Monday, September 5, 2011

Environmental Regulation and Jobs

The short answer is that it’s the wrong question.  Now for the longer answer.

The main tradeoff with regulation is output, not employment.  If you increase the cost of making something, you need more people to make the same amount, or you need people to make something else instead, something you wouldn’t have wanted to make without the regulation.  That’s why economists who study regulations measure their impacts on productivity and output, not jobs.  But the topic is jobs, so let’s consider it.

There are three potential sources of unemployment in an economy, the level of aggregate demand, the trade balance and structural mismatch.  Let’s look at each.

By far the most important determinant is the demand for goods and services.  Demand is grossly insufficient in the current US economy as debtors retrench, and the result is mass unemployment.  Environmental regs have nothing to do with this.

The second factor is trade.  By itself a trade deficit is equivalent to a job shortage; what we produce is less than what we consume.  The gap can be closed by aggressive fiscal policy, but only for a while.  The verdict of history is that deficit countries (those with chronic external deficits) face ever-increasing financial pressures.  Do tough environmental regulations magnify trade deficits?  There is a large empirical literature on this question, and the best answer at the moment seems to be maybe, a bit, but trade imbalances are mainly due to other causes.

The third factor is structural mismatch.  This may be due to workers having the wrong skills or being in the wrong locations, so that unemployment is higher until the mismatch can be rectified.  As those following current economic debate know, our unemployment is almost entirely due to insufficient demand; structural factors have nothing to do with it.  (We don’t see wages shooting up in sectors starved for the right kind of labor.)  In theory, environmental regulation could cause short-term industry shifts that would exacerbate structural unemployment—if we had any.

But there is a second interpretation that can be given to the structural theme.  Sometime it is not labor that is not matched with demand, but capital.  A sudden, unforseen shift in technology or the pattern of demand can render a large part of the capital stock unproductive.  It is forced to shut down, and this leads to a loss of jobs until new capital can be installed.  The most vivid example in modern history was the opening of the former Soviet bloc in 1989: once trade barriers came down it became clear that much or even most of the capital stock in the CMEA countries was “wrong”.  High levels of unemployment were unavoidable during the years required to install new industries.  (Over two decades later, the process is still incomplete.)

There is no historical example of environmental regulation on the scale of the-fall-of-the-wall.  Some economists think that the regulatory spurt of the early 1970s may have caused a fractionally lower growth rate in subsequent years, but their argument is about productivity, not employment.  (It is not anti-green to note that there is often a tradeoff between protecting the environment and producing more stuff.)  Is it even possible to imagine a shift in environmental policy as wrenching as the collapse of Communism?

Yes.  Suppose that the IPCC, NAS and the vast majority of climate scientists are right, and that climate change is a gathering, world-altering threat.  Suppose further that, for political-economic reasons, serious action to forestall this threat is not taken.  Neither of these are much of a stretch, are they?  Then suppose that at some point in the future the climate system produces a planetary hiccup, an event that makes the process visible and alarming.  This could take the form of a rapid deterioration in one or more terrestrial icecaps, or perhaps a large, measurable release of methane.  Panicked into action, political leaders quickly patch together a draconian agreement to suppress carbon emissions.  This could be a 1989 for global capitalism.  It might be too little, too late to save the environment but too much, too quick for refashioning the capital stock.  Millions more would be thrown out of work.

If you take climate change seriously, this is something to consider.  The way to avoid it is to begin taking progressively more stringent action against carbon emissions as soon as possible, to provide more adjustment time and make the change in direction reasonably predictable.  “Jobs or the environment” makes sense only if the environment is optional.  If it’s a constraint, smarter, more timely regulation is the way to hang onto the “jobs” part.


FuzzyFace said...

I think you're missing something. Regulations, whether environmental or not, increase cost of production. That leads to increasing cost of the product, which in turn drives down demand. Yes, we have insufficient demand already, but why would it be a non-event to make it even lower?

Yes, if AGW is correct, it would be prudent to back off on the human contribution to warming - but our knowledge of climate science is still very poor, and so far climate theories have been remarkably bad at predicting anything that has subsequently been verified. Why then, should we believe that any particular regulations that are being proposed will actually improve things?

Peter Dorman said...


Be careful when shifting between micro and macro. Shifts in relative prices change the composition of demand, not its aggregate size. As for climate change, read the links, especially the NAS. If you still have a beef, take it up with them.