The President’s Broken Window Fallacy

Carbon Policies and Jobs

By Benjamin Zycher

In my earlier essay discussing President Obama’s speech on climate change and “carbon pollution,” I noted the weakness of the evidence on the effects of increasing atmospheric concentrations of greenhouse gases (GHG) and the poor predictive performance of climate models. I also noted the trivial prospective temperature effects of even draconian anti-carbon policies regardless of what one believes about the underlying climate science, and the obvious implication that wealth redistribution, essentially from red states to blue, is the real underlying goal motivating these policy proposals.

I turn now to some of the poor economic analysis in the speech, in particular the jobs promised as an ancillary benefit of costlier electricity, specifically in the form of complementary employment growth in the wind and solar power sectors. As Mr. Obama claimed: "And that means jobs… manufacturing the wind turbines [and] installing the solar panels…"

At a general level, employment created — that is, shifted — as a result of a government policy is a cost rather than a benefit for the economy as a whole, unless the policy improves resource allocation by, say, correcting for some sort of market inefficiency. (Whether or not government policies can be predicted systematically to improve the efficiency of resource use is the central focus of the vast public choice literature). As counterintuitive as that may seem, imagine that a federal policy had the effect of increasing the demand for high-quality steel. That clearly would be a benefit for steel producers, or more broadly, for owners of inputs in steel production, including steel workers. But for the economy as a whole, the need for additional high-quality steel in, say, an expanding wind-power sector would be an economic cost, as that steel (or the resources used to produce it) would not be available for use in other sectors. More generally, the creation of “green” jobs as a side effect of environmental (or carbon) policies is a benefit for the workers hired (or for those whose wages rise with increased market competition for their services). But for the economy as whole, that use of scarce labor is a cost because those workers no longer would be available for productive activity elsewhere.

There is the further matter that any expansion of the wind and solar electricity sectors must mean a decline in some other sector(s), with an attendant reduction in resource use there. After all, resources in the aggregate are finite. If there is substantial unemployment, and if the labor used in wind and solar activities is not highly specialized, a short-run increase in total employment might result. But in the long run — not necessarily over a long period of time — such policies favoring certain industries cannot create employment; they can only shift it among economic sectors. In the context of the Obama carbon policy, an expansion of wind and solar power would accompany a contraction of the coal-fired power sector, and a contraction of other sectors due to an overall increase in electricity prices. Moreover, there is also the adverse employment effect of the explicit or implicit taxes that must be imposed to finance the subsidies needed to increase wind and solar generating capacity; that such subsidies are likely to be required for the foreseeable future is a topic explored in detail in this AEI study. 

Because wind power and solar power are more costly than conventional generation, policies driving a shift toward heavier reliance upon the former would increase aggregate electricity costs, and thus reduce electricity use below levels that would prevail otherwise. The 2007 Energy Information Administration (EIA) projection (Table 21) for total U.S. electricity consumption in 2030 was about 5.17 million gWh. The latest EIA projection (Table A8) for 2030 is only about 4.28 million gWh, a decline of about 17 percent. The change presumably reflects some combination of assumptions about structural economic shifts, increased conservation, substitution of costlier renewables for some conventional generation, and a price increase from about 9.6 cents per kWh to about 10 cents (in 2012 dollars). It would be surprising if that reduction failed to have some employment effect. 

Figure 1 displays data on percent changes in real GDP, employment, and electricity consumption for the period 1970 through 2009, obtained from the Bureau of Economic Analysis, the Bureau of Labor Statistics, and the Energy Information Administration, respectively.     

It is obvious from the aggregate trends that electricity use and labor employment are complements rather than substitutes; the simple correlation between the percent changes for the two is 0.53, meaning, crudely, that a percent change in one tends to be observed with a 0.53 percent change in the other, in the same direction. The simple GDP/electricity and GDP/employment correlations are 0.61 and 0.78, respectively.

The correlations by themselves are not evidence of causation, the determination (or refutation) of which requires application (and statistical testing) of a conceptual model. But the data displayed in Figure 1 make it reasonable to hypothesize that the higher costs and reduced electricity consumption attendant upon the Obama effort to reduce emissions of GHG would yield a reduction in employment rather than the increase promised by the president.

It is certainly possible that the historical relationship between employment and electricity consumption will change. Technological advances are certain to occur, but the prospective nature and effects of those shifts are difficult to predict. The U.S. economy may evolve over time in ways yielding important changes in the relative sizes of industries and sectors; but, again, the direction of the attendant shifts in employment and electricity use is ambiguous.

Notwithstanding the assertions of the president, there exists no evidence in support of the notion that a reduction in electricity consumption would yield an increase in employment. Like all geographic entities, the United States has certain long-term characteristics — climate, available resources, geographic location, trading partners, economic and legal institutions, etc. — that determine in substantial part the long-run comparative advantages of the economy in terms of economic activities and specialization. Figure 2 presents the historical paths of the electricity intensity of U.S. GDP (kWh per dollar of output) and of the labor intensity of U.S. electricity consumption (employment per kWh). 

Between 1970 and 2011, the electricity intensity of GDP has increased and declined over various years. But for the whole period, it has declined slightly at a compound annual rate of about 0.5 percent. The labor intensity of U.S. electricity consumption — in a sense, the employment “supported” by each increment of electricity consumption — has declined more or less monotonically over the entire period, at an annual compound rate of about 1.2 percent. This may be the partial result of changes in the composition of GDP (toward services), and perhaps the substantial increase in U.S. labor productivity in manufacturing; several hypotheses are plausible. But these data do not suggest that a reduction in electricity consumption would yield an increase in aggregate employment; if anything, they suggest the reverse. While the employment/electricity relationship may have declined over time, there is no evidence that it is unimportant in an absolute sense, and it is far from inverse.

That there are no free lunches is an eternal truth, notwithstanding the assertions of experts and public officials. The Obama version of this ancient snake oil is simple: we can have a stronger economy and more employment if we discard part of the power-generating capital stock. That is a blatant example of the old broken window fallacy: if a window is broken, output and employment will rise because someone has to hire someone else to replace the window. That first someone, of course, is forced to buy window replacement instead of some other good or service, so that the broken window induces a shift of resources rather than an increase in aggregate wealth. For the economy as a whole, the broken window — or the electric generating capital forced into retirement — is a net loss. We cannot become richer over time by making ourselves poorer in the here and now.