Climate Change and Economics: The Invisible Hand Never Picks Up the Check

Disclaimer:  I am now retired, and am therefore no longer an expert on anything.  This blog post presents only my opinions, and anything in it should not be relied on.

Over the past few days, I have been reading Kim Stanley Robinson’s “Green Earth” trilogy, an examination of possible futures and strategies in dealing with climate change thinly disguised as science fiction.  One phrase in it struck me with especial force:  “the blind hand of the market never picks up the check.”  To put it in more economic terms:

·         Firms, and therefore market economies as a whole, typically seek profit maximization, and because the path to profit from new investment is always uncertain, to focus particularly on cost minimization within a chosen, relatively conservative profit-maximization strategy.

·         To minimize costs, they may not only use new technologies (productivity enhancement), but also offload costs as far as possible onto other firms, consumers, workers, societies, and governments.  Of these, the most difficult is offloading costs onto other firms (e.g., via supply-chain management), since these are also competing to minimize their costs and therefore to offload right back.  Therefore, especially for the large, global firms that dominate today’s markets, the name of the game is to not only minimize costs from workers, consumers (consider help desks as an example), and societies/governments, but also to get “subsidies” from these (time flexibility or overtime from workers, consumers performing more of the work of [and bearing more of the risk of] the sales transaction, governments not only providing subsidies but also things such as infrastructure support, education and training of the work force, and dealing with natural disasters – now including climate change). 

Often, especially in regard to climate change, economists may refer to the process of the invisible hand never picking up the check as the “tragedy of the commons.”  The flaw of this analysis is to limit one’s gaze implicitly to tangible property.  If one uses as a broader metric money equivalents, then it is clear that it is not just “common goods” that are being raided, but personal non-goods such as worker/consumer/neither time that translates to poorer health and less ability to cope with life’s demands, sapping productivity directly as well as via its effects on the worker/consumer’s support system, not to mention the government’s ability to compensate as it is starved of money.  And all of this still does not capture the market’s ability to “game the system” by monopolizing government and the law.

Another point also struck me when I read this phrase:  macroeconomics does not even begin to measure the amount of that “cost raiding”, instead referring to it as “externalities”.  And therefore:

Economics cannot say whether market capitalism is better than other approaches, or worse, or the same.   It cannot say anything at all on the subject.

Further Thoughts About Economics and Alternatives to Market Capitalism

A further major flaw, imho, in economics’ approach to the whole subject is the idea that cost minimization should not only be a desired end but also the major goal of an enterprise.  I am specifically thinking of the case of the agile company.  As I have mentioned before, agile software development deemphasizes cost, quality, revenue, time to market, and profit in favor of constantly building in flexibility to adjust to and anticipate the changing needs of the consumer.  And yet, agile development outperforms approaches that do concentrate on these metrics by 25% at a minimum and sometimes 100%.  

If the entire economy were based on real agile firms, I would suggest that we would see a comparable improvement in the economy – permanently.  Moreover, the focus on the consumer should lead to a diminution in “cost raiding”.  The focus on being truly in tune with the consumer’s needs, for example, should diminish raiding the consumer’s time in the sales transaction and forcing them to use the help-desk bottleneck.  And I still live in hope that agile development with fewer time constraints will empower the developer with the ability to seek out and implement his or her own tools to improve processes, thereby allowing better retraining.   

Implications of Climate Change for Economics and Market Capitalism

Robinson includes a critique of market capitalism in his work, and concludes that it has to change fundamentally.  I find the critique itself problematic; but that doesn’t mean he isn’t right in his conclusion.

The fundamental question to me is, what happens when externalities go in reverse, and suddenly the things that have led to ongoing profits lead to ongoing losses?  Robinson paints a frightening picture of a world in which brownouts, blackouts, killing cold, and killing heat are common, and insurance, whether private or governmental, cannot adequately compensate, leading additional costs to settle, inexorably, on their last resort, business.  Then, implicitly, firms must cannibalize each other, with the largest being best equipped to do so.

I tend to place things in less apocalyptic terms.  According to Prof. deLong, GDP performance can be thought of as part improvement in productivity and part expansion of the workforce.  The climate change scenario necessarily implies a shrinkage of that workforce (in labor-hours) faster than productivity can climb, and therefore a constantly shrinking market.  In that case, the market’s rising need for “cost raiding” as the market shrinks simply speeds up the shrinkage of the market – not to mention the underlying societies.  And that, to me, is the fundamental flaw that needs correcting. 

Theoretically, one option is to capture things like “the social cost of carbon” in company accounting – an idea I wrote about five years ago.  Practically speaking, the uneven effects of that on companies mean real impact on the employees of coal and oil companies, a fact we have already seen a small foretaste of, and that has further revealed the ability of oil and coal companies to entirely snarl the political process to prevent adequate steps at limiting “cost raiding” – and that makes our carbon pricing efforts in real-world terms more likely than not to be inadequate to reverse the “cost raiding” trend.  

The obvious alternative, which I and others have argued for and I in fact picked up on eight years ago when I first understood the dire implications of climate change, is “World War II in America”, governmental interference in the economy comparable to that of WWII in order to “win the war on climate change”.  Only, of course, the aim is to lose the war with as little damage as possible.  So suppose we do that; what then?

The obvious answer is, “sustainability” – meaning practices that will ensure that having “won the war”, we don’t lose it again in the future by slipping back into the old carbon-guzzling, ecology-devastating, arable-land-destroying habits.  Is that enough?  Robinson says no, that despite sustainability, cost raiding will continue to increase in other areas.  And here I tend to agree with him, although I am not sure.

It appears, reverting to Prof. deLong’s point above, that it is possible with sustainability to continue to improve both human welfare and corporate profitability, by improving productivity with a more or less stable (almost certainly shrunken) population and workforce.  However, productivity improvement may well be less than in the Industrial Revolution – it has already slowed for an unduly long time.  And if that is the case, then there is no market-capitalism path forward that involves today’s increases in corporate profitability and avoids cost raiding increases.

I don’t know the answer to this.  I feel, however, that the beginnings of an answer lie not in perpetually increasing the size of the workforce by improving human welfare, while somehow not increasing population, but rather in perpetually increasing “consumer productivity”:  the value that people get out of their lives, that they can then invest in others.  More specifically, I think markets can be divided into those for carrying out daily tasks (“Do”), those for socializing and participating in society (“Socialize”) and those for learning and creating (“Learn”).  A balance must be kept between these efforts in any individual’s life, so the perpetual increases must be achieved inside each of these three sets of markets. 

I would argue that today’s market economies use “Do” to crowd out much of the other two sets of markets, and are less good at perpetually increasing the value of “Socialize” and “Learn”, although the crowding-out may mean that “Do”’s superiority is illusory.  I have no clear idea as to what to do about my conclusions, except to examine each set of markets more closely to gain clues as to how to achieve this perpetual value increase.

Just some thoughts.  And oh, by the way, Robinson is indeed worth reading.

Climate Change: The Poison of the Pseudo-Reasonable Economist

In the dog days of summer, as the average global land temperature for the first 6 months of the year is a whopping two-thirds of a degree Fahrenheit above any recorded temperature before it, and almost certainly as hot as or hotter than any time in the last million years, I find myself musing on one pernicious form of climate change obstructionism.  Not climate change deniers -- their lies have been endlessly documented and the contrary evidence of accumulating data from appropriate scientists continues to mount.  No, I am speaking rather of fundamentally flawed but seemingly rigorous arguments, especially from economists, that serve in the real world only to detract from the urgent message of climate change, and the will to face that message, by understating its likely impacts.

I gathered these two examples of the genre from the blog of Brad deLong, economics professor at Berkeley.  I hope Prof. deLong will not be offended if I describe him as the packrat of economic theory (net-net, it's a compliment); he seems to publish both the realistic alarms of Joe Romm and the examples I am about to cite with equal gusto, and to do the same with some of the more dubious efforts of Milton Friedman and Martin Feldstein in other areas.  In this case, I am going to use the screeds of Robert Pindyck and Martin Weitzman, cited over the last month, as examples of this kind of pseudo-reasonable economic analysis.

Weitzman:  The Black Swan Is a Red Herring

Weitzman's recurring argument, which he has been making for a long time now, is that a "serious" effect of climate change is unlikely -- he calls it a "black swan" event -- but that because it could have unspecified catastrophic consequences, we should try to plan for it, just as a business plans for unlikely concerns like Hurricane Sandy in its "risk management" policies.  Sounds reasonable, doesn't it?  Except that, by any reasonable analysis of climate change's fundamental model and how it has played out over at least the last five years, merely catastrophic consequences are far more likely than uncatastrophic ones, and catastrophic consequences beyond what Prof. Weitzman seem to be contemplating are the likeliest of all.

When I first began reading up on the field 6 years ago, it was still possible to argue that the very conservative IPCC 2007 model (whose most likely scenario assuming everyone started doing something about climate change projected a little less than 2 degrees Celsius global temperature increase) was at least plausible.  After all, back then, the data on Arctic sea ice, Greenland ice melt, and Antarctic ice melt was still not clearly permanently above the IPCC track -- not to mention the fact that permafrost had not clearly started melting.

However, even at that time it was clear to me from my reading that, in all likelihood, the IPCC and similar models were understating the case.  They were not considering feedback effects from Arctic sea ice melt that was well in advance of "around 2100, if that" predictions, nor the effects of permafrost melt that was very likely to come.  I would also admit that I thought the effects of climate change on weather in the US and Europe would not be visible and obvious enough for political action until around 2020.   Meanwhile, Weitzman (2008) was publishing a paper that argued that climate science simply couldn't provide enough exact predictions about temperature increase and the like to make catastrophic climate change anything but a highly unlikely event in economic modeling.

Well, here we are 7 years later.  Prof. Hansen has crystallized the most likely scenario by analyzing data on the last such event, 55 million years ago, and showing that a doubling of atmospheric carbon translates to a 4 degrees Centigrade increase in global temperature, two-thirds from the carbon itself, and 1/3 from related greenhouse-gas emissions and feedback effects.  Moreover, a great deal has been done to elaborate on the more immediate weather and "catastrophic" effects of this increase, from Dust-Bowl-like drought in most of the US and much of Europe by the end of this century to sea level rises of at least 10+ feet worldwide -- and extension of salt-water poisoning of agriculture and water supplies to an additional 10 feet due to more violent storms.

I cannot say that I am surprised by any of this.  I can also say that I see no sign in Prof. Weitzman's comments that he has even noticed it -- despite the fact that, according to Hansen's analysis, we have already blown past 2 degrees Celsius in long-run temperature increases and are beginning to talk about halting emissions growth at 700 ppm or about 5.5 degrees Celsius.   No, according to Prof. Weitzman, catastrophic climate change continues to be a "black swan" event.

So the fundamental assumption of Weitzman's statistical analysis is completely wrong -- but why should we care, if it gets people to pay attention?  Except that, as our entire history has confirmed and the last 6 years have reconfirmed, when people are told that something is pretty unlikely they typically take their time to do something about it.  As temperature increases mount, the amount of catastrophe to be coped with and the amount to do to avoid further increases mounts exponentially.  Just as with comets or asteroids striking the Earth -- but with much less justification -- appeals to "risk management" and "black swans" give us license to do just that.  No, when you deny for six years the ever-clearer message of climate science that the climate-change forces causing catastrophic effects are likely, quantifiable on average, and large, you might as well be a climate change denier.

Pindyck:  The Discount Rate of Death

I must admit, when I saw the name Pindyck but not the conclusions of his paper, I was prepared to be fascinated.  I have always regarded his book on econometric modeling, which I first read in the late 1970s, as an excellent summary of the field, still useful after all these years.  You can imagine my surprise when I found him echoing Weitzman about how "climate science simply isn't sure about the extent and impacts of climate change, and therefore we should treat those impacts as unlikely".  But my jaw almost became unhinged when I read that "we really have no idea what the discount rate [for a given climate-change-inspired policy action in a cost-benefit analysis] should be", and so we should not even attempt to model the costs and benefits of climate change action except in wide-range probabilistic terms.

Iirc, the discount rate in a business-investment analysis is the rate of return that will justify investing in a project.  Now, there are workarounds to estimate probabilities and therefore at least approximate return on investment for a particular investment -- but that isn't the source of my bemusement.  Rather, it's the notion that one cannot come up with a discount rate for a climate-change-mitigation investment compared with an alternative, and therefore, one cannot do model-based cost-benefit analysis.

Here's my counter-example.  Suppose a company must choose between two investments.  One returns 5% per year over the next 5 years.  The second contains exposed asbestos; it returns 10% over 5 years, and 20 years from now, everyone in the company during that period will die and the company will fold.  What is the discount rate under which the company should choose investment 2?  It's a trick question, obviously; the discount rate for investment 2 must be infinite to match its infinite costs, and therefore there is no such discount rate.

But that's my point.  The costs of climate change are likely and catastrophic, and so you need a really high discount rate to justify the alternative of "business as usual".  The only way you can get a low enough discount rate to justify "business as usual" is to assume that climate change catastrophe is very unlikely. And so, as far as I'm concerned, the "we don't know the discount rate" argument takes us right back to Weitzman's and Pindyck’s "climate change catastrophe is unlikely."  

Thus, Pindyck's discount-rate argument is also a red herring, and a particularly dangerous one:  It seems to move the playing field from climate science, which climate scientists can easily refute, to the arcana of econometrics.  Not only does Pindyck fail on the climate science; he uses that failure to cloak inaction in pseudo-economic jargon.   And so, when Pindyck's "analysis" winds up making it even harder than Weitzman's to argue for climate-change action, I regard it as particularly poisonous in effect.

The So-Called deLong Smackdown

Prof. deLong occasionally publishes an article called a “smackdown” in his blog that seems to correct him on something he clearly views himself as having erred on.  Frankly, I don't view the above as a smackdown; although I wish he and Prof. Krugman would admit that they underestimated gold's disadvantages by comparing it to the S&P 500 index rather than the S&P 500 total return index.  Rather, I view this as a wake-up call to both of them, if they truly want economics to deal with the real world.  As Joe Romm points out, underestimation of effects for the sake of absolute sureness of a minimum effect by the IPCC is not new, nor is an extensive body of literature giving a picture both far more somber and far better reflected in current real-world weather and climate.

But what are we to make of Weitzman and Pindyck, who apparently have been denying that literature, and then using that denial to peddle a far weaker reason for action, for the last six years or so?  3 years, maybe, as the Arctic sea ice shrank to a new dramatic low only in 2012; but six?  No; unless we succumb entirely to the old NPR comedy routine “It’s Dr. Science! He’s smarter than you are!”, this behavior is disingenuous and has poisonous effects.  And, because any sort of modeling of the medium-term future should take account of economic effects, it hinders real-world planning just as much as real-world action.  Heckuva job, economists – not.