Citigroup climate risk study part 2 – stranded assets

The CitiGPS study makes a unique contribution to the climate change risk literature: reducing GHG emissions will lead to stranded investment assets. These assets include both fossil fuel holdings and the equipment that uses those fuels. Protecting those investments is at the heart of much of the resistance to addressing climate change risk.  Removing political barriers is probably the single greatest difficultly in moving to implement policies to mitigate this risk; many policy proposals are at the ready so there’s no lack there. Given the apparent urgency of acting, perhaps it’s time to ask the question whether these asset owners should be compensated by those who will benefit directly, i.e., the rest of us? 

What’s behind the reluctance of political actors to propose this type of solution is the belief in the underlying premise of benefit-cost analysis. Economists have unfortunately perpetuated a misconception on the public that so long as total societal benefits exceed costs, a policy is justified even if those suffering those costs are not compensated for their losses. The basis of this is the Kaldor-Hicks efficiency criterion. In contrast, market transactions are presumed to only occur if both parties gain through Pareto efficiency--one party fully compensates the other one for the transaction. Public policy now casts aside this compensation requirement. Unfortunately this leads to significant redistribution impacts that are too often left unexamined. And of course, the losers resist these policies, with a ferocity that is accentuated by both loss aversion (where potential losses are felt more strongly than gains) and that these losses are usually concentrated among a smaller group of individuals than the spread of the benefits.

Too often public agencies are running over these interests to push for societal benefits without compensating the losers. A recent example that I was involved with was the adoption by the California Air Resources Board of the in-use off-road diesel engine regulations. CARB mandated the premature scrappage of construction equipment that had been purchased to comply with previous regulatory mandates from CARB and the US EPA. CARB claimed societal air quality benefits of $13 billion at the cost of $3 billion to the construction industry. Yet CARB never proposed to pay the owners of the equipment for their lost investments. GHG regulation is proceeding down the same path.

If the benefits truly justify adopting a policy, and GHG reductions certainly appear to meet that criterion, then society should be willing to compensate those who made investments under the previous policy environment that endorsed those investments. Certainly there’s questions about whether those investors truly had property rights in the resources they used, but that issue should be addressed directly, not as an implicit assumption that no such property rights ever existed. (This question about property rights has been raised in regulating California’s water use.) Too often policy proponents conflate a goal of an improved environment with goals to redistribute wealth. By jumping over the property rights question, wealth also can be redistributed implicitly. Societal equity issues are important, but they shouldn’t be achieved through backdoor measures that make all of us worse off. Requiring politicians and bureaucrats to consider the actual cost of their policy proposals will make us all better off, and maybe even remove obstacles to a better environment.

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2 thoughts on “Citigroup climate risk study part 2 – stranded assets

  1. Pingback: Reblog: Leaking Coal to Asia | Economics Outside the Cube

  2. mcubedecon Post author

    Here’s an example from RFF of a discussion about applying benefit-cost analysis to climate change policy that relies on the standard underlying premise that those who lose need not be compensated. In this case, it’s that the rest of the world need not compensate the U.S. for the costs of the Clean Power Plan even though the net benefits are a negative $6 billion for the US, but a positive $30+ billion for the world.
    http://www.rff.org/blog/2015/global-benefit-cost-analysis-us-climate-policy-heresy-or-evolutionary-logic

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