Saturday, June 3, 2017

The Cost of Climate Change: It’s Not About Psychology

You know there are problems with economics when things that are perfectly reasonable in the context of economic theory are clearly absurd once you step out of it.  Case in point: the claim in today’s New York Times piece by Neil Irwin that the economic cost of climate change vs the actions we’d need to mitigate it depends on “how, as a society, we count the value of time.”

In economics?  Yes.  The present value of climate and climate mitigation costs depends on the discount rate, the extent to which we devalue something a year from now because it’s a year away.  That’s how you do a cost-benefit analysis.  It really matters for climate policy because the costs tend to be upfront and the benefits decades or even centuries down the road.  Economists wrack their brains over how to select exactly the “right” discount rate to perform these calculations.

But think about it for a moment.  While there’s a “technical” aspect to time preference—investing today can result in measurable returns over time—the discount rate also depends on psychology: how present-oriented are we?  How much do we live in the here and now rather than looking down the road and preparing for tomorrow?  We all occupy different places on this classic grasshopper-ant continuum, and we usually shift our position over the course of our life cycle.  Yet how does this psychological characteristic, either individually or socially, affect the economic consequences of acting on climate change, or not?  It certainly affects the kinds of choices we’re likely to make, but the consequences?

The whole point of Aesop’s grasshopper-ant fable is that there’s a real world that both insects inhabit, with consequences that don’t depend on their psychology at a moment in time.  Grasshoppers are not better off because they follow the myopic dictates of their grasshopper brains.  This was obvious 2500 years ago, and it’s obvious today.  Economists’ obsession with identifying the “right” discount rate for cost-benefit calculations is a product of their own warped world (the logical and empirical craziness of welfare economics) and has nothing to do with rational decision-making about how to adapt to ecological constraints.

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5 comments: said...

But even in a benign socialist paradise, in evaluating competing policies, comparisons of the complicated differences between time paths will need to be made, and these efforts will inevitably involve something like discount rates. What is the alternative?

Peter Dorman said...

The alternative is to simply present the time profiles of costs and benefits for various courses of action. We might also find it convenient to agree on some rules for what constitutes an acceptable profile, like "you can't impose a substantial risk of destroying the world over a foreseeable time duration".

We don't need to be in a socialist paradise to analyze policy that way.

Incidentally, I learned about this in practice, doing CBA myself, figuring out how time profiles can be constructed and what their usefulness can be. said...

That may be the best response, if one is not going to do a NPV. But then one is reduced to a lot of handwaving, and there is always the problem that the further out one goes into the future, the less reliable are the projections of what will happen.

I also note that there is an odd business with regard even to the Stern Report in connection with discount rates. They make this 300 year projection and go out of their way to use a barely above zero discount rate so that what is happening 300 years out actually still has some noticeable present value today. But in fact the cutoff at 300 years is arbitrary and implies a sudden jump from a barely above zero discount rate to an infinite one. Or, alternatively, they are just saying "we do not know what will happen after 300 years," which may not be unreasonable.

Oh, and I have also done CBAs in practice, when I worked for the Wisconsin Department of Natural Resources in the mid-70s. Looked at ones done for alternative urban sewage treatment plant proposals.

Peter Dorman said...

The bottom line, Barkley, is that economists don't need to issue a final judgment about what to do about climate change. Their job is to provide the clearest, most accurate and most illuminating input possible on the economic consequences over a foreseeable time horizon. There are many other aspects that ought to be considered as well -- public health, ecological, ethical/philosophical and so on. Economists should do their job as best they can and let the others do theirs. Then a political process determines what gets done -- as it always does.

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