Why is the conventional wisdom of climate economics so pessimistic?
Cross-posted from Real Climate Economics.
The House Committee on Science, Space, and Technology held a hearing yesterday on climate change science, economics, and policy. It was fascinating to listen to, and will no doubt provide much rich food for thought and discussion (for starters see Andy Revkin, or Chris Mooney, or Steve McIntyre for a skeptic’s view). The witnesses included two climate scientists (Kerry Emmanuel and John Christy), a physicist turned climate researcher (Richard Muller), a corporate lawyer (Peter Glaser), a business school expert on forecasting (J. Scott Armstrong), and a respected economist (David Montgomery). Several of the witnesses are quite well known, and each is worth a story, or several. However, I will focus here only on Montgomery and his testimony.
Montgomery, now an independent consultant, was one of the principals for many years of Charles River Associates (CRA), an economics consultancy that is generally business friendly; he is frequently published in the peer reviewed literature, and has taught at prestigious universities. He and some of his former colleagues at CRA specialize in climate-economy models, and have consistently produced policy analyses that are relatively pessimistic about the economic costs and benefits of GHG mitigation. His testimony yesterday [PDF] did not focus on his own modeling results but essentially suggested — by criticizing more optimistic studies in various ways — that any direct regulation of CO2 emissions by the EPA could only be economically harmful. He in fact relied more on economic theory and historical example than on specific modeling results in making his arguments. As a consequence a rebuttal is necessarily an exercise in describing and criticizing the theoretical and empirical assumptions he makes.
Such an effort requires more than a few hours of a busy junior professor’s evening. However, having prepared for the hearing by reading his previous testimony, listened carefully to what he said, and then read his more detailed written testimony, I can’t resist getting started. It’s an interesting challenge because he is such an excellent defender of the conventional wisdom. And the conventional wisdom of environmental economics is eminently reasonable sounding as it clearly lays out the reasons why we can’t afford to prevent potentially catastrophic climate change.
First, it’s important to recognize that conventional climate economics (which I consider a specialized subset of environmental economics) has an enormously powerful array of tools to bring to bear on the questions of climate policy. For example, conventional analysis can incorporate any of a wide range of estimates of the magnitude of avoided climate damages; that is, a range of estimates of the size externality from current emissions. Similarly, varying principles of equity can be incorporated by (for example) using different ways of calculating the declining marginal utility of income, or by varying the pure rate of time preference (one of the components of the discount rate for future costs and benefits). More broadly, the same theoretical framework can support quite different empirical and normative judgments. Those of us who share a substantial fraction of Montgomery’s assumptions, but reach different conclusions, have both an opportunity and an obligation to show which assumptions we make differently.
Before this tale is ultimately finished (and I expect it to take several chapters), I am going to have to discuss, among other topics, Montgomery’s views of the potential harm from climate change, his beliefs about technological change, and his perspective on international relations, because all enter into his chain of argument. I want to start with two modest points, however; one concerning the relationship between output and welfare, and one concerning the consideration that nations should give to the welfare of other nations’ citizens.
First, Montgomery holds two beliefs that are in tension: one, that capital and labor markets are “efficient” and can be assumed to be generally at equilibrium at times of “normal” economic growth (that is, profits are being maximized and labor is receiving its marginal product), and two, that there is an unpriced externality to GHG emissions. He claims that since investment in pollution regulation MUST have lower private returns than available alternatives (otherwise it would be done already by rational firms), therefore labor productivity, total wages, and total economic output must all fall if the quantity of allowable emissions is reduced by regulatory fiat. However, if there is any externality at all, by definition social welfare can be improved by internalizing it. This will lead to a drop in output in the industries affected, and to a drop in the wages and profits in that industry, but again, overall welfare — something that includes, but is not limited, to economic output (GDP), will go up. On average, workers and everyone else will be better off. (Of course one could err by going too far, but Montgomery’s theoretical framework makes this a contingent, not necessary, error.) How those gains are distributed is another question, of course. But those gains can be real and potentially significant, especially if one considers other co-benefits of emissions reductions. (Note of course that if the externality was one — like health impacts — that directly impacts economic production, both economic output and total welfare could increase.)
Second, Montgomery assumes that nations do in fact — and normatively should — balance their own economic costs of emissions reductions against only their own benefits from avoided damages, not global damages. He describes this as an appropriate empirical characterization of what countries do, and normatively justifies it on the basis that if that’s what a country expects other countries to do, it would be useless and thus normatively unwarranted to do otherwise. This is importing game theoretical reasoning, and ignoring the possibility that other normative reasons to want to act justly or virtuously might be warranted. Crucially, however, the basic theoretical framework makes it perfectly possible for a nation to incorporate the well being of non-citizens into its own domestic welfare function, and whether to do so or not is a choice, not a fact. The importance of course is that if one believes — as Montgomery apparently does — that countries cannot be persuaded to empathically value the well being of those harmed by their pollution, then pessimism about global cooperation is inevitable. However, some level of other-concern is plainly evident; what role it may yet play remains an open question, but it a place where one might find some possibility of hope.
There is much more to be said on both of these topics, to say nothing of the details of Montgomery’s critiques of input-output models. I hope to continue this exposition shortly. Meanwhile, I encourage my colleagues to look at Montgomery’s testimony, and to consider how we ought to respond to those who, while otherwise sympathetic to the arguments for strong emissions reductions, find his smooth talk about the futility of climate policy and its potential harm to the economy to be fairly persuasive, or even just plausible enough to justify delaying strong mitigation action.