Update on this post is here.
Daniel Hall at Common Tragedies has responded to my request for economic analysis. I was really wondering about the effects of different types of regulation–say, a mandate for minimum fuel-efficiency standards versus an overall greenhouse gas cap or tax. He writes, “I’m skeptical there’s much room in the aircraft market for efficiency standards that are economically justifiable.” But some of his additional comments taking on my TCS Daily article will not hold for airlines. Let’s take a look at them:
Evan . . . repeats what is apparently the latest conservative meme on climate change policy: that reducing emissions through a carbon tax or a cap-and-trade system will be far more economically costly than innovating our way into emissions reductions.
Climate change is not my bailiwick, so I’m not sure what the “latest conservative meme” is, unless my being conservative and saying something makes it a meme. I’m writing strictly about aviation, not all emitting sectors, and I’m not committed to a particular policy solution. (I am interested in seeing what happens with the forthcoming inclusion of aviation in Europe’s Emission Trading Scheme; I do not think many of the the various country-level travel taxes being proposed or enacted in Europe make economic sense or are particularly “green.”) Furthermore, Aviation has some unique characteristics. Airline deregulator Alfred Kahn’s wise quote, “I really don’t know one plane from the other. To me, they are all marginal costs with wings,” does not always apply.
It’s not past inter-industry profits that drive innovation; it’s the promise of future returns that leads investors, both inside and outside an industry, to pour in investment funding to encourage innovation.
I must disagree here. There are only two producers of 130-seat-plus commercial aircraft (yeah, I’m not counting Russia): Boeing and Airbus. They have long lead times for new aircraft. The A380 took thirteen years from conception to delivery; the Boeing 787 will have taken eight. The development processes were closely attuned to the market for aircraft. Designs were reworked, shelved, or delayed by the Asian financial crisis and the post-9/11 airline slump. The last new jetliner to enter service before the A380 was the B777 in 1996. Several U.S. airlines, suffering losses and entering bankruptcy, delayed or cut back their investment in new planes from 2001 to now. This caused Airbus and Boeing to fine-tune their new designs to the fast-growing Middle East/Indian and East Asian markets, where profitable airlines have provided the critical investments in new aviation technology. It’s airlines that buy new planes. There’s no other market for the product. Healthy, innovative aerospace and healthy, profitable airlines go hand in hand.
An emissions price will increase the returns to innovation by giving fuel-efficient aircraft a larger edge over their more highly polluting brethren. Under any standard economic story this will lead to more innovation.
This is true in theory and for other industries, but would it actually work out this way for airlines? The highest-efficiency planes are just now coming on line, with the promise of even greater advances in the future. Airlines are seeking out these planes, and the order books for Boeing and Airbus are already full for several years to come. But as emissions caps or prices raise the cost of flying an older plane, and the waiting lists are long, what will airlines do? Margins are already notoriously thin in the airline industry. They could lease fuel-efficient planes (making this man happy), but many lease companies offer older, less fuel-efficient planes. The secondary market is similarly flawed. Could Airbus and Boeing produce more? They could, but it’s not likely. Boeing ramped up production on the 737 in the 1990s, only to face the early-2000s slump in orders, resulting in layoffs and losses. Both Boeing and Airbus now prefer to maintain the steady long-term production pace promised by their full order books. Airlines that cannot buy more fuel-efficient planes and cannot afford to keep flying their older, less-efficient planes will be forced out of business. This problem will be especially acute for cargo express airlines, which have picked up older planes no longer in service with passenger airlines. The workhorses of these fleets (FedEx, UPS, DHL) are the trijets B727, DC-10, and MD-11, and UPS still operates the four-engine narrowbody DC-8. Without enough aircraft coming on line to replace these planes, the cargo carriers may not survive.
Daniel is right that under standard theory, emissions pricing would lead to more innovation, and it will probably do so in the long run. But in the short run, effective emissions pricing or caps will probably cause massive dislocations in the industry and set it on a poor footing, leaving airlines with fewer resources to invest in the very planes they need to escape the dislocations, in turn forcing aerospace companies to delay or shelve innovative new technologies. We need to take the high transition costs of emissions cuts into consideration when designing policies to ensure that we don’t threaten future innovation.