A Free-Market Energy Blog

Energy Externality Pseudoscience: Unmasking Krugman's Argument Against Fossil Fuels

By -- November 15, 2011

Opponents of fossil fuels have long championed solar power and wind power as replacements. Unfortunately, there is no evidence that solar and wind can provide the cheap, plentiful, reliable energy that our standard of living requires. They have never come remotely close to competing economically on a free market. In fact, due to their low concentration and high intermittency, they have proven unable to provide substantial baseload power in any country, ever, even when exorbitantly subsidized.

When confronted with these facts, opponents of fossil fuels offer a seemingly scientific counterargument. Fossil fuels are only cheap, they say, because fossil fuel companies aren’t required to pay for the “hidden costs” or “negative externalities” of their product. These “hidden costs” are harms not reflected in the prices we pay–such as the presumed damage from future climate change. Companies should be required to pay these “hidden costs,” the argument goes, and if they were, solar and wind would actually be cheaper than fossil fuels.

In a recent column, “Here Comes the Sun,” Paul Krugman invokes this view to argue for major taxation on fracking (and, by implication, all other fossil fuel production). To believe otherwise, he says, is to be economically illiterate.

Fracking–injecting high-pressure fluid into rocks deep underground, inducing the release of fossil fuels–is an impressive technology. But it’s also a technology that imposes large costs on the public…Economics 101 tells us that an industry imposing large costs on third parties should be required to “internalize” those costs — that is, to pay for the damage it inflicts, treating that damage as a cost of production.

Unfortunately, this analysis fails both Political Philosophy 101 and, surprisingly given Krugman’s credentials, Economics 101.

It is true, as Krugman says, that the price of a product does not reflect all the negative effects that come with the product. For example, when the automobile industry overtook, the horse-and-buggy industry, there were many negative impacts on the workers and families of the latter industry, who had to suffer temporary unemployment, go through retraining, etc.

But Economics 101 does not tell us what to do about such effects. For example, it doesn’t say whether the automobile industry should have been forced to pay a tax for “imposing large costs on third parties” it drove out of business. Such questions are the province of political philosophy. Krugman is welcome to argue for his personal political philosophy, which, in my reading, is a hybrid of utilitarianism, egalitarianism, and economic authoritarianism. But he should not abuse his economic prestige to smuggle his political views under “Economics 101.” The idea of dealing with pollution issues via “externality” calculations rather than by proper definition of air and water rights, is highly dubious and anything but self-evident.

That said, it can be valuable in understanding the economic impact of an industry to analyze negative impacts that are not reflected in prices. But we must simultaneously analyze the positive impacts that are not reflected in the prices we pay. But Krugman and others steadfastly refuse to consider the “hidden benefits” of fossil fuels–even though they are massive.

A very clever video on YouTube illustrates the issue of hidden benefits with regard to the Internet. “How much money would someone have to pay you,” the host asks, “to give up the Internet for the rest of your life?” In other words, how much is the Internet really worth to you? The video’s featured economist, Professor Michael Cox, says his students mostly answer that no amount would be enough–and when they propose amounts, they are in the high milions or billions. Most of us would say the same, because the Internet is an indispensable value in our lives.

And yet how much do we actually pay for it? Less than a thousand dollars a year. “What the market has done,” observes Cox, “is create a tremendous gap between worth and cost.” This gap is a wonderful thing–so long as we don’t forget it when assessing the importance of indispensable values to our lives.

An equivalent gap between worth and cost exists between what we get and what we pay for indispensable sources of cheap, plentiful, reliable energy such as coal, oil, and natural gas–since energy is the resource that makes every other resource in our industrial economy possible.

Consider: If you were a factory owner, how much more would you be willing to pay for the coal-powered electricity that allows your business to exist? How much would you be willing to pay for the natural gas that keeps you from freezing in the winter? How much would you be willing to pay for the gasoline in the ambulance that saves your child’s life? A lot more than you do.The reason we get energy for such a bargain is because of the wondrous nature of the free market, including another part of Economics 101 Krugman conveniently omits: the marginal nature of prices.The price we all pay for a given good or service is set by the marginal buyer–the buyer who, among those having successfully bid for the good or service, was willing to bid the least for it.

This means that every other buyer valued the good more than the price paid. Thus, with every product or service, the total value consumers gain from buying it is necessarily higher than the total price they pay for it. And in the case of indispensable values, such as the Internet or cheap, plentiful, reliable energy, that value is incomparably higher. We should never confuse the price we pay for fossil fuels with the value we get from fossil fuels.

An honest attempt to guesstimate the full economic impact of fossil fuels would have to take into account, at the absolute minimum, the following:

  • Cheap, plentiful, reliable energy adds dozens of years to life and makes those years incomparably more enjoyable.
  • Given current technology and economics, including the desperate need for industrial-scale energy around the world, fossil fuels will be indispensable for decades to come. This is especially true because of the environmentalist assault on nuclear power, which has set back that technology decades.
  • Industrial-scale energy has historically made us far less vulnerable to climate, not more–and would be essential to coping successfully with any serious climate change, natural or manmade.
  • Solar and wind have never produced cheap, plentiful, reliable energy in any country, ever.

None of this enters into Krugman’s “scientific” evaluation. He treats the price of fossil fuels as fully reflective of their positives, and regards it as scientific to fixate on their negatives (real or fabricated) and demand that massive taxes be levied. What level of taxation? Krugman doesn’t say–but let’s explore the alternatives.

If the Left imposed a carbon tax that was large enough to force the entire economy to run on solar and wind, the entire economy would collapse. If the tax was large but not large enough to totally bankrupt the fossil fuel industry, it would do little to reduce greenhouse gasses but make us far poorer, including far more vulnerable to the climate–cheap energy being the key to making the climate livable. Any level of tax is pseudo-scientific and destructive, because it is based on an evasion of the indispensable, life-and-death positives of fossil fuels.

What should the government’s policy toward pollution be? This is a complex subject, but in my view the proper principle to guide policy is individual rights. The government should clearly define air and water rights, and enforce individual cases according to objective evidence of physical harm.

How such rights should be defined is in part an issue of the economic and technological context; since it is never possible to eliminate all waste, what amount of waste constitutes a rights violation must take into account the full context of what waste is preventable in a given economic and technological context and what isn’t. In today’s context, to call CO2 emissions “pollution” is to call human survival “pollution.” No view could be more damaging to our economy–or to the human environment.


  1. Tom Tanton  

    Alex, while I certainly agree with your position that “positive” externalities should be included, it also makes sense to properly quantify the negative externalities, which Krugman et.al. never seem to get around to, or worse use a cost of control approach. Back in the mid 1980s a few of us used a damage function based approach, that was ultimately adopted by regulators (CEC and CPUC.) It showed that renewables were still not cost effective, even when fossil was burdened with the externalities. Of course renewables’ costs have changed, but so has the cost of fossil, and fossil has also gotten increasingly clean (and consequently would cause less actual damage to monetize.) Renewable advocates were none too pleased to be faced with some actual numbers.


  2. Kent Hawkins  

    This is a very good, thought provoking article. To help bring home of what one would be willing to pay to ensure fossil fuel energy was available as needed is to consider the equivalent number of servants that the average North American household would need to maintain its current standard of living.

    For direct electricity use alone this would be an average of 10 servants over a 24 hour day. Peak time considerations could easily double this. Our needs are not distributed evenly over the day, and servants have to sleep too.

    Now consider the impact of immediately giving up gas-fuelled automobiles. We may be able to do this sometime in the fairly distant future, and this is a much longer discussion. Today, we would need alternative modes of transportation, including for example litters, which need litter bearers, and other forms of animal transport including extensive walking on our part. Think of treks some Africans make to obtain medical/health care, education, employment, water and food.

    Add to this the energy content (another equivalent of the servants needed) to bring these modern conveniences to us. This includes the manpower saving tools we have produced in order to do manufacture and deliver these products to us.

    The number of servants for the average household becomes quite large and could easily be in the range of 50-100 plus. Now we need to house, feed and manage these servants, another multiplier.

    This is a limited attempt to illustrate the value of the benefits we have with modern day energy sources, conversions, transportation and use. I would add that we must quickly become better at accessing and providing these energy sources and this should be one of our short-term focuses.

    Some will argue that time is running out on us. So let’s address the question of how we can achieve the environmental goals that we want to set in the short term. Renewable energy sources cannot do this, and will not be able to do so without significant improvements in conversion efficiencies, storage and means of transportation of energy, which will take many decades before ready for commercialization. Direct conversion of solar to electricity (now think of electrification of transportation) is the most likely of these to succeed, but not until after many decades of development.

    In the short term, the next 10-20 years or so, the only approach that will do this is aggressive conservation. Think in these terms. If you object to our present means of producing electricity and other uses of fossil fuel, in effect, stop using electricity and driving your car. Alternatively move to a country that does not have these and live like the people there. Like it or not, this is the harsh reality.

    Our future is dependent upon us making the optimal decisions today, and this article exposes some of the erroneous thinking that exists. Improving our existing energy sources, systems and infrastructure provides the optimal strategy to ensure the longer term success of our species. There are no “quick fix” solutions, as many would appear to think, other than aggressive conservation.


  3. Ed Reid  


    IIRC, CA had three different damage cost estimates at one point: one for emissions in the LA basin; one for emissions in the remainder of the state; and, one for emissions produced “downwind” of CA.


  4. Steffen  

    Really great article, Alex.
    I would like to mention two additional points.
    CO2 is a fertilizer. This might not look like a big deal, but even a little more CO2 concentration in the atmosphere will be very beneficial to crops.
    And, of course, any intervention by government – especially phony non-solutions like wind and solar – causes economic damage. That means capital is wasted and/or not created that could be used to deal with other problems. Healthier food, medical research, basic technological advances, safer cars, etc. That’s a cost and it will cost lives.
    Even if these points are not easily quantified, they are certainly significant. So “cheap” energy (and cheap everything) is in itself beneficial, contrary to the narative of green/red ideologues.


  5. JavelinaTex  

    Absolutely outstanding argument Alex. Tom & Kent make outstanding additional points.

    Just one example of what has been entirely ignored is the Value Proposition of gasoline and the automobile. Freedom is what you get when you purchase gasoline. It is often totally ignored that despite fuel taxes in Europe that run in the $80 to $100/ barrel range, families in Europe still tend to own automobiles. Not as intensely as in the US, but nonetheless they do own and drive autos.

    What is also interesting is to see how the Entertainment Industry has tended to embrace the environmental extremist views. Can you imagine Rock & Roll (and R&B/Soul) from Chuck Berry to Bruce Springsteen… without the “Fast Car” songs?


  6. Raman Gupta  

    @Kent Hawkins: There *are* “quick fix” solutions, though in today’s corrupt culture, quick != easy. That quick fix would be to free up the energy market as Alex advocates. Let all energy sources compete on the market freely, without subsidies or special taxation, and without being subject to ridiculous environmental regulations. Instead of environmental regulations, refer to Alex’s alternative rights-based solution to pollution which is objective rather than based on pull peddling in Washington.

    Nuclear energy alone has the potential to sustain human life and growth for the foreseeable future, and would almost certainly develop quickly in a truly free market, and doubly so if people believe that fossil fuels are “running out” (though they are not).

    *Forget* conservation — I want *more* positive externalities in my life, and that means *more* energy use.


  7. T. Caine  


    I agree with the method of analysis and the need to weigh the full breadth of positives and negatives, seen and unseen, in their entirety. However, I’m not as convinced that the results would be so glaringly positive for as far as coal is concerned. Natural gas is an unavoidable component of our energy mix for the foreseeable future, but coal strikes me as the horse and buggy.

    I’m not sure that comparing externality of the natural evolution of industry employment to the contamination of drinking water or air is really apples to apples. One seems much closer to an affront on the personal freedoms, or individual rights, you touch on while the other is a change in the economic value of skill sets.

    I think it’s important to note that not all fossil fuels are created equal and wouldn’t wind up in the same place on the bottom line if broken apart. As Tom notes, fossil fuels have become cheaper to harvest and plants have become more efficient, but the externalities of new plants are very different from trying to quantify the hidden costs of keeping old plants open—especially coal. Comparing renewables to a brand new natural gas fired cogeneration plant is one thing, but comparing them to a 50+ year old coal plant is another animal. Correct me if my stats are off, but a quick search was yielding the median age of our nation’s coal plants at 1966, with over 30% being built before 1960. The liabilities of the oldest part of the fleet (i.e. the dirtiest and the least efficient) have to be assessed as well.

    As for raising the price of electricity and its affect on the economy, I don’t think the doomsday scenario of coming to a screeching halt is inevitable. Of course, it would depend on the degree of rise in cost, but even in a significant advance I think that Kent’s point of use touches on a more likely outcome—though I would peg it as less arduous. If power costs rise conservation, but moreso efficiency, would rise to decrease consumption. As an architect, I think buildings would be a huge component. Buildings draw somewhere between 35-40% of our electricity, but most buildings could easily be 20% more efficient (especially our homes which I believe account for half of that number). Cheap power makes efficiency less of a priority, but more expensive power would make using less that much more equitable.



  8. Tom Tanton  

    Ed Reid, we actually had estimates for each air basin by locale and that varied by time (as ambient air quality changes/changed.) What was perhaps most interesting is that the largest damage in some locales was not necessarily associated with public health. Transport from one basin to another was included in receptor damage.


  9. JavelinaTex  

    T. Caine, one thing you have to consider as a positive externality of Coal is that it contributes to low natural gas prices. Yes, right now Natural Gas is low because new reserves have brought out a high elasticity of supply. However, if we replaced all of our coal amd nuke capacity with gas, you would increase Gas Demand by about 75% to 40 TCF/year. I would not want to bet that our production and reserves could keep up with that type of demand increase with prices nearly as low as they are today. Also, our “unclean” coal problem is a financing and “no one wants to pay” issue. Cleaning up our more modern plants (about 220 to 250 GW) is not all that expensive in the big picture scheme. It is only if one considers CO2 a pollutant where you come up with truly large numbers. Nearly all the health impacts of coal are due to non-CO2 causes.


  10. Kent Hawkins  


    We are saying much the same thing, but I am apparently being less clear about it. Some others may also misinterpret my comment so I welcome the opportunity to clarify it. I repeat my summation.

    “Improving our existing energy sources, systems and infrastructure provides the optimal strategy to ensure the longer term success of our species. There are no ‘quick fix’ solutions, as many would appear to think, other than aggressive conservation.”

    The optimal strategy is to continue with nuclear and fossil fuel energy sources. I would label sudden changes (including aggressive conservation) from this course “quick fixes”. Another example of a “quick fix” would be the massive implementation of wind plants and the equally massive increases in our grid infrastructure to accommodate its unreliable and diffuse energy source. Our focus should be on the optimal extraction, conversion, transportation and use of existing sources, where I am sure there is room for improvement.

    I introduce conservation as the answer to the expected objection (of the belief) that time is running out. If that is the argument, and there is disagreement with my optimal solution, then this is the only logical “quick fix” that will address the time objection. However, the societal changes required in a short time frame are very large and the likelihood of being able to achieve the necessary level of conservation is very small. But let us not rule out conservation measures within the optimal solution.

    The “quick fix” that many are looking to is wind (and to a lesser degree solar). If pursued as enthusiastically proposed, this will lead to a failure in our electricity system and economy, which will impose aggressive “conservation” in very unpleasant ways.


  11. Chris Fillie  

    Some very good points, especially about the power density of fossil fuels and the FACT that they cannot be replaced by renewables as such… Solar has just hit about 1.9 to 1 EROI, fossil fuels, while declining as easy sources/finds become scarcer, is still well above 7 to 1 on global average, with some oil fields still yielding in the 20+ range.

    While many green advocates fail to see this huge discrepancy between EROIs, the “hidden benefits” argument is a bit of a non-issue. All things purchased are purchased for their benefits, hidden or not. To say that a factory owner would pay far more for coal or oil to run his/her factory than market rates rather than disproves Krugman’s points, actually strengthens them, and disproves the authors own about the terrible specter of actually having to pay for externalities, or subsidize the alternatives that must be created to replace such sources.

    Yes, cheap fuel is great, but it is limited. And there is NOTHING (that we know of) that can replace it on Earth. Thusly, by using it in an unmanaged way that reflects only costs of extraction, we are, in a way, stealing from our future by liquidating the greatest power source ever discovered in terms of energy invested for energy returned. Even worse, as tragedies go, we spend it on stupid things that have NO ASSET VALUE, and may be creating massive future liabilities. If we were using oil to build assets that would help us live fat in the future, I would be supportive.

    For instance, I look at ANWR in Alaska, and deep sea finds (of which we DO NOT yet have the technological capacity to safely extract) as a strategic reserve for future generations to help build and maintain infrastructure. The real problem I see is that, due to these “hidden benefits” (AKA extreme give-aways) received when we buy fossil fuels, we carelessly use the vast majority of this precious resource on ridiculously wasteful endeavors like moving 2 tons of steel to move our increasingly overweight artery clogged half-dead paper pushing selves from home to work and to the store and back…

    Truly a tragedy of the commons and a failure of property rights and asset valuation of MASSIVE proportions. Oil is a resource of the commons, yet we actively encourage, for very small lease rates, the few people/corporations with the capital to build the extraction infrastructure total free reign to extract all they can and dump all they can into the market as fast as they can… does this really make sense?

    Can we really argue that this is a good idea? Can we really argue that we are entitled to spend this resource as we please, to liquidate it as fast and consume it as cheaply as possible, without regard to future generations? And if your answer is… well, we’ll find “alternative” sources for them… then why the beef with funding research and enacting subsidies to begin and advance this search?


  12. aepstein  

    Re: Chris’s point about the unsustainability of cheap fuel, I disagree on a moral and economic level.

    Morally, if it were true that cheap fuel couldn’t be substituted for in the future, people should still use as much as they are willing to buy today using prices set by supply and demand. Over time, people would have to economize more and more as price went up, but–and this is the crucial moral point–they would not have to sacrifice for “future generations.” I do not believe there is a conflict between us and people 100 years from now, but if there were one I believe the only moral course is to benefit the living here and now instead of sacrificing their irreplaceable lives and well-being to their great-great-great grandchildren. (If the proper course of action under this very negative scenario to take place, people would of course lower their procreation and the transition would occur as humanely as possible.)

    Another moral point is that there is no basis for criticizing people for using automobiles, unless you think that is artificially driven by government controls. An automobile is a great means of transportation, if you’re focused on the human, rather than some detached “efficiency” calculation about what humans “should” want or be willing to tolerate.

    Economically, there is every reason to be optimistic about the potential for cheap fuel. In general, there is the fact that nature gives us an effectively unlimited supply of raw materials that human ingenuity, when liberated, turns into resources faster than we can use the raw materials it previously turned into resource. As a practical matter, we have an enormous amount of radioactive material in the earth’s crust that could be converted to portable fuel in various ways, and we are on the frontier of new discoveries of natural gas, and even those pale in comparison to the volume of methane hydrates that exist in the bottom of the ocean. As I like to say, we’re not running out of oil, we’re running out of freedom.


  13. David Bergeron  

    Chris Fillie, the ERIO argument ignores the value of all other resources; aluminum, glass, copper, iron, labor, land, and capital. These other resources have great utility to improve life. Squandering them on on-grid solar is a terrific waste. William Baumol wrote a paper claiming than if the energy opportunity cost of the resources which are ignored in the EROI analysis were properly considered, investments in energy sources with a net negative present value (such as on-grid solar) are likely also net negative energy investments. His point is that all goods and services are substitutes for energy at a ratio of their market prices. Wasting $100 of aluminum on solar panel frames could have saved or created $100 of energy if used in market directed ways. And the market would have directed the ‘way.’

    I’d be interested to know your source for the 1.9:1 EROI of solar. Baumol would claim it is about 0.2:1. Given the large negative NPV of on-grid solar, it is not only a clear energy loser today, but may very well always be an energy loser for the on-grid application. So no amount of tax on externalities would cause on-grid solar to become viable. I’m sure many other alternatives, including some renewables will beat solar to the real market.


  14. obiwankenobi  

    Thanks for a great essay, Alex, except Dr. James Mahaffey, author of
    “Atomic Awakening: A New Look at the History and Future of Nuclear Power,” disagrees with your position that the environmental activists caused the cost of nuclear power to escalate. According to Dr. Mahaffey the industry did it to themselves and nuclear power was on the decline well before TMI.
    BTW: An interesting book I read recently might help some of the commenters better understand how free trade and innovation leads to prosperity. Check out Matt Ridley’s latest book, “The Rational Optimist: How Prosperity Evolves” for a detailed discussion of the history of civilization from the prosperity perspective.


  15. LetsThinkClearly  


    Re: Dr. Mahaffey’s alleged idea that “the industry did it to themselves” in causing the price to escalate, it would be helpful and interesting if you could provide a summary of what the nuclear industry supposedly did to itself that raised costs.

    Also, while Alex wrote a minor aside that environmentalist assaults have caused setbacks in nuclear technology, you are discussing to what extent environmental activists caused escalating nuclear power costs. That’s in interesting topic, but with respect to Alex, this point was not raised or asserted in this essay.


  16. clarence letouche  

    Kent Hawkins writes: “The “quick fix” that many are looking to is wind (and to a lesser degree solar). If pursued as enthusiastically proposed, this will lead to a failure in our electricity system and economy, which will impose aggressive “conservation” in very unpleasant ways.” Solar and Wind will not, indeed, offer a “quick fix,” if by this term you mean a successful response to rapidly depleting supplies of affordable fossil fuels. That’s “affordable” fossil fuels. The theory of “peak oil” or gas, or coal, if you choose, has never been about running out of these inputs. Rather, peak oil theory seeks above all to underscore the point that our industrial and technologically based culture was made possible by, and is currently dependent on, abundant supplies of “cheap” energy inputs, in this instance non-renewable supplies of fossil fuels. We are not running out of these inputs, but we are running out of the readily available supplies, the “low-hanging” fruit of easily explored fields. The reserves of these fields are also dwindling at a rather fast clip too, and are not being replaced by new discoveries. As such geologists are forced to explore in areas where production and extraction will be exponentially more difficult, hence expensive, increasing the cost of these fuels across the board. Factor in the increasing demand for these fuels from China, India and other emerging nations, not to mention the desire on the part of producers to begin cutting back on exports as they use more of their own oil for domestic purposes, and what you have here is a very different energy regime from the one that built industrial America. The inputs are the same, but the prices will be very, very different—I consume a lot of peanut butter, because at $1.80 a pound, I consider it cheap, which is to say I can afford to consume a lot of it. If the price of peanut butter was to increase to $10.00 a pound, t would no longer consume much of it, as it is now unaffordable. I’d learn how to get along without peanut butter. Additionally, their is a good deal of propaganda emanating from the Bakken Tar Sands, obviously disseminated by the companies who stand to gain from both private and public investment in their enterprise of bring shale oil to market. The latest USGS survey indicates that there is indeed a large amount of shale oil to be found, but estimate that 4% of it is profitably recoverable at today’s prices. The same study estimated that 50% of the shale oil is profitably recoverable at 10 times today’s prices. So the question is not whether solar or wind will offer a “quick-fix”, or even short-term replacement of our current energy regime—they certainly will not. The question is one that no one seems to want to ask, let alone contemplate—that is, how do we manage a highly complex industrial/technological civilization as it begins its energy descent? How do we power down and maintain any semblance of civic order? To close, I don’t encounter much science on this website, let alone reputable, peer-reviewed science. What I do find is a good deal of already-discredited neo-liberal economic theorizing and the worst sort of revanchist libertarian politicking. Which leads me to conclude that this website is yet another propaganda organ financed by the usual suspects, the small minority who would profit short-term from the continued myopia and ignorance of the majority, putting all of us at great risk in the long-term.


  17. Debunking “Externalities” – Center for Industrial Progress  

    […] more on this issue, see my article “Energy Externality Pseudoscience” and Eric Dennis’s article “What’s in a […]


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