It's not over 'til the fat tail zings

When Marty Weitzman speaks in a room full of environmental economists, people tend to listen. His talk at today's NBER environmental economics summer institute was no different. They had to listen. Weitzman used all but two slides, and they only had figures on them -- one "straight from Wikipedia."

It helps that Weitzman has a compelling story to tell: Climate change is fundamentally a problem about uncertainty. We are conducting an experiment with our planet by doubling CO2 levels in the atmosphere from pre-industrial levels. Concentrations have not been this high in hundreds of thousands of years. By and large, we don't know much about the implications. Tackling this uncertainty is crucial. Extreme outcomes -- fat tails -- matter and should be at the heart of much of research.

These statements seem innocuous enough. Yet extreme events are sidelined by 99% of economic research on this topic. Marty Weitzman's recent work On Modeling and Interpreting the Economics of Catastrophic Climate Change falls in the other 1%.

He argues compellingly that the majority of economic research on the topic fundamentally misses the point. And his conclusion is clear enough: We have to act now to prevent catastrophic consequences.

Fair enough. McCain and Obama are on board. But that still leaves the fundamental question: What should we do? How much should we spend now?

Taken to the extreme, one could -- wrongly and unnecessarily, I might add right away -- interpret the results as saying that we should spend 100% of current GDP on tackling climate change. After all, there's a small chance that life as we know it might end. Stop reading this post now, turn off your computer, and use as little energy as humanly possible to survive at a bare subsistence level. That would be both stupid and, it turns out, unnecessary to solve the problem.

MIT economist Robert Pindyck took his role as official discussant of the presentation laudably serious and took the trouble of calculating one possible solution to the Weitzman conundrum. (Pindyck used a displaced gamma distribution, in case your inner nerd's curious.) He came up with rough estimates that would justify spending anywhere from 1 to 6 percent of current GDP to tackle climate change. That's higher than most economic studies, which ignore these extreme events, but it chimes with numbers from the Stern Review.

Many economists have criticized Stern for coming up with his large estimates by essentially fudging the numbers (for example, by using unusually low discount rates). Weitzman (and now also Pindyck) say that does not have to be the case. All that's necessary is taking the possibility of extreme events seriously.

Comments

[odograph]

This is an env-econ post closer to my own thinking than I've seen in a long time. I could quibble, but the big picture that this is about uncertain risks is right on:

He argues compellingly that the majority of economic research on the topic fundamentally misses the point. And his conclusion is clear enough: We have to act now to prevent [potential] catastrophic consequences.

The interesting thing for me, the thing I've thought about a bit recently, is how the uncertainty changes as we move to different stages of the AGW question.

We can put CO2 in a glass box, shine a light on it, and measure with high accuracy what it does. We can do that with sample gases from earths atmosphere as well. We can scale up from there through scientific modeling to climate modeling and stay scientific. By that I mean we can bring in physical behaviors with measurable uncertainties. A whole-earth climate model, even for a single point in time, is horribly complex, but it is a scientific build-out.

The interesting thing is when we jump to future modeling of earth's climate, including future human economic activity. I have much less faith in predictions of human CO2 production 10 years from now. Under what laws? Which which countries growing? With what resource constraints?

IMO, those later economic questions blow the uncertainty wide open.

But, we can fall back to the scientific models, say that some PPM of CO2 shows the potential for dramatic climate change ... and say that we shouldn't really go there.

[Carlos Viesca]

I think that uncertainty goes quite further than it is implied in this contribution. By no means we have the technological or analytical capacity to model future climate. Is such a complex phenomenon involving dynamic interactions of numerous variables, some of which generate threshold reactions that precipitate drastic shifts in certain parameters and so on. The point is that is complex, very complex, and just by saying it will be uncertain, it should be scary enough to really star shifting our social, economic and political paradigms. Lets see how some of the most strategic economic activities that rely on climate certainty and predictability, could be affected:

Agriculture: Imagine the cost of not knowing when o how much land to seed, or what to plant (drought o flood resistant crops). Hence think of the costs to insure crops.

River freight: Imagine that all the cargo moved through the rivers worldwide could not be planned year round due to loss of certainty of water level in rivers.

Hydro-power generation: It relies on the certainty of water level in dams. In order to cover the demand they are expected to do, they would have to pay huge insurance bills.

Fisheries: Authorities rely on the certainty of the reproductive input (which depends on water temperature) in order to estimate catch quotas for the following season. If it can’t be done accurately, if quotas are to high over-fishing would impact fish stocks severely, or affect the industry if to low.

Health: How to anticipate how many climate related diseases will expand they range from more tropical latitudes or how to prepare for uncertain extreme cold or heat?

Likewise construction industry, air and maritime transportation, forest management, tourism, even space traveling are strongly affected by uncertain climate due to economic cost of insurance, inability to pay credits, not matching demand, etc. Re Swiss, one of the larges reinsuring companies worldwide is considering for their strategic planning issues on climate change. The lesson is: when an insurance company is foreseeing something, you better start doing so.

[joshua corning]

All that's necessary is taking the possibility of extreme events seriously.

Not very smart really...Al Gore is not the only one who got nailed for blaming Katrina on global warming.

John took the notion that hurricanes are caused by global warming and put them into a study on the cost to coastal waters. Now that the link between hurricanes and global warming has been severed all the work he put in to that study is worthless.

He argues compellingly that the majority of economic research on the topic fundamentally misses the point.

I think this guy has missed the point. The trend is that more and more studies already done have been found to over estimate costs of global warming.

[odograph]

I think you ignored the "uncertainty" aspect Joshua, or didn't really engage with it.

There is considerable uncertainty in hurricane prediction, but a pretty good model for the way higher ocean temperatures might change their power.

It's the same progression we see elsewhere. The simpler science about oceans and a theoretical hurricane is not very hard ... but the uncertainty explodes when you are talking about how many powerful hurricanes might occur, make landfall, meet populated areas, etc.

I would guess that you are focusing on economic predictions for hurricane loss, which focus on the last most fuzzy sort of predictions.

(It is much simpler to say with high confidence that GW is bad, and increases probability of strong hurricanes.)

[joshua corning]

It's the same progression we see elsewhere. The simpler science about oceans and a theoretical hurricane is not very hard ... but the uncertainty explodes when you are talking about how many powerful hurricanes might occur, make landfall, meet populated areas, etc.

No it doesn't. we have seen a 1 degree increase in world temps over the past 150 years with no corresponding change in hurricane frequency or strength.

Under your premise anything can happen and we must pay top dollar on all worse case scenarios no matter how unlikely.

Well i guess i should rephrase that...it is not as if you are advocating for paying top dollar to stop starvation or eradicate malaria....we must pay top dollar on all worse case scenarios that you deem important no matter how unlikely.

[odograph]

No one seriously makes the AGW case based on hurricanes alone. But for some reason denialists like to make the counter argument based on hurricanes alone. Why is that?

(This tree is interesting, it shows potential for damage in an uncertain way, but it is not the forest.)

But ... here's what NOAA hosts on their pages:

"The surfaces of most tropical oceans have warmed by 0.25-0.5 degree Celsius during the past several decades. The Intergovernmental Panel on Climate Change (IPCC) considers that the likely primary cause of the rise in global mean surface temperature in the past 50 years is the increase in greenhouse gas concentrations....

...Some recent scientific articles have reported a large increase in tropical cyclone energy, numbers, and wind-speeds in some regions during the last few decades in association with warmer sea surface temperatures. Other studies report that changes in observational techniques and instrumentation are responsible for these increases."

So ... bzzt.

[John Mashey]

OK, all I want to know is:

a) These studies, whether Stern, or Nordhaus, or many others assume GDP growth rates, CAGRs, of:
2% 6X
2.5% 10X
3% 16X

where the 2nd number is the rough relative size of the economy in 2100. If you thn divcide by whatever population growth you expect in (world, US, wherever), you get the increase in GDP/person.

b) Then they apply various policies, and say how much dealing with climate change costs.

c) As far as I can tell, there is no effect in these studies of Peak Oil & Gas: that is, somehow there is no effect from having to totally rework major pieces of the energy infrastructure.

Does that make sense to everybody? I.e., ZERO effect on economic growth from major changes in energy supplies? I've been looking for somebody knowledgable to explain how that works. [Yes, I know we're getting better on energy efficiency, I like technology, there are subtitutions, etc. The point is that we have an industrial civilization built on $20-$30/bbl oil, the equivalent of which we're not likely to see again for a while.]

[odograph]

John, I don't think we have any idea the real quantity of coal to be burned between now and 2100.

... which is why I fall back to the idea that "lots" would be bad.

With uncertainty fuzzy answers are best, aren't they?

[John Mashey]

That's a different question, the climate aspects of which have been studied in the Kharecha & Hansen article on Peaks [i.e., we burn all the oil and gas, but if we don't stop burning coal, which dwarfs the others, it's not good.]

The question, again is:

to what extent does GDP growth depend on energy, or more precisely:

work = technical efficiency * energy used

In many models, work seems irrelevant to GDP. I'm no economist, so I don't understand that, which is why I keep asking.

A very few folks, like Robert Ayres and Benjamin Warr (& a few others, like Charles Hall) think that ~60% of growth {Solow Residual / technology / total factor productivity) is mostly ~work, with some help from computers over last 30 years. I get nervous that they might be right.

If GDP growth continues indefinitely, with zero impact from declining fossil fuel supplies, then everyone will be richer.

If not, then we'd better be working really hard on a) efficiency and b) the long, long build of sustainables to replace the massive energy from oil+gas. I.e., see Hirsch Report. Otherwise, GDP flattens and maybe even goes down.

From a climate viewpoint, that leaves the people 2100 not richer, but poorer, and trying to build dikes and seawalls and dams with very little petroleum left. They might be able to buy Terabyte iPods for next to nothing, but that won't help much in CA's San Joaquin/Sacramento River Delta, which is already below sea level.

What I'd really like is to see a convincing argument, with good references that says "Ayres & Warr are wrong, there's nothing to worry about, because a)... b)... c)..." Then I could sleep better.

[odograph]

People on the fairly libertarian side, Tyler Cowen and Will Wilkinson, promote GDP as a path to national happiness, but also acknowledge declining returns.

Maybe that line above jumps into a big subject, but what I'm trying to get across is that I like GDP as a measure, but I'm more cautious about it as a goal or guide for our future.

I mean, once you (speaking of random individuals or countries) become to some definition *rich*, what next move will bootstrap your happiness?

Is it more money, better health, getting in shape at the gym, spending more time in nature?

I worry that a GDP focus makes us richer in a strict numeric sense, but that we might end up collectively with fatter bank accounts and emptier lives.

The ultimate horror in Idiocracy was a trashed planet ... but everybody had a big screen TV and a big gulp.

So what's better? What was better, should we have upped everyone's auto horsepower by 100 in the 90's, or should we given them ... heck, a France-style national holiday in August?

(I find questions like that more real in my 40s than I did in my 30s.)

[John Mashey]

That's a whole separate argument.

Let me try again:

global warming implies, at the very least:

a) People near coasts need to be building seawalls/dikes, and maybe replacing infrastructure. For instance, the San Francisco Bay Area has numerous sewage plants at sea level, and either we will have to build dikes and use more energy for pumps, or they will have to rebuild them uphill, maybe every 50 years. There are two airports a sea level, and some major roads. Much of Silicon Valley will be below sea level. Of course, we know about the Netherlands, but unless you've studied the problem in detail, you might not understand how truly different, and ugly it is to deal with sea level rise, rather than building dikes to extend the land versus a static sea.

As a simple example, *you* have a house at sea level. Your town is deciding to build dikes, but where? Will your house be inside the dikes or outside? How high do dikes have to go before the town to decides to draw the line further inland and uphill? Will there be any exciting politics? If you're outside the dike, do you jsut eat the cost, or do you expect someone else to pay you? Who?

We had a Conference about this earlier this year. This area is wealthy, unusually well-educated, with sophisticated local governments who in fact worry about 50 years off.
It is still very, very ugly, and construction uses energy.

Now, by comparison consider Bangladesh.... what options do they have? Will they be rich enough to have options?

b) Water is an issue lots of places, and coping with the likely changes will be expensive.
===
Anyway, rich societies have more money to spend on such things, so it matters how rich or poor they are. In some cases, there may well be sea-level infrastructure that cannot be protected and cannot be replaced at affordable cost. In some further distant future, if things go the wrong way, such infrastructure might include New York City, London, Miami, Mumbai, Shanghai, Amsterdam, etc. I didn't mention New Orleans on purpose, since I have difficulty envisioning its existence in 2100.

So, regardless of philosophical issues (which are fine, but a different discussion), we've got about another 100 years of the Petroleum Age, with production declines starting within the next decade. There will still be oil, just not very much.

If energy doesn't matter to GDP, and GDP growth happily crunches along like it has for the previous 100 years of the Petroleum Age, then all is well, and that's what the models seem to say. I just keep asking why.

[odograph]

I consider it fairly humorous that I have a house at 35-40 ft, and that the famous 10M map, when zoomed, shows mine OK and my neighbor's gone.

So yeah, I could be on either side of the Great Orange County Seawall.

I think the way to bridge my answer and yours is "grow smarter." That will probably happen anyway, and as has been typical of US policies, it will probably be a parallel mix (mess) of private and public moves.

Insurance companies are famously leading the way, right? They write less insurance if fire of flood prone areas, and growth changes.

[tidal]

@ john mashey.

Have you asked Robert Ayres himself? w.r.t. critiques?

"Accounting for Work" looks as though it has 52 citations on Google Scholar, and none appear to be critical (although a great number of them appear to be cites by Ayres and collaborators themselves.). I know that Vaclav Smil made some minor criticisms, iirc - I will try to post them more specifically (they aren't online.)

[John Mashey]

tidal:
thanks, actually I've had long email discussions with Bob about this, and reviewed the forthcoming book, etc. Still no good answers, which is why I keep asking :-)

[tidal]

@ John Mashey.

Here are Smil's concluding quotes, from a longer discussion w.r.t. to energy/GDP studies, in particular attempts (including Ayres/Warr specifically) to relate exergy or emergy to economic value/growth. (Fwiw, I am not at all persuaded that these criticisms are sufficient to abandon Ayres/Warr et al's inquiries...).

"The main criticism of exergy is that it does not capture such qualitative attributes as energy density, cleanliness, ease of conversion, and relative environmental impacts. For materials, exergy does not capture such qualitative factors as tensile strength, heat and corrosion resistance, ductility, and conductivity (Cleveland, Kaufmann, and Stern 2000). In practical terms, actual calculation of exergies in a national economy would be extremely challenging. In sum, the intent of energy-based valuations may be laudable, but their execution must remain unsatisfactory. Energy-based valuations have brought more heat than light to our understanding of economic and social values (Mirowski 1988). They have been subject to a number of fundamental methodological problems typical of the social sciences (Reaven 1984).

True understanding calls for a multidimensional approach. We should definitely pay attention to embodied and net energy, but we must also realize that even such a fundamental entity as energy (be it under the exergy or emergy label) cannot be an adequate surrogate for valuing space, time, qualitative attributes of materials, biodiversity, mental labor, ideas, social order, cultural riches, and morality. At the same time, it is clear that money-based valuation cannot encompass most of these qualities either, because it relegates them to the realm of externalities, a grievous mistake when routinely applied to the environment." (Smil, Energy in Nature and Society. 2008. Excerpted from section pp. 335-346)

The final references he makes are to:
Cleveland, C.J., R.K. Kaufmann and D.I. Stern, 2000. Aggregation and the role of energy in the economy. Ecological Economics 31: 301-317.

Mirowksi, P. 1988. More Heat than Light. New York: Cambridge University Press.

Reaven, S.J. 1984. The concept of net energy. Explorations in Knowledge 1: 191-231.

@ John Mashey again. As I said, I am not particularly impressed with this critique. And, as I understand your concern - Solow/Romer residual doesn't really do any better at explaining growth... I think that Smil's critique could actually apply to any attempt to reduce a multifaceted economic reality to a single-dimension explanatory variable... especially one as vague as "technical progress"...

[John Mashey]

Tidal:
Thanks, I'll put those on my list to check out.

Another way for me to describe my unease is:

1) In doing attribution studies and fitting curves, say of GDP, one always has to be careful:

if f(A) gives a good fit, with small residuals to GDP then:

1)It might be that f(A) => GDP : A is the cause
or
2) GDP => A
or
3) that GDP <=> A : GDP and A covary, which probably the general case; richer societies can take advantage of more energy, i.e., how the US got rich by being early to use oil widely.
or
4) that f(B) => GDP and B => A : B is cause and drives both. I.e., if GDP goes up with number of aluminum cans shipped, it's more likely that population is driving both.

Most of the studies seem to act more like 2) or 3)

In this case, f(work) seems to give good fits to GDP over various countries [with, esp in US, a positive residual over last 30 years], so it is at least a reasonable candidate.

And a least it makes sense:
as an old farmboy, I know:

a farmer with no energy but his own labor is a subsistence farmer, and

a farmer with a team of horses is way better off

a farmer with a 400HP combine, diesel fuel, and electricity can handle many acres.

So, there can be many confounding variables, but this is at least plausible enough to worry about, a bit.

[Lee A. Arnold]

The big thing to watch is Greenland. As Al Gore says, if the Arctic starts to clear in the northern summertime, then Greenland is next. And, if that melt makes its way out to the ocean, there will be a rise in sealevel much faster than the IPCC 4's most-likely estimate. On the other hand, if the freshwater causes a density shift in the North Atlantic conveyor, heat transport from tropics to Europe would diminish, making parts of the northern hemisphere colder for a while.

The only big global warming changes that are identifiably in present motion (I think) are (1) icemelt and other changes in the hydrological cycles concerning rainfall and so on, and (2) movement of plant and animal species -- which, given prior habitat fragmentation by human settlement, is likely to accelerate the extinction rates.

Katrina's connection to global warming is not determined. That's all we can say. If intensity increases over the next twenty years or so, and cyclone intensity is linked to global warming by statistical analysis of real data (it already shows up in some models,) then Katrina will be included in the examples of global warming.

[Lee A. Arnold]

John Mashley, I think part of the answer to your question is in (1) the definition of work and (2) the rate of change.

(1) Don't forget that "work" in economics is NOT defined as it is in physics. The service economy can find enormous GDP value in work which takes much less real physical energy: information services, personal services, etc. Energy input per GDP has been decreasing for decades. The question is whether or not there will be enough physical energy available to get people the physical things they need within that larger economy, e.g. food, heating, clothing, shelter. The remainder of the economy can go fairly weightless, and still have an enormous GDP.

As to the rate of change, neoclassical economists maintain that the market will make the adjustments -- that is, short of sudden dislocations where an extra-market "fix" is needed. If "peak oil" makes a sudden dislocation, instead of a quick wind-down which takes fifty or a hundred years, then we would have a problem.

[Lee A. Arnold]

I have begun to wonder if there is a more disconcerting problem for markets and governments -- a problem that happens to tie into the climate debate at the knowledge level. The general outline is as follows:

A major condition of our time is the growing symbiosis of two separate and inexorable tendencies: (a) the increasing network effects of environmental externalities and social transaction costs, due to the crowding and growing complexity of the world; combined with (b) the increasing narrowness of personal knowledge due to advancing specialization and the division of labor, --with this individual narrowness leading to a simplified, and rather incompetent, common culture.

Markets alone won't fix this growing symbiotic combination, because (a) prices can't transmit all that kind of information sure enough and fast enough -- and even if they could, (b) YOU don't have enough knowledge to evaluate it for proper market demand, to finally make the price "right."

So the solution for some problems is going to be a return to targeted institutions, administered democratically, that use expert knowledge to adjust some prices or regulate some markets. We see the questions already in the crises of subprime finance and the atmospheric carbon sink.

[John Thacker]

As to the rate of change, neoclassical economists maintain that the market will make the adjustments -- that is, short of sudden dislocations where an extra-market "fix" is needed. If "peak oil" makes a sudden dislocation, instead of a quick wind-down which takes fifty or a hundred years, then we would have a problem.

Which is of course why attacking speculators for driving up the price of oil based on peak oil speculation is entirely the wrong thing to do. If you believe that future production is going to decrease, then the price needs to be higher now to help find ways to conserve. The argument (apparently advanced by Krugman et al.) that the current price should depend exclusively on current production seems very wrong to me.

Markets alone won't fix this growing symbiotic combination, because (a) prices can't transmit all that kind of information sure enough and fast enough -- and even if they could, (b) YOU don't have enough knowledge to evaluate it for proper market demand, to finally make the price "right."

Perhaps, but prices can do it better than "expert knowledge" or democratic administration. Far too many of our elected officials think that, e.g., speculation should be reduced and oil prices come down.

The crisis in subprime financing is one caused by targeted institutions using expert knowledge and democratic institutions. Things like the Fed, lowering interest rates, Fannie Mae and Freddie Mac playing with the house's money when it comes time to repurchase mortgages, Congress and Administrations encouraging home ownership and community lending to people who ordinarily couldn't get mortgages and loans, and zoning and building restrictions that make bubble worse (see the work of Ed Glaeser and others.)

[John Thacker]

Markets alone won't fix this growing symbiotic combination, because (a) prices can't transmit all that kind of information sure enough and fast enough -- and even if they could, (b) YOU don't have enough knowledge to evaluate it for proper market demand, to finally make the price "right."

Actually, Mr. Arnold, I think that people are perfectly capable of driving less when the price of gas increases. That seems to work a lot better than Congress deciding that, no, the markets are wrong and there's actually quite enough oil supply and the price should be lower, but we'll try to encourage people to conserve without letting the price signals work for them.

Perhaps theoretically your democratically administered expert systems could do better, but in reality I see the market and prices telling people to conserve and politicians telling people to ignore the market and that prices should be lower.

[Lee A. Arnold]

John Thacker -- Well I don't think anyone here was attacking high oil prices, but I'll have to read through this thread again.

Prices only transmit information about allocation: scarcity, resource availability and substitution, technological efficiency, and preference in demand. I see no logical argument, and no real evidence, that this covers all the sorts of information that it is necessary to know, to make responsible choices in the world.

Read the top post: it deals with the relative import of future extreme climate events, although they may have a low statistical likelihood as to intensity and frequency. There is no way the market will automatically price this in, at present. Weitzman is saying what Stern implied. The way to avoid it is to make the market steer away from it, starting now.

There are many other instances of necessary information that is not automatically provided by prices, such as market failure. My argument is that, due to the complexity of systems, this condition is going to get worse. And that the combined problem of "network effects of negative externals + inherent limitations on personal knowledge" is outside the regular categories of market failure, and it is not corrected by the "wisdom of crowds" idea.

In reality I see people losing their jobs and the economy tanking -- partly because the freemarket nutters sold us on financial deregulation and lack of transparency. Now we have to bail-out these boneheads in order to avoid crashing the whole economic system. Enough of this! Regulation and legal transparency are "democratically administered expert systems," i.e. another form of good institution.

[Dano]

One other thing about Weitzman's uncertainty issue is that we don't know at what point we'll start to have ecosystems flipping.

This will have the effect of sending human societal systems into unfamiliar territory. We will no longer have the ability to rely on certain ecological and economic systems.

The costs for being in these new regimes? We don't know. But there likely will be increased costs. And will we have cheap energy to address these problems? Not bloody likely. And where will the free or low-cost surface fresh water come from? We don't know.

Again, we don't have sensory apparati to apprehend future impacts. So we have to use our cognitive processes. And too many of us are more interested in who won Dancing With the Stars than what problems we are causing the grandkids.

Best,

D