Ezra Klein Is Shrill!
links for 2007-12-06

Global Climate Change Economic Analysis Cage Match: Robin Robert Hansen Misreads Marty Weitzman

Robin Robert Hansen writes:

Robert Hansen's Blog: The Stern Review on the Economics of Climate Change: Blistering Peer Reviews: In the latest issue of the Journal of Economic Literature, two papers deliver devastating reviews on the Stern Review on the Economics of Climate Change... by serious, mainstream economists: William Nordhaus of Yale and Martin Weitzman of Harvard. These are not individuals and articles that can or should be ignored. Of course, they will be ignored by the mainstream media – while at the same time Al Gore’s receipt of the Nobel Prize carries the media day....

I have always said that my objections to the prescriptions of the most vocal climate change advocates are on three levels: one, the climate models depend too much on positive feedbacks that are not understood; two, the models have not really been tested, but instead are calibrated to the historical data; and three, even if one accepts the models, one then has to move into the economics of optimal policy, and there the best analysis suggests relatively modest reductions in carbon emissions for the near term. I like to ask environmentalists to summarize their prescriptions with the appropriate tax per barrel of oil: tell me what you think the price of oil should be increased by, in order to recognize the impact of carbon.

But back to the reviews of the Stern Review. So the Stern Review made big headlines when it came out, as it was commissioned by the UK government and was ostensibly a serious analysis of the economics of climate change. Both Nordhaus and Weitzman deliver fatal blows.... Weitzman says: "However, in my opinion, Stern deserves a measure of discredit for giving readers an authoritative-looking impression that seemingly objective best-available-practice professional economic analysis robustly supports its conclusions, instead of more openly disclosing the full extent to which the Review’s radical policy recommendations depend upon controversial extreme assumptions and unconventional discount rates that most mainstream economists would consider much too low...."

To summarize the contrast: The Stern Review calls for a carbon tax of $350 per ton of carbon in 2015. Nordhaus’ model, which has been peer-reviewed many times, calculates the optimal carbon tax in 2015 to be ONE-TENTH of that, or only $35 per ton carbon. I find it useful to put these quantities in terms of something we understand more readily: $350 per ton carbon converts to $1 per gallon of gasoline, while $35 per ton carbon converts to 10 cents per gallon of gasoline. We are talking big differences here.

So what is wrong with the Stern Review’s economics? It is real simple – they use an extremely low interest rate, close to zero. Everything follows from this, and in my opinion, the assumption is crazy....

Another point in this criticism is the essential inter-generational fairness issue. Per capita income worldwide has been growing at around 1.3% over many decades – and this is the number that the Stern Review uses. At that growth rate, per capital world consumption will grow from today’s $10, 000 to about $130,000 in two centuries. Which generation is the relatively poor generation? Are we so sure that we are impoverishing our children and our children’s children? What about all the new technologies, institutions such as democracy and market economies, physical infrastructure, and knowledge that we are bequeathing them? Do we not think that people 200 years from now will enjoy more leisure, better health, better technology, and generally be better able to pursue life, liberty, and happiness?

Read the articles, they are really convincing. For most of the media, of course, that will be too difficult. Much easier to report on Al Gore winning an Academy Award – oops, I meant a Nobel Prize.

20071208_delong_micro.jpg When Robin Robert Hansen argues that we should do little about climate change in the near future because "the climate models depend too much on positive feedbacks that are not understood... the models have not really been tested," he makes the decisive error of failing, as Tyler Cowen puts it, to recognize that on this issue uncertainty is not our friend.

And this is how Robin Robert misreads Marty. Because Marty's major point in his review is that uncertainty is not our friend and that because uncertainty is not our friend the Stern discount rate is not crazy:

Marty Weitzman: There is a general point here and a particular application to the economics of climate change. The general point is that from experience alone one cannot acquire sufficiently accurate information about the probabilities of tail disasters to prevent the expected marginal utility of an extra sure unit of consumption from becoming unbounded for any utility function having everywhere-positive relative risk aversion, thereby effortlessly driving [the conclusions of] cost-benefit applications of expected utility theory [to an endorsement of the generalized precautionary principle]. The degree to which this kind of "generalized precautionary principle" is relevant in a particular application must be decided on a case-by-case basis that depends upon... a priori knowledge.... In the particular application to the economics of climate change, where there is so obviously limited data and limited information about the global catastrophic reach of climate extremes for the case T > 6 C, to ignore or suppress the signiÖcance of rare tail disasters is to ignore or suppress what economic theory is telling us loudly and clearly is potentially the most important part of the analysis. While it is always fair game to challenge the assumptions of a model, when economic theory provides a generic result (like "free trade is Pareto optimal") the burden of proof is commonly taken as resting on whomever wants to overturn the theorem in a particular application. The take-away message here is that the burden of proof in the economics of climate change is presumptively upon whomever wants to model optimal-expected-utility growth under endogenous greenhouse warming without having structural uncertainty tending to matter much more than risk. Such a middle-of-the-distribution modeler needs to explain why the inescapably-thickened tails of the posterior-predictive distribution... rare disasters under uncertain structure, [are] not the primary focus of attention and does not play the decisive role in the analysis.

So Weitzman concludes that good policy today:

combines the gradualist climate-policy ramp of ever-tighter GHG reductions... with the option value of waiting for better information about the thick-tailed disasters... fnding out beforehand [whether] we are on a runaway-climate trajectory... [confronting] honestly the possible options of undertaking currently-politically-incorrect emergency measures if a worst-case nightmare trajectory happens to materialize... having some semblance of a game plan for dealing realistically with what might conceivably be coming down the road... supplement mainstream economic analysis of climate change (and mainstream ramped-up mitigation policies for dealing with it) by putting serious research dollars into... contingency planning for worst-case scenarios.... It may well turn out that... early detection is impossible... too expensive... comes too late... so we should stop stalling and start making serious down payments on catastrophe insurance by cutting CO2 e emissions drastically. But these are conclusions we need to reach empirically.... Instead of declaring immediate all-out war on greenhouse-gas emissions as advocated by Stern, maybe we would do better by steadily but surely ramping up GHG cuts over the next decade or two while simultaneously investigating seriously the nature of the runaway-climate disasters.... We can always come back in ten or twenty years time and declare all-out war on global-warming emissions then if we then think it is the best option.... The Stern Review has its heart in the right place -- it is not nice for us to play the role of nature's grim reaper by bequeathing the enormously unsettling uncertainty of a very small, but essentially unknown (and perhaps unknowable), probability of a planet Earth that in hindsight we allowed to get wrecked on our watch. However, Stern does not follow through formally on this really unsettling part of the global warming equation.... I don't mean to imply that there is some off-the-shelf turnkey consensus model of the economics of uncertain catastrophes that the Stern Review was negligent in not using.... But I think progress begins by recognizing that the hidden core meaning of Stern vs. Critics... is] tails vs. middle and about catastrophe insurance vs. consumption smoothing.