Tuesday, June 17, 2008

The Common Sense Economics of Global Warming

Short-term v. Long-Term

The review (by Freeman Dyson, a physicist) of A Question of Balance by leading economist Bill Nordhaus in the New York Revew of Books is quite good for those wanting to know about the economics of global warming. Nordhaus creates a model to show the various costs of the various proposals to mitigate any negative effects global warming might have on future generations.

The proposals under consideration are the 1) do nothing proposal, 2) the optimal proposal based on the Kyoto Protocol - eg a worldwide tax on carbon emmissions to give the greatest net present value economic return, 3) the Stern proposal - based on the economic methodology used in the Stern Report and 4) the Gore proposal which calls for drastic phased-in cuts in emmissions with a 90% cut by 2050. Number 5) is what Nordhaus calls the 'low cost technology backstop' which is what some economists might call the Schumpeterian model, eg that human innovation and profit-seeking will create technologies which will reduce the cost of producing things with a lower carbon footprint.

The winner, of course, is number 2) - that is why it is called 'optimal'. Nordhuas shows that by adjusting policy as time goes on the net gain is $3 trillion current dollars. But this proposal means US participation in the Kyoto Protocol. This of course is tbd, to be determined. And this alternative, like most long-term predictions, leaves much to be desired as the future is by defintion unpredictable. Additionally, and this might be pedantic, it is tautological. Of course it is optimal, it is adjusted to be optimal.

This brings us to the 'second best' solution, oftentimes the one used most in economics, number 5). This in economic lingo is the Schumpeterian approach, where economic incentives create human innovation to reduce costs. Pollution is costly in production, it spews energy instead of capturing it for use. Dyson is somewhat sceptical of this proposal, but as we learn from the new Japanese fuel cell cars, the Schumpeterian dynamics continue without sceptics.

These new cars don't use fossil fuels and don't pollute carbon, the cause of much of our global warming. (Workers' take is a little more radical than the mainstream, and asks, why is global warming bad? Is not change part of who we are as living evolving organisms living on an evolving, changing planet? Has this not been our condition since the beginning of time? And if so - yes it is so - why is change something to be feared and to be mitigated against?) And Kudos to Honda for making these cars available at below cost, they want to encourage the creation of an infrastructure for hydrogen distribution. Some might call this dumping, others doing well by doing good.

The point is is that policy does not drive human behaviour, it is behaviour that drives policy, and policy merely tries to keep up with behaviour, oftentimes with negative unintended consequences. Note that the new Hondas (and if fuel cells are used in cars today why can they not be used in ALL energy creation tommorrow?) are not at all ethanol-based, the policy that governments are driving towards, with the unintended consequences of escalating food prices for some of the world's poor.