How Environmentalism Raises Profits at the Expense of Wages

by George Reisman
by George Reisman

In my last article, “How Government Budget Deficits Reduce Wages and Raise Profits,” I explained why those who complain about profits rising at the expense of wages should not blame the free market but, in part at least, the growth in government budget deficits. I’d now like to show that in addition they should blame the environmental movement and the government intervention that it has inspired.

Environmentalism operates systematically to withhold land and natural resources from the market. Wherever it can, it prohibits economic development, in the form of housing construction, power-plant construction, and road construction. It attempts to stop the opening of new mines and especially new oil fields. While it claims to favor what it calls renewable natural resources, it also attempts to stop logging operations, even though new trees can be grown to replace those removed. It has also succeeded in imposing limits on the emission of such chemicals as sulfur dioxide, nitrogen, and chlorofluorocarbons (cfcs) into the atmosphere, and in these cases systems of “tradable emissions rights” have been established. It currently seeks similarly to limit the emission of carbon dioxide into the atmosphere and to establish a system of tradable emission rights in its case too; indeed, a limitation on carbon dioxide emissions and a system of tradable emission rights for carbon dioxide already exist in the European Union.

Under a system of tradable emission rights, the government acknowledges long-standing emissions and confers a legal right for them to continue. For example, if for many years, a firm has been emitting a ton of sulfur dioxide into the atmosphere each year, the government may grant it a legal right to continue doing so indefinitely and, in addition, to sell that right in the market from year to year or to sell it permanently, just as the firm might rent or sell any other durable property that it owns. Newcomers who wish to emit sulfur dioxide, or established firms that wish to increase their emissions, cannot do so unless they buy emission rights from the firms that possess them. Emission rights quickly become scarce and progressively more valuable as the need for additional production of the kind that must result in more emissions intensifies and comes up against the barrier of the prohibition on a larger volume of emissions.

I do not know of any reliable estimates of the aggregate dollar value of the tradable emissions that are now purchased in a given year in the United States or around the world. But whatever it may be, it represents a clear addition to the aggregate amount of profits in the economic system. This is because the firms that sell their emission rights thereby have sales revenues for something that costs them virtually nothing whatever to provide. And so long as they sell these rights merely on an annual basis or for a limited term of years these sales revenues and profits will be recurring.

Furthermore, looking at things now from the perspective of the purchasers of the emission rights, the need to purchase emission rights equivalently reduces the funds available to business firms for the purchase of other things, notably capital goods and labor services. Thus, the effect of the existence of tradable emission rights is both an increase in the aggregate amount of profit in the economic system and a decrease in the aggregate amount of wages paid in the economic system.

The effect of payments for emission rights on wages can be further inferred from the following considerations. Assume for the moment that the price of emission rights were to count simply as an additional cost of production, added to all of the other costs of production, and to correspondingly drive up the prices of goods to the point required to cover this additional cost. If this happened, the quantity of goods demanded in the economic system would fall. It would fall simply as the result of the combination of higher prices and limited funds with which to pay prices.

The result of the fall in the quantity of goods demanded would be unemployment. If unemployment is to be avoided, the prices of goods must not rise. But in order for them not to rise, their costs of production must also not rise. In order for costs not to rise in the face of the addition of the new component of cost that is constituted by the price of emission rights, another primary component of cost, notably wages, must fall. In other words, the value of tradable emission rights ends up being at the expense of wages. Thus, environmentalism and the system of tradable emission rights serve to raise profits and reduce wages.

It must be stressed that if wage rates do not fall in order to offset the additional costs constituted by the value of tradable emission rights, then the result is both higher prices and unemployment. In this case, while wage rates in terms of money do not fall, wage rates in terms of buying power still fall because the same wage rates in money must be used to pay higher prices for goods.

The fact that such are the consequences of the system of tradable emission rights should not be taken as a criticism simply of that system. The imposition of the same environmentalist restrictions on production without an accompanying system of tradable emission rights would result in even worse consequences. This is because the costs of complying with the environmental regulations would then be far greater, with the result either that prices would have to rise or wage rates fall by that much more.

For example, a firm that could avoid a million dollars of additional costs if it could emit an additional ton of sulfur dioxide would simply have to incur those additional costs even though elsewhere in the economic system there was a firm that would incur additional costs of only a few thousand dollars if it reduced its emission of sulfur dioxide by a ton. The absence of tradable emission rights in this case would cause the needless imposition of almost a million dollars of unnecessary costs, requiring a corresponding rise in prices or fall in wages in the economic system. It is clearly the substantially lesser evil in this case even if the right to emit a ton of sulfur dioxide were to be sold for several hundred thousand dollars.

The problem is not the system of tradable emission rights. The problem is the prohibition of the increase in emissions that is the necessary accompaniment of the increase in production. The prohibition of additional emissions thus serves to prohibit the increase in production. Of course, in the absence of prohibitions on additional emissions, there would be no basis for the existence of systems of tradable emission rights, and thus they would simply not exist.

As indicated at the beginning of this article, environmentalism’s prohibitions on production go far beyond those that have been accompanied by systems of tradable emission rights. With or without tradable emission rights, the effect of imposing laws and regulations based on environmentalism is to make land and natural resources artificially scarce relative to human labor and thus to enhance the economic value of land and natural resources while reducing the economic value of human labor, above all, wage rates. In the terminology of the old British classical economists, what environmentalism is doing is increasing the portion of national income that takes the form of “land rent,” and doing it at the expense of the portion of national income that is wages.

The rise in the economic value of land and natural resources – the rise in land rent – shows up in the form of a rise in profits. All net monetary earnings derived from the ownership of land or natural resources are profits from the point of view of business accounting. Profits rise to the extent that the prices of minerals and of agricultural products rise relative to the costs of producing them. And precisely this is what happens when the demand for these products rises and environmentalism has meanwhile succeeded in preventing commensurate increases in their supply.

The leading example of this phenomenon at present is the recent rise in the price of oil and natural gas. A growing population and a growing need for oil here in the US, coupled with major economic progress in China and other parts of Asia, has substantially increased the demand for oil and natural gas. However, the environmental movement has done everything in its power to prevent increases in the supply of these commodities.

It has prevented the development not only of the oil deposits in the North Slope of Alaska but also oil and gas deposits on the continental shelf off California and the Gulf Coast, as well as oil and gas deposits present in the vast land areas set aside as wilderness preserves and wildlife areas. In addition, it has prevented the construction of new atomic power plants, whose existence would serve to diminish the demand for oil by the electric power industry and thus make oil more available for other purposes, and at a lower price. The same is true in connection with coal mining. Its expansion too is blocked, and thus the availability of this major substitute for oil is also held back. The result is that the need for oil is made that much more intense and its price correspondingly higher.

Different parts of the supply of minerals and of agricultural commodities have different costs of production. For example, there are some petroleum deposits which are so easily accessible and so productive that they can be exploited at a cost of production of perhaps just $3 or $4 per barrel. But such petroleum deposits can meet only a small portion of the demand. The rest of the demand must be met by exploiting higher-cost deposits, deposits with a cost of production of $10, $20, $30 per barrel, and more. Every time the price of oil rises because its supply is prevented from increasing, profits are increased on all the petroleum deposits in production.

The same principles apply to wheat production and housing construction. The result of all increases in demand not matched by an increase in supply, because environmentalism prevents the increase in supply, is a rise in price and an increase in the portion of the good’s price that reflects the resulting greater scarcity and higher value of land and natural resources. And, as we have seen, this higher value of the economic contribution of land and natural resources that environmentalism causes takes the form of higher profits.

In sharpest contrast to today’s markets that are distorted by environmentalism and the government intervention that it has brought about, a free market would produce results of an opposite kind. In a free market, with its powerful incentives to increase production and to find new and more efficient ways of doing so, supply would increase not only commensurately with the increase in demand but more than commensurately. Lower-cost methods of production would be found that would make it possible for prices to be driven down rather than up. A free market operates to increase the supply of useable, accessible land and mineral deposits relative to the supply of human labor and thus to make them progressively cheaper in real terms.

Accordingly, profits based on the ownership of lower-cost natural resources and farm land would be sharply contained, and even diminish, as scientific and technological progress and capital accumulation served to make available more such deposits and farm land or equally good or better substitutes for them and thus to drive the prices of products produced by means of such deposits and land closer to their low costs, meanwhile further reducing those low costs.

In a free market, wages rise relative to the value of land and natural resources and are thus correspondingly higher relative to profits. This was the record of the United States and the rest of the Western World for approximately 200 years following the start of the Industrial Revolution.

Environmentalism is a movement dedicated to the undoing of the Industrial Revolution. If not checked, one of its results will be the progressive reduction of wages and the further elevation of profit incomes based on the ownership of land and natural resources.

July 27, 2006

George Reisman [send him mail] is Pepperdine University Professor Emeritus of Economics at Pepperdine University's Graziadio School of Business & Management in Los Angeles, and is the author of Capitalism: A Treatise on Economics. Visit his website.

Copyright © 2006 George Reisman

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