TT's Lost in Tokyo — by TokyoTom

Bob Murphy, an economist at Rob Bradley‘s Institute for Energy Research, has posted on the main Mises Blog a link to a paper that he has submitted to an economic journal, “Rolling the DICE: Nordhaus’ Dubious Case for a Carbon Tax“.

[Update:  Bob thoughtfully copied environmental economist David Zetland on his draft paper, and while he has not returned to comment at his own Mises thread, Bob has made further comments at David’s blog and at his own shared blog.]

IER promotes Murphy’s paper as ambitiously “tackl[ing] the basic premise of pricing carbon … using William Nordhaus’ DICE model as the representative of economic orthodoxy”, but it seems to me that both his objectives and his achievements are far more modest.  Murphy:

(1) fails to attack either the fundamental premises of orthodox cost-benefit analysis as applied to climate change or the basic premises of the DICE model,

(2) focusses chiefly on various uncertainties involved in the parameters in Nordhaus’ model, while ignoring not only that such uncertainties cut in more than one direction, but that other economists have strongly argued that Nordhaus has underestimated or mishandled important damages and uncertainties (e.g., John Quiggin and Sterner & Persson) and has simply misunderstood the usefulness of CBA in the face of important uncertainties that CBA cannot easily handle (e.g., Martin Weitzman, Richard Tol, others),

(3) fails to note the point (made by McKitrick and others) that even if imperfect, carbon taxes, if substituted for income, capital gains and other taxes, will significantly lessen important economic distortions; and

(3) fails to offer much in the way of Austrian approaches to CBA, much less to the property rights and preference issues involved in economic decisions involving significant externalities or open-access common resources, fails to point to possible ways in which government policy may be inefficient, costly, and subject to the skewing effects of rent-seeking, and fails to recommend important policy changes that are needed to facilitate a transition to a lower carbon economy, by promoting economic freedom, competition in energy and power markets, easing corporate tax depreciation rules that slow innovation, and strengthening property rights and common law enforcement mechanisms (Bruce Yandle and Jon Adler have both made concrete suggestions on desirable policy changes; what is holding back people at LvMI?)

In short, what Murphy delivers is flawed and far less than billed.

[Update:  As Ludwig von Mises himself noted (see my blog post “Mises on fixing externalities“), private property institutions arose in response to the economic inefficiency of older systems that did not force economic actors to bear the external effects of their actions.  We are intelligent and occasionally rational creatures – why should we not be pro-actively considering what institutions might be desirable and feasible for dealing with the effects of our activities on the atmosphere and  climate (and oceans, ecosystems and unowned species, or how to improve governance in countries that don’t recognize or protect property rights)?]

I copy below (with some typo corrections) the comments that I posted on Bob’s Mises thread; I will try to revisit later to add links and further resources:

Bob, thanks for posting this

Here are a few quick notes:

– although you note that every step in Nordhaus’ analysis involves uncertainty, you have failed to note Marty Weitzman’s recent work that tells us how strongly uncertainly serves as a factor SUPPORTING early action – an important factor that neither Nordhaus nor you take into account at all. Weitzman states, “the influence on cost-benefit analysis of fat-tailed structural uncertainty about climate change, coupled with great unsureness about high-temperature damages, can outweigh the influence of discounting or anything else.”

– while you indicate that one key area of uncertainty is that future GHG concentrations may be overstated, your observations actually suggest the opposite – that because the oceanic sink is finite, as it becomes saturated atmospheric GHG concentrations are apt to rise even more sharply.

– while you indicate that the temperature increase form a given GHG concentration may be overstated, you ignore the possibility of the opposite – that the long-term temperature impact of a given GHG level may be higher than the number Nordhaus has used. Further, given paleo evidence that Hansen has noted, it appears unlikely that climate sensitivity will be less than 3 degrees C.

– Similarly, while you note that economic damages from a given temperature increase may be overstated, you fail to address the possibility that such damages may be understated – and also fail to note that the Earth is apparently more sensitive to climate changes than has been expected, witness the rapid Arctic/Greenland melting that we are seeing at only a 0.7 C increase, and the rapid expansion of tropical zones.

– it is a distinct possibility that Nordhaus has underestimated nonmarket damages, as John Quiggin and others argue. In any case, Nordhaus does not account for the changing relative prices for various goods and services that the changing composition of the economy and climate change will induce,as Sterner and Persson have noted in a recent paper at RFF:

“future scarcities that will be induced by the changing composition of the economy and climate change should lead to rising relative prices for certain goods and services, raising the estimated damage of climate change and counteracting the effect of discounting. … [C]hanging relative prices … has major implications for a correct valuation of future climate damages. We introduce these results into a slightly modified version of the DICE model (Nordhaus 1994) and find that taking relative prices into account can have as large an effect on economically warranted abatement levels as can a low discount rate.”

– in looking at damages, you tend to focus on the US picture alone, without regard to other nations – largely poorer ones – in which greater net losses are expected to be felt. You also completely fail to address, even in the case of the US, that benefits and impacts will not be uniformly shared, and that those with net benefits presently have no obligation to compensate those shouldering losses.

– while you fairly note that Nordhaus’ analysis can be helpful in comparing the relative net costs and benefits of different proposals, you fail to note that with changed assumptions, even using Nordhaus’ model as is, much higher estimates of “optimal” levels of carbon taxes can be derived.

– You point to Nordhaus’ remarks on how free-riding be various countries will drastically affect the benefits to be derived from any carbon taxes, but argue that this itself is a justification for the US to free ride, rather than for us to work to coordinate compliance by others.

– You also seem to be very worried that a coordinated approach would actually result in heavily distorted worldwide production, when widespread noncompliance by the various Kyoto parties indicates how ready nations are not to unilaterally assume burdens that other nations will not share.

– You also express concern that any coordinated approaches to climate change may be difficult to unwind as information changes, when it is clearly that various nations (and their industries) are acutely aware of comparative advantage and quite ready to react to what others are or are not doing (in the fact of the easy movement of capital).

– Further, you have confused measures like possible geoengineering and carbon sequestration approaches – which would be incentivized by carbon taxes and are a form of “mitigation”, with what is properly considered as “adaptation” to unavoided temperature increases and climate changes.

There are of course many other points that one would like to see Austrians making – such as the benefits of freeing up the economy from burdensome regulations (while strengthening property rights and private litigation remedies), adding greater degrees of freedom and competition to energy markets to drive greater energy efficiency, allowing immediate depreciation of capital investments, and the desirability of avoiding government-directed investments and subsidies – but perhaps these are things you intend to address in another paper spelling out a truly Austrian approach, rather than nitpicking at a single conventional CBA argument?

Sincerely,

TT

(I apologize that this is link-poor, but it seems like the best way to actually have this comment posted.)

Published: June 12, 2008 7:49 AM

Bob, allow me to suggest that you (and others) may also wish to consider taking a look at addressing also the recent short pieces by Joe Stiglitz, Tom Schelling and Ken Arrow others in last year`s The Economists’ Voice; they are as relevant as Nordhaus, and much more accessible to the average reader:

Joseph Stiglitz, A New Agenda for Global Warming

Kenneth J. Arrow, Global Climate Change: A Challenge to Policy

Thomas C. Schelling, Climate Change: The Uncertainties, the Certainties and What They Imply About Action

Published: June 12, 2008 9:41 AM

I copy below comments I made on June 11 (Tokyo time) on Bob Murphy‘s June 4 blog post, Cap and Trade Is Not a “Market Solution”, that have apparently been held up for moderator approval (perhaps because my three links triggered the blog’s spam defenses?):

Bob, I thank you for posting your piece from IER, which has stimulated a relatively even-tempered and productive discussion.

But allow me to express a little disappointment.  Even as I agree fully with the gist of your post (the largely self-evident and unsurprising point that politicians prefer, as an alternative the more honest, open and politically less-palatable approach of direct Pigouvian taxes of the type supported by a wide range of mainstream economists, to address the concerns of scientists, economists, business leaders and others about man’s contribution to ongoing climate change by dressing up such taxes as a “market approach” involving a cap and trade program), I think that:

(1) you unfairly conclude that, since it will be government that will be implicitly pricing carbon emissions, such pricing “won’t reflect genuine economic scarcity” at all, when Austrian approaches do not deny that lack of property rights will result in economic actors ignoring external costs, but simply indicate the government pricing of resources can only imperfectly reflect economic factors;

(2) you’ve gone to a bit of unjustified rhetorical excess with your statements that:

– “[t]his is no more a “market price” than if the government decided to sell people permits giving them permission to sneeze”:  rather, it’s more like the government trying to price grazing rights, resources extraction rights or other user fees on “public lands”– yes, such prices are not market prices (and are perhaps more likely to be underpriced rather than overpriced), but that does not mean that they do not represent or at all reflect valuable resources.

– “Cap and trade is not a market-based solution” – while not a true market solution, a cap and trade approach is clearly one that makes use of markets.

– “Cap and trade … can therefore be justly viewed as a tax, stealthy or otherwise, on energy – the lifeblood of our economy” – this not only overbroad, as it would only tax certain types of energy, and overdramatic, it completely ignores the point that certain activities (a wide array not limited to combustion of fossil fuels, including release of other GHGs) are perceived as adversely affecting (now and in the continuing future) many within the country as a result of externalities involving an open-access and unowned and unmanaged commons, which is precisely what expressly motivates (actually or allegedly) so many – including many in your profession – to support Pigouvian approaches;

(3)  surprisingly, you failed to take the opportunity to add to the discussion by informing your readers of Austrian concerns, including the following:

– the calculation problem;

– whether, as you note it posting here, there is any reasonable basis to “trust governments around the world to implement the scheme ‘properly'” (by exploring problems with rent-seeking and bureaucratic incentives);

– whether it is desirable for the government to presume that it should act as the owner of the atmosphere in creating emissions rights (as opposed to citizens generally or long-standing/homesteading users of fossil fuels), and the related ethical issue of creating rights to emit that cut off those who may be harmed from any direct remedy (such as a share of the proceeds of the sale of rights); and

– the underlying institutional problem of lack of clear or enforceable property rights (for which past interferences by government have some responsibility); and

– whether growing concerns (and private responses) regarding the shared global issue (affecting nations with different circumstances and legal systems than ours) of increasing GHG emissions might be addressed less expensively and more rapidly by voluntary actions and national and international litigation rather than by coordinated action by various governments and implemented by individual nations.

None of these points is easily addressed, but they would help to provide a Austrian framework that may be useful to your readers. 

(4)  Finally, it is disappointing that you completely failed to take on any of your mainstream colleagues (such as those in Gregg Mankiw’s “Pigou Club”  http://en.wikipedia.org/wiki/Pigou_Club) who support either carbon taxes or cap and trade approaches. 

I understand that you’ve got a paper in the works addressing Nordhaus, but he’s hardly the only one writing specifically on climate change; I hope you will also be looking at Marty Weitzman at Harvard, Richard Tol and a few others noted here and here:

http://mises.org/Community/blogs/tokyotom/archive/2007/12/16/the-social-cost-of-ignoring-carbon.aspx
http://mises.org/Community/blogs/tokyotom/archive/2007/10/17/reason-congratulations-to-al-gore.aspx

Sincerely,

TT