Udi-ism Berkeley 4/2005 Presentation

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Udi-ism Berkeley 4/2005 Presentation

  1. 1. Unity in Diversity - A Third Way Alternative to Capitalism or Central Planning? Stephen Lee Technical Executive Power Delivery & Markets Electric Power Research Institute April 15, 2005 Berkeley China Review Seminar
  2. 2. Market’s Invisible Hand? <ul><li>“ When individuals further their own interests, Adam Smith believed, they generally serve the interests of society as a whole. It is a remarkably seductive hypothesis, and sometimes it holds up; yet all too often, it doesn’t.” p.168 </li></ul><ul><li>“ Gerard Debreu of UC Berkeley and Kenneth Arrow of Stanford, both of them received the 1983 Nobel prizes for this achievement, … establish the conditions under which Adam Smith’s “invisible hand” worked. These included a large number of unrealistic conditions, such as </li></ul><ul><ul><li>Information was either perfect or at least not affected by anything going on in the economy </li></ul></ul><ul><ul><li>Whatever information anybody had, others had the same information </li></ul></ul><ul><ul><li>Competition was perfect </li></ul></ul><ul><ul><li>One could buy insurance against any possible risk” </li></ul></ul><ul><li>“ My research … on the consequences of imperfect and asymmetric information (where different individuals know different things) … has shown that one of the reasons that the invisible hand may be invisible is that it is simply not there .” p.13 </li></ul>Quotes from “The Roaring Nineties” by Joseph Stiglitz, 2001 Nobel economist, with Akerlof and Spence
  3. 3. Market Failures <ul><li>Among the “market failures” … were those associated with agency problems , where one person has to act on behalf of another . Because of imperfect information … and because of the failure to align incentives , it is often the case that he does not . p.14 </li></ul><ul><li>A central problem of modern economics is how to align interests – how to provide incentive structures that make the agent more likely to represent his or her rightful clients. p. 168 </li></ul><ul><li>In “20:21 Vision”, Bill Emmott, the Editor in Chief of The Economist , noted the failures of capitalistic markets to address environmental problems and their undesirable effects of increasing the income disparity between the rich and the poor within a country and between the rich nations and the poor nations. </li></ul>Quotes from Joseph Stiglitz’s “The Roaring Nineties”
  4. 4. The Danger of Booms and Busts in Markets <ul><li>“ Bubbles are dangerous, because when they burst – and they always do – they can leave havoc in their wake…” p.58 “During the bubble, of course, all kinds of resources get wasted – in amounts that are often hard to fathom, and make government waste look small by comparison.” p.63 </li></ul><ul><li>Busts become prolonged if decisions are based on today’s profits and ignore externalities, i.e., social costs </li></ul><ul><ul><li>“ Fire workers as soon as it is clear that you don’t need them… Firm loyalty – either of workers to their firm or the firm to its workers – were values of a bygone era.” </li></ul></ul><ul><ul><li>“ This meant that employment fell far more quickly as the economy went into the downtown.” p.183 </li></ul></ul><ul><ul><li>Company savings at the expense of unemployment benefits and other social costs which are shifted to the government </li></ul></ul>Quotes from Joseph Stiglitz’s “The Roaring Nineties”
  5. 5. UDi-ism (Unity in Diversity) <ul><li>Tier 2 assets (e.g., air, water, land, health) belong to the states and the citizens </li></ul><ul><li>Create a Tier 2 class of investment capital (may change corporate governance and voting rights) as private companies use Tier 2 assets in their factories or plants </li></ul><ul><li>Distribute Tier 2 revenues and benefits to all contributing parties in social accounts or as financial incentives. (This turns doing public good into personal incentives. Social accounts become a realizable personal asset, e.g., distributed by the State as tax rebates or added to retirement benefits.) </li></ul><ul><li>People (investors, management, workers, customers, residents, and regulators) will then behave in accordance with the objectives of minimizing the total Tier 1 + Tier 2 costs (UDI cost), which approximates all direct and social costs </li></ul>
  6. 6. Basic Principles of UDi-ism (Unity in Diversity) <ul><li>Tier 2 Assets and Prices to capture externalities </li></ul><ul><li>Tier 2 Ownership and Rights </li></ul><ul><li>UDI Cost = Tier 1 Cost + Tier 2 Cost </li></ul>What if the price of a hamburger includes a medical cost due to health effect? What benefits will it bring to the consumer and to the country? What new and healthier food will become good businesses?
  7. 7. Example of Tier 2 Concept <ul><li>Sin tax is a form of Tier 2 cost </li></ul><ul><li>Gasoline tax is another form of Tier 2 cost </li></ul><ul><li>Tax is not based on market principles </li></ul><ul><li>Tax is a stick not a carrot </li></ul>Today’s Price = Tier 1 Cost + Cigarette Tax UDI Price = Tier 1 Cost + Tier 2 Cost (for health effects) <ul><li>How is Tier 2 pricing superior to a consumption tax? </li></ul><ul><li>Induces better products and rational consumer behavior </li></ul><ul><li>Responds to changing conditions and values of the consumers </li></ul><ul><li>Tier 2 revenue goes into social accounts </li></ul>
  8. 8. How to Set the Tier 2 Prices <ul><li>Some Ideas: </li></ul><ul><ul><li>Scientific studies to quantify these costs and benefits </li></ul></ul><ul><ul><li>Poll the residents of different communities using Internet </li></ul></ul><ul><ul><li>Use trading and market means </li></ul></ul><ul><ul><li>Negotiation </li></ul></ul><ul><li>What social costs & benefits? And who and where? </li></ul><ul><ul><li>Land use </li></ul></ul><ul><ul><li>Vegetation effect </li></ul></ul><ul><ul><li>Wild life effect </li></ul></ul><ul><ul><li>Human health effect </li></ul></ul><ul><ul><li>Interference with communication </li></ul></ul><ul><ul><li>Aesthetics </li></ul></ul><ul><ul><li>Water use </li></ul></ul><ul><ul><li>Air quality </li></ul></ul><ul><ul><li>Cultural or historical </li></ul></ul><ul><ul><li>Economic benefit from construction </li></ul></ul>
  9. 9. Concept of Tier 2 Assets <ul><li>Tier 2 assets (e.g., air, water, land, health) belong to the states and the citizens </li></ul><ul><li>Create a Tier 2 class of investment capital (may change corporate governance and voting rights) as private companies use Tier 2 assets in their factories or plants </li></ul>“ It is a position not to be controverted that the earth, in its natural, cultivated state was, and ever would have continued to be, the common property of the human race .” -- Thomas Paine, Agrarian Justice
  10. 10. UDi-ism (Unity in Diversity) Tier 1 Costs (Direct Costs) UDI Cost = Tier 1 Cost + Tier 2 Cost * Best UDI Decision Tier 2 Costs (Public Good) Decision is not optimal if Tier 2 costs are ignored
  11. 11. How Profit Maximization May Become More Aligned with Public Good <ul><li>If Tier 2 costs are actually charged with real currency </li></ul><ul><ul><li>Firms that consume or degrade public good in its production process pay the State a Tier 2 cost (based on community’s value) </li></ul></ul><ul><ul><li>Company’s UDI profit motive = Maximize (Revenue - Tier 1 costs - Tier 2 costs) </li></ul></ul><ul><ul><li>A clean power plant will have a competitive edge due to lower UDI cost of electricity </li></ul></ul><ul><li>If Tier 2 costs are implemented as price labels only </li></ul><ul><ul><li>The State may let the firm with clean power production receive a tax credit equal to a fraction α of the Tier 2 cost reductions </li></ul></ul><ul><ul><li>Company’s UDI profit motive = Tier 1 profit + α x Tier 2 savings </li></ul></ul><ul><ul><li>This will tilt the firm’s decision to give Tier 2 savings some weight </li></ul></ul><ul><ul><li>Design question: what is the threshold value of α to be effective? </li></ul></ul><ul><li>Corporate tax rate has a component decided by the public based on annual evaluation of the company’s record on improving public good </li></ul>
  12. 12. How Boom and Bust Cycles Can be Moderated by UDI-ism 3 Incentive Structures Scales = Economic Health Years The UDI profit motive would also dampen the boom and bust cycle of markets because the Tier 2 costs are typically long term and corporate governance would be influenced by Tier 2 stakeholders, i.e., States and residents who contribute Tier 2 capital in return for UDI capital ownership Tier 1 Short-term Profit Only UDI Profits Central Planning
  13. 13. Example of Better Businesses and Consumers <ul><li>New and healthier consumer products, including food, electronic products (toxic waste), automobiles (cleaner and more fuel efficient) </li></ul><ul><li>New and cleaner power plants such as fuel cells which will overcome the initial market barrier sooner and gain their truly economic market shares </li></ul><ul><li>Car manufacturers may earn Tier 2 incentive payments from the government by making and selling cleaner cars, and improving the average gas mileage of their entire fleet </li></ul><ul><li>Car drivers, who pay higher gasoline prices but drive cleaner cars with better gas mileage, may receive tax credits. Tier 2 revenues can be used by the government to reward desirable consumer and business behavior </li></ul><ul><li>Individuals could also have social accounts that give credits for Tier 2 contributions to society. For example, doing volunteer social work would earn credits in the social account. These credits would be translated into retirement benefits or medical benefits. </li></ul>
  14. 14. UDI-ism for Solving Global Warming <ul><li>Under the Kyoto Protocol of 1997, nations would commit to reducing their collective greenhouse gas (GHG) emissions to at least 5 percent below 1990 baseline levels by the year 2012 </li></ul><ul><li>Each participating country would determine how to achieve its particular target, including the trading of emissions rights within and across national boundaries (Cap and Trade) </li></ul><ul><li>With UDI-ism, the price of CO2 emissions may be set by market forces and then worked into the cost of electricity produced by different types of power plants (Not a fixed GHG Tax, but market-based price for each nation) </li></ul><ul><li>The power market will work without tax subsidies for new power plant technologies like fuel cells, wind or solar </li></ul>
  15. 15. Assumptions on Power Plant Types and Fuel Prices
  16. 16. Levelized Annual Costs to Determine Optimal Generation Mix without CO2 Cost CT (combustion turbines) Gas Coal
  17. 17. Levelized Annual Costs to Determine Optimal Generation Mix with CO2 Cost = $40/ton CT (combustion turbines) Gas Nuclear Fuel Cell Power Plants Comb Cycle
  18. 18. Levelized Annual Costs to Determine Optimal Generation Mix with CO2 Cost = $40/ton Load Duration Curve Hours of Operation Duration Per Year 0 Load (Electricity Demand) Area = Electric Energy Produced by FCPP
  19. 21. Summary of Remarks on CO2 Example <ul><li>Did not determine the market price of CO2 </li></ul><ul><li>Only performed sensitivity analysis by varying CO2 price </li></ul><ul><li>The impact of having a CO2 cost on the market share of coal-fired power plants is dramatic. It drops from a 60% share if the cost of CO2 is $20/ton to zero when the cost of CO2 is $25/ton. </li></ul><ul><li>When the CO2 cost exceeds $21/ton, a new competitive picture emerges. All of a sudden, nuclear generation becomes very competitive and it displaces coal-fired generation. When the cost of CO2 exceeds $27/ton, fuel cell power plants become competitive. </li></ul><ul><li>Between $20 to $30 per ton, a drastic reduction in CO2 emissions. </li></ul><ul><li>Electricity cost increase may be acceptable to consumers (8% when CO2 cost is $30/ton) </li></ul><ul><li>No tax subsidies are needed for new technologies </li></ul><ul><li>CO2 fund collected can be used for environmental cleanup </li></ul>
  20. 22. Example of Applying UDI-ism to Rice Production on an Island <ul><li>Purely fictitious for exploration of concepts only </li></ul><ul><li>To study the use of a Tier 2 water cost to mitigate the cyclic drought conditions on rice production </li></ul><ul><li>An island 11 miles long, with two rice farms at each end of the island </li></ul><ul><li>Producer A, located at the West end of the island, can produce rice at $10 per lb and uses 10 gallons of water for each lb of rice. </li></ul><ul><li>Producer B, located at the East end of the island, has a drought-resistant strain of rice which costs $12.50 per lb to produce but uses only 2 gallons of water per lb of rice. </li></ul><ul><li>Both producers have to pay a transportation cost of $1 per lb per mile to bring their rice to the inhabitants </li></ul><ul><li>For each mile, the normal demand is 2 lbs of rice </li></ul><ul><li>Water supply is 140 gallons in normal year and 40 gallons every 5 th year </li></ul>
  21. 23. Market Shares of Producers A and B in a Normal Year
  22. 24. Market Shares of Producers A and B in a Normal Year With Water Costing $1 per gallon
  23. 25. Revenues of Producers vs. Cost of Water
  24. 26. Effect of Tier 2 Water Cost on Rice Shortage and Prices of Rice Price of rice went from $14 to $20
  25. 27. Economic Benefits of UDI-ism Over Each Five-Year Drought Cycle
  26. 28. Summary of Remarks on Rice Example <ul><li>Incorporating a Tier 2 price of Water into market prices of rice provides the natural competitive environment for drought-resistant strain of rice </li></ul><ul><li>Total water consumption is greatly reduced </li></ul><ul><li>Effect of drought on social cost is greatly reduced </li></ul><ul><li>At a water cost of $1.50 per gallon, rice shortage cost is zero </li></ul><ul><li>Substantial market price increase for rice, however, </li></ul><ul><li>Tier 2 water revenue can be used for social programs for subsidizing rice costs for the poor </li></ul>
  27. 29. U.S. Power Market Experiments <ul><li>Market Failures Put the U.S. Power Industry at a Crossroad </li></ul><ul><ul><li>California power market failure in summer of 2000 </li></ul></ul><ul><ul><li>Market manipulation and bankruptcies of Enron, etc. </li></ul></ul><ul><li>More than one year after the August 14, 2003 blackout, the transmission business still need reforms to provide the incentives for building more transmission </li></ul>US went through deregulation which caused investments to become unsteady and unbalanced between generation and T&D. Distribution Transmission Generation Capital Invested in US as % of Electricity Revenues
  28. 30. Example of Overcoming NIMBY Against Long Cross-states Transmission Projects <ul><li>Not In My Back Yard (NIMBY) syndrome is a major hurdle </li></ul><ul><li>New transmission lines crossing multiple states are impossible to get approved because of provincial interests and environmental objections </li></ul><ul><li>A new economic framework is needed to solve this problem </li></ul>
  29. 31. Market Reform <ul><li>Under Capitalism and imperfect Market, Maximizing managers’ personal gain ≠ maximizing shareholder profit ≠ maximizing economic efficiency ≠ maximizing public good </li></ul><ul><li>Third Way – an alternative to Capitalism and Central Planning </li></ul><ul><ul><li>Unity in Diversity (UDi-ism) </li></ul></ul><ul><ul><li>Preserve the creativity and energy of self interests </li></ul></ul><ul><ul><li>Channel these diverse self interests into a common interest </li></ul></ul><ul><li>How? </li></ul><ul><ul><li>Externalities taken as free resources will be internalized into economic decisions by corporations and individuals </li></ul></ul><ul><ul><li>Monetize quantifiable social costs, e.g., environmental costs and include them in Tier 2 pricing (may be implemented in the beginning as a displayed price adder for public awareness of the true cost of a product) </li></ul></ul>
  30. 32. Scenario of a Cross-States Transmission Project <ul><li>A transmission project crossing three States A, B and C </li></ul><ul><li>State B residents highly value their environment </li></ul><ul><li>State B residents will be only minor users of the transmission </li></ul><ul><li>Without their approval, the project cannot be built </li></ul><ul><li>Solution: </li></ul><ul><ul><li>Poll the residents of all three States to place a dollar value on each of the social costs and benefits associated with the transmission project </li></ul></ul><ul><ul><li>The methods for calculating these costs and benefits may be set by objective and scientific boards with regular polling of people’s changing values and preferences </li></ul></ul><ul><ul><li>Provide a Tier 2 framework for a fair cost-benefit sharing </li></ul></ul>
  31. 33. How to Apply UDI-ism to a Cross-State Transmission Project <ul><li>Monetize all costs and benefits associated with building and operating the line, direct costs and social costs, to all parties </li></ul><ul><li>What social costs & benefits? And who and where? </li></ul><ul><ul><li>Land use </li></ul></ul><ul><ul><li>Vegetation effect </li></ul></ul><ul><ul><li>Wild life effect </li></ul></ul><ul><ul><li>Human health effect </li></ul></ul><ul><ul><li>Interference with TV or communication </li></ul></ul><ul><ul><li>Aesthetics </li></ul></ul><ul><ul><li>Water use </li></ul></ul><ul><ul><li>Air quality </li></ul></ul><ul><ul><li>Cultural or historical </li></ul></ul><ul><ul><li>Economic benefit from construction </li></ul></ul><ul><li>These costs and benefits are added together as the Tier 2 net cost of the transmission project. </li></ul>State B incurs high Tier 2 costs
  32. 34. Example Continued <ul><li>Minimum guaranteed return on Tier 1 cost and social discount rate on Tier 2 cost </li></ul><ul><li>Transmission Access Charge has two tiers: </li></ul><ul><ul><li>Tier 1 minimum charge + incremental market value </li></ul></ul><ul><ul><li>Tier 2 fixed charge </li></ul></ul><ul><li>How much customers in three States pay based on % usages </li></ul>State B customers use 5% of this line
  33. 35. Example Summarized State A State B State C Customers Customers Customers Transmission Company $7.98 $1.14 $13.68 $0.74 $2.12 $1.48 Keeps $18.46, was guaranteed $15.06
  34. 36. Example Continued <ul><li>How transmission revenue is distributed: </li></ul><ul><li>How customers and the residents in three States come out in terms of “net costs or earnings” </li></ul><ul><li>Tier 1 and 2 costs are charged to customers but Tier 2 revenue belongs to the State & its residents </li></ul>State B is compensated for its Tier 2 capital in the line Market Value Adder revenue and Tier 2 revenue of the States belong to the States, not the customers in the States.
  35. 37. All Parties Are Winners Under UDI-ism <ul><li>Investors and Businesses get </li></ul><ul><ul><li>Consensus from the states and the communities to build truly economical projects </li></ul></ul><ul><ul><li>True market values for investments </li></ul></ul><ul><ul><li>Long-term competitiveness, sustainability and profitability </li></ul></ul><ul><li>States and residents get </li></ul><ul><ul><li>Fair compensation for social costs </li></ul></ul><ul><ul><li>Benefit of a region-wide beneficial investment </li></ul></ul><ul><li>Customers pay fair and true costs </li></ul><ul><li>Economy is improved due to true economic efficiency </li></ul><ul><ul><li>Projects would be optimized to minimize total UDI cost </li></ul></ul><ul><li>UDI-ism may be a third way economic system which may fix the problems of today’s capitalistic markets </li></ul>
  36. 38. Discussion <ul><li>For more info: http://home.comcast.net/~stphenlee/ </li></ul><ul><li>E-mail: stphenlee@comcast.net </li></ul>

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