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Inviting Inflation—and Energy Dependence

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Inviting Inflation—and Energy Dependence

A new proposal for a disguised carbon tax comes at a particularly bad time. May 2, 2022
Economy, finance, and budgets
Infrastructure and energy

Carbon taxes, and their functional equivalent disguised in the form of energy taxes, have faced political obstacles and serial failures to take effect ever since the debacle of the 1993 Clinton–Gore “BTU” tax. Now a bipartisan group of American lawmakers has proposed a “border carbon adjustment” tariff intended to reduce society’s use of hydrocarbons and usher in energy innovation. But carbon taxes have failed, so far, for good reason: they’re a bad idea and would do little to cut hydrocarbon use or stimulate productive innovations. And whether framed as a border adjustment or as the broad-based levy that Congress toyed with enacting three years ago, any carbon tax would be inflationary—meaning this latest proposal couldn’t come at a worse time.

It’s easy to ignore the benefits of cheap energy when, well, it’s cheap. Energy is needed for everything that is fabricated, grown, operated, or moved. Since hydrocarbons directly supply 84 percent of the world’s energy and are indirectly embodied in all the rest, the inflationary potential of any carbon tax is clear. In normal times, energy typically accounts for only about 10 percent of the cost of most products and services. But double the spending on energy, and the average overall final price tag for a product or service rises at inflationary levels. With today’s energy prices already doubled, or more, the consequences are apparent. Over half of wheat’s inflation, for example, is a direct result of higher prices for natural gas, the fuel needed to make fertilizer.

The energy-inflation arithmetic is equally clear at the macroeconomic level. Before the runup in global energy costs—a trend that began well before the war in Ukraine—global spending by consumers and businesses on energy accounted for about 10 percent of global GDP. Double energy costs, and you don’t get more GDP: you get inflation.

Advocates claim that a carbon tax is an efficient way to reduce hydrocarbon use because it “disincentivizes” their use by simply raising the price. Whether the mechanism is directly to tax energy to make it more expensive, or indirectly to tax it by making it more expensive to buy imported products built in other more hydrocarbon-intensive countries, both have the stated purpose of raising prices. High energy prices do indeed discourage consumption, but they also debilitate citizens and economies, especially during times of inflation. So carbon-tax advocates propose that some of those collections would flow back to the economically disadvantaged—which would be pretty much everybody if a tax or tariff were high enough to curb energy use meaningfully.

We have some idea of how significant a tax would have to be to deter hydrocarbon use. For example, in the decade leading up to the 2008 recession, world demand for oil kept rising even as prices rose 200 percent. Oil use dropped only when economies collapsed from the financial crisis. Carbon-tax advocates know that political support will require that energy prices go up only slightly. But any paltry tax wouldn’t measurably affect hydrocarbon use and would therefore utterly fail to achieve the ostensible goal.

Carbon-tax proponents also suggest that the higher costs for hydrocarbons would stimulate both innovation in alternative-energy domains and reshoring of energy-intensive industries. Foundational innovations don’t emerge from punitive taxation, but such taxation is a formula for political backlash. It’s equally fictitious to believe that a border-adjustment tax would induce some rush to low-carbon reshoring of manufacturing. Such a managed economy would, intentionally, yield more expensive goods, and at even higher costs if required to use energy from a subsidized green-energy system. This scheme would not only ignite more inflation but also invite fraudulent accounting, cronyism, and kleptocracy. Because America’s economy uses so much energy, even a modest tariff would drain billions of dollars out of the private economy into government coffers, where much of that would flow to those positioned to benefit. And, as history has shown, any new “modest” tax invariably expands over time.

Proposals to prop up green energy will have more severe inflationary effects than their advocates let on, not only because of the magnitude of the efforts needed but also because of the thus-far ignored inflationary impacts of simply trying to fabricate the quantities of hardware needed.

For perspective on the scale of the challenge: getting to today’s state of green-energy affairs took about 20 years and well over $5 trillion of global spending on hydrocarbon alternatives. Yet hydrocarbons’ share of world energy has declined only by 2 percentage points over that time. The favored alternatives of wind and solar energy still supply only about 3 percent of global energy. As for electric cars, spending on them famously doubled last year—yet batteries still power just 0.8 percent of all transportation, while oil still fuels nearly 97 percent.

Our current episode of energy inflation emerged from a perfect storm at the intersection of three forces. First were government policies in Europe and the United States that have been, for years, hostile to expanding conventional energy production. Second were pandemic lockdowns, which wreaked havoc on energy supply chains. Third was Russia’s invasion of Ukraine. Now the head of the International Energy Agency (IEA), the president of the European Union, and the president of the United States insist that a key solution to combat energy inflation and to delink from Russian oil and gas exports is to redouble a commitment to green energy to replace hydrocarbons. But an accelerated energy transition wouldn’t do much delinking—though it would fuel inflation.

And now comes the ignored inflationary potential arising from what it will actually take to build the quantities of alternative energy machines needed to significantly impact hydrocarbon’s dominance. As the IEA and others have quietly noted, producing exactly the same energy as that supplied by hydrocarbons by building wind turbines, solar modules, and batteries instead requires, on average, an increase of 1,000 percent or more in the use of common minerals such as copper, aluminum, and nickel, as well as comparable or greater increases for elements such as lithium, manganese, cobalt, and rare earths. Yet as the IEA observes, the world’s miners are not producing, nor planning to produce, enough minerals for that kind of growth.

The astonishing growth in the supply of commodity minerals needed for green aspirations almost certainly can’t happen in the timeframes proposed by policymakers. And the mere attempt to pursue that materials-intensive path inflates mineral prices. For example, aluminum is now trading at a 30-year high, and copper and nickel are up 250 percent in a few years. Just as with energy, mineral inflation ripples through everything in the economy because the very same materials are used to build trucks, appliances, computers, and homes.

A recent analysis from the International Monetary Fund (IMF) found that the pursuits of minerals to fuel the IEA’s desired green-energy strategy would lead to historic levels of minerals inflation that would last for a decade. Such a path would reverse a century-long record of a slow but continual decline in the average cost of mineral commodities. As it has with cheap energy, the modern world has become even more complacent about cheap minerals.

Some analysts have finally come to realize that access to the gigatons of minerals needed for the green transition would also have undesirable geopolitical consequences. Europe would become less dependent on Russia but more dependent on China. The U.S. would rely less on its domestic hydrocarbon industries—but more on Chinese minerals. Here, the IEA has been quietly honest in its analyses. China has over the past two decades engineered a global market dominance in most key energy-minerals that is greater than OPEC’s market share for petroleum. Good luck negotiating energy-mineral prices in that future.

In any case, a carbon tax would fuel inflation at a particularly terrible time. Those eager to find a compromise to reduce society’s dependence on hydrocarbons should consider other options.

The first and obvious possibility involves technologies that enable radical improvements in the efficiency with which hydrocarbons are used. Cost-effective technologies that burn less fuel to achieve the same output are inherently economically productive, which both creates wealth and lowers the costs of products and services. And then, a wealthier economy would be better able to afford the costs of building climate resilience into infrastructure and supply chains, something that should be done anyway.

What about outright replacing many uses for hydrocarbons? Next-generation nuclear power is the only energy source with truly game-changing potential. Existing nuclear reactors should be preserved and more like them built. But to achieve a radical expansion in the applicability of nuclear energy, more design options are needed. Fortunately, the profound physics advantages of nuclear fission offer engineers potential that is impossible with anything else known.

Still, any sensible and orderly market adoption of technologies that improve hydrocarbon efficiencies would require some faith in markets. And the eventual development of next-generation nuclear designs would require patience to navigate design-engineering realities and prove out capabilities. Those virtues—faith in markets and political patience—may be two resources in genuine short supply.

Photo by PATRICK T. FALLON/AFP via Getty Images

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