Firing Up The Economy, Literally

Guest Post by Willis Eschenbach

I’ve spent the last week in the Solomon Islands, which is northeast of Australia. It’s a wonderful place for me to come back to, even if only for a week, as I lived here for nine years. It’s a curious place, one of the UNs “LDCs”, the “Least Developed Countries.” It is the most rural country in the Pacific, with about 90% of the people still living in small scattered villages on hundreds of islands. Most people from outside the Solomon Islands have never heard about it until I say that the capital city, Honiara, is on the island of Guadalcanal.

I wrote my last post from here in the Solomon Islands, about how energy and GDP are different ways of measuring the same thing. I got to thinking about the Solomons GDP ($1,600 per year, tied for 187th out of 225 countries with countries like Chad and Tajikistan) and the energy use in the Solomons. Here’s the Solos’ energy consumption by type of fuel:

Figure 1. Energy Use by Fuel Type, Solomon Islands. Photo Source

As an aside, looking at that chart, you’d think that the Solomons should be the poster child for alternative energy. Three-quarters of the country’s energy comes from biomass, what’s not to like?

What’s not to like is trachoma and lung disease from cooking over open fires, plus lots of unburnt hydrocarbons and brown carbon from wood smoke, huge inefficiency losses, and other issues. But I digress. Looking at that graph, I was reminded that we mark the dawn of human civilization by a single act – the domestication of fire.

Fire was our first use of a concentrated energy source, our first step towards a GDP greater than what humans can do unaided. Unfortunately, for much of the Solomon Islands, it remains the only energy available in concentrated form. Three quarters of the energy used is plain old garden variety fire. In addition to household use, it provides the energy for two of the very few ways that the rural islanders can make money – copra (dried coconut meat) and cocoa. Both require heat for drying.

Now, given the general equivalency of energy consumption and GDP, what does that mean for the Solomons? It means that this lovely environmentally correct bio-fuelled country will never climb out of its poverty without more energy. Fire is not nearly enough to fuel an economy in the 20th century.

What about the petroleum fuels? What are they being used for in the Solomons? Here is the breakdown:

Figure 2. What the Fossil Fuels (diesel, petrol, natural gas, kerosene) are Used For in the Solomon Islands. Photo Source

The main thing that sticks out is that, in great contrast to the US situation, more than half of the Solomons fuel is used for transportation. This is a consequence of the way things are transported here … mostly by outboard canoe. There are perhaps a hundred miles of paved road in the entire country. Everything is moved by boats large and small. The big boats take things to the provincial centres (such as they are), and people go to buy them in their small canoes powered by outboards.

The good news in the graph is that electricity sector is 100% diesel-powered, so at least there is hope there. The islands are steep and rainfall is abundant, and there are some good hydropower sites. That means some substitution is possible.

Overall, once again we see that development in Solomon Islands is a function of energy, and that as long as they are relying on fire and a handful of petrol, they will never fire up the economy in any significant manner.

Now, I started this whole island travelogue with a very specific point in mind. It has to do with a pet peeve of mine. This is the pernicious idea that the way to solve the “energy problem” is to make fuel more expensive through taxes, so people will use less of it and become more efficient in its use. (As an aside, I don’t see the “energy problem” as being people using too much fuel, but as being people who don’t have affordable fuel. But hey, that’s just me.)

There’s two problems with that “tax our way to energy freedom” idea. First, in the Solomons, a trip from Gizo Island to Kolombagara Island in a particular boat might take, I don’t know, call it ten litres of fuel. If fuel prices go up and the operator can only afford eight litres, he’s stuck. He can’t economize and get more efficient like the theory says he’s supposed to, the outboard engine burns so much an hour. And he can’t just use the eight litres he can buy, it will leave him marooned in mid-ocean. He’s stuck in port, and out of the game.

There’s a worse problem, though. This is that taxing energy is taxing the wrong end of the production process. This slows the whole production process down before it can be started. I saw this in Honiara when fuel prices got high in 2008. For a while you couldn’t buy fish in the market of the capital city. Why? Because fuel cost too much, so it wasn’t worth it for the guys to go out fishing … and a significant chunk of the fuel price in the Solomons is taxes to the Government.

This is taxing the wrong end of the production process. Countries should tax the outputs of production (in this case the fish) and not the inputs (fuel, fishing gear, and boats). You want to encourage people to fish by making the entry cost for production inputs as low as possible.

There’s also a more subtle problem with taxing the wrong end of the production chain. Output prices are typically some multiple of the price of production. This means that adding a dollar on the input side often leads to a two dollar jump in the final price … not good.

Then, when the boats can go out and fish because the cost of inputs is low, the country should tax their output. Tax the fish in the markets. It will perhaps make the fish slightly more expensive for the customer … but at least there may be fish in the markets, instead of empty boats tied up by the markets. When the fuel prices were so high in 2008 and fish were either wildly expensive or unobtainable, the health of the kids suffered because fish is a main source of protein in the islands. That’s not a direction that I want to go.

In summary:

1. Taxing energy to force people to economize and become more efficient can be very counterproductive at the poor end of the economic spectrum. People are already using as little energy as they can possibly get away with, because from their point of view energy is already very expensive. In addition, they may not be physically able to economize or increase their efficiency.

2. If a country decides to use taxes as a (very blunt) instrument of energy policy, it should tax the outputs of production, rather than the inputs to production. This allows production to increase, instead of crippling it.

3. In the absence of often unavailable changes in efficiencies (see outboard motors above), forcing people to use less fuel through taxes means lowering the GDP. For places like the Solomon Islands, that’s the last thing we want to do, lots of folks there are way out on the economic edge already.

Finally, in the very best Solomons fashion, this is being written while I’m waiting for the departure at the airport, because the plane is two hours late. Or as they call that here in the Solos, “right on time” … wish me luck, when and if the plane arrives I’m bound back to Nowherica.

w.