The fallacy of external costs

A report by the International Monetary Fund says that the world spent the incredible sum of 5.200 billion USD on fossil fuel subsidies in 2017. According to this report, the US alone spent a whopping 649 billion USD – more than the already quite gigantic defense budget.

The US is not the worst subsidizer in this report, that distinction would go to China. But China is not considered to be a developed economy yet and hence is a bad example of what comes next.

What does the IMF put into the subsidy group bracket then?

If your gut tells you that this would be direct payments towards producers or consumers of fossil energy, one would be very hard pressed to find any of that in the US or in pretty much any other developed economy for that matter.

The IMF report identifies 3 kinds of subsidies:

  1. Direct payments to either consumer or producers or both;
  2. Undercharging for consumption taxes and/or lenient tax treatment for the cost of business (foregone taxes);
  3. Not properly pricing for local air pollution, climate change and environmental costs – also called “negative externalities”;

And its this 3rd group of negative externalities that generates the really big numbers.

An externality is an unintended consequence of human action.

An example: railway stations are being built and operated in order to allow travelers to board and un-board trains that will bring them to the intended destination. They also provide homeless with shelter when the weather is bad and also constitute a rallying point for them with lots of passersby they can try to get some money from.

Railway stations have not been built with helping homeless people in mind and in some countries begging is heavily restricted.

From the vantage point of a bum, in a sense, this can be seen as a positive externality of the railway station. It’s rather doubtful if anyone else sees it that way.

Where there are homeless people, security issues tend to get more serious and smell as well as trash issues tend to occur with more frequency. There is a need for additional cleanup and also more frequent patrols by securities or police which constitutes a cost to the operator of the railway station. From their point of view, this is a negative externality.

Let’s apply the general concept to fossil energy now.

Producing and burning coal, oil and gas produces the effects we search – movement, heating of electrical power when we need it. It can safely be considered that today’s level of civilization and standard of life would not be possible without fossil fuels.

According to the World Bank, global GDP was a sliver more than 80 trillion USD in 2017. This figure would likely be in the single digits without fossil energy.

However, fossil fuels also produce byproducts that are unwanted.

The byproducts of fossil fuel combustion pollute the air, water, and soil. This makes us sick and we might also die or die sooner from it. Also, quality of life goes down and the environment gets harmed. This becomes painfully apparent in cities such as Bejing, Dheli or Lagos to name but a few where at certain days breathing becomes hard.

Cities in developed countries are much less affected by this as there are strict air pollution laws in place but when Paris is hit by the “Canicule” you can still see the negative side effects of fossil fuel – and you can most certainly smell it.

This pollution is local as it does not travel very far. So, in a sense, a country that allows this to happen maybe saves on filtering but pays through the health care system. In developed economies, however, those pollutants have maybe not disappeared altogether but they are very low so their negative externalities must be regarded as reasonably low.

That said, those consequences are real and therefore can somehow be calculated although the method in every single case definitely merits further discussion.

The above said is also true for noise.

Then there are the so-called climate gases – chiefly CO2 and methane emissions. And here it gets all woo-woo.

The IMF has largely resorted to phantasy numbers when pricing those externalities and to be sure, they also make up the bulk of this more than 5 Trillion USD figure.

Let’s come back to the US example. What they have done is taking the assumed carbon emissions of the US in 2015 (5,4 billion tons) and multiplied by a 36.- USD per ton price they have just pulled out of thin air.

Positive externalities derived from the use of fossil fuels are of course not considered. They should be subtracted from those alleged costs for fairness sake.

But wait, we have just seen above that the world generates more than 80 Trillion USD in GDP each year. I think it’s hard to assume that fossil fuels are not at least responsible for 3 quarters of this GDP. This means 60 Trillion USD of GDP would not have been created without fossil fuels. If we subtracted those 60 trillion from the little above 5 trillion in assumed negative externalities, we have 55 trillion in positive externalities from fossil fuels. I am being generous with the non-fossil fuel economy here.

We would be back at muscle power and unreliable renewables which means we would go back to where we were 400 years ago. Whatever renewable energy there is would be only for a slim caste of very rich persons condemning the rest of humanity to subsistence levels. Greetings from the Panem franchise. Is this what the IMF folks want for us?

The positive externalities dwarf the alleged cost of carbon emissions by more than an order of magnitude.

Also, a higher CO2 concentration favors plant growth so huge agronomic benefits would have to be subtracted again from the alleged costs.

The plot thickens.

And here we are still in the realm of “CO2 is bad and causes global warming” which is far from being a proven fact but still a fancy theory that unravels with every model that runs awry.

Anything humans do on this planet produces negative externalities – and hopefully some positive ones. Windmills are monstrous contraptions that spoil huge swathes of land devaluing it through the hideous looks, their infrasound and their shredding of birds, insects and other airborne lifeforms. Does anyone put a price on them? It’s also fair that if a price is put on the CO2 produced by fossil fuels, that the same practice should also apply to the production of windmills and solar arrays.

Their production has released CO2 into the air and that backpack must be considered a subsidy if we applied their logic. The madness never ends.

So, in order to keep things straight, we must dismiss those unfit attempts by the IMF – and really also the European Commission which has received a study on the internalization of transport externalities prepared by CE Delft – and stick with the classical definition of a subsidy.

A political act to make a tangible allowance to someone with the objective to foster a practice or to relieve a burden. It must directly change the profit and loss situation of the recipient as it must be tangible. And it must be funded by the public purse which means the tax or ratepayer. It’s a market-distorting measure that needs justification.

And by that count, the subsidy for solar energy alone is about 1/3 higher per MMBtu than the total wellhead price for Natural gas in the US.

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