Tag Archives: benefit-cost analysis

Underlying economics of polarization

Matthew Kahn, USC economics professor, writes about a new book, Why We’re Polarized,

Rising polarization is taking place because there is now a fundamental disagreement across our society concerning who has the property rights to different resources.

While Kahn is correct about property rights being at the core of the dispute, he glosses over the real issue by going off to discuss game theory and bargaining. That real issue is how different groups in society gained those property rights, whether its entitlement to jobs or use of natural resources or control of social mores. Much of these property rights were gained through coercion of some form, such as slavery, land grabs or paternalistic social structures. Resolving these requires agreeing first on basic societal morality and ethics, and then turning to how to resolve the redistribution of those rights, rather than just plunging straight into bargaining.

Commentary on the “The Road from Serfdom”

Danielle Allen writes eloquently in the December issue of the Atlantic Monthly in the “The Road from Serfdom” about how too many Americans rightfully feel disenfranchised today and many of the reasons why they feel that way. Her description of how we got here is well worth the read. However, she misattributes the roles of economists (and lawyers) and errors in their recent prognostications on how economic progress would unfold.

Allen blames much of the current economic woes on the rise of economists in policymaking. She talks about how economists superseded lawyers in that role, implying that lawyers were somehow better connected to society. The real transformation happened several decades earlier when lawyers took over from the broader set of general citizenry. Just as she identifies how economists (of which I am one) are trained to think in one fashion, lawyers are similarly taught to think in another way that tends to focus on identifying constraints and relying on precedent. Lawyers are also taught that the available solutions require directives through laws and contentious conflict resolution. Lawyers are rarely instructed in how actual institutions work, contrary to Allen’s assertion–lawyers usually learn that as on-the-job training. In fact, it is economists who developed institutional economics that studies the role of such organizations. Economists arrived to propose solutions that could work through incentives and choice and negotiated solutions. So we traded one set of technocrats for another set. Perhaps we have not done well by either set, but we also should not ignore why we chose those professions guide us.

The mistakes that economists made were not as simplistic as Allen describes. She points to a claim that economists did not understand how disruption would impact specific communities and what two decades of disruption would look like in those communities. As contrary examples, I wrote here about how climate change will impact communities, and about how we need to compensate coal mining communities as part of our reductions in greenhouse gas emissions, and even the shaky foundations of benefit-cost analysis.  Instead economists did not foresee two important transformations since the 1970s. (Economists made a similar mistake after the fall of the Berlin Wall, failing to acknowledge that markets need well functioning institutions and laws to facilitate beneficial transactions.)  The first was that agglomeration of knowledge industries (technological and financial) would be so geographically intensive and that these industries would accrue so much wealth. The second was that Americans would become so much less mobile, both geographically and socially. There are many social and policy factors that have led to these trends, but these stories are much more complex than Allen describes. No one could have foreseen these unprecedented changes that have shattered the lives of too many people that have remained behind in communities emptied of economic purpose.

That said, identifying the rise of the ideologies of Nobel Prize winners Friedrich Hayek and Milton Friedman (who were economists) as a key source of our conundrum is accurate. Allen does not discuss the parallel rise of the fantasies of Ayn Rand that fueled the mythologies of Hayek and Friedman. Rand’s work was a surprising path for spreading those ideologies, particularly given how bad her writing was. We now have a core of elites who believe that they somehow are “self made” with no outside help and even overcoming the “parasites” of society. That will be a difficult self image to overcome.

“Making the perfect the enemy of the better” for a carbon tax

In an opinion article published on Utility Dive, Kenneth Costello argues that adopting a carbon tax would be a mistake. As he says, “(i)nstead of a carbon tax, why not give more consideration to adaptive strategies, which can evolve over time in response to new information?” His arguments make several key errors and underestimate the political will required to deliver his preferred option.

We need not rely on the social cost of carbon (SCC) to set a tax. Instead of using a benefit-cost approach implied by the SCC, we can use a cost-effectiveness approach by setting the tax to achieve an expected amount of greenhouse gases reduction. This is really no different than how we conduct most of our private transactions–we don’t directly weigh the monetary benefits of buying a new car against its costs–we decide what type of car that we want and then spend the money to buy that car. We may not achieve the mythical “positive net benefits” using such a strategy, but the the truth is that benefit-cost analysis is problematic in the context of climate change, as Martin Weitzmann among others pointed out.

We have a good idea of how increased prices that would result from a carbon tax impact demand, contrary to Costello’s assertion. We have seen that over and over with changes in gasoline and electricity prices in the last half century. (One paper found that the early CAFE standards did not affect automobile fleet fuel economy until gas prices fell in 1984.) We can adaptively manage a carbon tax (which also can be implemented as a global trade tariff framework) to steer toward our emissions reduction target.

Costello instead proposes that we focus solely on climate adaptation by hardening our infrastructure and other measures. This illustrates a lack of understanding of the breadth of the expected impacts and the inability of a large segment of the world’s population to undertake such mitigation without a large wealth transfer. Further, such adaptation focuses largely on the direct impacts to humans and ignores the farther ranging ones on our global environment. Those latter effects, such as ocean acidification and melting of the tundra, can lead to catastrophic outcomes that cannot be readily adapted to, no matter what is spent. And there other effects that that we may not even know about. Focusing so narrowly on what might be adaptive strategies will lead to a gross underestimation of the costs to adapt.

Finally, Costello overestimates the political barriers to implementing and managing a carbon tax and overestimates the political will to implement adaptation strategies. Contrary to his assertion, environmental groups such as EDF and NRDC have been at the forefront of using prices and taxes to regulate environmental pollutants. (I have worked for several of them on such proposals.) Yes, politicians want to avoid taxes, but that reflects the more general problem of wanting to avoid any hard choices. And we only need to look at the state of the U.S. infrastructure to see how difficult it is to persuade the political system to make the investments that Costello recommends. This will be a tough road either way, but the carbon tax option cannot be simply dismissed based on Costello’s analysis.

 

Our responsibility to our children

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Greta Thunberg’s speech at the UN has sparked a discussion about our deeper responsibilities to our future generations. When we made the huge effort to fight World War II, did we ask “how much will this cost?” We face the same existential threat and should make the same commitment. We can do this cost effectively, and avoid making most stupid decisions, but asking whether this effort is worth it is now beyond question. We will have to consider how to compensate those who have invested their money or their livelihoods in activities that we now recognize as damaging to the climate, and that will be an added cost to the rest of us. (And we may see this as unfair.) But we really have no choice.

J. Frank Bullit posted on “Fox and Hounds” a sentiment that reflects the core of opposition to such actions:

What if the alarmists are wrong, yet there is no counter to the demands of enacting economic and energy policies we might regret?”

So our energy costs might be a bit more than it would have otherwise, but we get a cleaner environment in exchange. And even now, renewable energy sources are competing well on a dollar to dollar basis.

On the other hand, if the “alarmists” are correct, the consequences have a significant probability of being catastrophic to our civilization, as well as our environment. We all have insurance on our houses for events that we see as highly unlikely. We pay that extra cost on our house to gain assurance that we will recover our investments if such unlikely events occur. These are costs that we are willing to accept because we know that the “alarmists” have a point about the risks of house fires. We should be taking the same attitude towards climate change assessments. It’s not possible to prove that there is no risk, or even that the risk is tiny. And the data trends are sufficiently consistent with the forecasts to date that the probabilities weigh more towards a likelihood than not.

Unless opponents can show that the consequences of the alarmists being wrong are worse than the climate change threat, we have to act to mitigate that risk in much the same way as we do when we buy house insurance. (And by the way, we don’t have another “house” to move to…)

Helping policymakers with difficult decisions in deep uncertainty

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Severin Borenstein at UC Berkeley argues against the “try everything” approach to searching for solutions to mitigating greenhouse gas emissions. But he is confusing situations with relatively small incremental consequences (even the California WaterFix is “small” compared to potential climate change impacts.)

Instead, when facing a potentially large catastrophic outcome for which the probability distribution is completely unknown, we need a different analytic approach than a simple cost-benefit analysis based on an “expected” outcome.

We need to be looking for what decision pathways lead us to the situations create the most vulnerability, not for which one has the “optimal outcome.” Policymakers and stakeholders looking desperately for any solution intuitively get the notion of robust decisionmaking, but are not receiving much guidance about how to best pursue this alternative approach.  Economists need to lead the conversation that changes the current misleading perspective.

Paying off coal miners to improve the environment

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Finally, a real world example of how benefit-cost analysis should be used in practice. Alberta takes the revenues that represent a portion of the society wide benefits and distributes those to the losers from the policy change. Economists have almost always ignored the problem of how to compensate losers in changes in social policy, and of course those who keep losing increasingly oppose any more policies. Instead of dreaming up ways to invest carbon market revenues in whiz bang solutions, we first need to focus on who’s being left behind so they are not resentful, and become a key political impediment to doing the right thing.

Creative Pie Slicing To Address Climate Policy Opposition | Energy Institute at Haas

Severin Borenstein’s post raises an important issue that economists have ignore for too long. I posted the following comment there:

We gave politicians the tool of benefit-cost analysis which they have used to justify their policy objectives, but we completely failed to drive home the requirement that those parties who are on the losing end need to be compensated as well. I looked in my edition of Ned Gramlich’s book on Benefit-Cost Analysis (who taught my course), and the word “compensation” is not even in the index! Working on environmental regulations, I regularly see agency staff derive large positive ratios for the “general public” and then completely dismiss the concerns of particular groups that will be carrying all the burdens of delivering those benefits. If we’re going to teach benefit-cost analysis, we need to emphasize the “cost” side as much as the “benefit” that politicians love to extol.

Source: Creative Pie Slicing To Address Climate Policy Opposition |