November 14, 2006
Figures still justify swift climate action
Those who believe in the free market are highly resistant to the idea of man-made climate change, let alone to arguments for government action to halt emissions of greenhouse gases. Is this resistance rational? Or is it another case of the human desire to believe true what is merely convenient? On one point these sceptics are correct: the man-made climate change hypothesis appeals to believers in environmental limits to growth, the evils of capitalism and the need for government regulation. Lord Lawson, the former British chancellor of the exchequer, makes that point well in a recent assault on the activists.* But what should matter is not the emotions that drive the people on either side of the debate, but rather whether the arguments advanced are persuasive. Sceptics start by arguing that the science behind the man-made warming hypothesis is flawed. Some even argue that it is a fraud, in which case it would be the biggest and potentially the costliest ever. Scientific knowledge is indeed provisional. The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free.
Willem Buiter: I have three comments on Martin’s third climate change piece, one on discounting, one on the case for acting now and one on the modalities of acting now.
Discounting
A key element in the calculation of the appropriate discount rate to be applied to future costs and benefits is the ‘pure rate of time preference’ or the subjective, psychological discount rate. In a world of successive overlapping generations, the ‘pure rate of time preference’ has at least two aspects. The first is each generation’s preference for earlier consumption over later consumption in its own lifetime - call that ‘individual pure time preference’. The second is the discount rate applied by current generations to the life-time well-being of future generations – call it the ‘generational discount rate’. Both these subjective discount rates can be approached from a positive perspective (how do we discount our own future well-being? how do we discount the well-being of future generations?) and from a normative perspective.
I will adopt the normative perspective here. Even as regards individual pure time preference, I’m with the great Cambridge economist Pigou, who considered subjective discounting to be evidence of ‘defective telescopic faculty’, that is, undesirable and indefensible myopia. I would, however, be reluctant to override an individual’s choices about how to allocate consumption over his own lifetime, even if these choices are ‘distorted’ by myopia. However, as regards the well-being of future generations, there is no moral case for any discounting at all. Any probability of human extinction should, of course, be taken into account, but that is conceptually quite distinct from discounting the well being of future generations given that they are around. There is the further twist that, in the case of global warming, the probability of extinction may be partly endogenous to the decisions that will be made as regards carbon emissions.
Even the 0.1 percent per annum discount rate applied in the Stern Report to the wellbeing of future generations is therefore morally indefensible. If without such discounting conventional cost-benefit analysis of choice over time does not work, too bad for conventional cost-benefit analysis. There are, fortunately, other more robust tools.
The case for acting now
Martin is bang on as regards the case for acting now. Sure, science is an imprecise art, and no doubt the conventional scientific wisdom reported in the Stern Report will be overturned in due course. But these revisions could as easily strengthen the case for acting early as weaken it. And the cost of doing nothing now and being wrong are so much higher than the cost of acting now and being wrong. If we drastically curb global carbon emissions and fifty or a hundred years from now it turns out that global warming was much less of a threat than predicted in the Stern report, we will have wasted 1 percent of global GDP, and we will have been forced to breathe cleaner air along the way. I can live with that. If we sit on our hands and the Stern Report is right (or a scenario worse than outlined in the Stern Report were to materialise), my grand children will be canoeing down Oxford Street. The cost of errors of omission is so much higher than that of errors of commission that acting now is a no-brainer.
But how?
Martin proposes a global carbon emissions tax. Greenhouse taxes would indeed provide the right incentives, provided they are set at the right levels. So would a global emission quota, plus trading in emission permits. Even if a (sequence of) annual global quota(s) could be agreed upon, the initial allocation of the emission rights, first between countries and then within countries, would give rise to a huge distributional fight.
The fundamental problem of the pure public good nature of greenhouse gas abatement makes achieving and sustaining a cooperative solution unlikely. The odds might be better if we just got the major past present and future sinners around the table: the US, the EU, Japan, Russia, China, India and perhaps Brazil and Mexico. Perhaps an agreement reached among these players could, with appropriate combinations of sticks and carrots, be imposed on the rest of the world. But I am not holding my breath (although I may have to if emissions are not curbed).
Posted by: Willem Buiter, London School of Economics | November 16th, 2006 at 12:10 pm | Report this commentMartin Wolf: Fundamentally, I agree with Willem. I would underline just two implications.
First, on discounting, the only normative reason for doing so is that future generations will be richer than we are. As I pointed out in the column, this then is a distributional ethic. That ethic also has implications for what we should be doing in our world today. I have no problem with the consequence that the rate of return sought on ordinary public investment projects would then be higher than on the “project” of slowing climate change. The latter is a choice of states of the globe. It is a fundamentally different sort of choice from deciding whether to build a bridge or a tunnel somewhere.
Second, I would underline his point about the enormously divergent potential losses of being wrong in either direction. If we act, provided it is at reasonable cost, as the Stern report suggests it would be, we may, at worst, be just a little bit poorer 50 years from now. If we do not act, we may find we have irrevocably altered the state of the planet. So we ought to act. If the theory of man-made climate change turns out to be a mistake (we have surely increased greenhouse gas concentration enough already to test this), we can reverse the policies. If it does not, we will have done something about it.
Of course, as Willem points out and I have also argued, we will probably fail to act.
Posted by: FT Forum - Martin Wolf | November 17th, 2006 at 10:12 am | Report this commentRichard N. Cooper: The Stern Report evidently chooses a very low discount rate – 1.6 per cent – in evaluating the benefits of climate change, which is necessary if far distant gains are to have significant present value. It is rationalized by the dubious application of a theoretical model concerning how we humans value the future. Bjorn Lomborg correctly suggests there are many activities we could undertake today that would make future generations much better off, per dollar invested, than mitigating climate change; he mentions provision of clean water, sanitation, preventive health care, and education. Wolf responds by accepting that point, but arguing we should do all of them.
There are two problems with that. The first concerns the limited capacity of governments to undertake many large scale global projects simultaneously, particularly if they require substantial funding, which would require additional taxes. The second, more technical problem is that undertaking all viable projects with a social rate of return above Wolf’s approved 1.6 per cent, or even 2.1 per cent, would (I suspect) absorb a significant fraction of current gross world product, thus depressing current consumption and by the same token raising significantly the growth rate of future consumption – and hence, on the basis of the theoretical model – raising the appropriate discount rate. In other words, 1.6 per cent would be too low even if the framework for calculating it is accepted, essentially because many other undertakings would exceed that standard.
There is one respect, however, in which mitigating climate change differs from other worthy global projects: if done through carbon emission taxes, which Wolf seems to embrace, it would generate significant revenue, thus easing rather than tightening fiscal burdens. This revenue could enable other meritorious projects to be undertaken.
Posted by: FT Economist Forum | November 20th, 2006 at 10:29 am | Report this commentMartin Wolf: I very much appreciate the effort Dick Cooper has invested in putting me right on climate change. But I remain unpersuaded on the two points of disagreement he considers above.
First, I remain unconvinced by the logic of the so-called “Copenhagen Consensus”. As I understand the conclusion was that if one had $75bn of public resources, it would be far better to spend the money on alleviating the plight of today’s destitute than of tomorrow’s victims of climate change. I agree, as I wrote in my column. But why does this mean we should not tackle climate change, as well? I do not accept that this is a legitimate statement of the choice. It is deliberately designed to put the option of mitigating climate change in the worst possible light.
Suppose someone came to reasonably well-off parents and told them that for $200 they could immunise their children against infectious diseases and for an extra $2,000 they could correct any defects in their teeth. One would assume that sane parents would choose immunisation. Does this mean that they would refuse the dental treatment? Not necessarily. While they would prefer immunisation to dental treatment, they might well prefer the latter to a new car, a second holiday, a new extension to their kitchen or any one of hundreds of alternative expenditures.
Exactly the same applies here. Global GDP at market prices is around $45,000bn. My rough and ready calculations suggest that global spending by governments cannot far be short of $15,000bn. $75bn is 0.17 per cent of global GDP and 0.5 per cent of global government spending. The $450bn putative cost of tackling climate change is 1 per cent of global GDP and 3 per cent of global government spending (though, in fact, very little of it would fall on the government).
Could Dick explain why the relevant choice is between the $75bn and the $450bn, not between both and the rest of the $15,000bn or even the rest of the $45,000bn? I cannot see the point of this comparison. I would argue that the relevant comparison cannot be with the most intra-marginal spending one can imagine, but with some marginal expenditures (the vast amounts wasted on defence budgets, for example).
Dick argues that one reason for making this the choice is that governments have limited capacity for action. I agree on this, too. But again, the question is: why is this the constraint here? Governments are spending colossal quantities of money now. Would it really be at all difficult for them to spend a bit more on climate change, particularly when the fiscal costs would be met automatically through revenue from carbon taxes (or auctioning of emissions permits) and the market would deliver most of the needed changes through private sector responses to price signals?
The second question Dick raises concerns the discount rate. I have come to the view that one cannot sensibly make the calculation standard economics wants to make – i.e. compare dealing with climate change with all other projects. The reason I have come to this view is that the alternative, which he advances, leads one to a very strange position, indeed: it is one in which the far future simply does not matter at all.
Let me give an illustration. Assume that all scientists agreed that if we continue on our present path for another 50 years, there would be little change in temperature until 2150, but then, via a series of irreversible feedback effects, the earth’s temperature would rise by 70°C over a century, ending life as we know it. Assume that the costs of preventing this was known to be a reduction in GDP growth of 1 percentage point. Assume that the growth of the economy would be 2 per cent a year forever with this cost of mitigation and 3 per cent a year until 2150, without it, whereupon GDP would fall smoothly to zero over the succeeding half century of explosive climate change, as humanity perished.
Which of these paths should one choose if one wished to maximise the present value of GDP? Assume one chose a discount rate that exhausted the current investment budget under the higher growth option (that is, without the costs of mitigation). Assume, too, that this discount rate turned out to be 3 per cent. Then one would have to prefer the option of faster growth followed by mass extinction, because this is the one with the higher present value.
Is that not more than a little bit peculiar? The point is that one cannot sensibly compare a decision on what the planet might be like a century from now with whether to build another bridge across the Thames. Choosing states of the world is not like choosing a marginal investment project.
Posted by: FT Forum - Martin Wolf | November 20th, 2006 at 8:12 pm | Report this comment