Taking economics bashing to the next level (i.e., economics bashing on crack)

From Scientific American (The Economist Has No Clothes, Unscientific assumptions in economic theory are undermining efforts to solve environmental problems):

Unfortunately, it is clear that neoclassical economics has also become outdated. The theory is based on unscientific assumptions that are hindering the implementation of viable economic solutions for global warming and other menacing environmental problems.
...

Because neoclassical economics does not even acknowledge the costs of environmental problems and the limits to economic growth, it constitutes one of the greatest barriers to combating climate change and other threats to the planet.

Huh? Much of the environmental economics research of the past 40+ years is focused on measuring the costs of environmental problems. And on the teaching side, millions of introductory microeconomics students are told the best example of a negative externality problem is environmental pollution.

The critics wear leisure suits. And I'm offended by the naked economist picture.

Update below.

The introductory piece claimed that environmental economists ignored the environment. The extended piece (Brother can you spare me a planet) acknowledges this work but says it is all wrong:

When environmental economists calculate the environmental costs of economic activities, they assume that the relative price of each bundle of an environmental good, service, or amenity reveals the "real marginal values" of the consumer. The creators of neoclassical economics conceived of the construct of marginal values after substituting utility for energy in the equations borrowed from the theory in physics. In the resulting formalism, a marginal value essentially represents how much more a consumer is willing to pay to acquire incrementally larger amounts of a good, service or commodity. ...

The formalism is simply a tool.

In environmental economics, the presumption that optimal private decisions "based on mutually advantageous exchange" lead to optimal social outcomes for the state of the environment is a primary article of faith. The environmental economists also assume that the mechanisms of the market system will resolve environmental problems when "prices are right." The right price in neoclassical economic theory is a function of the prices that economic actors have paid, or are willing to pay, to realize some marginal benefits of environmental goods and services.

Actually, most environmental economists begin with the recognition that the prices may never be right (unless government policy makes them so with taxes on emissions equal to the marginal damage).

Environmental economists often use cost-benefit analyses to place a value on environmental externalities, or environmental goods and services that are "external" to market systems in the sense that they are presumed to exist outside of the closed market system. The problem that these accounting procedures are intended to resolve is that "real marginal values" can only be determined by dynamics that operate within closed market systems. Given that the vast majority of the damage done to the natural environment by economic activities cannot be valued in these terms, environmental economists have developed indirect methods designed to estimate the "use-value" of these resources.

Right on.

For example, contingent valuation methods are used to assess the economic value of recreation, scenic beauty, air quality, water quality, species preservation, bequests to future generations and other nonmarket environmental resources. The methods are intended to assess the willingness-to-pay function of economic actors who would prefer to preserve natural environments (preservation or existence values), maintain the option of using natural resources (option values), and bequeath natural resources to future generations (bequest values). (6) Most contingent valuation surveys seek to determine the maximal amount that individuals are willing to pay for an increase in the quality of an environmental resource and the minimal amount they are willing to accept as compensation to forgo this increase.

For the sake of argument, let us assume that contingent valuation studies are capable of revealing maximal social outcomes of environmental policy decisions. Are we then to believe, as one such study showed, that reduction in chemical contaminants in drinking water was not important in economic terms because the value of a statistical life associated with a reduction in risk of death in 30 years was only $181,000? (

This is a problem of discounting far into the future.

Is $26 a measure of the real marginal costs of pollution because this is the average price that a household is willing to pay annually for a 10 percent improvement of visibility in eastern U.S. cities?

It is one measure of such costs. It might be biased due to a lack of information or information comprehension.

Is the value of a whooping crane the $22-per-year average that one set of households was willing to pay to preserve this species and that of the bald eagle the $11-per-year average that another set of households would spend to preserve this apparently less valuable species?

One dirty little secret: aggregate those values and the net benefits of protection are positive. Also, comparison of the whooping crane study and the bald eagle study involves more than a simple comparison of willingness to pay values. Maybe whooping cranes were more scarce than bald eagles (endangered vs threatened species) at the time of the study? Maybe the income of the whooping crane sample is higher than the income of the bald eagle sample? I don't know the answer to these questions but you must dig deeper (i.e., improve your understanding) before you dump on environmental economics so hard. 

Comments

[jim casey]

yes its true I tell all my students to ruin the environment. in fact - i beg them to drive bigger cars, leave the AC on at home when they come to class and throw their beer cans in the trash.

[Will]

I was considering bringing this to your attention. My wife sent it to me, as it's going around her grad department's listserv.

I had a number of problems with the article, obviously, but let me start with one. He quotes (from Hanley, Shogren, and White's Environmental Economics text:

"The power of a perfectly functioning market rests in its decentralized process of decision making and exchange; no omnipotent planner is needed to allocate resources. Rather, prices ration resources to those that value them the most and, in doing so, individuals are swept along by Adam Smith's invisible hand to achieve what is best for society as a collective. Optimal private decisions based on mutually advantageous exchange lead to optimal social outcomes." (4)

Then says:

In environmental economics, the presumption that optimal private decisions "based on mutually advantageous exchange" lead to optimal social outcomes for the state of the environment is a primary article of faith.

Okay, but the Hanley et al. quote comes from the beginning of their chapter on market failure--the very next sentence starts to describe the ways in which optimal outcomes may not happen.
I'd say the author is either lazy or just interested in making his point. I found the entire exercise to be typical of the critiques of caricatures of economics that are pretty easy to find.

The author is also an English professor, so is perhaps not the right person to be critiquing economics.

[Paul]

The author also has a few similar write-ups on the Encyclopedia of Earth website. In his bio on that site there it says that he is a full Professor of Environmental Science and Public Policy but at the school website it states that he is faculty associated with the Environmental Science and Public Policy department (in English). It seems a little disingenuous. It seems kind of funny that an English professor gets to call economics unscientific in Scientific American and the Encyclopedia of Earth, which by the way has the subheading: Content, Credibility, Community).

[David Zetland]

I posted this a few days ago with a note that "I agree." My agreement was with his contention that things will not go as smoothly as marginal substitution might predict, i.e., that discontinuities (even better, Knightian uncertainty) will be very disruptive in our existing systems.

Environmental economists and ecologists have been debating these issues for years and have far more to say than the strawman Nadeau sets up.

I forwarded to piece to Marginal Revolution, but nothing from them as of now...

[John Whitehead]

From the Nadeau website at GMU:

Robert L. Nadeau, Professor of English, has attempted throughout his career to bridge the gap between C. P. Snow's two cultures of humanists- social scientists and scientists-engineers. His scholarship attempts to assess the societal implications of scientific and technological progress, and employs a wide range of subject fields on both sides of the two-culture divide. Nadeau has published seven books in the areas of science and literature, the history and philosophy of science, neuroscience, nuclear disarmament, and the two-culture conflict. He is currently completing a book on mainstream economics and the environmental crisis.

Sigh. There are a lot of things about ecological economics to recommend its study and application. The tone and uninformed mistakes of some of its messengers is not one of them.

After hearing it over and over again, I can't break away from this caricature:

"Modern economics is crap because of something that occurred 200 years ago."

"Economists don't address environmental concerns."

"When economists address environmental concerns they have nothing useful to say."

"My reading of the economic literature leads me to believe that what I don't have a deep understanding of must be wrong."

"I have no formal economic training. I've picked up my knowledge of mainstream economics by a thorough reading of the critics of mainstream economics."

[NSA Wiretap]

Holiday Inn Express Manager: "We have this guy over here that says he has a couple articles he wants to submit. They seem to be well written and have definitely convinced me that neoclassical economics is completely bunk."

Scientific American Editors: "Yea? What is his background?"

Holiday Inn Express Manager: "Well, he is an English professor, but he writes about all kinds of science, including neuroscience!"

Scientific American Editors: "Neuroscience you say? If he can write about that he can definitely write about economics. Tell him we will publish it online!"

[john]

Of course we are outraged, we are economists! (have we been wasting our time? God, I hope not...my life is in ruins).

But seriously:

1. The author does have a point, economics is unashamedly utilitarian in its approach, and there is something about using a utilitarian argument when dealing with what we might regard as a non negotiable, unquantifiable good that sticks in the craw. Economists sometimes seem to make a virtue of this as they are cool, cynical and detached. But push them on it and they give in.

2. Economics is not a science. I know from experience that quantitative analysis is often sloppy and assumptions ignored. [There is, to some extent, a conspiracy to ignore these common failings amongst writers in the canon. Difficult to get published in a respected journal unless you toe the line.]

People are right to rail against conventional economics, not only because of its theoretical flaws, but because despite these it often informs policy [sends a shiver down my spine]. For example, the naughty idea that industrial policy played only a negative role in development. As though history never ever existed.

Of course environmental economics does try and right a few wrongs, but it is always good to view your disciple with a critical eye and recognize your own bias.

[reason]

I too have problems with the cost/benefit analysis of environmental problems, because it is self-referential, but relates to things outside the system. We have to make to make of assumptions about things we can't possibly know in order to reduce to a multi-dimentional problem to a single number. John says economics is utilitarian (meaning only related to the use of things rather than their inherent worth) but it is not even that, when it values everything according to their market worth. That is just their value to that subset of mankind with purchasing power.

[reason]

... We have to make to make of assumptions ....
We have to make all kinds of assumptions ....

[reason]

I know a lot people think reductio ad absurdum arguments are some how a dirty trick. But they are important when you want to know when something is a scalable basic principle or merely a pragmatic locally applicable heuristic.

Imagine a world in which starvation is a serious problem, but the plentiful rich prefer golf courses to any other form of recreation. Will the market plow up the golf courses or violent revolution? That is why cost/benefit analysis angers some people. Economics has to realise there is a distinction between necessity and preference and be prepared to make it.

[reason]

Alternatively,
imagine (perfectly feasible) that a particular environment decision is in the short term expensive but ensures the survival of all life on earth in the long term, which is otherwise highly endangered. Depending on your discount rate, you may (perfectly rationally) choose extinction for all your descendents. See the problem? The question you are asking is the wrong question because you are converting the question to another question in trying to make it a cost/benefit question (cost and benefit FOR whom exactly).

[reason]

You see cost/benefit analysis comes originally from a perfectly valid use of evaluating investment decisions within a firm, where the costs to the firm are all monetary and the benefits (also to the same firm) are also monetary. Trying to use the same analysis where the costs and benefits are:
a) not all monetary, (and there is no functioning market to value them)
b) the costs and benefits acquire to different people;
is not (in principle) a valid excercise.

[John Whitehead]

Reason,

"imagine (perfectly feasible) that a particular environment decision is in the short term expensive but ensures the survival of all life on earth in the long term, which is otherwise highly endangered."

I agree benefit-cost analysis doesn't work well with that type of temporal difference in benefits and costs. But I don't think that we bother with benefit-cost analysis on that issue. Don't we just go with the policy? Benefit-cost analysis is most useful when the policy answer isn't obvious.

[John Whitehead]

Reason,

Invalid means "being without foundation or force in fact, truth, or law." I think you are over-stating your case. Benefit-cost has limitations but it is a helpful decision making tool.

[reason]

And further - there is the small (not so) problem of inevitable ceterus parabus assumptions, which do not hold for whole world analyses. (The problem being the opportunity cost estimates are often laughably inaccurate when you extend it a whole world scenario because of the enormous and often unforseeable substition possibilities. In other words, dollar costs often don't translate into real costs very well.)

[reason]

No - adding up dollar costs for one person and dollar benefits to another is invalid by the normal utilitiy assumption in economics.

[John Whitehead]

Interpersonal comparisons of costs and benefits can be justified by the potential Pareto improvement criterion.

Without interpersonal comparisons of costs and benefits, formally or informally, government can not make any decisions about policy to correct market failures. The status quo will reign.

[reason]

John,
no that is just not true. Government very often has to make decisions without interpersonal comparison of costs of benefits (for instance on the basis of moral arguments or political judgement). They just can't do it pseudo-scientifically.:-) That is part of the reason you need a political decision making system, because these sort of trade offs are not subject to any sort of fair financial solution. And the Pareto argument is only valid IF compensation is actually made and accepted. How often is that actually done.

[John Whitehead]

Reason,

There is no truth. We all are seekers.

Note the adjective on Pareto Improvement in my comment. A "potential Pareto Improvement" is synonomous with Kaldor-Hicks efficiency.

Also, most all government policies have winners and losers and thus involve an interpersonal comparison of costs and benefits.

Finally, benefit-cost cost analysis is a tool ... in input into the political decision making process ... not a decision maker.

[CalDem]

The mistake everybody makes is to assume that all the natural sciences are pure, perfect exemplars of the scientific process where you don't have to make assumptions or deal with messy real world data.

In fact,any non-lab scientist deals with all the issues the economists do. Ecologists, soil scientists, exotox people, hydrologists, they all have simple models that don't fully capture the data, they have messy data where statistical models are often inappropriate, and they disciplinary biases (usually against policy involvment.) that distort their findings.

Economics is critisized more than these other disciplines because we try to be relevant. but the reality is that all science is messy.

[notsneaky]

"And the Pareto argument is only valid IF compensation is actually made and accepted. How often is that actually done."

No, the Pareto compensation principle is valid even if the hypothetical compensation never takes place. That's actually what makes it useful.

[notsneaky]

And as far as cost-benefit analysis goes; you (or the government or policy makers or environmentalists, or whomever) do it, even as you reject it. Maybe you're assigning different costs and benefits to different phenomenon than others (like assigning value of "infinity" to the survival of a given species), but you're still doing it. What's needed is a better, stronger argument for why, for example, economists or policymakers have undervalued the benefits of certain environmental goods or underestimated the costs of certain environmental bads, rather than an outright rejection of cost-benefit analysis.

Also, going back to the original article. Note that it's even long way off from "cost-benefit analysis is inappropriate when dealing with environmental problems". The author actually asserts that economists ignore environmental goods/costs completely (i.e. don't do cost-benefits analysis), then he backtracks and corrects himself somewhat saying that economists do consider environmental goods/costs but that they let the market do the evaluation (which is of course nonsense as anyone who paid attention in a Principles course during the section on externalities can tell you). But that's still short of "cost-benefits is inappropriate".

[reason]

Notsqueaky...
I'm not sure what you have in mind by you'll have to explain...

No, the Pareto compensation principle is valid even if the hypothetical compensation never takes place. That's actually what makes it useful.

So I read that some policy will cost person A $x and benefit person B $y dollars and so in this case as long as $y > $x it is ok to do it even if person B doesn't compensate person A. (And remember the utilities associated with $x and $y and not proportional to the dollar amounts). Call me dumb but you'll have to explain that one, it doesn't make any sense to me.

As for:

Maybe you're assigning different costs and benefits to different phenomenon than others (like assigning value of "infinity" to the survival of a given species), but you're still doing it.

well no that is not what I am doing at all. To be doing that I would have to be doing it in a particular case and I'm not. I'm questioning the whole concept of weighing various non-monetary considerations using a monetary measuring stick. There is a huge problem in how to scale different personal preferences.

As for the original article, I suspect it is mostly nonsense. I was jumping in, in support of another commentator. Maybe what I really want to say, is cost/benefit analysis is often used as an attempt to make a difficult decision look artificially easy by ignoring lots of considerations.

[reason]

OK I followed the link with Kaldor-Hicks. The explaination is not sufficient to explain why anybody would ever use it, but I think I can guess. The argument must be that equity is a seperate problem and has to be ensured elsewhere. So the validity of the cost-benefit analysis is still contingent on adequate equity equilisation in the society as a whole. Besides which the criticism of Kaldor-Hicks on the Wikipedia page looks pretty damning. I still think it is the much the same as trying to project a multi-dimentional map of political views on a single left-right access. You lose a lot of information.

[reason]

P.S. The best damnation of naive cost-benefit analysis I have seen was from George Montbiot in the Guardian http://www.guardian.co.uk/commentisfree/2008/feb/19/climatechange.carbonemissions where he condemned the Stern report for balancing the value of lives lost in Bangladesh with inconvenience to people in the UK when deciding whether something should be done about global warming. He came to the conclusion that something should be done, but Monbiot saw red because the answer could have been the other way around. Monbiot is not always right, but he speaks inconvenient truths out loud, and that is useful.