I possess such great tools and, apparently, unique intellectual rigor, I think that Kristof is a bit off the mark (perhaps that’s his political science background coming though?).

Too often, both within the field of economics and, perhaps even more, outside of the field, the clean mathematical answers that economic models provide are confused with intellectual rigor. As some notable economists (Summers & Krugman among others) have recently pointed out, math does not have a monopoly on intellectual rigor. Legal opinions are extremely rigorous and most of my attorney friends haven’t taken a math class since high school algebra. This is not to say that economics is not a rigorous field, it most definitely is and its models can provide elegant solutions to certain problems, but it is a field that has limits like any other and it certainly is not the only rigorous field in the social sciences. I’d also suggest that it does not have the best tools and could learn a great deal from fields such as geography, ecology, and the natural sciences.

Turning to science for inspiration as an economist is not a new idea. Much of the strength of economic thinking, as well as most of its weaknesses, stem from its obsession with physics. Economists, by and large, love mathematical models. If they could reduce everything to Latin symbols and equal signs they’d be all the happier. They, like physicists, like to come up with elegant models that explain why things happen and then go out and test them. And here is where economists run into a problem. The universe, and in turn physics, is governed by certain laws. We may not know what they are but they certainly exist and they typically don’t change from day to day. Gravity worked yesterday, it worked today, and it will continue to work for the foreseeable future. So when a physicist comes up with a new model he or she can go out and test it and see if it works and know that if it does or doesn’t work today they conditions that led to that result will not change too much tomorrow.

Obviously this only goes so far. As our knowledge of the universe expands our understanding of the “laws” of physics will continue to change. But the point remains, basic laws, once we get them right, don’t change. The same cannot be said of economics and there’s the rub. An economist can come up with a model and go out and test it today and it works and when they test it tomorrow it suddenly doesn’t. This is because economists don’t model the behavior of the laws of the universe. They model human behavior. And humans are nothing if not irrational and inconsistent. So attempts by economists to neatly express how humans will behave fall back on assumptions that are not broadly applicable. Thus, economic models give us ideas as to how people may behave in certain circumstances but these models are not absolutes and should not be treated as such. Human behavior is not gravity. It changes often and for reasons that are not in the models. Economists broadly understand this and don’t claim that their models are absolutely predictive. But the field as a whole remains too heavily reliant on mathematical models of behavior. More work examining individual motivations behind behavior and less attempting to model a ‘representative agent’ would be helpful. At the same time, recognition outside the field that economic models are not the word of God would be nice as well.

Expecting the general public to have a greater understanding of the limits of economic models brings me to a second problem however. The public and policy makers are too concerned with “knowing” the absolute correct answer. This is the real reason for the rise of economics in national debates that Kristof points out. The only feature inherent to economics that allows it to dominate current policy debates is its ability to provide one “right” answer. Look at the end of Kristof’s article: “What kind of aid works best? For those who want to be sure that to get the most bang for your buck, there is also a ‘proven impact fund’…” These are questions asked by a generation raised on Cost Benefit Analysis and who expect immediate measurable returns for every dollar spent. Characterized by some as the “engineering” management style this view sees the world as a series of cause and effect relationships. Do A and B will happen and if C happens then you did something wrong. The real world doesn’t work that way but is the dominance of this view that leads to the dominance of economics.

There is real danger in the dominance of both economics and the engineering mode of management. Yes, we should expect that our aid programs work to solve the problems set out before them and to that end data collection and measurement is important. My brother just spent six months demonstrating this with respect to aid organizations in Afghanistan. So in this regard I agree with Kristof. Randomized field tests can be helpful and the information that de-worming kids is more cost effective than building schools in some areas is important. But maximizing the distance that each dollar goes in accomplishing an aid goal is not the only important thing and taking the view that it is can dangerously obscure other, equally important, goals.

With respect to aid, first among these is increased understanding of issues. In contrast to the engineering style of management, which calls for specific models of a situation and strict control of the process and results, adaptive management calls for a much more expansive and integrative approach. Critically, adaptive management acknowledges that any approach to a complex problem must cope with substantial amounts of uncertainty (differentiated from risk by the fact that risk implies we know it exists and whether it might happen. Uncertainty implies we don’t even know it exists) and builds in mechanisms to evolve and respond to new information. Adaptive management is much more suited to dealing with problems in the real world. Problems arise, however, when funders take an engineering approach and demand specific models with a strict process and clear success metrics when they give aid money. These strict processes and success metrics remove the opportunity for adaptation to new information and research into the roots of problems. It may not be glamorous but solving these problems requires long-term funding commitments to projects that will not have clear results for many years, if ever.

So while Kristof is right, despite his subpar political science background, about the fact that economics possesses some neat tools for solving these problems, and statistical examination of aid programs can improve their effectiveness, he suffers from the same mindset that has given rise to the dominance of economics. An expansion of what is defined as rigorous, what qualifies as good management, and an acceptance that there are not always clear metrics for success in solving these problems would well serve both economics and the field of humanitarian aid. 

Chilean Water Markets: Part I

Note:  This is an edited version of the paper I just handed in for a course.  For the paper itself (along with the references, deleted here) email me.  The first part will go through the background of the Chilean water market and the second will discuss my biggest issue with the water market.  

In 1981 the authoritarian government of Augusto Pinochet overhauled Chile’s water market. The new Water Code (el Codigo de Aguas) shifted the previously state-run water sector to a new, free market model based heavily on the neoliberal ideas of Milton Friedman. The new water code instantly became the leading example of regulation by free markets, and neoliberal ideas in practice, in the world. The Chilean model was heavily promoted alongside the Washington Consensus in the developing world. By the late 1990s, however, there was increasing recognition that there were significant flaws with the Water Code and the World Bank, among others, began to examine the Chilean water sector more critically.

Criticism of the water allocation system focused on three weaknesses: (1) poor dispute resolution mechanisms; (2) a lack of water basin management frameworks; and (3) insufficient environmental protection. Within Chile, there was also concern over monopolistic and speculative behavior in the market for non-consumptive water rights. In 2005, these criticisms and the concern over speculation and monopolies led to a reform bill (Modifica el Codigo de Aguas) that adjusted the Water Code to address some of the flaws in the previous decree.

Thus, the current Chilean water market still serves as a leading example of the neoliberalization of natural resource management. But, where previously this system was praised, it is now recognized as having several critical flaws. A great deal of the scholarship on solving these flaws has focused on reforming the Water Code to weaken some of its strongest neoliberal tendencies and increase the involvement of the state. In the extreme case there have been calls for the re-nationalization of water. I argue that, in fact, correcting these flaws involves broadening the scope of the neoliberal tendencies of the Water Code, not weakening them. That is, articulating private rights in the Water Code for instream flows – defined as a right to a certain minimum rate of flow in the water body.

The Water Code defines water as a national good for public use (son beines nacionales de uso público) but water rights are unquestionably private property. These rights, once issued, are permanent, absolute, and are not tied to land titles. They can be traded, inherited, sold and are treated as any other type of real estate. Expropriation can only occur with explicit legislation and the state must pay market value for the rights. Furthermore, although the state – after the 2005 reforms – has the right to tax unused water rights, non-use of rights is not sufficient grounds to expropriate rights.

Water rights are issued by the Dirección General de Aguas (DGA), which must issue rights upon request if water is available and unclaimed. If there are multiple requests for the same water, the DGA is required to hold an auction. Requests for water need not specify to what use the water will be put. This has led several commentators to claim that the state does not prioritize one use above another and allows water to be put towards the most effective use as determined by the market. Others have criticized this stance, claiming that the code is not as fair as it appears. Indeed, the structure of Water Code implicitly values certain uses above others.

A final, critical part of the Water Code is the distinction between consumptive and non-consumptive rights. Non-consumptive rights were introduced into the Water Code as a means of encouraging hydroelectric development on rivers that had already had their consumptive rights allocated. These rights allow users to remove water from a body of water, use the water (ostensibly for hydroelectric generation), and return the water, unaltered, to the watercourse. Consumptive rights, on the other hand, allow the user to remove water from a body of water and use it however they like, with no requirement for return flows. There is also no beneficial use doctrine, as is common in other water regimes. Notably, consumptive and non-consumptive rights are the only two types of water rights outlined by the Water Code.

Chilean Water Markets: Part II

The foundation of Chile’s water management regime is that, by stepping out of the water market, the state allows the market to freely allocate water rights to the sectors of the economy that can make the most efficient use of them. In this way, water rights are allocated in an economically and, by extension, socially optimal manner. Thus, the only role of the state is to create the governance structure – the Water Code – that allows the market to function.

In this system it is critical that the governance structure be constructed properly because, in order for the system to function, there can be little state involvement beyond the initial rule setting. In other words, and as Chile is discovering if the initial structure is designed incorrectly, the government cannot intervene to fix it later because this intervention would undermine confidence in the market.

Market participants must have faith in the strength of the property rights established in the system. An overly activist state would undermine faith in the strength of property rights and thus the market for these rights. Therefore, because the Chile cannot intervene to correct flaws in the market, the Water Code must send the proper price signals. If the Code is written to structurally bias the market toward one economic use of water it is, by definition, sending an incorrect price signal that will lead to inefficient allocation of water rights.

Since the Water code only recognizes consumptive (municipal, industrial and irrigation) and non-consumptive (hydroelectric) rights, the Chilean water market does not consider additional economic uses and values for water. If water has an economic value not represented by these two rights the market is incomplete and thus inefficient.

And in fact, instream flows do have an economic value. In some locations, the economic value of instream flows may exceed the value of out-of-stream uses.

Increased instream flow due to dam removal in Idaho was found to have annual economic use values ranging from $193 million to $311 million with additional non-use values associated with the increased flows. In Colorado each additional Mm3 of instream flow was found to have an economic benefit of $17 in low flow periods. Now, this benefit declined to zero in high flow periods which points out an obvious economic lesson: there are flow rates above which water can be removed from the river without harming the value of the instream flows. However, once the flow rate is reduced past a certain point, there is an economic loss associated with further reductions. In order for water allocation to be optimal, this loss from reductions must be balanced against the gain from the activity causing the reduction. The market is only capable of determining this optimal level if the users of instream flows have a protected right to those flows and there is a price associated with these rights.

These examples are specific to the United States, but it can be assumed that there are similar values associated with instream flows in Chilean rivers. The intuition for this assumption is thus: most of the use value associated with the instream flows in other studies is due to the economic benefits associated with tourism. Looking at Chile, multiple studies of Chilean Patagonia have found that the annual value of tourism in Patagonia is greater than USD80 million. It is clear that not all, or even most, of that money can be attributed to instream flow. But, with one of world’s best whitewater rivers in the Futaleyfú and numerous other locations to raft and fish, it is certain that instream flow does have economic value in Chile.

Although the Water Code enshrines a system that depends on the market to operate, it is worth taking a moment to discuss the role of institutions in the Chilean water market. Markets never develop in a vacuum and the history and power of institutions have a lasting impact on both the development of markets and their execution. Although the state has little to no role in the Chilean water market, the courts play an important role in dispute resolution. In fact, it is the inability of the courts, the DGA, and local canal associations to effectively and fairly mediate disputes that leads to some of the most vexing problems with the water market.

The lack of an instream water right can be explained in part by the Chilean approach to water. In this view, water must be extracted, as with any other natural resource, in order to have economic value. This view is very strongly ingrained in the Chilean system and its institutions and is as much a reason for the current structure of the Water Code as a result of that structure; it is also incompatible with the idea of there being economic value to instream flows.

The interplay between the Water Code and Chilean institutions should make it clear that problem is too complicated for a simple solution; adding a new category of rights to the Water Code alone will not solve the problem of misallocation. The new rights will require equal protection in the courts in order to have any force or market value.

Thus, although structural reform of the Water Code is necessary – in the form of the addition of instream flow rights – it is important to note that adding rights to the Water Code is not sufficient. The Water Code is part of a larger system which is still very much dependent upon institutions. Reforming those institutions must also be a priority.