Saturday, October 18, 2014

The Biggest Nonlinearity in the Short Run Cost of Mitigating Climate Change

David Roberts, bless ‘im, has another fine post in which he sums up a pair of recent journal articles that cast doubt on estimates of the cost of stabilizing greenhouse gas concentrations.  The two main points he emphasizes are both quite sensible.  First, long-term economic prognostication is a fool’s errand.  He highlights a telling quote from one study by Rosen and Guenther:
[G]iven all the uncertainties and variability in the economic results of the IAMs [integrated assessment models] … the claimed high degree of accuracy in GDP loss projections is highly implausible. After all, economists cannot usually forecast the GDP of a single country for one year into the future with such a high accuracy, never mind for the entire world for 50 years, or more.
Precisely.  Or as Keynes put it,
The sense in which I am using the term [uncertainty] is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth owners in the social system in 1970.  About these matters there is no scientific basis on which to form any calculable  probability whatever. (The General Theory, 1937)
The second point is that economies are complex interdependent systems whose interconnections can’t possibly be modeled by analysts who know only the world as it is now, not the world as it will become.  One disturbing factor, of course, will be climate change itself, which will likely have deep, and mostly impossible to foresee, effects on many aspects of the economy.  Similarly, different technological and institutional configurations of the future economy of the planet can’t be captured by models that consider them separately, or only in light of their market connections.

Now I’d like to add two further observations to the mix.  The first is that the long run economic costs of climate change mitigation, the ones that will show up over the course of 50 or 100 years, are really irrelevant.  The case for taking action doesn’t depend on them, and future people will have to figure out how to cope with them when the time comes.  It’s the short term costs, the ones that will make themselves known during the first years of serious policy implementation, that matter.  They matter for policy, because if we can anticipate them we can take actions to minimize their impact.  Crucially, they matter for political economy, since the opposition to action on climate change is ultimately about short run costs: who bears them and how big they are expected to be.

The second observation is that the biggest nonlinearity is hiding right under our nose: the potential for writing off a portion of the capital stock.  All existing models assume that capital goods are employed until they fully depreciate, with reduced productivity of the stock related smoothly to more rapid depreciation: if a change in relative prices means a unit of capital is a bit less productive, its lifespan will be a bit shorter.

This assumption rules out a fundamental nonlinearity: each unit of capital has a tipping point, a critical balance of revenues and operating costs that separates utilizing it from abandoning it.  Consider a simple example: an airplane.  A large passenger airplane is a significant piece of capital investment.  Its profitability depends on the cost of providing air travel and the willingness of travelers to pay for it.  If the cost of fossil fuel rises due to a carbon tax or cap, airline companies have to raise prices and cope with the resulting loss of demand.  This can mean somewhat fewer flights and more empty seats.  But there is a level of price increases at which the plane is simply taken out of service: it’s no longer profitable to operate it.  Indeed, an entire company may liquidate, going from a substantial capitalization to scrap.  There is almost certainly some fuel price that triggers this discontinuity, although we don’t necessarily know what it is in advance.  The same point likely holds for many investments in transportation, shipping, real estate and fuel-intensive manufacturing.

If this view is correct, economists should put research into the short run effects of fossil fuel prices on the capital stock into high gear.  The cumulative effect of such writeoffs will be macroeconomic disruption, which we can offset through policy if we can see it coming.  Above all, identifying the investments most at risk from climate policy will tell us more about the political barriers we face than a thousand surveys about public attitudes toward science.

For more on cost, see this post from The Road from Carbonville.


Thornton Hall said...

So this is exactly like an expensive cancer drug. Not much sense in figuring out how taking it now will affect my life in 50 years time.

But what, exactly, would I do with the knowledge that it will cost my insurance company $12,000 a month? I will take the drug. What if it bankrupts my insurance company? I will take the drug. What if that means insurance executives buy their mistresses condos in Brooklyn instead of Manhattan? In that case, I take the drug.

What are these policy changes? Every business venture is a gamble. Climate change is like a war, some companies will get rich and others will go bankrupt. Do we really need to have a conversation about job training for displaced refinery operators? Did we talk about job training for the tourism industry before entering WWII made them all redundant?

Thornton Hall said...

Other things that cause airlines to "prematurely" retire airplanes:

-Reaction to 9/11
-TSA Screening procedures
-Car fuel efficiency gains out pacing airplane gains.
-video conferencing
-New National Parks a short drive from population centers.

Why is climate change the one that allows Boeing to extract policy concessions from society?

john c. halasz said...

As usual, I have no idea what Thornton Hall is trying to say. All economists are bad and fraudulent, therefore there is no need to think about and try and understand economic matters?

IANAE but I've made the same points as Peter Dorman. But I'd like to call and raise him. Not only will capital stocks and infrastructure on both the energy producing and the energy consuming or using ends need to be written down (eventually to zero) faster than "normal" rates of depreciation, but 1) we need to make sure, as much as possible, that our remaining use of old energy and resources goes to building out a renewable, sustainable alternative system, within the available "budget", both in GHG and energy cliff terms, (since peak oil and gas in conventional terms has arrived), and 2) at the same time as a vast amount of investment must be written down, a vast amount of new investment in alternatives must be generated. I don't see how that would be possible without a good deal of public investment and indicative public planning, that is, without mobilizing the fiscal, regulatory and coordinating capacities of the state. said...

Being picky, I am not sure I see specific nonlinearities associated with capital depreciation induced by environmentally induced changes in relative prices. I think the bigger nonlinearities in the system remain those coming specifically from the ecological and environmental sides themselves.

Thornton Hall said...

Well, John C. Halaz, we are using different paradigms.

Peter Dorman said...

Barkley, shutting down a unit of capital is a local nonlinearity. It becomes global if the tipping points for individual units are clustered. It's like death. This is a nonlinear event for a single person (so to speak) but not for society -- unless the factors affecting mortality have a common tipping point for a sufficiently large portion of the population (like viral exposure in an epidemic).

The analogy to post-1989 E. Europe is useful here. I know you've written on this, but what I've seen of your work was concerned with systemic instability. I have in mind something much simpler: you couldn't cover your costs if you continued to produce goods that were suddenly unmarketable. There is a minimum price below which you won't even try to sell a Skoda. If the price falls below this you shut down. That's a local nonlinearity. But it's happening simultaneously in a large number of enterprises, so it becomes a nonlinearity for the economy overall.

john c. halasz said...

Brother, can you pair a dime?

Thornton Hall said...

Shutting down a unit of capital, like an airplane, right?

Ok, that can happen for lots of reasons, right?

If enough people stop flying *for any reason*, airlines eventually retire some of their fleet early, right?

On the same page?

Ok. Who cares *why* capital gets retired early? And why is there a distinction between reasons where some reasons require a policy response where as other reasons are simply "the market at work"?

I was making two points:
Who cares? The owners of capital. In other words, not the democratic majority.

Why make a distinction? Free market dogma.

Why does this dogma persist? Peter Dornan could tell us if he could perceive that it's dogma. But he can't.

john c. halasz said...