Transcript Real Trade Theory Professor Christopher Bliss

The Stern Report
Is it the Answer?
Christopher Bliss
[email protected]
The Hayek Society
31st January 2007
Where I am Coming From
• Nick Stern (forget the Sir Nicholas in this
context) is a long-standing close friend
• But some of his critics are friends too
(Dasgupta and Nordhaus)
Sources
The Report is huge, and although I have spent many hours reading it, I
confess that parts have been skimmed rather than studied deeply.
Even my light reading shows me that some media accounts are
inaccurate or confused.
The text can be downloaded, free of charge, from the HM Treasury
Home Page
Comment from Partha Dasgupta (FBA and FRS) may be found at:
www.econ.cam.ac.uk/faculty/dasgupta/STERN.pdf
Comment from Bill Nordhaus may be found at:
nordhaus.econ.yale.edu/SternReviewD2.pdf
A Cautionary Note
The Report admits to uncertainty concerning
the future, but this is mostly expressed as
quantitative uncertainty, concerning in
particular the size of National Product. It
does not write about the qualitative
uncertainty that arises from life-changing
technological alteration. This is beautifully
depicted by Tom Schelling in his 2002
Presidential Address to the American
Economic Association.
Tom Schelling on Climate Change
“"Even if we had confident estimates of climate change for different regions of
the world, there would still be uncertainties about the kind of world it is going
to be in 50, 75 or 100 years from now. Imagine it were 1900 and the climate
change associated with a three-degree average temperature increase were
projected to 1992. On what kind of world would we superimpose either a
vaguely described potential change in climate, or even a specific description
of changes in the weather in all seasons of the year, even for our own
country. There would have been no way to assess the impact of changing
climates on air travel, electronic communication, the construction of
skyscrapers, or the value of California real estate. Most of us worked
outdoors; life expectancy was 47 years (it is now 75); barely a fifth of us
lived in cities of 50,000 or more. Anticipating the automobile we might have
been concerned about whether wetter and drier weather would bring more
or less mud, not anticipating that the nations roads would become
thoroughly paved. The assessment of the effects on health would be without
anti-biotics or inoculation. And in contrast to most contemporary concern
with the popular image of hotter summers to come, I think we would have
been more concerned about warmer winters. later frost in autumn, and
earlier thaw in the spring.”
The Science
• I am no expert on the science of global warming. Yet the basic
Physics is rock-solid, and some of the worrying projections in the
Report (and elsewhere) look reasonable to me. That there is no new
science in the Report does not concern me.
• The scientific point that puzzles me most is the high level of carbon
re-absorption that is posited. It is claimed that long-run stabilization
of atmospheric carbon concentration is feasible, notwithstanding
huge and continuing world economic growth.
• There is more than one scientific projection involved. The Report
mixes long-run projections, sometimes to the end of this century, or
into the next, with the claim that extremely urgent action is
demanded (tipping points).
• The science concerned with tipping points in the fairly near future is
far more speculative than the claim that long-term temperature rise
with continued emissions is inevitable.
Politics
Notwithstanding Stern’s stellar academic standing,
this is not an academic study.
It is an intensely political document. It proposes
and justifies a program for world-wide emissions
control. It argues that the costs of doing nothing
are massive; the cost of dealing with the
problem are modest.
The economic modelling is tailored to support the
above case. There is no sensitivity analysis.
Social Welfare Function
The Report is based on cost-benefit analysis. So it a maximizes a Social
Welfare Function. The function chosen is something like:
∑t ∑iU(cit)
(1)
Where t is the time period and i an index of individuals alive at t.
I have set the utility time discount rate to zero. Stern has it equal to 0.001, the
probability of extinction, but that is zero in effect.
The objective (1) is not necessarily utilitarian in the sense that U measures utils
enjoyed by different people. It could be that U measures the UK Treasury’s
relative valuation of consumptions by different parties.
What matters is that all generations are treated symmetrically, and that the
curvature of U measures the UK Treasury’s aversion to inequality, within
and between generations.
The above approach is non-standard, because there is no third summation
over states of the world, weighted by probabilities. For the way in which
Stern treats uncertainty, see below.
The Log Function
The Report sometimes uses a special case of (1):
∑t ∑ilogcit
(2)
This has the implication that the extra consumption it is necessary to give to Bill
Gates to justify taking $1’s worth of consumption away from a poor Indian
farmer, is equal to the ratio of Gates’ consumption to the farmer’s
consumption. This represents moderate aversion to inequality.
Also, if all per-capita incomes will grow at 2% per annum for the next 50 years,
marginal increases in incomes 50 years in the future are valued at about
one-third the same marginal change in incomes in 2057. That implies that
income protection in the medium distant future, paid for by present
generations, has to extremely effective. Stern argues that this test is met.
The Report argues that marginal changes, such as that detailed above, are not
what the economics of climate change are about. However, marginal mental
experiments do test the plausibility of objective functions.
Investment and the Ramp
The previous slide looked at the cost-benefit of the present generation
reducing consumption a little to save the generation in 50 year’s
time over three times as much.
That is a simplistic account of the picture painted by Stern. He has all
those alive over the next decade reducing consumption to avoid a
permanent reduction in consumption in the medium future at least
ten times as large.
As an alternative to using the present reduction in consumption to
reduce emissions, the present generation could invest instead. With
a return of about 4%, this appears to beat emissions reduction, at
least over early years from now. This leads to The Ramp, the idea
that emissions reduction can wait until later, if human and physical
capital investment is increased.
Against this approach Stern seems to favour the Fire-Insurance View.
Pessimistic Assumptions and the
Fire Insurance View
Stern has been widely criticized for choosing the most pessimistic assumptions
from the menu of possibilities. For example, his favoured prognosis is far
more dire than that of the UN’s IPCC.
A possible justification for this is that the worst outcomes have enough
probability weight attaching to them to justify just calculating whether the
present cost of avoiding any possibility of those outcomes is worthwhile.
I call this Fire Insurance because it is similar to exactly that. Destruction of an
uninsured home by fire is such a huge disaster that one readily pays a
significant premium to avoid it, even though the probability of a fire is tiny.
Stern argues for a precautionary principle. The probabilities are only guesses.
Just in case the disaster outcome is more probable than it seems, let us
treat it as near certain (my way of explaining it, not the Report’s).
Finally, note that the fire-insurance analogy is misleading in one respect. If I
insure my house against fire, I pay the fee, and I get the benefit. Emissions
control means that the present generation pays the fee, and future (richer)
generations are protected.
Climate Change and the Prisoners’
Dilemma
Prior to the publication of the Stern Report my own
position was as deeply pessimistic as is
possible. I believed that climate change is a real
and large problem, and I thought that practically
nothing could be done about it. It seemed to me
that climate change is a huge global Prisoners’
Dilemma problem, and that defection all-round is
the only equilibrium outcome.
So when press reports of the line to be taken by
the forthcoming Stern Report began to appear, I
said to myself: “Surely Nick understands the
Prisoners’ Dilemma”.
The Prisoners’ Dilemma and
Cooperation
The Stern Report is well-aware of the Prisoners’
Dilemma, and this is discussed explicitly in Part
VI, Chapter 21. The discussion is not as sharp
as one might wish. There is reference to
changing the climate of thinking, so that nations
and voters become more aware of their
collective responsibilities. The theory of repeated
games is also cited, and there is a light
discussion of punishment strategies and their
problems.
Is Global Warming a Repeated
Game?
The Stern Report recourse to the theory of repeated games is
problematical. The global warming problem differs from the repeated
version of the Prisoners’ Dilemma problem in at least the following
respects:
• If one thinks of each round of the game as one year of policy, then
each year changes the game. The stock of CO2 in the atmosphere
alters, and long-term (more than one year) investment projects are
part-finished.
• In reality the game is not a full-information, common-knowledge,
game. Players do not make a simple bi-modal choice:
(Cooperate,Defect). They can choose from a wide range of actions,
defecting to any degree desired. And they can dissemble and cheat.
Punishment systems in this sort of game are difficult. Punishing
even small-scale defection is not credible. So selfish players will
always go right up to the trigger level of defection.
• The EU emissions control protocol was initially ineffective because
national governments cheated blatantly.
Carbon Trading and its Regulation
The Stern Report advocates Carbon Trading, as the efficient way to reduce
emissions at minimum cost. In principle carbon trading makes sense. But
how is it to be implemented? Two simple systems have been discussed.
• Existing emitters are allocated rights to emit, proportional to, but at a
reduced level, to their existing emissions. If existing emitters cannot cut
back to the required extent, or anyone wanting to start-up new plant that will
emit, must buy certificates on a world market for emission rights.
• All certificates giving a right to emit greenhouse gases must be purchased
from an international agency that will auction off the right number of
certificates to fix world emissions at the appropriate level.
The first scheme rewards old emitters relative to new enterprises. The second
places huge sums of money into the hands of an international body. How
are these funds to be disbursed? Will they help poor countries to pay for
their emissions, or will they partly pay for development aid?
Transfer, Bureaucracy and Politics
The previous slide indicates that the control of emissions, in particular in
combination with carbon trading, raises the possibility of substantial
transfers to the poorest nations. However, such transfers could happen
anyway, if aid is deemed to be effective, and if the politics of rich countries
allows it.
The Stern Report advocates large-scale assistance by rich countries for poor
countries, to help the latter adapt. How would the politics of that play out?
Imagine a populist politician saying: “Why should the taxes paid by my poor
voters be used to feather-bed the Chinese, given their repeated violations of
human rights?”
Any carbon trading scheme needs to be policed, to ensure that illicit emission
of CO2 does not occur. This should require a huge international
bureaucracy, and will imply endless possibilities for argument and friction.
What will the ultimate penalties be?
The Stern Report cites successful international cooperation in the case of the
outlawing of ozone-depleting chemicals. But this is a relatively easy field.
What about the Nuclear Non-Proliferation Treaty, that was undermined by
non-compliance from the start, and is now dissolving before our eyes?
Another Dragon: Protectionism
Suppose, for the sake of this slide at least, that the
Stern message is entirely right, and that it can
be sold to the world. The Global-Warming
Dragon is slain. But another dragon is lurking in
a corner.
Already, in the European Union, voices are heard
asking how emerging country exports can be
allowed access to Union markets, when the
production of these exports pollutes far more
than the Union production that competes with it.
The Costs of Carbon Stabilization
To my inexpert eye, two features of the Stern Report
appear as remarkably optimistic.
• Carbon concentration can be stabilized while economic
growth continues, and emissions remain positive,
although at a greatly reduced level. This depends upon
natural re-absorption. Forests are mentioned. But it is
only net growth of forest carbon that is absorption. How
can this continue indefinitely? A similar question arises
with regard to absorption by the World’s oceans.
• The cost of stabilization is strikingly low – 3% of GDP at
the high end. The Report does not justify this estimate. It
mentions several technologies, talks about cost
reduction via experience, and cites some outside
studies.
Costs and Benefits Now and in the
Future
Recent rapid economic growth in Brazil, China, India, and elsewhere, has lifted
millions of people out of poverty. Nothing can be considered that would put
those gains at risk. Where that growth has been an effective means of
poverty reduction, international aid, generally, has not been. Its scale has
been small, and it can be defective as an instrument for poverty reduction.
Usually it transfers money to governments, which typically means to
ineffective and corrupt governments.
The Report proposes a different kind of international aid, involving costs paid
largely by the current rich to the benefit particularly of future poor people.
No direct monetary transfers are required.
Some big problems are untouched by actions on global warming. Even if the
control of emissions is of particular importance for sub-Saharan Africa
(SSA), that control will not solve the catastrophic condition of the SSA
region. And if the auctioning of emission rights produces big monetary
transfers to SSA, that could inhibit economic growth there, because
transfers have the same effect as resource abundance.
Concluding Remarks
The Stern Report is an impressive piece of work. If my
claim that it is a political document is correct, then it is a
political document with more academic references than
any previously seen.
The report relies heavily on the insurance principle to justify
the urgency of action, and to reject the Ramp. Its benign
conclusions concerning costs and benefits depend
heavily on surprisingly low estimates of the costs
involved.
Can it happen? The argument gets quite “hand-waving”
where implementation is concerned. The recourse to
Repeated Game theory is dodgy. And the apparent need
for a huge international bureaucracy is not confronted.