Monday, October 19, 2009

Klaus: Notes on the economic analysis of the global warming issue

Translation from Czech: L.M.

Instead of participating in the addition of further arguments of the philosophical i.e. unquantifiable type - which is what currently dominates the "ideological clash" between the champions of freedom on one side and the environmentalists and advocates of non-freedom on the other side, let us focus on some elementary economic data, hypotheses, theories, and models which underlie these big "confrontations". Maybe, exactly these considerations will convince a reader or two. Otherwise, the discussion resembles a "dialog of the deaf". It's self-evident that only a small wedge of all these problems has been selected for this article.

It is more than obvious that we are objects in a strange game that is being played with all of us. It is more than obvious that among those who are deciding about these issues on behalf of us, i.e. among the politicians, no genuine dialog about global warming or its costs is taking place - especially not about the costs of mitigation (and I know quite a bit about the situation). It is also more than obvious that a majority of the world's (and even our) politicians - without dedicating any time to a serious investigation of these questions - has concluded that the global warming game is an easy, politically correct, and personally highly beneficial card (which moreover guarantees that they're not and they will never be responsible for the costs of this fight because the costs will be covered by future generations).

My book Blue, Not Green Planet (Prague 2007), published as The Blue Planet in Green Shackles (CEI 2007) in English, was dedicated to this topic two years ago. The immediate driver that made me write that book was my strictly scholarly disagreement with the unreputable approach of the environmentalist economists (Stern, Garnaut) and, last but not least, their depreciation of the importance of the discount rate for all intertemporal decisions (those that are concerned with any comparisons of different time epochs). Climatological chimeras of some environmentalists are an entirely different issue - one that is, nevertheless, equally lacking in earnestness.

When the book was being written - at the end of 2006 and in early 2007 - I was inspired, among other things, by Nordhaus's critical review of the Stern Report (Nordhaus 2007, Stern 2007, Klaus 2007, pp. 76-78). The results of Stern's calculations were - according to Nordhaus as well as myself - crucially influenced by the choice of the discount rate by Nicholas Stern's author team - namely the discount rate close to zero - which is what they continue to assume, despite all the subsequent criticism. In other words, Stern effectively fails to distinguish the temporal dimension of this whole problem: the year 2100 is equally important, it has the same weight or value as the year 2000 which is completely absurd. At any rate, it completely contradicts the standard reasoning of economics. Later, my discussion about these matters was elaborated upon in my essay written with Daniel Tříska, On the Criticism of the Usage of the Solidarity and Discrimination Concepts in the Intertemporal Analysis of the So-Called Global Problems (Klaus & Tříska 2007, Klaus 2009).

In 2008, Nordhaus published an extensive book, "A Question of Balance: Weighing the Options on Global Warming Policies" which extended as well as quantified his original argumentation. I was pleased by the title of Chapter 1: "Summary for Concerned Citizens". He added a comment that most technical articles about global warming (especially the publications of the U.N., the so-called IPCC) begin with a "Summary for Policymakers" but he was more interested in the "participating" people with some interests, i.e. the "normal" people. Building on his mathematical model which has been optimized and improved for decades, his book offered 15 alternative scenarios assuming different responses to the climate change (starting from doing nothing and ending with extreme policies advocated by Stern and Gore). In this model-based framework, he has made a set of convincing conclusions about the complete inappropriateness of a majority of the policies suggested by the environmentalists. He has determined that they would extensively harm the world's economy and the economic development in general. The costs of "mitigation", i.e. the costs of policies meant to reduce the CO2 emissions, would vastly exceed their possible positive effects. A very convincing summary of similar issues can be found in the new, 2009 article by another important participant of these discussions, Indur Goklany, "Discounting the Future" (Goklany 2009a).

It has to be emphasized that Nordhaus studies exclusively economic consequences of global warming that he compares with the costs of the recently proposed mitigation policies designed to stabilize the global mean temperature (but he doesn't notice e.g. the very meaninglessness of the attempts to "stabilize" the global temperature which is historically very unstable) [1]. It's equally desirable to note that Nordhaus essentially adopts - without any questions or doubts - the climatological aspects of the U.N. Intergovernmental Panel for Climate Change (IPCC) which is, in my opinion, a mistake but even in the context of my present article, I am exclusively focusing on the economic argumentation, just like he did. The climatological discussion is to be postponed to another occasion (but I refer to Chapter VI of my book, in the Czech language to the book of Dr Kutílek from 2008, to many contributions in the CEP booklet from 2008, to Motl in 2008, to Svoboda from 2003; in the literature written in English, to Singer 2008, Curtin 2009, Essex and McKitrick 2007, Monckton 2007, Plimer 2009, and many others).

At any rate, it's self-evident that the global warming that is underway right now - if it is underway at all - is very moderate, hardly measurable, highly irregular, and having no immediate relationship with the evolution of the CO2 emissions. Bob Carter, a leading Australian climate scientist, gave a talk at the climate change conference organized by the Heartland Institute in March 2009 and he very resolutely said that "since 1940, the planet was getting warmer for 19 years and cooler for 49 years. Consequently, the current global mean temperature is approximately equal to the value in 1940" (Carter 2009, page 19). At the same moment, we also see that "despite the vanishing growth of the temperature in the most recent 68 years, the CO2 concentrations increased by more than 20%" (ibid). "Despite the immense, two-decades-long efforts and despite the enormous expenses, there has been no success in attempts to prove that the human influence on the climate is measurable. It turns out that this effect is lost in the noise and the variability of the natural climate changes" (page 23). There are many texts of this kind but this particular one seems to be their apt summary to me.

Nordhaus avoids this discussion. He begins with the economic argument that the discount rate - a quantity that is needed for any intertemporal calculations - should be close to 5.5% which is, first of all, very different from zero. According to Nordhaus, the progression of time is therefore a completely crucial argument. Building on the standard, i.e. not extremal or "fringe" economic theory, he is convinced that the discount rate has to express the real capital revenues because investments attempting to slow down climate change don't exist in the vacuum. They must compete with investments of all other kinds. Because of this very reason, the economists, whenever they analyze investments (which include more general interventions and policies of all conceivable types), work with the concept of "opportunity costs" which is one of the pillars of the economic way of reasoning in general.

Using his model (called DICE-2007 - where DICE stands for "Dynamical Integrated Climate & Economy" model), Nordhaus decides that the "optimal policy" is smaller than the alternative policies by orders of magnitude (Nordhaus, pp. 82-83):

Type of policyglobal costs of decelerating
of warming in 250 years,
in 2005 constant prices
Stern's$27.7 trillion
Gore's$33.9 trillion
Nordhaus's$2.2 trillion

In the table, the costs of Nordhaus's "optimal" and two alternative policies are based on the acceptance of an important yet questionable assumption which must be mentioned: the CO2 concentration will be capped by 2.5 times the pre-industrial levels [2]. This number has a lot of consequences. If we wanted the CO2 concentration to be kept at 2 times the pre-industrial level, the costs of the "optimal" policies would nearly double, to $3.95 trillion. But if the limit were 1.5 times the pre-industrial levels, they would increase ten-fold, to $27.2 trillion. (Approximately equal coefficients also multiply the costs of the alternative policies which brings us to hundreds of trillions.) As you can see, the differences are enormous and the dependence is highly nonlinear. I am mentioning these numbers for us to start to suspect that random figures emitted by policians' mouths at one EU, U.N., G8, or G20 summit after another (minus 20, 30, 50, 80% in CO2 emissions) are hugely important and they have consequences. However, the politicians are ignorant about this point, sometimes deliberately so.

It is obvious that all these calculations are just a modeler's exercise (however not one based on a U.N. or EU office but rather one created by one of the most prominent economists of the current era whose economics textbook - that he co-authored with the famous Paul Samuelson - has been used for decades, affecting the maximum number of students in the whole world). It's also clear that this model - much like all similar models used by climatologists - is using a sequence of questionable assumptions. And I repeat that Nordhaus doesn't question - in my eyes, highly disputable - conclusions of the IPCC at all. Nevertheless, his basic assumptions build on elementary logic and they are especially rooted in economic theories of the standard type. Robert Solow, an economics memorial Nobel prize winner, who is otherwise pretty close to the environmentalist attitudes, considers Nordhaus's work on these topics as "common sense, realism, and a precision economics analysis" (1993, page 164).

In the first 2009 issue of World Economics magazine (from January-February), Canadian economist Prof Dore defends Stern's model and sharply attacks Nordhaus in his article "A Question of Fudge". Dore's text is seemingly very technical, inaccessible to non-economists and even non-theoretical economists. But if we separate its mathematical apparatus from the economists' jargon, the whole article boils down to a dispute of aprioristic assumptions, even though it pretends to be an utterly neutral scientific debate. Let's see why it is so in some detail:
  • Dore criticizes Nordhaus e.g. for the fact that his calculations "only consider things that are valuable for human beings but they neglect moral values such as the health of the ecosystem" (page 95). If I ignore the observation that the "health of the ecosystem" is a very strange and ill-defined notion, it remains incomprehensible why the health of the ecosystem is considered to be a "moral value". (The term "value" seems to be overused which I consider to be a conceptual mistake and an escape from the analysis.) But what is a "moral value"? In my Blue Planet, I tried to explain that economists can't see any "objective" values that are independent of the human being (in the economic sense of the words) because the value is always subjective. Values without a human being or subject, without a human vantage point, are meaningless and cannot be defined. Who can determine the magnitude of a "moral value"? What is the mechanism to find this quantity?

    To avoid misunderstandings, it is completely unquestionable that the ecosystem or - using the normal vocabulary - the world around us deserves (and gets) extraordinary attention of the people, for reasons that are both aesthetic as well as entirely "egotistic" (related to the care about one's own future and the future of the human race) [3] but the health of the ecosystem can't have a "moral value". One can't work with it.

  • Dore can't accept Nordhaus's thesis that the investment costs attributed to the deceleration of warming have to "compete with all other investment expenses" (page 96). In fact, he misunderstands even the fact that the "public costs" and the "private costs" may be added with each other (which betrays his entirely statist world view). He is not interested whether the revenues (benefits) of the climate investments are high or low. He is essentially concerned with none of these things because his deciding factor is an unstructured, unspecified, unquantified (and unquantifiable) "protection of the interest of the future generations" (page 100). According to Dore, "Nordhaus forgets that the climate change is a public domain of a higher order" (page 101) which has a higher priority than anything else. However, Nordhaus is as aware of the rules of the public domain (and externalities) as Dore, if not more so [4]. The difference is that Nordhaus also knows what every serious economist does: that the public domain is less extensive than non-economists (and politicians) think or claim - and the same comment holds for the externalities, after all. Nordhaus also knows that the economists don't distinguish the public domain of higher or lower orders.

  • As soon as one adopts Dore's aprioristic argument which is apparently above everything else, then any discussion about the size of any parameter of any model is completely useless and is nothing else than an artificial "shadow puppet show" whose only purpose it to make a less qualified reader believe that the debate is scientifically serious.

  • Dore wants to twist the situation by one more statement that he is presenting a general discussion within economics between the "new classical economics" (based on the the hypothesis of rational expectations that are adapting to the exogenous shocks) on one side and the Cambridge school (of price rigidities, asymmetric information, the "principal agent" problem, moral hazard, etc.). This point seems to be just another trick or finesse. These things definitely do play a role in the economists' heads but I don't think that Nordhaus could be considered to be a champion of new classical economics - by anyone else except for the environmentalist ideologues.

  • Many of us do not think that we should acknowledge that the state has the right to control, regulate, or organize anything in the economy. But Dore wants much more to be inserted to the core of our reasoning (page 103), namely "the stewardship of the entire biosphere", which is a nearly incredible ambition based on the "pretended knowledge" (Hayek) that the mankind doesn't possess and will never possess.

  • Dore authoritatively claims that the "opportunity costs don't exist" because in the global warming case, "there's no problem of the choice" (page 104)! It exists elsewhere but not here? We are obviously facing circular reasoning here. It makes any discussion useless.

  • Dore is primarily unhappy that Nordhaus claims that "climate change is just a minor perturbation" (using Dore's words). I also think it is but it is up to Dore to present serious arguments that it should be viewed as a "large perturbation". The answer will be strongly influenced by our choice of the discount rate.
In the previously quoted article by Goklany (Goklany 2009a), several numerical conclusions of the Stern Report and the IPCC models are summarized. It contains quite a lot of possibilities and numbers but for the purpose of this discussion, I can choose just a few of them and I can also ignore the error margins and focus on the "average values" only. My only goal is to list a few numbers that are important for a rational decision whether the hypothetical global warming in the foreseeable future is a "minor" or a "large" perturbation. I will be comparing the present with the year 2100 (even though Goklany also offers estimates for the year 2200).

Goklany isn't checking any maths. He is only thinking about the IPCC numbers - much like I am. All the numbers below are GDP per capita figures, in the 1990 U.S. dollars (i.e. without their expected inflationary depreciation). I will be mentioning the results of the calculations in the scenario where nothing will be done with the temperature at all and the temperature will increase by 4 °C as a result. (To be sure, I must mention that the whole 20th temperature has only seen 0.74 °C of warming which means that the IPCC has to posulate more than a five-fold acceleration of the warming rate.) This value is very strange, especially if we realize that the temperature difference doesn't depend on the CO2 concentrations linearly but rather logarithmically (and surely not exponentially), a fact that all serious climatologists know very well (in Czechia, Dr Kutílek probably offers the most convincing arguments about this issue, in Kutílek 2008).

Despite this warming, an unbelievable economic growth will take place - according to the very optimistic IPCC economists:

GDP per capitain 1990in 2100
third world$900$66,500
developed world$13,700$107,300

The third world's wealth will be - according to the IPCC as well as Stern - much higher than the wealth of the developed world in 1990 (approximately five times). I think that this statement is controversial but whenever we start from a low number, a similar fast growth is possible. Whatever we can think about it, it is self-evident that even Nicholas Stern, the main warrior for the radical interventions against the CO2 emissions and, consequently, interventions into the economic development and the human lives, admits that the future generations of our Blue Planet are likely to be much better off than we are today!

But that's not the whole story. The calculations by Stern and the IPCC claim that the higher temperature (by 4 °C) in 2100 will cause the loss that only lowers the GDP per capita by 2.9%, relatively to the situation with no temperature change (!). (The interval, including error margins, goes from 0.9% to 7.5%.) Even if we subtract 7.5% from those $66,500 (for the presently poor countries) and from $107,300 (for the currently developed world), we are talking about reductions that are irrelevant relatively to the impact of the proposed CO2 reduction by 20, 30, 50, or 80% today, which would influence our whole way of living. Should we make this sacrifice for the happiness of the future generations?

Our ancestors - without directly thinking about it, in the same way as N. Stern or Al Gore are "thinking" about the future generations - have endowed us with the immense wealth of "tangible" as well as "non-tangible" things, i.e. material wealth, capital of diverse kinds, but primarily ideas, technologies, and institutions. Indur M. Goklany says very nicely that they were not doing these things deliberately. Instead, we see an "invisible hand reaching the future generations at work" (2009a, page 40).

That's why I fully agree with this author that "climate change is not a defining challenge of our age" (2009b), or that it mustn't become the defining challenge. It's our task to protect our epoch from such a development. However, some people are still trying to define the characteristics in this way. Because it can't be done seriously, any non-serious tool may be found useful, too. Even Prof Dore couldn't control his emotions and even during a technical analysis of Nordhaus's model, he didn't resist to mention that "Nordhaus's approach will be celebrated by the U.S. and Canadian oil lobby" (page 102). If Dore is thinking in this way, he should also think about the influence of the need to get grants from the government on the work of the environmentalist professorial Sirs - and his own (which is very nicely described by R.L. Gordon 2009). Global warming is really (and fortunately) - as long as we keep both climatological and economic approaches rational - just a "minor perturbation".

But let's return to Nordhaus. His book reaches a critical conclusion: "The economic damages caused by climate change - if there won't be any mitigation policies at all - will be comparable to 2.5% of the annual GDP of the whole world at the end of the 21st century" (2008, page 6). This is a small loss. The loss created as a consequence of a completely useless, radical crusade against global warming would be much higher. I completely agree with David Henderson that "at places with so many uncertainties, unclarified, and unknown things, politics should be evolutionary and adaptive" rather than revolutionary and fixed for long years (Henderson 2009).

Václav Klaus, "Kontexty" (Contexts) 4/2009


[1] The long-term instability of the global mean temperature is being shown by many authors. In the Czech language, it is being comprehensibly presented by several authors in a publication of the Center for Economics and Politics, 2007, page 10, and other authors.

[2] It's questionable whether they can rise in this way at all. Some authors argue that the total reserves of "fossil fuels" inside the Earth are not high enough (e.g. personal communication with R. L. Jenne, National Center for Atmospheric Research). In his text "Carbon Dioxide in Atmosphere (2000-2080)", published in 2009, it turns out that the complete burning of all fossil fuels can only increase the CO2 concentrations by 62%.

[3] R. Solow in his - previously quoted - article says that "if sustainability is meant to be more than a vague emotional commitment", then it is the kind of behavior that allows all future generations the choice to live "as well as the ancestors did" (1993, page 168). To me, it looks like a good pragmatic starting point.

[4] In his book, Nordhaus explicitly says that "global warming belongs to the global public domain" but he also adds that "it will be very expensive to decelerate it or eliminate it" and he especially says that "it brings very unpleasant scientific and economic uncertainties with it" (2008, page XI).


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