Friday, October 19, 2007

The Stern Review on the Economics of Climate Change: Blistering Peer Reviews

In the latest issue of the Journal of Economic Literature, two papers deliver devastating reviews on the Stern Review on the Economics of Climate Change. The reviews are by serious, mainstream economists: William Nordhaus of Yale and Martin Weitzman of Harvard. These are not individuals and articles that can or should be ignored. Of course, they will be ignored by the mainstream media – while at the same time Al Gore’s receipt of the Nobel Prize carries the media day.

The Journal of Economic Literature is the sister publication to the American Economic Review and is put out by the American Economic Association, the leading professional society for economists. Abstracts of the papers, and instructions on how to buy them, are available here.

I have always said that my objections to the prescriptions of the most vocal climate change advocates are on three levels: one, the climate models depend too much on positive feedbacks that are not understood; two, the models have not really been tested, but instead are calibrated to the historical data; and three, even if one accepts the models, one then has to move into the economics of optimal policy, and there the best analysis suggests relatively modest reductions in carbon emissions for the near term. I like to ask environmentalists to summarize their prescriptions with the appropriate tax per barrel of oil: tell me what you think the price of oil should be increased by, in order to recognize the impact of carbon.

But back to the reviews of the Stern Review. So the Stern Review made big headlines when it came out, as it was commissioned by the UK government and was ostensibly a serious analysis of the economics of climate change. Both Nordhaus and Weitzman deliver fatal blows, although they try to temper it a bit. Here is a quote from Nordhaus:

“The central methodology by which science, including economics, operates is peer review and reproducibility. By contrast, the (Stern) Review was published without an appraisal of methods and assumptions by independent outside experts. Nor can its results be easily reproduced…(this) does mean that fatal flaws in evidence and reasoning, which might have been caught in the early stages under normal ground rules, may emerge after the report has been published.”

Weitzman says,

“However, in my opinion, Stern deserves a measure of discredit for giving readers an authoritative-looking impression that seemingly objective best-available-practice professional economic analysis robustly supports its conclusions, instead of more openly disclosing the full extent to which the Review’s radical policy recommendations depend upon controversial extreme assumptions and unconventional discount rates that most mainstream economists would consider much too low.”

Now in the spirit of full disclosure, I recommend everyone look at the papers for themselves. Nordhaus and Weitzman go out of their way to point out the positive aspects of the Stern Review. But the overwhelming conclusion, especially from Nordhaus, is that the extreme policy prescriptions of the Stern Review are way overblown.

To summarize the contrast: The Stern Review calls for a carbon tax of $350 per ton of carbon in 2015. Nordhaus’ model, which has been peer-reviewed many times, calculates the optimal carbon tax in 2015 to be ONE-TENTH of that, or only $35 per ton carbon. I find it useful to put these quantities in terms of something we understand more readily: $350 per ton carbon converts to $1 per gallon of gasoline, while $35 per ton carbon converts to 10 cents per gallon of gasoline. We are talking big differences here.

So what is wrong with the Stern Review’s economics? It is real simple – they use an extremely low interest rate, close to zero. Everything follows from this, and in my opinion, the assumption is crazy.

The essence of carbon policy is that we incur costs today for benefits many years into the future. Changing our energy usage patterns will be costly for us today, and the benefits of lower temperatures come 50, 100 or even 200 years in the future. Any time you are considering investing today for benefits in the future, you have to consider the interest rate. Investments to stabilize climate should yield returns – a rate of interest – in the ballpark that other investments yield. If we can invest in human capital, for instance, and earn 10% per year, why should we invest in climate stabilization if it yields a zero rate of return?

Nordhaus has some great examples to illustrate the unreasonableness of using a zero discount rate for climate policy: “Suppose that scientists discover a wrinkle in the climate system that will cause damages equal to .1 percent of net consumption starting in (year) 2200 and continuing at that rate forever after. How large a one-time investment would be justified today to remove the wrinkle that starts only after two centuries? Using the methodology of the (Stern) Review, the answer is that we should pay up to 56 percent of one year’s world consumption today…In other words, it is worth a one-time consumption hit of approximately $30,000 billion today to fix a tiny problem that begins in 2200…the Review would justify reducing per capital consumption for one year today from $10,000 to $4,400 to prevent a reduction of consumption from $130,000 to $129,870 starting two centuries hence and continuing at that rate forever after.”

Another point in this criticism is the essential inter-generational fairness issue. Per capita income worldwide has been growing at around 1.3% over many decades – and this is the number that the Stern Review uses. At that growth rate, per capital world consumption will grow from today’s $10, 000 to about $130,000 in two centuries. Which generation is the relatively poor generation? Are we so sure that we are impoverishing our children and our children’s children? What about all the new technologies, institutions such as democracy and market economies, physical infrastructure, and knowledge that we are bequeathing them? Do we not think that people 200 years from now will enjoy more leisure, better health, better technology, and generally be better able to pursue life, liberty, and happiness?

Read the articles, they are really convincing. For most of the media, of course, that will be too difficult. Much easier to report on Al Gore winning an Academy Award – oops, I meant a Nobel Prize.

Vinod Khosla and the Invisible Hand

On Monday, October 15, 2007, I saw the invisible hand at Dartmouth College.

Vinod Khosla, a founder of Sun Microsystems and now a venture capitalist focused on renewable energy, gave a talk to Tuck and Thayer students and faculty. It was truly amazing. Khosla laid out his vision of how the world was going to transition away from a petroleum and coal-based energy economy to one that would rely on renewable, low-carbon emitting forms of energy. But more than just the vision, Khosla is part of the invisible hand of market economics, of what I recall so fondly from graduate school as “price theory.” Khosla is playing a fundamental role in bringing together the scientists, entrepreneurs, professional managers, and investors that are needed to form the organizations that will provide us our energy needs of tomorrow.

But the most important part of his talk was his incredible optimism, his beliefs in the power of science, entrepreneurship, and markets. He described some of the truly amazing technologies that he is funding, from designer cells that focus all their internal mechanisms on producing butane, to “sub-critical” nuclear reactors, to cellulosic ethanol, to significant improvements to the mundane old internal combustion engine.

Throughout it all, he focused on the pragmatic, and the scalable. He will invest in projects that may not become huge, but primarily he wants to develop sources of energy that can supplant significant amounts of petroleum and coal. I may disagree with his views on climate change (see my other post of today) but I don’t disagree that we do have to transition away, gradually, from petroleum and coal.

It was wonderful when he dismissed an engineer’s criticism of biomass energy on the basis of thermal efficiency. I have always thought that engineers focus way too much on process efficiency, in regard to what percent of some input source (e.g., wattage from the sun) is transformed to the final product. What really matters is the economic efficiency of the process – dollar value of inputs vs. dollar value of outputs. BTUs are not all the same – BTUs in the form of sunshine are not all that useful in economic life, but BTUs in the form of gasoline are valuable.

I left feeling invigorated, and confident that if our politicians do not restrict our freedoms too much, there is little that we cannot accomplish. Certainly my confidence in thinking that my children will be able to enjoy even better forms of heating and cooling, lighting, and transportation was tremendously enhanced.

Sunday, October 14, 2007

Gore Gets the Nobel

OK, let's all give Al Gore due credit for winning much of the world over with his efforts over climate change. It is true, the fellow has been quite relentless on the issue for some time. Now he gets the Nobel Peace Prize.

I still don't quite understand the Peace Prize aspect of this. The original language in Alfred Nobel's will is "to the person who shall have done the most or the best work for fraternity between the nations, for the abolition or reduction of standing armies, and for the holding and promotion of peace congresses." The story with climate change is allegedly that changing weather patterns will cause new strife between nations, especially in regard to migration and fighting over water resources. Maybe. Maybe not. Seems to me like many of the predictions over effects of climate change -- might happen, might not happen, and if it does, might be easier to mitigate down the road than try to prevent right now.

At about the same time that Gore got the Nobel, a judge in the UK ruled that the UK government may send the film to all secondary schools and they can show it to students, but they must note that the film is politically one-sided and is inconsistent with even majority scientific opinion in places. The ruling was in a lawsuit filed by an heroic parent -- who won back 2/3 of his legal costs since the judge ruled that he substantially won the case.

Here is one quote from the "guidance" that teachers in the UK must be given if they are to show the film:

The High Court has indicated that schools can lawfully show AIT to pupils without
breaching ss. 406 or 407 of the Education Act 1996, but that, in doing so they must
bear in mind the following points:

• AIT promotes partisan political views (that is to say, one sided views about
political issues)
• teaching staff must be careful to ensure that they do not themselves promote
those views;
• in order to make sure of that, they should take care to help pupils examine
the scientific evidence critically (rather than simply accepting what is said at
face value) and to point out where Gore’s view may be inaccurate or departs
from that of mainstream scientific opinion;
• where the film suggests that viewers should take particular action at the
political level (e.g. to lobby their democratic representatives to vote for
measures to cut carbon emissions), teaching staff must be careful to offer
pupils a balanced presentation of opposing views and not to promote either
the view expressed in the film or any other particular view.

The entire guidance is available here.

Dr. William Gray, climate change skeptic and a very respected US meteorologist (the two are almost now mutually exlusive, to the detriment of science), has this to say: "We're brainwashing our children."

What Did Israel Bomb in Syria?

Mystery still surrounds the September 6 strike by Israeli aircraft deep inside Syria. Much of the mystery is that the event was initially hardly noted -- particularly that Syria itself did not even issue a complaint. Slowly now more information is coming out. At the time of the event, one telling comment I heard was that there was an amazing coincidence of interests between Israel and Syria in keeping their mouths jointly shut.

New reports suggest that that telling comment was true. Papers today are reporting that the Israeli fighters hit a partially constructed nuclear reactor -- a Syrian reactor being built, supposedly, with the help of the North Koreans. If this is true, it explains why Syria did not complain too loudly. Israel's silence, of course, needs no explanation.

Also of interest is the ease with which the Israeli planes accomplished their mission.

It may be, however, that the Israeli's acted too fast. Clearer evidence on North Korea helping the Syrians build a reactor would be helpful.

I bet we hear more about this event over the next months. It is one of those things that gets a tiny story at first, and when you read it, you think, like Bob Dylan in Ballad of a Thin Man: "Because there's something happening here but you don't know what it is..."