Conversation Pieces

A number of people responded to my posts on Stimulus, Climate and Apple. I will try to respond to a sample. Feel free to comment again if you think your point wasn’t covered.

On Stimulus

Stimulus: Giving money to everyone would be great. Unfortunately, it is a non starter. People are afraid someone else will get more than them. People are afraid it devalues their effort and money. People with money look upon it as an opportunity to prosper at the expense of others and blame them for their situation. When people are threatened in their own situation, they are not amenable to remedying that of others.

My thought is that this why framing it as a tax cut helps. Then you can say, no people just get to keep their money.

On Apple

AAPL is worth its future earnings, plus its cash hoard. Suppose AAPL were to become unprofitable. At that point shareholders could pressure for its dissolution, and, its cash hoard would be distributed– it has no debt, so its assets must be paid to equity holders. Now suppose AAPL remains profitable. Then there is no reason to liquidate, and the company continues to exist, the hoard continues to grow, and shareholders get paid from new shareholders, who in turn have a claim on the hoard. In each case, you have a claim on the cash hoard. Where I think you go wrong is your assumption is that an unprofitable AAPL would maintain a no-dividend policy while losing money, burning through the cash even until debt and liquidation. The current no-dividend policy is maintained by a very profitable company such that investors maintain confidence in management of their cash assets. Were investors to lose that confidence they could always use their votes to change the policy.

I think this is the exact right way to go about the problem. So, the question we would want to ask is how much success will the shareholders have at forcing dissolution. The history of US companies seem to suggest, not much.

Indeed, I am not aware of a major company that went into voluntary liquidation.

More likely it seems to me, is that AAPL would be bought-out and dissolved. However, management can fight this in part by moving their cash hoard into difficult to liquidate assets.

So if we ask, when AAPL is dissolved what is the modal estimate that shareholders will receive, I am guessing the answer is zero. Now, of course the expected value is not zero, but discounting back from the point of dissolution and considering an appropriate amount of uncertainty is likely to give us quite a small number. This should be a source of concern for investors.

Moreover, the larger point is that APPL’s management and staff is opposed to dissolution. At a minimum I think folks should recognize that.

On Climate

Moving to cooler places would likely not work due to difficulties in migration. The world does not currently have an equal population distribution of people over land largely due to constraints by nation-states on immigration. Typically those restrictions have been by the favored restricting the unfavored. There is little reason to expect this would change in the climate change case. Even if it did, as shown in the EU, language knowledge can be a huge barrier to moving even among highly-developed societies without any legal restrictions. While this might not be an issue in large polities such as the United States it’s far from clear to me that many people in the developing nations would have anywhere they could feasible move to in the “too cold” parts of the world.

I think this is good as well. One thing we might be interested in asking, however, is what policy would we advocate if we knew that leaders would adopt our policy. This is by no means the end of the question, but it could help anchor our goals.

Simply based on what we are discussing here it seems like agreement to reduce migration restrictions would be preferable to an agreement to reduce carbon emissions. For one, the immediate effect of the former is to expand global GDP while the immediate effect of the other is to reduce global GDP.

Clearly there are more considerations, but I think the “maybe opening immigration is preferable” argument is a serious one.

I think you are misunderstanding the problem with climate change, because you are focusing on the word “climate” rather than the word “change.” The problem isn’t that hot places will get hotter; it’s that all places will get different. The costs of adapting to change are roughly quadratic in the rate at which the change happens. As climate change accelerates, the costs of adapting to that change will become very high. Under some scenarios, they will become so high that they exceed all our available resources, and our species will become extinct. Under more plausible scenarios, the species won’t become extinct, but the world will just suck, because we’ve spent thousands of years (and more intensively the last couple of hundred years) adapting to a world that was a certain way, and all the benefit of that adaptation will be lost when the world ends up being a different way.

I think this gets to the heart of the matter and helps explain why my position is so weird.

When I read literature on climate change authors make suggestions like: under a worst case scenario our entire civilization could be destroyed within 50 to 100 years.

As some who thinks about capital structure my response is, oh well that’s not so bad. Our entire civilization will have to be rebuilt in 70 years anyway.

The expected useful life on most long lived structures is around 75 years or so to begin with. Expected macro-economic depreciation, however, is significantly faster than that for several reasons.

Maintenance Costs: Over the lifetime of a structure routine maintenance costs will typically exceed building costs by as much as a factor of 3. Thus most of the cost of the structure is not in building it, but keeping it functional. And, even with regular maintenance most structures will no longer be operational or will need major renovations after 75 years.

Population Growth: As the population expands the capital stock is spread over a larger number of people. This means more structures will have to be built anyway to support new people. Indeed, the world population has more than tripled over the last 75 years, meaning that most structures were built for a population size that did not even exist 75 years ago.

Tastes and Technology: As time moves along fashions change and technology changes. People wind up wanting different structures. Often larger and more elaborate than the ones they had before. This implies two things. One, that our built environment is expanding faster than population and so an even greater portion of it is new. Two, that many structures are abandoned, demolished or renovated even before their useful life is up.

Putting all those factors together an effective macro-economic depreciation rate of 10% is not unreasonable. That suggests a half-life of roughly 7 years. Which means that in 70 years we will have gone through 10 half-lives which implies a 99.9% deterioration.

Or to put it another way, within 70 years 99.9% of the value of all of our structures will have come from new construction, repairs, renovations or remodeling that have occurred between now and then.

This is why I suggest that it is not a matter of whether or not we will rebuild our civilization but where.

Add to that the fact that one of our major goals as humanity is to foster growth in the tropics. Which is in large part to say that the current set of structures in the tropics are woefully deficient. Rather than attempt a big build there, why not attempt a big build somewhere else and move the folks to the new place.

Lastly, and most importantly, we have no idea what the end state of global climate change is going to look like. We can only guess and some of those guesses are pretty frightening. There’s a real chance that the CO2 we’re pumping into the atmosphere will eventually cause runaway global warming, an extinction level event for we poor, misguided homo sapiens.

Is this really true though?

During the Paleocene–Eocene Thermal Maximum temperatures were roughly 15C –20C hotter than they are today. Yet, as best we can tell the conditions prevalent at the time were not consistent with a human extinction level event.

Now perhaps things will be different this time. Perhaps it will get even hotter. Perhaps some other dramatic effect will cause the climate to be much harsher. Still, we would want to have some reason for supposing that this is true.

There are many unfortunate things in the world. And, of course, this will all end very badly. There is nothing we can do about that. All that we have is to do the best we can with what we’ve got.

The question before us is: is dramatically curtailing our use of fossil fuels the best we can do?

Being Wrong on the Internet

At least three controversies have caught me by surprise while blogging: stimulus, climate change adaptation and dividend policy.

In each case I felt like I offered a pretty straightforward quasi-obvious take on an issue that was brushed aside in favor of a food fight.

Stimulus

I was obviously a non-player in the larger stimulus debate but the fact that no one echoed my sentiment seemed strange to me as it looked like the basic starting point for a conversation.

In late 2008, early 2009 the economy was crashing and lots of families, businesses and institutions were reporting serious cash flow concerns. Either they were running short or were afraid they would run short. Relatedly credit was rapidly drying up as collateral values were falling and unsecured credit was becoming very difficult to obtain.

So, here is an idea. Lets give people a bunch of cash. They say they’re afraid they won’t have enough cash. We have a cash making machine. Lets use our cash making machine to make cash and then give it to people.

If you care about the weeds of these type of things then I would have suggested that we suspend the payroll tax yet have the US Treasury issue IOUs to the Trust funds of roughly $1 Trillion to cover the approximate value of lost revenue. Everyone still gets their credits.

If you want to be horribly weeds-y then you can say we will have the Treasury deliver $1 Trillion in 13-week notes to the Federal Reserve. The Federal Reserve will then enter $1 Trillion into the Treasury’s account, which will then be used to clear transactions from the Treasury’s account to the account of banks processing payments from Treasury to vendors, employees, retirees, etc.

Yet, the core idea is pretty basic. We use our cash machine to print cash and then we give it to people.

I would expect someone to say: I hear where you are coming from Karl but . . . . and that would be worse than where we are now.

The closest someone came was when I brought it up to Peter Schiff on his radio show and he said “well if that’s such a great idea why not give people $1 million”

To which I replied, “ultimately that would create a lot of inflation”

To which he said, “well then won’t this plan?”

To which I said, “Yes, but 300 times less”

To which he said, “Oh so you think a little inflation is good. I happen to think no inflation is good”

And, that I think, was a conversation with a meaningful endpoint. Peter essentially argued that any inflation was worse than what we have now. I argued that some inflation would actually be better than what we have now.

Yet, most of the argument went like this: Saltwater! Freshwater! Multipliers! Keynesians! Liquidationists! Big Government! Dark Ages of Macro! Pretense of Knowledge! Trains, Yeah! Trains, Booh! Aggregate Demand! Regime Uncertainty! You’re an Idiot! You’re an Ass!

But, the core strategy of looking at a problem, taking the most obvious solution and then at a minimum trying to explain exactly why it won’t work was largely bypassed.

Even if you know the simple answer is a bad answer I think its worth going through this process just so everyone can be on the same page and be sure that they are in agreement as to why the simple answer won’t work.

People will say that this was an ideological problem, but I am skeptical as I’ll explain below.

Climate Change

One of the core ideas behind climate change is that if humans continue to burn fossil fuels then the earth will become warmer.

As it stands there are some places on earth that are so hot that no one wants to live there. There are also some places that are so cold that no one wants to live.

A baseline guesstimate might be that if the earth got warmer then the number of places that were too hot would expand and the number of places that were too cold would contract.

A possible strategy then would be for humans to move from the places that are newly too hot to the places that were formerly too cold.

Now this may very well be a horrible idea. In which case I would expect someone to say: I hear were you are coming from Karl but . . . . and that’s why that plan won’t work.

I’ve received a lot of email and tweets on this issue. I have tried to go through them all. So far I haven’t seen one that comes at it like that. Lots of folks mocked me. Some were kind enough to send along information on exactly how hot the too hot places might get and what the consequences of excess heat might be.

Yet, so far, nothing addressing why moving to cooler places won’t work.

Again, even if we are certain this won’t work its probably worth stepping through exactly why it won’t work. At least so everyone can be on the same page.

Dividend Policy

I’ve made what I assumed to be the banal observation that a key part of how firms compensate their owners is by transferring command of goods and services to those owners. In practice, that is to say, giving the owners cash.

At the same time Apple has sent repeated signals that it does not intend to transfer command of goods and services to its owners.

Now to the extent these signals are accurate I think they would cast some doubt on the potential for Apple’s owners to be compensated by Apple.

Now again you might say: I see where you are coming from Karl but . . . . and that’s how Apple’s owners will be compensated by Apple.

I even have some ideas on how this could happen.

Yet, and its still early, I believe not a single response has addressed this issue. Most have centered around estimates of my IQ. Some have addressed how Apple’s current owners could be compensated by future owners and a few have suggested that Apple is a great company because it does not intend to compensate its owners.

Again though, we haven’t stepped through exactly how the Apple compensation process might work. And, I think its worth doing so that at least everyone can be on the same page.

 

Now my take on this is that it extends from over-chunking. People try to take on ideas to aggressively rather than cutting them up into tiny pieces. I watch folks around me do this all the time. I even watch them get into bitter disputes over the answer. However, the larger the dispute gets the bigger chunks people try to take. They say, well you just don’t get XYZ where XYZ is some vastly complex set of ideas.

Rather, I would suggest we say ok, lets start with something everyone agree on. Then slowly, bit-by-bit, lets make our way to the point of disagreement. Once there we will often find that the nub of contention is quite small and that the answer is trivially obvious.

Indeed, this is so often the case, that my primary concern is making sure that once we get to the nub the obviousness of the answer does not serve as a source of pain and embarrassment for the person arguing the opposite.

There are a lot of ways to avoid this but one helpful technique is once you get close to the nub act as if the answer is going to be what the other person believes. Then act surprised to find that it’s the opposite and importantly don’t mention that this now proves your point. Simply continue on constructing the argument until the other person says, “You know actually I think you may have been right.” At which point you’ll want to change the subject as soon as convenient, so the other person will not have to ruminate on their wrongness.

There is always plenty of time later for pointing out how awesome and brilliant you are, but if you do it in the middle of a serous discussion it will only serve to hurt the other person’s feelings.

First Core Dump of 2012

Autosales

Seem to have ended the year strong but not quite as strong as I might have thought. I was looking for continued gain, up to 13.8M SAAR or so and it doesn’t look like we will see that. The numbers for Honda and Toyota are key as I had expected a stronger rebound from them than we are seeing so far.

Construction

Construction ended the year completely as expected, up slightly mainly on residential multifamily. Public construction seems to have stopped falling and this is consistent with my view going forward. We should see sales tax receipts improve for state and local governments and with that a willingness to fund more projects.

Non-residential construction will probably continue to be driven by oil exploration well into 2012. The office market just doesn’t feel ready to come back. Though we might see increased hospital construction. I would have to look more into that.

Fed Policy

It looks like the Fed is building the institutional infrastructure to make a creditable commitment to be irresponsible. Of course, it is couched in terms of the Fed making explicit what it thinks a responsible path for interest rates would be. This is potentially very helpful, but it naturally depends on how bold they are willing to be.

Oil

Kevin Drum makes the point that the global economy is energy constrained. I think that is correct and it underlies some of views about US energy policy. I don’t think we are likely to see “many" wild swings in oil prices, though. Such swings generate a huge arbitrage opportunity. To take advantage of it what you need is a place to store excess capacity. Oil – being the accommodating resource that it is – provides that naturally. We call it the ground.

In a world of high prices and tight capacity the smart thing is for folks with shallow wells to actually decrease pumping. This will lead to higher prices sooner, but smaller spikes as you start pumping only during the spike.

Also, its not clear that in the face of very easy money that this has to be contractionary. I’d have to think more about it, but the natural response is to push labor and capital towards energy extraction, conservation and alternative production. What’s key is that high energy prices should make the Fed less hawkish not more.

Growth is Banal

I wanted to do this as post titled “BREAKING: Humans primarily concerned with survival and procreation.”  My point is that Matt Yglesias is right that economic growth is primarily about doing the same old stuff in new ways because quite frankly the range of stuff that most humans want to do is not that wide.

Fruit Tree Recessions

Nick Rowe does business cycles with fruit trees. I should write more on this but if Nick reads the following he probably know what I mean.

If there is uncertainty in this economy then Y will not equal C, properly defined, because some folks will hoard trees and allow the fruit to go uneaten or at least use it in some non-typical way.

Further, the propensity to hoard trees should create a bond market and an interest rate which reflects the desire of folks to tree hoard.

Ron Paul

I take the opposite position as Will Wilkinson and Adam. To quickly get to the heart of my opinion, even if Ron Paul were at some point an out-and-out white supremacist, I don’t think this should be a permanent albatross around his neck.

I have an easy time forgiving these things because I grew up in an environment where homophobia was simply the air that we breathed. The things I have said, and honestly done, bring me to tears when I think about them.

I am forever sorry. I cannot even bare to ask for forgiveness.

Why A Recovery Now

Brad Delong asks why I think the recovery is starting now and how fast it will be. So the short answer is I don’t know how fast. It depends on how fast the natural rate of interest rises and how long the Fed signals that it will keep the overnight rate at zero.

My answer for why now and not before is that what drives of the natural rate of interest in this environment is marginal productivity of capital, which rises as the capital-to-labor ratio falls from depreciation and population growth.

When we think of growth models we usually have something like a factory in the back of our heads but the same thing should apply to household consumption. More folks combined with older cars and no new housing units increases the marginal return to durable goods.

Eventually it rises high enough to push the natural rate above zero. What I was looking for were signs that this was happening which I expected to show up in rents and used car prices. Both were rising through the middle of 2011, telling me that this would likely begin to happen in 2012.

Yves Smith is Not a Smithian.

She rips into Matt Yglesias’s Smithian take on 2012. A couple of things to note.

• I don’ think the distressing gap tells us much as a predictive device. The short answer is that its not clear which way the gap will close.
• I don’t think the shadow inventory is hyper relevant as far as my forecast are concerned because if the houses stay vacant the people have to go somewhere – likely apartments. Moreover, these numbers actually aren’t that big when you compare them to the short fall in housing production. And remember a multifamily project can take over a year to complete. So when we are talking 2012 starts we are talking 2013/2014 inventory.
• The point about the Wicksellian natural rate is not that it is determinate of rates we see but that it tells us whether the prevailing rates are contractionary or expansionary.
• Lastly, and this is a long conversation, I just don’t think its true that middle class incomes will need to rise for the economy to recover. The quickest road to recovery in my mind would be an inflationary burst that caused middle class debt burdens to erode but real incomes to fall. The set-up of the global economy right now seems to be to shift income shares towards resource extractors and a high earning elite. Monetary policy that makes it difficult for this to happen – by holding down inflation – will slow the recovery.

How Many Conversions Were There?

Dean Baker makes the point that lots of housing units came from conversions of industrial or commercial property and thus aren’t counted in starts. My sense is that they should be counted in new home sales and inventory which track starts pretty closely. We don’t see a lot of new home sales or inventory that never showed up in starts. However, this is an point to look deeper into.

Honey, Flies and Macro

Paul Krugman says that he only treats mendacious idiots as if they are mendacious idiots. The thing is, that its not clear to me that badgering political opponents is an effective strategy for convincing contemporaries or speaking to posterity.

Part of what Paul winds up doing is causing people to resent reasoned analysis or even intelligence generally. This is the opposite of helpful.

Send Me to Siberia

Mike Casey wants to send me to Siberia. I am happy to go. Novosibirsk is nice, in June.

More seriously, moving to the top of the world is an obvious response to a warming world. Its made even more appealing by the fact that in some of the damage models you see negative numbers for Russia and Canada. Its seems natural that this would prompt someone to say – ah, well then we should get more people into Russia and Canada.

Now, I would expect responses along the lines of, yeah we thought of that but here’s the deal . . .

Instead, the – I believe exclusive – response I’ve gotten on Siberia is mocking me for suggesting that people move to North to avoid global warming, implicitly on the grounds that Siberia is cold and barren. Yet, that seems like an objection that certainly doesn’t make sense, no?

An Accolade by Any Other Name

James Wimberley nominates one my posts as the dumbest of 2011.

Read the whole thing as a fine example of yahoo values, data-free scaremongering and reckless optimism, and an indifference to economic reasoning.

Whether my values are yahoo or not I cannot say. I wasn’t aware of any scaremongering on my part, and certainly not of the data-free kind.

I am tickled, and at this point intrigued, by the repeated references to my position as optimistic, reckless or otherwise. My general philosophical disposition is black-on-black existential nihilism, which most people take and I accept to be a sternly pessimistic disposition.

Lastly, of all things one might say about my positions, that they are indifferent to economic reasoning is among the least likely to be true.

Wimberley continues

It´s very likely to Smith that humans will stop needing food, transport, consumer durables, heating and cooling, and shelter because of an unspecified information singularity, as in Charles Stross´ SF romp Accelerando. On the other hand, the risk of population losses on a genocidal scale as a result of well understood and carefully modelled climatic processes can be ignored.

I have not read Accelerando, so I don’t know exactly what Wimberley is referring to but I certainly don’t think that humans will stop needing any of those things. The issue, of course, is the cost of production.

The second paragraph at least reflects an actual argument. Future generations will very probably be richer and better able than us to afford the costs of adaptation and mitigation. However, this depends on how much. Faced with a trend in damage and adaptation costs rising to infinity, there is some point at which we should spend the money to mitigate. The equilibrium depends on the cost curves and the discount rate. You need a model to work it all out and infer whether the date is in the future (Nordhaus) or has already passed (Stern).

A few things. First, damages and adaptation and mitigation costs refer to real things. For reasons alluded to in previous posts I am an infinite set skeptic. That is, I am doubtful that real things can take on infinite values. Yet, let’s set that aside for now.

Its simply not the case that if trend damages and adaptation costs rise to infinity that there is some point at which you should mitigate. Suppose that we simply mean that damages grow without bound. If mitigation costs grow without bound but faster then it will never be worth your while.

Suppose that we mean there is a vertical asymptote such that damages take on an infinite value in finite time. Then if mitigation costs start higher, grow faster and there is vertical asymptote of mitigation costs which occurs before the damages asymptote then there does not exist a time T such that damages > mitigation costs.

All of that being said, Wimberely is correct that the key question is what are in fact the damages, adaptation and mitigation costs. This is the conversation that I want to have.

Amazingly, there have actually been attempts by economists to think about this: Stern, Quiggin (eg here), Weitzman, Nordhaus. Professor Smith is a professional economist. It´s very curious that he does not think it worthwhile to use the tools of economic analysis to address the most important question of public policy of our generation.

For example, one key issue in the debate. The use of high rates of time preference, rather than Stern´s and Quiggin´s near-zero, leads to discount rates of 5% or so. These imply a morally unacceptable indifference to the fate of our grandchildren, many of whom will still be alive in 2100 – their incomes and costs valued today at 1.04c on the dollar if we accept 5%.

I find it very worthwhile to use economic analysis though I don’t always write in economic language. My main point is that we are overestimating the costs of adaptation, but underneath it all is an assumption of a relatively high rate of time preference.

The fundamental logic being that irrespective of how we think we ought to treat our grandchildren, we do not in fact treat them as if their future happiness is worth that much to us.

In the late 90s the US Treasury was selling I-Bonds for real 3.4% return. Before the Global Financial Crisis long term TIPS were trading at roughly 2.25%. Yet, these products weren’t hit with trillions of dollars in demand as grandparents recognized the ability to establish large guaranteed gifts to their grandchildren.

Even more directly New York Life is currently offering a 5% inflation protected annuity specially marketed towards grandparents.

The later example is especially illuminating because New York Life is in the business of convincing you to do this. Rationality issues might cloud your decision to buy I-Bonds, but if it was possible to frame the issue in such a way to get you to invest in your grandchildren’s future the New York Life has an interest in finding that way and exploiting it. Yet, they have not succeeded on a mass scale.

A form of reasoning that allows an avoidable catastrophe is unsound, however much it´s embedded in human nature. The duty of scholars is to fight our cognitive illusions, not to parrot them.

I agree that scholars should work to fight our cognitive illusions but I would count the first sentence above among them. Given any event chain that we can lay out there are all sorts bad things that can happen. Whatever path you choose lowers the probability of some catastrophes and raises the probability of others.

Simply saying that we should restrict ourselves to some subset of event chains because a particular catastrophe takes on probability zero within that subset is not sensible.

You might want to argue that we should lower the probability of all potential catastrophes. Though, I doubt that is a position people would actually want to take if faced with the option.

What’s Changed on Climate Change

Matt Yglesias writes

Back in 2008 both Barack Obama and Hillary Clinton and John McCain and Mitt Romney all seemed to agree, in principle, that it ought to be a high priority to enact some kind of binding limit on American greenhouse gas emissions. Even given that, the path to a binding workable global agreement was clearly frought with peril since there’s a divergence of perspectives between newcomers to the high emissions party (China) and those who’ve been there a long time (United States). But in the intervening three years, the politics of this have been totally transformed in a way that’s not even slightly backed up by the scientific information that’s come in over this time. Instead of debating whether or not emissions will be limited or reduced, we’re debating the Keystone XL pipeline as a kind of proxy war over fossil fuels.

What’s changed is whether or not the debate matters. To back up a bit more, in 2006 it would have been easy to suggest that:  look its probably impossible to alter the general trend line on global emissions but there is some damage associated with carbon and so it makes sense to tax carbon rather than to tax things we like such as work and savings.

As a bonus, this might speed up the arrival of wind or solar as a major player and that indeed might have some real upside effect.

Since that time the workability of this type of mild, tax-carbon-instead-of-work scheme has seemed to fall apart. We got a complicated mess in Waxman-Markey and even that couldn’t pass the Senate, with what looked like a favorable ideological make-up.

Thus failing compromise, the politics has mutated into pro and anti fossil fuel camps. Even this, however, could have been considered a sideshow, until recently.

Its is now becoming rapidly apparent that economic future for fossil fuels is much brighter than we would have suspected a few years ago. In particular, North America looks to be in a position to earn enormous rents from fossil fuel production.

Moreover, this comes at precisely a time in which interest rates and aggregate demand are very low. Large scale structural projects with multi-decade high rent payoffs are exactly the type of thing you need in this situation. And they are coming to us on a platter.

Thus, the nature of the signal changed.

In 2006 supporting, in theory, a carbon tax was a signal that you believed the science on climate change. In 2011, pushing for the Keystone Pipeline is a signal that you value US industrial production over symbolic statements about the importance of climate change.

Climatic Insouciance

In the wake of my initial posts on climate change Brad Johnson asked me to grapple with a number of different articles on the subject.

I think this is a conversation worth having but my core issue with the discussion’s current state is summed up in one of the pieces Brad points me to. Its entitled: Why two degrees really matters.

The problem is that it doesn’t actually tell us why 2 degrees matters. It tells us stuff like this

The warming-limit approach is analogous to how businesses conduct planning under uncertainty: Set a long-term goal, then work backward to determine how to achieve it, modifying plans dynamically as developments dictate. It’s operationally much more useful than a target for a single year. In fact, it can be used to derive such targets over many years, once the budget is allocated to developed and developing countries. It also has advantages over conventional, forward-looking policy analyses, which are hamstrung by the inherent limitations of economic forecasting models in accurately predicting the future.

Which is to say a lot of the discussion revolves around at what rate the planet is warming, what various emission targets would or could produce in terms of warming limits, etc. However, what I would love to get to center the conversation around is what we think is actually going to happen when the as the planet warms.

This is especially true, because I hear talk of apocalyptic scenarios bandied about. I am certainly not shy about apocalyptic thinking and analysis but to do it, we actually have describe the event chain that leads to the apocalypse.

If we can do that, we have something to work with.

Now, I am sure that someone, somewhere has done this. It would be helpful to get a pointer in that direction. As I said, I worked with the old Nordhaus models. I know those damage functions. I also know they are not really dynamic.

Nor, where they meant to be. These types of models were trying to bound prices on carbon. However, if we want to think about disaster, we have to talk about disaster.

Carbon taxes in a recession

Here are some quick and scattered thoughts that occur to me with respect to optimal carbon taxation in a recession. This isn’t meant to be a complete analysis, but merely a few things to consider.

In a recession we want to increase consumption spending whereas normally, or at least before this recession, more savings and less consumption is a good thing if anything. We’re also seeing some evidence that price elasticity of demand for gasoline is rising in the recession as people become more sensitive to costs, meaning the decrease in consumption for every dollar of carbon tax will be larger now. So any taxation that decreases spending is going to be more costly in a recession than not.

On the other hand, one can imagine carbon taxes primarily causing energy firms to make long-term capital investments in greener equipment today and only raise their prices slightly as marginal costs go up only slightly. It’s also easy to imagine carbon taxation being designed in a way to encourage this outcome, such as by phasing it in slowly or into the future at some point.

However, some workers may be complimentary to the old capital but not the new capital. The costs to laid off workers who must find a new industry are much higher in this economy than normal. If instead of affecting the timing and mix of capital spending among existing firms, the taxation causes a structural shift in industry, where new firms enter and old firms exit, this is a problem.

The basic problem is that the normal dynamism of creative destruction is more costly when it is harder for displaced workers to find new jobs. For this same reason I have concerns about suggestions that now is the right time to engineer a massive tax simplification plan, as this would perhaps hundreds of thousands of accountants out of business. In normal times I am the first to try to assuage concerns about creative destruction like this, and my point here is not that these changes aren’t worthwhile in a recession. I’m simply pointing out that some adjustment costs are higher now.

My biggest concern about carbon taxes in a recession is about sustainability and branding of the policy. One of the lessons of the current malaise is that any policy passed in a long recession stands the chance of being labeled part of the problem. In a short recession this could work the opposite, and that any policy passed will be seen by some people as contributing to the recovery.

One could help mitigate this by structuring a carbon tax bill so that is clearly and significantly contributes to the recovery. You could tie it to large, even obscenely large, mobility stipends paid displaced energy industry workers. Think of this as a bailout for coal counties. You could tie the tax to a bill allowing free citizenship to anyone with a college degree in math, science, or engineering, and charge them a fee that is used to fund an unconditional payment to every native tied directly to the headline immigration number that year.

In any case, my two-handed economist advice is that if any carbon tax were to be passed we should think about it differently than we would in normal times, as the relative costs have changed.

ADDENDUM: On twitter, @jeremyreff rightly points out that “carbon tax adoption and job displacement have to be read in context of tax that it would replace (i.e., payroll)”. This is an important aspect of the problem to be considered. If the carbon tax occurs in the future, and the money is spent today, perhaps via lower payroll tax, to make it revenue neutral then it is no different than normal fiscal policy except the outcome is more efficient. Are people more or less likely to exhibit Ricardian Equivalence when the future tax raise is a carbon tax?

ADDENDUM 2: Rational and forward looking will not necessarily exhibit Ricardian Equivalence if payroll taxes go down now and are offset by future carbon taxes. This is because people may respond in two ways to expected higher future energy costs: save the money they get from lower payroll taxes to pay their higher future bills, or invest it in more efficient energy technology that will lower the future bill.  In this way, Ricardian Equivalence seems less likely to be a problem for future energy taxes than other kinds of taxes, since some available means of future cost mitigation stimulate current demand rather than just savings.

Higher wages aren’t free, and why environmentalists should be the defenders of efficiency

Anyone arguing that employers in some industry should raise wages should have to sit down with a labor market supply and demand graph and explain what it is they’re asking for. As it is most people calling for so-and-so to raise wages don’t seem to be thinking about labor markets, and instead think of wages as something that you can always just raise without any consequences, for instance losses to workers via unemployment.

You can see this in the common refrain that workers would be better off if we had a vastly more unionized economy. Maybe workers would be better off, meaning those that can get jobs would gain. But if you’re going to hold wages above market levels you’re going to decrease employment, so you’ll benefit workers at the expense of those who can’t get a job or who take a lower paying job. Sure, there are exceptions to this, like when a union counters monopsony power. Or when unionization provides workers voice in a way that allows them to communicate more efficiently with management and raise productivity. But to prevent unemployment you need the cartelization of the labor market and subsequent higher wages to be either just enough to offset the lower wage resulting from monopsony power, or you need them to be fully offset by productivity increases. If wages go above this at all, than there will be unemployment. Rarely if ever is any time taken to argue why x% higher wages are the right amount to offset monopsony power. This dfficulty is mostly just ignored, and the fact that cartelized higher wages is an unmitigated good is just presumed.

Tom Philpott, writing at Grist, provides another example of ignoring the costs of higher wages. He tells us about the  “penny-per-pound” movement that is asking for Burger King, McDonalds, grocery stores, and other food companies to pay a penny more for each pound of tomato so that a particular group of tomato farmers can have their wages raised from $7.25 to $13.25. But what does Philpott think will happen to labor demand if the price of labor doubles? Even if the tomoto farmers promise in the short-run to not fire anyone, in the long-run does he really think that wages can remain at double the market level without downstream buyers gradually shifting to tomatoes grown in Mexico, California, Canada, or from the increasingly competitve greenhouse tomato industry? What will doubled wages do to farmers incentives to replace workers with machines? Consider the following from Philip Martin:

There were many other labor-saving changes in the mid-1960s in response to rising farm wages. Cesar Chavez and the United Farm Workers won a 40 percent wage increase for grape pickers in their first contract in 1966, increasing entry-level wages from $1.25 to $1.75 an hour at a time when the federal minimum wage was $1.25. Farm worker earnings rose faster than nonfarm earnings between the mid-1960s and late 1970s, prompting the use of bulk bins and forklifts in fields and orchards that eliminated thousands of jobs. Conveyor belts moving slowly down rows of vegetables made it possible to pick and pack lettuce, broccoli, and other vegetables in the field, eliminating jobs in packing houses.

Immigration critics like CIS, who Martin wrote his paper for, are quick to point out that there are many labor saving technologies that farmers could employ but haven’t due to low wages. In 1960 there were 45,000 workers picking California’s tomatoes. A decade later, the use of machines allowed the work to be done by less than 5,000. Would a doubling of wages cause tomato pickers to be replaced by machines? I don’t know. But it does put more pressure on the whole supply chain to shift away from these workers. Labor replacing technologies and production shifting to Mexico when that minimizes true costs doesn’t concern me per se, but this is a problem for the workers Philpott wants to help, and an issue he has to contend with.

My biggest problem with Philpott’s viewpoint however, is his contention that “low” agriculture wages tell us that we should oppose the cost minimizing efficiences and low prices pursued by Walmart and the agriculture system in general:

The creed of “Everyday Low Prices,” the zeal to churn out profit by maximizing sales volume and minimizing cost, lies at the root of our food-system dysfunction. Relentless cost-cutting means pressure to move environmental destruction off of corporate balance sheets, creating ecological sacrifice zones. It also drives companies to pay workers as little as possible, creating a vicious circle in which we need cheap, low-quality food in order to feed millions of low-wage workers.

This reflects a view of the world where the predominant way that companies lower prices is through grinding the working man ever  lower. But the history of agriculture and retail productivity in this country is an amazing success story, and the gains are so large that it would literally be impossible for a large percent to have come from driving wages down. Consider a few statistics. In 1950 food consumed at home took up 22% of an average households budget, and by 1998 this had been reduced by 7%. The retail price of food fell by around 25% from 1900 to 2000, and the farm price fell by over half. The current labor force dedicated to agriculture is 1/3 of what it was in 1900, but the level of output is seven times higher. The welfare gains to households that these numbers represent are massive.

Could these drastic changes have plausibly been driven by, or outweighed by, the “pauperization” of farm labor? First note that that over that same timeperiod that food budgets fell from 22% to 7%, the average income for farm families went from below to above that for nonfarm families. It is true that wages for hired farmworkers are extremely low. But they have always been low. You’d never get that sense from Philpott’s piece, but the figure below from Bruce Gardner’s “American Agriculture in the Twentieth Century” shows the ratio of average hired farmworker wages to manufacturing wages from 1920 to 2000. It’s hard to find a “pauperization” of farm workers in there, or a golden age of farmworkers for that matter.

The problem with trying to raise farmers wages by opposing Walmart and low prices in general is that farm worker wages are a very small part of the total bill. The total amount of farm worker wages in the U.S. are just over $20 billion, while the total amount of traditional food store sales in 2009 around $550 billion. Now all the food we buy doesn’t come from U.S. farms, and all food made on U.S. farms doesn’t get eaten by us, but the relative sizes here do give you some idea of difference in magnitude. If these stores were somehow holding wages down 50%, then that would account for less than 2% of the retail price of the food.

In contrast, Jerry Hausmann estimated that by offering lower prices and driving competitors to lower prices, big box stores, including Walmart, have made consumers better off by 25% of their annual food spending.  A study by Global Insight commissioned by Walmart quantified their impact on prices overall:

It estimated that “the expansion of Wal-Mart over the 1985-2004 period can be  associated with a cumulative decline of 9.1% in food-at-home prices, a 4.2% decline in commodities (goods) prices, and a 3.1% decline in overall consumer prices… This amounts to a total consumer savings of $263 billion by 2004.

Walmart doesn’t -and couldn’t- lower prices this much by “pauperizing” labor. They do it through operational efficiencies and driving down the profits of competitors and suppliers.  After all, is it really plausible that Walmart began entering the grocery market because they realized they could beat their competition by driving down agricultural wages that constitute 2% of the food bill? Or did they enter because existing supermarkets had large profit margins due to a lack of competition? Hausmann, at least, believes the latter is true, and provides this graph of rising supermarket profit margins throughout the 90s as evidence:

Farm work is not a well-paid or pleasant job. But if you want to advocate for higher wages for these workers you need to recognize the tradeoffs. And trying to improve the lot of these workers by opposing Walmart and lower food prices is the most expensive and ultimately unproductive way to go about it.

Another problem with Philpott’s argmument is that he is making a huge mistake, one common to environmentalists, in attacking efficiency. There is no greater friend to environmentalism than efficiency. Pollution is private benefits paid for with public costs, and as such is inefficient. Policies that mitigate pollution smartly are efficient. This is why so many economists, even conservative ones, favor a carbon tax: because it’s efficient. Environmentalists should not cede the banner of efficiency to those that oppose regulating pollution. They should not ignore the fact that taxing and regulating pollution can be a low cost policy, and that the right costs to consider are not just private but public as well.

By making themselves the enemies of low costs and efficiency, greens are on the wrong side of history, and they’re ignore the massive gains in human welfare that falling prices and rising productivity have wrought.

Of carbon taxes and price elasticities

Kevin Drum recently set off a round of debate in the blogosphere lately with a post about the price elasticity of oil and carbon taxes. He cited an IMF study that showed a long-run price elasticity of oil demand of -0.035. What this means is if oil prices go up 10%, then the long-run demand for oil goes down 0.35%. The implication he draws is that any reasonably priced carbon tax isn’t going to have much of an impact on demand, and so it’s not going to be an effective policy for reducing carbon emissions. There’s obviously some problems with this, some of which has already been covered by Ryan Avent, Megan McArdle, and Kevin Drum himself, with Jim Manzi and Kevin Drum, again, on the other side. Importantly, as Alex Tabarrok pointed out, this is but one estimate of the price elasticity of demand for oil, and it’s smaller than what you find in the literature. The following table from a James Hamilton paper, also linked to by Alex, reports the results of several literature reviews of oil and gasoline price elasticities:

As you can see, all of these elasticities are significantly above the IMF estimate. However, there have been several recent studies, including the Hamilton study, that argue that the price elasticity of demand has decreased in the past decade. Hamilton, in fact, argues that markets were surprised by how low the global price elasticity of demand was, and the unresponsiveness of demand explains the high gas prices of 2007-2008.

Another recent studyby Hughes, Knittel, and Sperling,  found short-run gas price elasticities of -0.034 to -0.077 for 2001-2006 compared to the much larger elasticities for 1975-1980, which range from -0.21 to -0.34. While these numbers are larger than the IMF numbers, they are never the less low and indicate that the average elasticities found in past studies may be too big.

However there are important caveats to these estimates that suggest the real current elasticity is higher. First, the evidence has indicated that the response of demand to price changes is asymmetric: price increases cause a larger response to demand than price decreases. This is because price increases are more likely to cause shifts to newer, more energy efficient technologies than price decreases are to undo such shifts. Any estimate of the average price elasicity then will be a downward biased estimate for the likely response to a price increase.

A recent paper by Davis and Killian The Journal of Applied Economics covers some other econometric issues in the literature. For instance, we know price and quantity demanded are jointly determined, which means that there will be a correlation between the price variable and the errors such that single equation or panel data methods, like those used in the reported IMF estimates,  will bias estimates towards zero.  Some studies attempt to use exogeneous oil shocks as instrumental variables. This approach is used in the appendix to the IMF study. But this requires the assumption that consumers will respond the same to these shocks as to normal real price appreciation. If consumers expect shocks to be more temporary than a demand led increase in price, this is a questionable assumption.

As Killian and Davis point out, another serious problem with these estimates is that they estimate the price elasticity of demand, and not the tax elasticity of demand. They argue:

“…the response of gasoline consumption to a change in tax is likely to differ from its response to an average change in  price. Price changes induced by tax changes are more persistent than other price changes and thus may induce larger behavioral changes. In addition, gasoline tax increases are often accompanied  by media coverage that may have an effect of its own.”

To overcome these issues, they look at U.S. state level demand for gasoline. Their results shed some interesting light on how the econometric mispecifications affect elasticity estimates. Using a single equation model they estimate an elasticity of -0.10. Using a panel data method, as done in the IMF study, the elasticity increases to -0.19. And finally using changes in state level gas taxes as an instrument they find an elasticity of -0.46, which more than four times larger than the single equation model.

 They conclude with an important caveat about the literature:

Overall, our results indicate that gasoline consumption is more sensitive to gasoline taxes than  would be implied by recent estimates of the gasoline price elasticity. Even under the largest plausible estimates, however, gasoline tax increases of the magnitude that have been discussed  would have only a moderate short-run impact on total US gasoline consumption and carbon  emissions based on our estimates. A natural conjecture is that the long-run elasticities will be larger,  but standard econometric models based on historical data do not allow the prediction of such long-run effects.

The International Handbook on the Economics of Energy also puts these estimates in the correct context:

Whatever their scope and origin, estimates of price elasticities should be treated with caution. Aside from the difficulties of estimation, behavioural responses are contingent upon technical, institutional, policy and demographic factors that vary widely between different groups and over time. Demand reponses are known to vary with the level of prices, the origin of the price changes (for example, exogenous versus policy induced), expectations of future prices, government fiscal policy (for example, recycling of carbon tax revenues), saturation effects, and other factors (Sorrel and Dimitropoulos, 2007). The past is not necessarily a good guide to the future in this area, and it is possible that the very long-run response to price changes may exceed those found in empirical studies that from relatively short time periods.

The evidence certainly seems to suggest that more recent estimates are better than earlier ones, but for a variety of reasons these will underestimate the long-run elasticities.

In The Long Run

Yglesias is distressed over the fact that Very Serious People are focused on the long run budget but not long run climate problems

No matter how hard I try, I can’t quite get my head around the combination of Washington’s obsession with decades-away projected fiscal shortfalls and it’s total lack of interest in decades-away projected climate disaster. If you asked me why the political prospects for addressing the climate crisis are so bleak, I’d say it’s easy to understand.

The worst effects of it are in the fairly distant future, the rich old people who run the country will be dead by then, etc. But at the same time, everyone’s obsessed with the idea that Medicare will be too costly in 2070. It’s considered both brave and serious to focus like a laser on the problem even while simultaneously insisting that it’s politically unrealistic to propose any changes that take effect sooner than 2022. It’s absolutely insane

I agree that its insane but of course in the other way around. 2070 is a long way away and being overly committed to highly sensitive projections is silly.  Still my baseline guesses are that

1. The US is broke is a theme that resonates with people
2. Being “responsible” with money is a sign of high status
3. People are more familiar with budget disasters
4. Money spent by Washington has the feel of money spent on Washington. That is people act as if the politicians get a particular joy out of spending other people’s money though the politicians have no equity position on that money.

 

In both cases I think people are overly concerned about both of these issues. I am not sure which one represents the most overconcern. With climate disasters the possibility for complete mitigation is probably higher than the budget. That is, there is the possibility of technology that could render this problem about as bad Y2K. Not saying that we should count on this, but we shouldn’t ignore it either.

With the budget deficit the path is a bit clearer though, it is possible that either the economy generally or health care will radically change rendering this problem moot. Yet, more importantly with the budget there is no credible current mitigation strategy. Any plan put in place today depends on people in the future deciding to go along with it and so its not immediately clear why forming a plan today is way better than just letting the people in the future deal with it.

Not Getting It on Climate Change

Based on my comments I take it that I am still not making myself clear on Climate Change in America.

A few more direct points

(1) Its not that rebuilding America would be a good thing because it produces jobs. Or that spending money or seawalls or air conditioning contributes to GDP. Its that these are bad, but they are not that bad. They are a cost but not a great cost.

(2) Cranking up really big damages almost always comes from loss of life. What reason do we have to suspect that lots of lives will be lost in the United States from Climate Change?

(3) There is a big difference between whether Climate Change will be bad for the United States and whether it will be bad for the rest of the world. Again big damages come from loss of life.

Yet, if those lives are in other nations they don’t show up as damages for the US. This is a central issue. Many folks may want to inflate the damages for the US so as to motivate Americans to do things that primarily benefit people in other countries. I understand the motivation here but simply see it as my role to say what, as best I can tell, is true.

Additionally, calculating damages outside the US is extremely tricky because its going to depend crucially on how developed the rest of the world is by the time the effects kick in and what international immigration policies are.

If in 100 years we wind up with a mostly developed globe and relatively free immigration the damages to climate change will probably be small for everyone.

If Africa and South Asia stay poor then there is a much different story.

(4) It is of course possible that climate change could be much worse than we imagine but this is true for all sorts of risks. The next flu could be worse than we imagine. The violence from revolutions in the Middle East could be worse than we imagine. Nuclear proliferation could be worse than we imagine. The probability of an asteroid strike could be worse than we imagine. The probability of mega-earthquakes could be worse than we imagine.

All of these things could go really badly and cause lots of death and destruction. We have to try to weigh these things as best we can and balance our efforts. This is the point of trying to get a handle on expected damages.

Moreover, recognizing our general uncertainty about the future makes it less sensible to invest heavily in one particular cause.

All that having been said you can still make the case for a carbon tax. Its just that the case centers around damages that are in the 5% of GDP range for the US.

More on Climate Change in America

I wrote before that part of the problem for climate hawks is that even expected damages from climate change are not that large. Not zero by any means but not as high as they would like. In particular a number of folks seemed to be upset with CBO testimony on the matter. Brad Johnson writes

The failure of the economics profession to come to grip with the clear science of climate change is a scandal that far outstrips its cheerleading of the housing bubble and other financial disasters. As previously discussed in the Wonk Room, conventional economics not only fails to accurately assess the threat of global warming, but also totally misrepresents the economic impact of taking action.

There are a couple of points to be made. First, they are doing analysis as it pertains to the United States, not as it pertains to the rest of the world. There are some big differences here because the US has an advanced, Northern Hemisphere economy.

The situation is different for some parts of the world, most notably Bangladesh and the analysis is considerably more difficult.

However, absent the entire global warming, anthropogenic debate, think about what economists would say if you said that over the next 100 years, from completely natural forces, the United States was going to get substantially hotter and its coasts were going to sink.

The debate would center around three possibilities.

The non-alarmists would say that we need to build seawalls and perhaps aqueducts in case of water shortages. Yet, more or less we should expect the primary response to be a booming air conditioning industry. America will become more like Phoenix and South Texas, and that seems to be good enough for the millions of people of flocked there over the last decade.

Those who were a little more concerned would say that we should start to rethink long-term infrastructure. No rail or even perhaps even highways for Miami. Its not going to be here so why dump money into it. Maybe we should also think about building infrastructure to the West of the Eastern Seaboard as well, as people will likely backup slowly. Lastly we might want to invest in some crop research for warmer climes and perhaps some tropical infectious disease prevention.

Those pulling their hair out would be talking about how we need plans to remake the Mid-West. People are going to be flooding back and the region is unprepared. Rather than letting the infrastructure rot, we need to be putting in major projects NOW! We need to create an economic substrate on which the New America can quickly be built.

There might also be a few radicals who mused about the opportunity to start some cities from the ground up, this time putting in mass transit first and institutions designed to stop anti-density constituencies.

In any case our core observation would also be three-fold. First people can and will move. They are not likely to just sit there while their town is flooded. There is enormous migration across the United States right now , mostly from colder places to warmer. We simply would expect that to reverse.

Second, temperature variation around the United States is so great now that even large increases in average temperature are not likely to create a United States were no place is, is a place people want to live.

Even as natural disasters increase people will either decide they want to live with them or move to safer ground. Its not like those of us in the Southeast are ignorant of the existence of Hurricanes or the fact that they can kill you.

Lastly, building new housing is not something the United States finds challenging. We absorbed 200 Million people over the last 100 years and new housing is typically only a small fraction of the economy. It uses the type of labor that is increasingly in less demand and so reigniting the housing industry would not be a major cost. We would have to come up with something and it would not enter positively into our damage calculations, but the damage would be small..

Getting the result that the US would fall off a cliff due to climate change as projected over the next century is hard to produce. If someone has data on how you might reach this conclusion I would be happy to hear it.

Is economics a science?

This is a question that popped up on twitter last night and I want to address it somewhat. First, I want to say up front that there is more agreement economists then the blogosphere and popular media would suggest. Here is Tyler Cowen making the same point, and I’d venture that most of the economist bloggers, even those who disagree with the mainstream on a lot, would agree with that.

That’s not to say there isn’t something to the critique. One of the strongest proponents of the un-scientific nature of economics is George Mason economist Russ Roberts. But I think even his criticism of the field is much more limited than most econ critics might think. His argument is that much of economics is a science, but a science like Darwinian biology:

Is economics a science because it is like Darwinian biology? Darwinian biology is very different from the physical sciences. Like economics it is a very useful way to organize your thinking about complex phenomena. But it is not a predictive or very precise science or whatever you want to call it…. Darwinism, like much of economics, exploits tautological reasoning. If the fossil record is incomplete or shows no change or vast periods or the pace of change is inconsistent with the fossil record, the theory is not discarded but modified with the concept of punctuated equilibrium. Is punctuated equilibrium true? There is no real way of knowing. It is our best hypothesis given very limited data. Is it a science? Sure. But it is a science that is unlike physics. That’s OK.  It is still a very useful way of organizing one’s thinking about evolution. And the “imperfection” of biology is fine unless you really want to know when the elephant got his trunk. Then you are in unscientific territory. It doesn’t matter whether our understanding of natural selection is imperfect or that we simply don’t have enough fossil data. Biologists understand the limits of their field.

This is to say economics is a science, but a more difficult one, and with real limitations on knowability. Russ argues that economists should have more humility about the precision and certainty of their estimates, and to do otherwise is to engage in what he calls “scientism”. I am a skeptic by nature, and so I find Russ’ strong statements of epistemic humility appealing. I also think that he is generally correct that economists, and all people for that matter, have to much confidence about their beliefs. We should be humble about what we know, and what our studies have shown.

But the question is what beliefs does such skepticism leave you with? If one is going to have very skeptical take on economics, then one should extend an appropriate (although not necessarily symmetric) amount of skepticism to other sciences. For instance, here is Russ applying his skepticism to climate science and comparing it to macroeconomics:

I remain agnostic on AGW. I am not a climate scientist. But I know something about multiple regression analyses with complex phenomena. It is my impression that like macro models, these models do not perform well with out-of-sample predictions. That is, they are fitted to the past and then used to make predictions about the future. When the future does not turn out to be like the past predicted, the models are tweaked (improved!). The problem with this methodology is that the tweakers of the models are prone to confirmation bias.

But even Russ falls short of applying his own rigorous skepticism. For example, here is Robin Hanson chiding Russ for his  uneven skepticism when it comes to his belief that handgun ownership deters crime.

The lesson to take from this isn’t that if you don’t believe economics is a science then you must reject climate science or believe guns deter crime. It’s that if you’re going to hold economics research to an extremely high burden of proof, then you should be prepared to subject all of your beliefs to such standards. What this will leave you with is mostly weak beliefs about the world for a lot of stuff that matters to you, whether it be about medicine, history, biology, psychology, criminal justice, climate science, or economics. Maybe widespread weak beliefs are a better approximation of the truth, I don’t know, but I do know very few people do or are willing to reason like that consistently. Maybe they should. But even here the vast majority of humanity has more belief changing to do than economists.

A final and related point I want to make is that macroeconomics is both science and engineering, as Greg Mankiw has argued in a paper that should be read (it’s very light reading, seriously) if you’re interested in delineating between the scientific and un-scientific parts of macro. Economics is also history, and moral philosophy, and contains many individual studies which in-and-of-themselves are not scientific. But economics as a field is a science in that all claims about reality must ultimately be rooted in empiricism, and models and paradigms must be falsifiable and eventually tested against reality.

It can oftentimes be difficult to see the scientific process at work in economics, as in other fields. Sometimes we are stuck at impasses where we are left with little more than theory to guide us, and sometimes empiricism is limited to testing particular model parameters, and ultimately our confidence should be limited by this. And sometimes what looks like pointless or tautological theorizing is really theorists attempting to build tools and lay groundwork for empiricists. It’s easy to look at some of this and think it un-scientific, but not all steps of the scientific process look like science.

Another question is, if economics weren’t a science, then would previous paradigms so have been done in by empirical outcomes? The old Keynesian Phillips Curve held that there was a tradeoff between inflation and unemployment. When that relationship broke down during the stagflation of the 70s, the Phillips Curve was invalidated, and this helped shift macro away from old Keynesianism and towards the new classical paradigm. Real Business Cycle models of the 80s were also invalidated by reality: it was clear that money mattered, and in the real world it was hard to find technology shocks to explain actual recessions.

The point here is that in the long-run economic paradigms and methodologies are judged by their ability to explain the real world. Even if individual contributions within the field may contain what looks like un-scientific analysis, the field proceeds as a science. Yes, it is a big field, and it isn’t hard to point to parts of sub-fields that are lacking in empiricism. But to wave you’re hand at economics in general and say it’s unscientific is to diminish a lot of important and useful work by researchers who’ve spent more time thinking hard about causality and empiricism than almost anyone who would make such a criticism. If you’re trying to convince people that economists should show more humility about what they know, then that is an awful arrogant way of going about it. People making such claims should be forced to sit down with James Heckman, John List, or Esther Duflo and explain to them why what they’re doing isn’t science and how they aren’t scientists.

CAFE vs Gas Tax

A new paper from Resources for the Future summarizes the literature:

…gasoline taxes are a far more cost-effective policy than CAFE standards because they exploit more margins of behavior for reducing gasoline use. Austin and Dinan (2005) and Jacobsen (2010a) estimate that CAFE standards are about 2–3 times more costly than a gasoline tax for a given long-run reduction in fuel consumption. In Jacobsen’s (2010a) study, total welfare costs average about $2 per gallon of fuel saved for a 1 mpg increase in the CAFE standard, while a gasoline tax that saves the same amount of fuel imposes welfare costs of about $0.80 per gallon. The cost disadvantage of fuel economy standards is even more pronounced in the short  run, as fuel taxes give all motorists an immediate incentive to save fuel by driving less, while new vehicle standards only permeate the vehicle fleet gradually.

Yet despite their much higher cost, CAFE standards are more popular than gas taxes. Our desire to have costs hidden from us is a very expensive preference. The Obama administration was able to pass aggressive CAFE increases in 2009, in contrast both democrats and republicans were campaigning on a gas tax cut in the 2008 election. Would either party be receptive to abolishing CAFE standards in exchange for a higher gas tax? I doubt it, but it would be good for the environment and the economy.

About that hockey stick graph

Just about everyone is familiar by now with the so called “hockey stock graph” showing that global temperatures have gone from steady to a sharp increase over the past two decades. The reason for it’s name is apparent in the graph below: the previous 1000 years are long and flat, like the long handle of a hockey stick, and the past few decades show a sharp increase, like the end of a hockey stick. A new paper from two statisticians questions whether the data actually produce a hockey stick shaped graph at all.

The paper look at the methods used to estimate a single global temperature series from the hundreds of data sets on temperature from tree rings, ice cores, and other natural phenomenon.  The dataset used to create the above graph contains 1,209 climate proxies ranging from 8855 BC to 2003 AD, eight global annual temperature aggregates from 1850-2006 AD, and 1,732 local annual temperatures dating 1850-2006 AD. Reducing these series to one timeseries of global temperatures is a difficult statistical task, especially given the spatial and temporal autocorrelation, missing observations, more covariates than timeperiods, regime switching, and weak signal to noise ratio.

The basic statistical task is that the authors have to model a relationship between the longer-time series, which are temperature proxies, and the more recent time series, which are actual temperature measures. If a reliable relationship can be modeled, then actual temperatures in can be backcasted in periods where such measures don’t exist, e.g. back before 1850, using the proxy variables.

Here is how the authors summarize their results:

On the one hand, we conclude unequivocally that the evidence for a ”long-handled” hockey stick (where the shaft of the hockey stick extends to the year 1000 AD) is lacking in the data. The fundamental problem is that there is a limited amount of proxy data which dates back to 1000 AD; what is available is weakly predictive of global annual temperature. Our backcasting methods, which track quite closely the methods applied most recently in Mann (2008) to the same data, are unable to catch the sharp run up in temperatures recorded in the 1990s, even in-sample… Consequently, the long flat handle of the hockey stick is best understood to be a feature of regression and less a reflection of our knowledge of the truth.

The authors present the following graphs of global temperature generated using bayesian models:

The long story short is that a hockey stick shape may not be the best representation of the data; some of their models produce graphs that look like hockey sticks, and some don’t. As seen in the figure above, using bayesian methods the long-handle of the hockey stick disappears. They conclude that proxy data may not be useful for predicting actual temperatures at time periods of several decades, let alone centuries.

However, the authors importantly note that “the temperatures of the last few decades have been relatively warm compared to many of the thousand-year temperature curves sampled from the posterior distribution of our model.” Furthermore, the evidence for global warming comes from a variety of sources and “paleoclimatoligical reconstructions constitute only one source of evidence in the AGW debate”. Global warming is still real, and still a serious threat, but this single visually compelling piece of evidence does not appear to be the best interpretation of the data.

ADDENDUM: In the comments Kevin Drum says that he doesn’t see a substantial difference between the two graphs. Fair enough. But I would point out two things about the graphs that illustrate the important differences. In the hockey stick graph the recent run-up in temperature anomalies exceeds the confidence intervals for the past century, whereas in the authors’ graph the recent run-up does not. Thus in the former case we can say the current run-up exceeds previous values in the past 1,000 years, whereas in the latter case we may not have exceeded previous values.  Comparing confidence intervals over the entire series emphasizes that fact further.

As one more illustration I’ll provide another graph from the paper which shows three different models that perform similarly:

Here the difference is clear. If the red line is the correct measure of temperature anomalies it is a significantly different story than if the green line is correct. The red line here provides a hockey stick graph consistent with the first graph that we are all familiar with, whereas the green and blue lines don’t look like any hockey stick I’ve ever seen. Now I know they do some things a little different in California where Kevin is from than they do here on the east coast, so I could chalk this up to cultural sporting differences… but I saw The Mighty Ducks, Kevin, they were from Anaheim, and their hockey sticks handles were flat like the red graph.

Final note,  please avoid using the comments to debate anything other than the statistical issues at hand; this is not the place to argue about climate science or climate politics in general. Let’s keep it limited to dimensionality reduction and time series statistical analysis.

The fault, dear brutus, is not in our farms, but in ourselves

An op-ed in the New York Times illustrates why those concerned about energy use and “sustainability” should not be concerned about farms and being locavores, but about households energy usage

Overall, transportation accounts for about 14 percent of the total energy consumed by the American food system.

Other favorite targets of sustainability advocates include the fertilizers and chemicals used in modern farming. But their share of the food system’s energy use is even lower, about 8 percent.

The real energy hog, it turns out, is not industrial agriculture at all, but you and me. Home preparation and storage account for 32 percent of all energy use in our food system, the largest component by far.

Driving to a nearby Walmart to buy factory foods may be more environmentally sound if it saves you a car trip because you’re going there anyway, or if it’s closer than wherever it is you buy local food. I don’t know if anyone has quantified the extent to which big boxes have helped the environment by allowing one-stop shopping, but it seems it would be significant.

And it sounds like foodies should be focusing on which ways to prepare food conserve the most energy. Is microwaving your food the most environmentally friendly thing you can do? Clearly, locavores and greens are focusing on the wrong part of the food production chain to wring energy savings out of. The urban farmer/locavore/foodie aesthetic is a high status one though; the Walmart shopper/microwaver is not.

The piece closes with this paragraph which I will second and should be repeated to urban farmers everywhere:

The best way to make the most of these truly precious resources of land, favorable climates and human labor is to grow lettuce, oranges, wheat, peppers, bananas, whatever, in the places where they grow best and with the most efficient technologies — and then pay the relatively tiny energy cost to get them to market, as we do with every other commodity in the economy. Sometimes that means growing vegetables in your backyard. Sometimes that means buying vegetables grown in California or Costa Rica.

Climate By Decade

The Economist has quite clear chart showing the decadal average temperatures from the 1850’s to today.

The obvious thing to note is that temperatures have risen fairly dramatically throughout the 20th century. But another interesting thing that this chart shows is a very large increase in technology giving us greater precision in measurement happening in the 1950’s. You can see this by the shortening of the error bars that happen after that time.

The Blame Game…

Soon, we will likely see the worst case scenario come to pass in the name of “preventing climate change”, and that is to have a command-driven regulatory agency dish out quotas and make peripheral tweaks to existing regulations in order to look like they’re doing something productive. It is unlikely that climate legislation will pass the Senate in this Congress or the next…and that is a tragedy.

I place the blame squarely on Republicans; centrist and conservative alike. I tend to think that Democrats gave a lot on this issue…and I grant them that even though their preference for centralized solutions to environmental problems are oftentimes wrong on the merits.

To be sure, cap and trade was not my most preferred solution, which is a carbon tax…which was never even close to the table due to the Republicans’ successful campaign against the word “tax”. A carbon consumption tax would have been the most efficient, least intrusive way in which to deal with whatever specter of environmental degradation exists (even if it’s not climate change, per se, and just happens to be smog). But, cap and trade was a very large step in the direction of markets anyway — and the ACES bill passed the house! I have previously voiced my concern about the (lack of) possible impact that the ACES bill will have, but my problem was not with the premise.

Let’s quickly review two simple definitions of how governments interact with markets:

• Policies that get the government involved in differentiating, selecting, and amplifying business plans.
• Policies that shape the fitness environment, while leaving business plan differentiation to entrepreneurs, and selection and amplification to market mechanisms.

Now, hold constant that this government will act in a way consistent with the fact that they believe that climate change is a serious issue. The most optimal solution is for the government to put a price on carbon (shape the fitness environment) and let businesses and individuals figure out how they will adapt to the new evolutionary landscape. Wait…that’s exactly what ACES did. Sure, there were a giveaways, and it questionable whether the bill would “do anything” to prevent global warming — but those are mostly semantics. The point is, it is consistent with my preferred role for the government.

However, since pricing carbon is not in the cards for this or the next Congress…and given that our government is looking to act against climate change…and given that there are a myriad of very, very inefficient regulations already on the books that fit into the first category of government action, we are all but destined for sub-optimal policy (like regulation by the EPA).

And I blame you, Republicans.

Its Getting Hot In Here

One possible unintended consequence of Global Warming: I am just eye-balling it here but apparently, the probability of a Sovereign default is strongly related to its average winter low temperature.

America’s Favorite Interest Groups

From Douthat:

This policy is typical of the way the federal government does business. In case after case, Washington’s web of subsidies and tax breaks effectively takes money from the middle class and hands it out to speculators and have-mores. We subsidize drug companies, oil companies, agribusinesses disguised as “family farms” and “clean energy” firms that aren’t energy-efficient at all. We give tax breaks to immensely profitable corporations that don’t need the money and boondoggles that wouldn’t exist without government favoritism.

He forgets the other group that fits best among those other interest groups: small businesses. But I am receptive overall to his point that the bigger redistribution problem in America isn’t downward via social welfare programs, but upward via corporate welfare and the mortgage interest tax deduction. I think a phasing out of these programs would be a good way to bring long-term austerity.

In addition, by leveling the energy playing field by removing existing distortions, this would seem to be an even more efficient first step towards fixing global warming than a carbon tax. Perhaps liberals should focus first on removing subsidies, and then on a carbon tax. The former has the benefit of being able to be framed as populist like Douthat has.

Dear carbon tax skeptics,

Preventing a tax on carbon will not get you a free market energy industry. Instead, it will get you inefficiencies like this:

Abengoa SA was offered a $1.45 billion loan guarantee by the U.S. Department of Energy to build a 250-megawatt solar plant in Arizona, and Abound Solar Manufacturing was offered a $400 million loan guarantee toward two plants where thin-solar panels will be manufactured.

The guarantees through the Recovery Act and other measures are expected by the awardees to create more than 5,000 jobs, according to a statement from the White House.

Obama during his weekly address said the investments will help the country establish leadership in “cutting-edge” solar technology, and create jobs to aid economic recovery efforts.

A transition to a clean-energy economy and doubling use of renewable-energy sources including wind and solar power “have the potential to create whole new industries and hundreds of thousands of new jobs in America,” said Obama in the address.

H/T Arnold Kling

The size of government is not the amount of governance

Matt Yglesias reminds us that government spending as a percent of GDP is a problematic measure of the real amount of government intervention:

…government spending share of GDP is a highly imperfect measure of the government’s role in the economy. For example, we could raise taxes by some gigantic amount and then use the funds to provide everyone with a basic health insurance policy. Alternatively, we could have a regulatory agency define “basic health insurance policy” and then make a rule that everyone who fails to purchase a basic health insurance policy has to pay a fine, and then raise taxes a modest amount and subsidize the purchase of basic health insurance policies for people who can’t afford it. There are pros and cons to each approach, but these are basic similar policies, despite the fact that they’ll lead to wildly different levels of government spending as a percent of GDP.

This I think highlights what will be a growing theme in governance: how can elected officials get done what needs to get done while hiding the costs. With respect to global warming, they have plenty of options. A recent piece by Vinod Khosia is a great example. The title promises a “simpler path to cutting carbon emissions”, in contrast to cap-and-trade or carbon pricing. I’ll let you be the judge of whether what Vinod delivers is more heavy handed than a carbon price:

Efficiency is another big lever. Why not set up a “fee-bate system” in which rebates go to those who purchase items that are among the most energy-efficient, be they refrigerators, cars or lighting, while the most inefficient pay fees to fund the rebates? Efficiency standards could update automatically every few years based on the top-tier performers, whose economics and consumer acceptance have been demonstrated.

And yet in the very next sentence he implores that “Most important, Washington must stop ‘picking winners’.” That’s a fairly stunning contrast there. We should stop picking winners, except of course for when we try and measure the efficiency of every consumer product and subsidize the “winners” of our efficiency contest.  So just subsidize the winners, but don’t pick them?

Like Matt’s health care example, a carbon tax will show up as government taxing and spending, but energy mandates will not. For instance a proposal from Sen. Jeff Bingaman, which Vinod supports, mandates that utilities use a minimum amount of energy from low-carbon sources. No government spending or taxing there, and yet much more inefficiency. Somehow Vinod concludes that this is a “market-based” approach. This is about as market based as CAFE standards, which by the way are also “technology neutral”.

It should be more understood that the policies that have the lowest taxes or government spending per GDP are not the most efficient or market friendly ways to do things. Examples that show this are not hard to find; they are everywhere you look.

CAFE or Market Price?

Adam wonders today about whether the rise in fuel economy of automobiles is a result of regulation, or a response of technology and wealth to price. I don’t have a lot of time, so here are a couple charts:

Inflation-Adjusted Price of Gasoline

[Click Image to Enlarge]

Average Fuel Economy

[Click Image to Enlarge]

Two things I would like to note from a quick comparison:

1. The spike in fuel economy is not abnormal*, and could probably be fully explained by ratex. There was a LOT of low-hanging fruit to be picked in by the end of the ’70s that would facilitate such a large spike.
2. Progressives will likely lament that average fuel economy has actually decreased…but of course that likely has nothing to do with physical engines becoming less efficient. It is most likely due to both increased luxury and safety — some of which is mandated, some of which is response to demand.

Addendum: CAFE standards were first ruminated in 1975 as a response to the (first 1970’s) oil shock of the previous years. However, the first laws were passed in 1978, setting a regulation of 19mpg for cars and 17.2mpg for trucks (4WD is a little lower). However, these individual numbers don’t matter. What matters is the average fuel efficiency of a company’s entire fleet of vehicles. The first combined fuel economy standard was 17.2mpg. Thus, a company could have any mix of vehicle as long as it hit this number (i.e. a truck with 5mpg and a car with 30mpg would pass CAFE standards). These standards were raised every year (except 1985, when they were relaxed) until 1991; where the CAFE standard stood at 20.7 until 2007, when George W. Bush expanded it to mandate 35mpg by 2020…and it has once again begun slowly climbing.

I don’t have the study at my fingertips, but CAFE standards have actually hurt the competitiveness of US automakers. High-end European automakers (BMW in particular) regularly balk the CAFE standards because of the premium they command, and thus simply pass the cost of the penalty on to their customers. Japanese automakers have steadily increased fuel economy beyond the standard ever since it was created. It is only US automakers who ride the line on the CAFE…having to play catch-up every time it changed.

Now, return to the graphs. If you look at the green line, it tells a very interesting story. It jumps almost immediately to 19mpg by 1979…which connects to its previous trajectory. But there is a languish between 1977 and 1979 where it levels off completely. My guess? Regulatory uncertainty. So CAFE, of course, can be held responsible for the jump in mileage — but the counterfactual that this would have happened anyway in the late 70’s – early 80’s, without activist government (and not to mention, CAFE is horrendous policy**), is just as strong.

Addendum 2: I suppose that one who was skeptical of the market price mechanism would point out that fuel economy has pretty much languished along with the CAFE standards…to that I would say 1. take a look at the price chart again, and 2. keep this is mind:

The average new car or light-duty truck sold in the 2003 model year tipped the scales at 4,021 pounds, breaking the two-ton barrier for the first time since the mid-1970’s, according to a report released by the Environmental Protection Agency last week.

In that light, cars are ridiculously more efficient. Since the early 90’s, we’ve just been piling on the luxury and safety at a very quick rate.

---

*By not abnormal, I mean with the numerous supply-side inefficiencies, a reaction of this magnitude to a move in price could be expected.
**My preferred policy? Gasoline taxes.

Sharing the blame for the failure of carbon taxes

David Leonhardt has a good article that is making the rounds about how it increasingly looks like non-market means of energy regulation are going to be how we fight climate change, rather than a much more efficient market oriented approach like carbon taxes. Matt Yglesias rightly lays blame at the feet of conservatives who have worked hard to stigmatize taxes in the public’s mind, and have thus poisoned anything labeled a tax; even good, market oriented things:

But overall what you’re seeing here is that creating a political culture in which “tax” is a four-letter word doesn’t eliminate the demand for government to try to achieve certain goals, including curbing negative externalities. It certainly doesn’t kill off “big government.” What it does is cut out efficient solutions to public problems, push the impact of government policy off the balance sheet, and generally obscure what’s going on.

I agree with all of that, but I think that many liberals also share the blame for a failure to pass a carbon tax because of their high demand for and tolerance of inefficient and wasteful energy policies. Part of the problem is exactly demonstrated by Yglesias and Leonhardt in their acceptance of the sort of command and control government policies they recognize are inferior to a carbon tax. Here is Leonhardt on energy efficiency:

The ideal energy policy, in fact, would include some ironclad rules and regulations, because people do not always respond rationally to prices. Consultants at McKinsey & Company argue that many families and businesses could already save money by taking simple energy-saving steps, yet they don’t do so. Building standards could overcome their inertia.

And Yglesias agrees that “an ideal world would still retain a role for a certain amount of command-oriented regulation, especially on the efficiency side.” This is several paragraphs after David told us that:

Under a command-and-control system, businesses and consumers have to focus not just on carbon use but also on the details of the government’s rules: the intricacies of vehicle and building standards, the types of appliances that qualify for subsidies, the fine print of the Energy Department’s loan applications. Each bit of compliance brings costs.

And how does he know that these costs are outweighed by the benefits? If we’re talking about government subsidies for weatherization, then you’ve got inefficient bureaucracy on both sides: the tax collection and the subsidy dispersal. In addition, weatherizing the country on a grand scale obviously involves a lot of bureaucratic problems and the use of government contractors above market wages, both of which introduce more inefficiency into the problem. And yet there is high demand for such policies from liberals, and it seems to me a completely unwarranted optimism about their cost effectiveness.

A similar example is found in Leonhardt’s discussion of vehicle mileage standards:

Fuel economy rules have cut per-mile gasoline use by 40 percent since 1975. As a result, vehicles have made more progress on energy efficiency than office buildings, houses and apartments.

Have fuel economy rules caused per-mile gasoline use to fall, or has technology, wealth, and a growing preference for high-mileage cars done it? And are cars getting more energy-efficient faster than buildings because of regulations, or because the energy efficiency is more transparent and observable in vehicles than in buildings? Apparently we need professionals to come in and tell us whether buildings are energy efficient or not, but no such service is required for cars. Energy regulation has I’m sure had some impact, but less than real prices, preferences, and technology. But David, in contrast, just assumes regulation has done all the work here. Again, this shows an unwarranted liberal optimism for command and control energy regulation, even in the middle of an article about the downsides of command and control energy regulation!

The problem here is twofold: conservatives hate taxes, and liberals have too much demand and tolerance for inefficient and wasteful energy policies. So the clear path for politicians is to avoid taxes and use the inefficient command and control instead. This is why I get so bothered about things like fuel economy standards: they are substitutes for making the right choices; both in a political capital sense, and in a real economic sense. To the extent that inefficient command and control policies actually help prevent global warming, they decrease the optimal price, welfare gains, and therefore benefits of a carbon tax.

If politicians knew that liberals were going to resist inefficient attempts to stop global warming, then they wouldn’t be so happy to substitute them for efficient policies like carbon taxes. Yes we would be better if conservatives would examine taxes on their merits, but we would also be better off if liberals got as outraged as libertarians about higher fuel economy standards. Every time a politician proposes an inefficient policy liberals should shoot them down and say “No! You do it the right way this time!”

There are libertarians and conservatives who want to cooperate on this, but every crappy energy policy that gets passed with liberal support undermines the notion that cooperating with liberals will result in policy that is not incredibly wasteful and inefficient. It’s hard to bargain for something as a group when you know that half of the group will settle for a shit offer.

What Are the Elasticities?

David Roberts lists a few well-taken points regarding the EPA analysis of the Senate’s climate bill:

So what’s the verdict? Overall, EPA finds that the impacts of APA will be broadly similar to the impact of the House’s American Clean Energy and Security Act (ACES), i.e., affordable.

But of course his first point (which is the quite insane selling point of carbon caps) is that the costs to the consumer would be negligible:

The impact on U.S. consumers will be “modest.” Says the report: “Average household consumption is reduced, relative to the no-policy case, by 0.0-0.1% in 2015, by between 0.0-0.2% in 2020, by 0.2-0.5% in 2030, and by 0.9-1.1% in 2050.” Averaged over 2010-2050, households will pay an extra $79 to $146 a year. Not exactly a steep price to pay to avoid catastrophe. (Incidentally, overall household consumption will continue to rise, even with the mild constraints of the bill.)

Not a steep price to pay to avoid what catastrophe, exactly? If consumption continues to rise, and this bill does very little to curb the most inefficient methods of power generation (current fixed coal-fire power plants) by using the price mechanism of the marketplace (the extra $79-146 could easily come from increased transportation costs), then are we really avoiding catastrophe?

According to evidence we have seen from the run-up of energy prices in 2007-08, demand becomes closer to unit-elastic at greater-than $3 a gallon for gasoline. Thus, if the extra costs to consumers are, in fact, in transportation costs…that might induce some of this sort of behavior. However, if those costs are diffuse among all kinds of energy use (general production, gasoline, heating oil, etc.) you might not ever hit a point where elasticities would cause people to make a change. That seems to be what the EPA is telling us.

I haven’t had much time to go through the bill, but I’m sure that there are plenty industry giveaways, rent seeking, etc. involved…and remember, this is a fairly ‘weak’ bill. So what is the point? The EPA doesn’t happen to measure the highly intangible “benefits” of avoiding catastrophic climate change…however, if there is near zero price incentives — maybe they were right not to measure the benefits. Maybe there are none at all.

Update: I should have also added that if you are serious in your belief that using carbon energy is harming the planet, then what you want to do is raise the price of carbon until it induces a change. You want to punish people for indulging. That’s the point. Supporting a weak (or useless) bill so you can pat yourself on the back later when it gets passed and claim that you “got something done” is pointless.

If You Can’t Beat Em . . .

Robert Waldmann suggests that we use special interest politics to our advantage:

Those of us who fear global warming want to make it more expensive to burn coal. One way to do this is to impose absurdly high wages and restrictive work rules on coal mines. We know how to drive prices up. It is easy. Militant unions have shown the way.

I propose the American Power and Give Coal Miners a Break Act. The idea is to impose a special minimum wage for coal miners (which must be even higher than the wages they get) *and* to require time and a half if they work more than 30 hours a week. This implies a higher price of coal, lower demand for coal , and, oh look 30 hours a week, just as many employed coal miners.

I am not sure what I think about this. The obvious retort is that we don’t want to provide intellectual justification to this type of politics. As James Hamilton likes to say, “a glass of wine may be good for the heart but a glass a day is not the best advice to give to an alcoholic”

On the other hand, I have become increasingly convinced that fighting what economist think of as public choice problems is really trench warfare against genetically engrained human tendencies. We might be able to convince one generation that the Corn Subsidy is a bad idea but that will do absolutely nothing to prevent the next generation from proposing the Local Food subsidy.

People want to reward activities that look like a good idea and are simply not inclined to be skeptical about their ability to discern good ideas from bad. Nor are they sensitive to their ability to create special interest groups via benevolently intentioned public policy.

Perhaps over time we can combat this problem by expanding an understanding of public choice theory, but I don’t think its possible to turn the tide simply by accumulating victories on individual issues.

And given that you “Make policy with the electorate you have, not the one you wish you had” I see a strong case for Waldmann’s proposal.

This all, of course, based on the assumption that we want to take costly action to prevent global warming, which is a whole ‘nother can of worms.

Can price ceilings and floors be efficient?

One feature of both the Kerry-Lieberman and Cantwell-Collins cap and trade plans that I don’t understand is the so-called “hard collar”. This will put a price floor and ceiling in place. Here is how Yglesias describes it for Kerry-Leiberman:

The Senate bill modifies this idea by mandating that permit prices trade within a certain band. That starts as a floor of $12 and a ceiling of $25 per ton. The floor increases at 3%+CPI, the ceiling at 5%+CPI.

My question is, how to you set a price ceiling or floor in a market without getting a shortage or surplus? If Company A values a marginal pollution permit at $30 and Company B values it at $27, but the price ceiling is $25, how does this market allocate that marginal permit? I’m not sure how you make sure the permits are allocated efficiently without allowing the price to rise above the ceiling. Both bills may include very effective mechanisms that deal with this that I am just unaware of. If so I would be glad to be educated on this.

I am persuaded by Yglesias that the floor makes more sense as an insurance policy against the level of carbon permits being set too high, or the system being gamed by illegitimate carbon offsets:

What the floor does is let you assume the worst about the offsets—the regulation is super-lax, tons of stuff is offset, and much of it has little value—and still be left with essentially an escalating carbon tax in the event that the market price of permits crashes.

I do kind of agree with him here. But if this is a likely possibility for offsets, than should we allow them in the first place? My guess is that a whole lot of the rest of the meat in Kerry-Lieberman is designed to set the stage for just these sorts of wasteful offsets. Cantwell-Collins, while much simpler (the full bill is only around 40 pages long), seems to leave a lot of wiggle room for this type of stuff as well. Why not get offsets out of the bills altogether?

Let’s Not Do Climate Policy Like Johnny Cash

The first day I got me a fuel pump
And the next day I got me an engine and a trunk
Then I got me a transmission and all of the chrome
The little things I could get in my big lunchbox
Like nuts, an’ bolts, and all four shocks
But the big stuff we snuck out in my buddy’s mobile home.

Johnny Cash, One Piece At A TIme

Ryan Avent at the Economist argues with Matt Steinglass, also at the Economist, about whether “leave it in the ground” is a desirable way to reduce global warming. Here is Avent:

In the end, reduction of fossil fuel consumption and carbon emissions is all about the demand side—the supply of fossil fuels on earth is more than sufficient to turn the planet into an oven, and so demand must be rationed. So either you commit yourself to disrupting enough of currently available fossil fuel supply to raise fossil fuel prices, or you quit worrying about supplies and focus on demand-side measures. The former seems to me to be utterly impossible and not that economically desirable, and so I’d urge my colleague to concentrate on the latter…

This debate plays out all over the place: do you support a marginal policy that would reduce global warming by some small amount, or instead focus on promoting the much more efficient carbon tax and forgo these piecemeal policies? I understand why this debate goes on, and I can understand why cynics who are skeptical that we will get a carbon tax would promote piecemeal policies, although I disagree with them.

What I don’t understand is why all libertarians and conservatives don’t recognize that given the public perception on the issue, this is our choice set: we’re either going to do it like Johnny Cash -sloppily, inefficiently, and, one piece at a time-, or we can do it all at once as efficiently as possible. As long as pollution is perceived as being underpriced there will be a large, economically justified demand for piecemeal attempts to reduce it. Why not support the efficient approach and remove the economic case for these inefficient piecemeal policies?

Can The Tea Party Movement Be Pragmatic?

Climate change policy should be a conceptual challenge for the Tea Party movement. Realistically, doing nothing is not a option; even if Tea Partiers are climate change skeptics, it is undeniable that the majority of the public are not, and will not be persuaded otherwise. Nor can you tax cut or deregulate your way out of the problem. So what policy should the Tea Partiers support? If they were pragmatic, they would support this:

Two senators, Maria Cantwell, Democrat of Washington, and Susan Collins, Republican of Maine, have proposed an alternative that they call cap and dividend, under which licenses to pollute would be auctioned to producers and wholesalers of fossil fuels, with three-quarters of the revenue returned to consumers in monthly checks to cover their higher energy costs.

Ms. Cantwell…said her bill would require every pollution permit to be auctioned rather than given away and was 39 pages long, compared with Waxman-Markey, which weighs in at some 1,400 pages.

Among all politically possible outcomes for climate policy, a transparant and simple auction that returns the proceeds to consumers is the best outcome that small government Tea Partiers could hope for. If they were pragmatic they would jump on this and do what they can to prevent alternatives like the 1,400 page Waxman-Markey bill:

But in trying to assemble a majority to pass it, Mr. Waxman and Mr. Markey dished out a cornucopia of concessions and exemptions to coal companies, utilities, refiners, heavy industry and agribusinesses. The original simplicity was lost, replaced by a bazaar in which those with the most muscle got the best deals.

Of course, it is difficult to sloganeer and protest in favor of second best options, and I’m not sure this emergent movement is capable of expressing itself any other way.

Green Jobs Debate, Part II

The debate over green jobs continues at the Economist. The polls show that Van Jones is winning this debate so far, taking an early lead away from his opponent:

I suppose one does not rise to the stature of Czar without the ability persuade people of the usefulness of whatever it is one will be Czaring over.

I think Morris’ is losing because he failed to immediately make clear that there are things the government should do. Since the more radical forms of libertarianism are often what people have in mind, it’s important when arguing for libertarian ideas to establish that there is a legitimate role for the government (only, of course, if there is in fact a legitimate role for the government). Coming out of the gate crowing “Let the market handle it!” when the problem at hand is a classic market failure will solidify you in people’s minds as the extreme libertarian caricature they generally default to anyway.

That said, Morris does a much better time this round. He makes the case for innovation prizes, and argues against fighting dirty energy subsidies with clean energy subsidies, mocking Jones thusly:

Rather than get rid of wasteful subsidies that transfer money from consumers to special interests in fossil fuels, his solution is to give others their chance at the trough.

Both sensible ideas, both defining a legitimate role for the government. He should have opened up with this point.

Jones rebuttal drives home three points: 1) green energy is more labor intensive than dirty energy, 2) the market is already distorted in favor of dirty energy, and 3) doing nothing is not a good option. If one is to argue for green jobs, this is the tract to take. One of his weakest points this time around is an argument that quite frankly works against him:

Mr Morriss claims that the work of moving to a cleaner economy is hampered by the lack of a universal and timeless definition of the term “green jobs”. This is a red herring. In public policy, we continually debate, revisit and reshape what should be included under any important label, whether the term is “American made”, “organic food” or “green jobs”. In a democracy, these kinds of debates are continuous and any resolution only provisional.

It would agree with everything he said, except to replace “continuous” with “ridiculous”, and “provisional” with “arbitrary”.

He has two points near the end I’d like to highlight. The first one is completely false and highlights an unfortunate thinking that I think drives a wedge between progressives and libertarians who actually agree on the second statement:

One, we do not have infinite amounts of carbon in the ground to burn. At some point, our earth will run out. Thus, it is sensible for governments to create incentives for alternatives to carbon-based fuels on a grand scale, now.
Two, our atmosphere does not have infinite capacity to absorb all the carbon that humanity could potentially extract and burn. If we emit too much, we will do irreparable damage to the climate.

There are very few useful things on this earth that we have an infinite capacity of. It is absurd to claim that a lack of unlimited supply of something we value justifies government action on a “grand scale”, and immediately. The fact is that we have alternative, non-carbon-based ways to create energy now, and if scarcity drives the price of carbon based fuels up (which is exactly what scarcity does!),  people will begin buying them. If Jones is right and higher prices of carbon-based fuels would not lead consumers and firms to begin demanding clean energy technologies en masse, then we should not be spending a single dollar on existing clean energy technologies, since they are apparently so incredibly far from being cost effective.

Green Jobs Debate

The Economist is hosting a green jobs debate between former Green Jobs Czar Van Jones and Andrew Morriss, one of the authors of “The Green Jobs Myth”. The pre-debate vote of reader support for the statement “This house believes that creating green jobs is a sensible aspiration for governments” was close to 50-50, so this one could go either way.

When green jobs are created by the public sector they are at best a coincidental byproduct of other worthy goals. Making green jobs an explicit policy goal means having two contradictory objectives: maximizing efficiency, that is output per dollar, and maximizing jobs, that is maximizing workers per output. If you consider that jobs cost dollars, these goals are almost exactly opposite. The only way they don’t work against each other is the extent to which you can costlessly exchange capital for labor, a rare if non-existent condition. Remember, maximizing workers per output is the same as minimizing output per worker.

The easiest defense of green jobs is to contrast it with doing nothing. The most difficult defense is to contrast it with a gas tax or cap-and-trade. This is where Jones is at his weakest:

Furthermore, governments will need to go beyond a simple cap-and-trade system for global warming pollution. Renewable energy standards and codes for energy efficiency will help build markets. Green banks and new financing tools will use public underwriting to help unleash private capital. And public investments in infrastructure will create a platform for innovative businesses to thrive and hire more workers.

Notice that when contrasted with cap-and-trade, the actions that he argues the government needs to take are completely unrelated to the kind of policies promoted by green jobs fans. For instance, weatherization would not fall under any of these categories, nor would direct subsidies to particular companies or technologies. Unless what he means by “green banks… will use public underwriting” is that “the government will subsidize things”, in which case he hasn’t really made an argument so much as an assertion. Once the cost of pollution is priced in to an activity, there is no more externality. What is the remaining justification for government action? He has dodged a very critical question here.

Jones is most successful in arguing that since government intervention in energy markets is inevitable and desirable, they need to explicitly prioritize green technologies, and cannot simply let the market handle it. This is a good argument for why the government should consider the environmental impact of it’s regulatory actions.

As to whether or not green jobs policies are protectionism, he argues that “In this context, policy is not a restraint on trade. It is a driver of innovation”. However, in reality it almost certainly is a restraint on trade. When a policy goal is to maximize American jobs, that has the effect of a “Buy American” provision. Here’s one recent example:

…when American stimulus funds subsidized a joint U.S.-China wind-power farm in West Texas, it turned out that Texas stood to get 30 permanent jobs to China’s 3,000. After Sen. Charles Schumer (D., N.Y.) protested, the Chinese agreed to build a wind-turbine factory in Texas.

Clearly, prioritizing American jobs often means a de facto restriction of American companies’ ability to spend money abroad, which is protectionism and a restraint on trade.

The “Success” of Green Subsidies

The size of European and Asian country’s green energy industries and the generous government subsidies and industrial policy they thrive on is looked at jealously by many American commentators who wonder “why not us?”. Leaving aside for the moment the disagreement about whether the composition of American industries is a worthwhile goal of public policy, there are reasons to be wary of heavy-handed green industrial policy. An article in the New York Times today is a great cautionary tale.

Generous subsidies from the Spanish government created a fast growing solar industry the small city of Puertollano. Things did not stay so rosy, however:

But as low-quality, poorly designed solar plants sprang up on Spain’s plateaus, Spanish officials came to realize that they would have to subsidize many of them indefinitely, and that the industry they had created might never produce efficient green energy on its own.

In September the government abruptly changed course, cutting payments and capping solar construction. Puertollano’s brief boom turned bust. Factories and stores shut, thousands of workers lost jobs, foreign companies and banks abandoned contracts that had already been negotiated.

This is the same government which, according to the Economist, spent an estimated 570,000 euros per green job. These are things to remember when people wonder why we can’t have “successful” green jobs programs like they have in Europe and Asia.

What’s In A Debate

If opinions on the shape of the earth did differ would it be the place of journalists to choose a side? What if they chose the wrong side? What if they ended up supporting a war over non-existent weapons of mass destruction? Is that a possibility that should concern us?

Derek Thompson posts this chart

and then says

As James Fallows pointed out here during the climate scientists’ email scandal, the New York Times treated global warming as a problem, and the Washington Post treated it more like a debate. This is silly. Global warming isn’t a debate. (and it’s alarming to watch the Washington Post sacrifice its integrity for some editorial hot air.)

Really? Are we to believe that the nearly 50-50 split among the American public is solely over the discount rate that we should use? 42 per cent says a Stern-like .01% , while the rest want to use the government’s long term average cost of funds?

I tend to think that there is genuine disagreement over the causes and consequences of global warming itself. This disagreement leads to differing assessments of what we should do to tackle the problem.

Now, Thompson might think that the 51% are tragically misinformed and that anyone who knows anything, knows that major action is needed now. Perhaps, he is even correct. However, that doesn’t make it “not a debate.”

According, to Greg Mankiw 93% of economists believe that raising tariffs decreases the general welfare. I am betting that most economic journalists believe the same thing. Promoting protectionism is a surefire way of getting yourself labeled an economic bumpkin. 

However, it would be madness to suggest that there is not a debate over protectionism in the United States. That well meaning people do not advocate for limits on what is imported in this country. Nor is it clear that if it was put to a vote, that broad free trade agreements would win.

Should People Really Be More Confident in Climate Change After Climategate?

Adam noted the pushback that Tyler Cowen is getting from suggesting that the Climategate could raise one’s estimate of the probability of Climate Change.

I think that while Tyler’s point is theoretically valid, and as I said before that any bad behavior was motivated deep belief that the fate of the world was a stake. However, it seems unlikely that this should raise most people’s assessment of the likelihood of climate change.

One’s assessment is only going to rise if this evidence leads you to believe scientists have more conviction than you thought.  However, anyone who is interested in the Climate Change issue but doesn’t think that scientists deeply believe in global warming, almost certainly believes that there is a conspiracy. If they believe there is a conspiracy then the emails only serve to bolster that belief.

Thus I have a hard time seeing whose mind is changed for the positive by this.

That being said, it doesn’t change my mind much to the negative. I have gone from probably a 98% belief that humans are causing Climate Change to around 90% – 95%.

It does, however, make me more interested in ensuring that the skeptics have a fair hearing. Previously I had written most of them off as cranks. Now I would like to at least see a back and forth, in which the strongest criticisms are refuted.

Climategate

Emails hacked from Climatic Research Unit of the University of East Anglia show researchers engaged in what may be a suppression of climate skeptics.

At this point I am not well enough up to speed on the specifics of the emails to comment on whether there was any gross misconduct and if so how much. However, I am a bit troubled by the nonchalant attitude that some bloggers have taken about this.

I understand that this does happen in science and it will continue to happen. However, given the gravity of the issue at stake the intellectual community cannot simply take a “boys will be boys” attitude about this. The public must be able to trust that at a bear minimum the scientific community itself believes in its ideals. That if people are caught suppressing important evidence that they will suffer damage to their careers.

We all know that researchers come to the table with bias and prejudice. This is precisely why a quasi-adversarial system, in which the weakness of each side are exposed through open debate, is so important.

I am sure everyone believes that small trends in the data which support their conclusion are important evidence and small trends which undermine their conclusions are anomalies. However, it is precisely because self-delusion is so natural that open debate is so important.

As a note, I have questioned the economic estimates of damage from global warming in the past.

Pigou Club Discontent

Ryan Avent delivers a hearty rebuke to Greg Mankiw

[Greg Mankiw] has made it clear that his support of a carbon tax is primarily about improving the overall efficiency of the tax code. That’s good to know. It suggests that those interested above all else in improving tax policy in an environmentally-friendly manner can continue paying attention to Mankiw, while those of us focused on the problem of climate change while mindful of economic costs can ignore him.

Asteroids and Climate Change

Contra Jonah Goldberg, Matt Yglesias argues that the possibility of an asteroid strike has no bearing our concern about global warming.

Personally, I’m sympathetic to the view that public policy should be more concerned than it currently is about asteroid strikes. But this is also a total non-sequitur. Failing to pass the Waxman-Markey bill or negotiate a good deal at Copenhagen doesn’t put us any closer to safeguarding ourselves against asteroids. Nor would enhanced monitoring of potential collisions require us to build new coal-fired power points. The two issues simply have nothing to do with each other.

This is not quite right. Whether asteroids or other existential threats should have a major impact on how we deal with global warming is debatable, but they are definitely related for two reasons.

First, and I in no way want to condone the style or tone of Jonah’s presentation, but there is a logical strain behind it. The underlying assumption is that the public and the scientific community have limited attention for existential threats and that too much of this attention is directed to climate change.

There are other bad things that could happen: asteroid strikes, pandemics, nuclear terrorism. We shouldn’t expend a disproportionate amount of national attention on any single one. In short, unless you believe the reservoir of public concern is infinite you can’t think that the public should be more concerned about asteroids but that asteroids have no impact on how much we should be concerned about everything else.

Further, the argument might go, we should be weary of over hyping nuclear terrorism because it fits with the basic world-view of the right. There is a natural tendency for nationalism to fuel this fear and so there is a strong chance it will receive too much attention.

Similarly, we should be weary of climate change because it fits the world view of the left. There might also be a tendency to give too much attention to the dangers of industrialization and consumer culture.

Now, I tend to think this argument may be overplayed on both sides. Though, yes there are people concerned about nuclear terrorism and climate change for all the wrong reasons, it is nonetheless the case that they are significantly larger threats than average. Its not so bad that they get a lot of attention.

Second, each additional threat lowers the optimal amount of resources spent on addressing all other threats. In practice the reason people are motivated about terrorism or climate change is because the two concepts are frightening. They are a source of worry and doing something calms worry.

However, from an analytical point of view the reason we should do something about these threats is because we care about the future. However, the greater the probability that the future will be destroyed anyway, the less important action is on any one threat.

That is, if we knew that preventing Iran from developing a nuclear weapon or reducing carbon would mean a prosperous future for our grandchildren then we should invest an enormous amount resources into assuring that it happens.  However, if there is a non-trivial chance that our grandchildren will live in disaster anyway, we should hedge. After all, there is a chance they we could suffer the consequences of action and they still gain no benefits from that action.

Now, I think the chances are pretty large that our grandchildren will in fact in enjoy a prosperous future and thus the effect of additional disasters on our calculus is not that great. However, it is not zero.

The Role of Cost Benefit Analysis

Ryan Avent points to this paper by Robert Stavins on cost-benefit analysis. In particular highlighting this passage:

Although formal benefit-cost analysis should not be viewed as either necessary or sufficient for designing sensible public policy, it can provide an exceptionally useful framework for consistently organizing disparate information, and in this way, it can greatly improve the process and hence the outcome of policy analysis

There is little that I could disagree with in this passage or in Stavin’s full post. Cost-Benefit analysis is useful but it is not everything. I, myself,  tried to illuminate some of the limitations to pure cost-benefit analysis in this paper.

On the other hand, one of the principle advantages of of cost-benefit analysis is that it forces us to be explicit about our assumptions. To build a model we must write down exactly what we are assuming and proceed only from those assumption.

Once, the model is done, we may not be satisfied. We may feel it fails to capture key elements. But, then we must be prepared to state explicitly what key elements are missing and why we think they overwhelm the conclusion of the model.

What I’ve tried to do in the climate change debate is shine a harsh light on the latter stages of this process. Waxman-Markey doesn’t do well under traditional cost-benefit analysis. Supporter, however, argue that this doesn’t matter because of the overwhelming narrative in support of carbon restrictions: Without significant reductions in carbon emissions we will wind up devastating the developing world.

Very well, I’ve argued, but there is a competing narrative in which carbon restrictions themselves harm the developing world. Carbon restrictions potentially reduce growth rates and slow the transition to an industrial economy.

We could exempt the poorest nations from international carbon restrictions, but this has two problems. First, it assumes that business interests in the developed world will go along with this. It assumes that companies will accept a competitive disadvantage and that the public will be insensitive to cries that we are loosing our jobs to counties with lax environmental regulations.

Second, we can’t ignore the emissions from China and India, which together are  home to hundreds of millions of the world’s poor.  Indeed, until recently the China and India were home to the majority of those in poverty. Heavy industry and high carbon emissions are part of the story of how over half of a billion people were lifted out of poverty in the last 25 years.

This doesn’t mean that there is no role for emissions restrictions. This doesn’t mean that we should forget about cap and trade. It does, however, mean that we need a careful and explicit effort to balance competing concerns. 

If we believe that damage from climate change will overwhelm the damage from emissions restrictions then we have to be clear as to why. What scenarios are we envisioning? What assumptions are we making?

Likewise, if we want to close the door on emission restrictions we have to be explicit as to why the benefits from potentially higher growth outweigh the possibility of devastation later.

The fact that both climate change and economic growth are non-linear processes with tipping points and varying dynamic regimes makes this thought exercise excruciatingly hard. It is, however, excruciatingly important.

Truth to Power

Glenn Loury and Brink Lindsey offer a powerful critique of the current administration.

Loury and Lindsey have word choice, mannerisms and even appearance that is all old school ivory tower and perhaps even little stuffy. But sit through it. The ideas are worth it.

America the Beautiful

I have great affinity for Ryan Avent as a blogger and friend but this kind of stuff just goes down hard.

So absolutely, if Obama can work out bi-lateral agreements, even just on principles, between America and China or America and India, then that’s great. But we’re the big obnoxious fat man in the room. It’s all an exercise in hope until we get involved, and when we get involved, it’s suddenly no longer just an exercise in hope. [emphasis mine]