Global Climate Change Policy: Some of the Economic Issues Involved

Global Climate Change Policy: Some of the Economic Issues Involved

By Robert E. Wright, Nef Family Chair of Political Economy, Augustana College SD for Greenfest, 19 April 2013

I’ve never understood why some people, mostly political conservatives its seems, push back so hard on claims that humans are changing the global climate. We’ve been doing it on a local scale for hundreds of thousands if not millions of years. Our buildings are mostly about climate control and in fact that euphemism is even used in the HVAC -- or heating, ventilation, and air conditioning -- business. A fire in a cave is a form of local climate control, as is a shelterbelt or hedgerow. Our cities are regularly several degrees warmer than the surrounding countryside, and the larger the city, the larger the differential. That several centuries of factories and a century of automobiles has caused larger scale changes is, therefore, not surprising to me. I don’t know if the claim is true or not as I am no expert in such matters but it does strikes me as quite plausible.

Of course simply because humans are changing the global climate – and specifically that we are making the climate warmer and more volatile – does not in and of itself necessitate any policy response. Policies should be implemented only when their total expected benefits exceed their total expected costs; policy proposals that would generate costs that exceed benefits should be rejected.

So first we need to know if the expected climatic changes will be positive or negative on net. If they are expected to be positive then clearly no policy action is necessary, unless it be to ask if we would benefit more by inducing even more global climate change. The net effect of climate change is a serious question, one that economists are better equipped to answer than scientists are because the latter typically do not understand how market economies adapt to changing circumstances. You might recall how an economist name Julian Simon schooled a biologist, Paul Ehrlich, who in 1968 predicted that we’d all be dead by now. Scientists and politicians tend to think that if things are different they are likely to be worse but economists generally show that different can be just different, with little to no net effect.

Higher sea levels, more violent storms, higher temperatures, stressed ecosystems, and so forth sound bad but if change is gradual and somewhat foreseeable they need not impose catastrophic costs. Robert Fogel won a Nobel Prize, for example, by showing that if railroads had not existed, U.S. economic growth would have been just three months behind where it actually stood in the nineteenth century. That sounds preposterous at first given the huge stress on railroads to economic development, but Fogel pointed out that without railroads, factories simply would have located along navigable rivers instead. Steel would still have been created but used in ships and buildings instead of for rails. And South Dakota would be more heavily populated in the middle and less heavily populated on each end. In the end, in other words, it doesn’t much matter if we have a fixed port at New Orleans or at Baton Rouge or at Vicksburg, or if we switch to a floating dock system. Where there is a will, which is to say a profit, there is a way.

More volatile weather looks like a loss all around and there is little to be said in favor of it, but the risks can be spread via global insurance markets and reinsurance. They can also be mitigated, with a little help from more enlightened public policies dissuading people from living in the most risk prone areas, like Fargo and parts of the Gulf Coast. They can also be mitigated by new construction standards and techniques like putting power lines underground instead of under trees. Bad things, like earthquakes, are going to happen anyway and better that they do so in a robust risk management environment than in a less developed one. Still, on net, it seems liked increased climatic variability will prove somewhat costly. How costly, though, I don’t know. And neither do you, or anyone else.

And here again economics has something important to say. How much should be willing to spend today to prevent, say, $1 trillion of damage in the future? If the future is tomorrow, then something up to like $999.99 billion. But what if the damage isn’t going to occur for, say, 30 years? The answer depends on how much money is worth and what the likelihood of the future damage is. If the damage is almost certain, money isn’t very valuable, and we are expecting no inflation, then we might use a discount factor of say 1 percent, in which case it would be rational to spend up to $742 billion today, if we compounded annually, to save the expense of paying $1 trillion in thirty years. If money is more valuable, some inflation is expected, and the savings of $1 trillion is somewhat uncertain, we might use an annual discount factor of 10 percent, in which case it would be rational to spend up to only $57 billion today to save $1 trillion in 30 years. If 20 percent is a better discount figure, then anything more than $4 billion expended today would be irrational.

Of course nobody knows what the expected costs of global climate change are, even if many suspect that the sign is negative. Nobody is quite sure when the costs will be borne. And the appropriate discount rate for any pre-emptive policy action is also far from certain. We can say, however, if the costs are distant and somewhat predictable, they will be minimized through market adjustments like those I just outlined. If the costs are imminent and largely unpredictable, we are all screwed already anyway. There is little that policymakers can do in either case, at least in the developed world. What we should focus on, therefore, are the world’s poorest and most vulnerable people as they will be hit far harder by climatic variability and their economies will be less flexible in their responses to gradual climatic change. So we should be concentrating our efforts on the world’s poor, a billion Latin Americans, a billion Africans, a billion Indians, and some 2 billion east Asians. But we should be doing that anyway, regardless of the state of the climate or the climate debate.