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By Siavash Mohades
With the recent political calls to increase governments' regulatory intervention and taxing activities to protect the climate, economic research has questioned whether such policies could protect long-run economic growth or even the climate itself. Europe's third decade of productivity slowdown is very likely to be amplified if green regulations are pushed in the business sector even more. These green policies should not be implemented without further consideration on how they impact both labour and firms' output.
© Greenpeace
For the first time ever, the European Union plans to impose a carbon tariff on imported goods to prevent companies from moving polluting activities to countries with weaker environmental rules. At first sight, the poorer countries bearing the cost of the carbon tariff are on the frontline of the economic loss of such a policy. Still, European consumers and producers are paying a hefty price for this policy to import the essential and intermediary goods that provide us with a prosperous daily life.
With the EU economy under the pressure of decades of decay in productivity and economic growth, the demand for locally produced goods that usually contain higher transport costs – for instance, cement or steel – has been possibly the last available channel of economic growth not related to the expansion of consuming services. Such policies might shut this channel of growth down entirely. In other words, we are facing an aggregate growth crisis and a reallocation issue that only adds to the pile of historical misallocation issues in Europe.
The recent slowdown of Europe's economic and productivity growth has been an established economic fact and even raised concerns for Mario Draghi during his reign over ECB. It is argued that this persistent slump is potentially driven by the supply chain of industries, policy uncertainty or the sluggish adaption of European firms and governments with the recent tech progress.
However, one may conclude that the regulatory sector- especially the governments – has remained responsible for a substantial part of the uncertainty imposed on firms through over-regulation of the business environment and sluggish responses to macro processes through poor monetary policy and uncoordinated fiscal policies across the union. All this uncertainty reduces firms' demand for both labour and investment, slowing down industrial production growth.
The Europe Economic Policy Uncertainty Index, by Hartwell (2020)
Firms are not different from a machine: they incorporate the input, namely labour and capital, use a specific production technique – formally called technology in economics – and produce a previously planned output. Typically, firms must evaluate the future stream of marginal products of an additional input before purchasing them. In economics, we call this evaluation "expectation formation". These expectations will be – mathematically and in an accounting sense – deviating from a precise band if the firm faces difficulty understanding the future. In other words, the expectation formation is obstructed.
Why do these expectations matter? Too much uncertainty will hinder the evaluation of future streams of marginal output, and firms will stop hiring or investing to minimise their deadweight loss. In principle, an efficient market economy requires a regulatory sector that protects ownership rights and businesses' certain environment without generating noisy-disruptive signals. In contrast, some green policies have caused a constant flow of surprises for firms since their primary purpose was to satisfy the voters or media rather than protect the economy in the long run.
Even though climate change is – and will be – expected to hit Europe harshly for an extended period, the current EU business sector and citizens play little role in the global crises. Importantly, as soon as EU countries banned certain industrial products and chemicals, pollution havens were created across Africa, Asia and South America – where those industries produced those goods using outdated technologies, resulting in even higher global emissions. These emissions were even magnified more when those goods needed to be transported to where they were needed more, namely the countries that imposed green policies since they were the driving force in the demand growth of polluting goods due to their steady growth of real income.
Eventually, imposing such policies raises the question of whether the green taxes are democratic: capitalism has not received enough credits for democratising certain goods and services. The real price (nominal price divided by price deflator) of food, leisure and services has declined by many folds since the 1940s. This reduction provides middle to lower-classes access to broader nutrition, better holidays, and higher welfare. Green taxes on flights or imported goods are necessarily a step back from all the achievements of the 20th century, even though they could contribute marginally to the ongoing climate crisis.
We remind the reader that the claim against the current path of green policies does mean that climate change does not matter or can be resolved quickly through any alternative, but as the evidence of the last two decades is guiding us, the best possible way to solve the climate crisis while not sacrificing the economy and welfare is to have a global mentality, long-run perspective in policy design and welfare increasing goals – since we expect the climate change to attack our welfare at some point in future.
Sources: Eurostat, ECB, Euronews, Guardian, Investment under Uncertainty (by Robert K. Dixit and Robert S. Pindyck - Published by Princeton University Press)
Written by Siavash Mohades
January 2023
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