GLOBAL warming sceptics often urged the world to wait until the science got better. This cry has abated somewhat as better science has confirmed the scope of the problem. But after spending the weekend at the American Economics Association, with side conversations into the Stern Report, I wonder if the same might be said to economists trying to put a cost on future global warming.
I came away from AEA with a renewed sense of wonder about the rapid improvements in economic science. Behavioural economics and neuroeconomics are revolutionising micro; experimental economics is pushing frontiers out in both micro and macro. Better data is finally allowing economists to test a wide range of common theoretical assumptions; I had a fascinating discussion yesterday with a fellow who is challenging the traditional view of switching costs and pricing.
But the richness of the change is making it clear how much there is still to learn. At a panel on housing prices, one of the discussants pointed out that housing economics is a field that should be at least as big as finance, given how much it matters to the economy, and yet they don't even have basic models for things like land. No one even knows how to build such a model--what do you do, superimpose it on a map? Housing economics is still awaiting its Modigliani-Miller, its Black-Scholes, and so forth.
The questions that the Stern Report attempts to answer about future utility and so forth are essentially insoluble; given the number of variables and intangibles, it's hard to see how they could be much better than random. That's why the chocie of discount rate has to do most of the heavy lifting. But perhaps this just gives us a sense of false precision. Perhaps we should simply go with the intuitive reaction to global warming, which is that it's bad and we should try hard to stop it, maybe up to 10% of income worth. As the science gets better, it can fill in. After all, we manage to have housing markets even without a good model of land prices.
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If we discount costs at 0% we must also discount benefits at 0%. Based on historic trends we are about 40,000 years away from another ice age, which will obliterate all structures on, and make uninhabitable, most of Europe, Russia, Canada and the northern United States. (see http://en.wikipedia.org/wiki/Ice_age) Global warming has the potential to eliminate that ice age. Although in economic calculation with a typical discount rate the benefits of saving the world in 40,000 years are trivial, they are massive if a 0% discount rate is used, far greater than any costs from global warming. Instead of making us willing to spend more to eliminate global warming a zero discount rate should make us willing to spend almost any amount to ensure the world stays warmer than in the natural state. (Although I think a discount rate of zero is preposterous nonsense.)Comment originally posted on January 10, 2007 8:00 PM
sglehr, that makes sense, except the number should be reversed, hence the use of the sketchy inputs to determine the discount rate. At the most basic level, the cost is the cost of the inputs needed to implement supposed AGW remedies (I say supposed because usually these things don't have the effect their proponent wish from their deepest heart of hearts). And the science suggests that there are great benefits to global warming and that our impact on global warming is much less than the public perception. That means very little result for our efforts. If we spend x amount of our oil and precious metal and mineral supply to reduce GHG, that's x amount of oil and resources that don't do any of the stuff that is relavent to our economy. It should be quite obvious that the discount rate should be near the expected GDP growthrate and the pure time preference is bullshit altogether. It could be argued that the discount should be less than GDP growth, but that agrument amounts to the assumption of near perfectly efficient markets. The argument goes that diverting these resources away from the economy results in the elimination of the least productive and counter-productive uses these resources would otherwise be put to. The size of the economy is diminished, but productivity increases because the elimination of couter-productive uses of resources, leaving a stable growth rate. Bullshit. Do your really think Kyoto will lead to better driving habits.(http://cumulativemodel.blogspot.com/2005/12/save-gas-avoid-brakes.html)Comment originally posted on January 9, 2007 11:17 PM
In order to truly answer the question of how much we should spend to combat global warming, we need to first put a dollar value on how much the planet's natural processes add to our GDP by performing many valuable services for free. How much is the free irrigation we recieve in terms of rainfall worth? How much is the heat that the gulf stream provides to Europe (reducing heating bills and encouraging more agriculture there) worth? What price would you put on tropical biodiversity? We cannot know whether it is economically more feasable to continue destroying resources as we are doing now and hence reduce our long term growth rate (possibly into negative territory) or to make some sacrifices now in order to ensure that those resources are around for generations to come. Should we treat the planet as a factory that produces goods we can sell and take care of it so we can recieve its benefits unto eternity or sell it for scrap metal right now and hope we can figure out where to get our next paycheck from before we die of starvation? The problem with a traditional economic analysis of global warming (or any other environmental problem) is that it starts off by assuming that our descendants will be much richer than us and so can afford to make a larger cut in their lifestyles to achieve the same environmental outcomes then we can. I'd argue that this basic premise itself is flawed. If environmental degradation is unchecked and becomes extremely severe, merely surviving will become a phenomenal challenge, let alone maintaining a positive growth rate for many decades. Just ask the farmers of southern Australia or the residents of New Orleans. Atleast their governments have the money to bail them out of an immediate survival crisis. Most of the world does not enjoy even that level of protection. As any student of elementary calculus can tell you, what matters over the long run is not the initial value you start from, but rather the slope you are travelling on. Given a steep enough slope, a function with any given initial value can overtake a function with even a much larger initial value. This is what most economic analyses of environmental problems miss - that if environmental problems hit not just our raw GDP numbers but our growth rates as well, it will not matter at all how rich or poor you or your grandchildren are - in the long run, you are all doomed. We therefore need to make sure that we safeguard the planet enough such that the natural processes whose fruits we enjoy in terms of free output that would otherwise take more human labor to produce can be enjoyed not just by us but by our future generations as well. Think of it therefore, as an insurance policy rather than as a tax. PS - Catalytic converters on cars, low sulfur emission powerplants, non-CFCs in aerosols, non-lead paint, non-asbestos houses... these were all going to cost us so much that we were going to end up living in the sewers and eating dirt to pay for them, or so big business would have had you believe back in the day. Reality of course (as W has learned no doubt) tends to do things differently. All this hoopla over how much a carbon-cycle neutral economy will cost is kind of overblown. I agree that it is the largest single problem that mankind has ever faced and will require a horrendous amount of money because it involves changes to the most basic habits of energy use that we have developed over the past 200-odd years, but if we applied even a fraction of the political and financial muscle we do to trying to open ANWR for drilling I'm sure we could unlock the market forces required to provide us with solutions to this problem at an ever-lower opportunity cost. It has happned many times before, and there is no reason it shouldn't happen again. But we need atleast to get started, rather than living in a state of denial until the problem comes around to bite us in our posteriors.Comment originally posted on January 9, 2007 10:54 PM
Why can't this be viewed as an expected value problem. If we are 20% certain that global warming will cost the global economy between 100 and 200 billion dollars (invented figures). And we are 50% certain that we can prevent this damage wouldn't it be prudent to spend between 10 and 20 billion dollars trying to solve the problem?Comment originally posted on January 9, 2007 9:01 PM
Are but 10% of whose income. If we are talking about 10% of your future income potential, then be my guest. However if we are talking about my clipping my future income too, then I'd rather take a pass. Before we consign ourselves to future poverty perhaps we should consider whether such an epic sacrifice is really necessary to head off global warming. Let us assume that in order to discourage the emission of CO2 governments choose to impose carbon taxes. If this new source of revenue is treated as found money and leads to a new wave of typically wasteful government spending then we will all indeed be a great deal poorer. If however the new government revenue is offset be equivalent reductions in say income tax, then things need not be nearly so grim. A future economy in which governments tax emissions (a negative externality) instead of work (generally considered a positive good) would certainly look different from what we currently expect, but we shouldn't assume that it would be poorer. Cheers SnugglebunnyComment originally posted on January 9, 2007 8:44 PM