William Nordhaus has long relied on traditional economic cost-benefit analysis to minimize the costs to the world economy from potential climate change impacts. This article discusses how he now views the increasing risk, the continuing uncertainty, and the likely increasing costs from delayed responses as driving the need for a more rapid effort.
From the current issue of American Economics Review:
Robust Social Decisions: We propose and operationalize normative principles to guide social decisions when individuals potentially have imprecise and heterogeneous beliefs, in addition to conflicting tastes or interests. To do so, we adapt the standard Pareto principle to those preference comparisons that are robust to belief imprecision and characterize social preferences that respect this robust principle. [This paper focused on decisions related to climate change.]
Beyond GDP? Welfare across Countries and Time: We propose a summary statistic for the economic well-being of people in a country. Our measure incorporates consumption, leisure, mortality, and inequality, first for a narrow set of countries using detailed micro data, and then more broadly using multi-country datasets. While welfare is highly correlated with GDP per capita, deviations are often large. Western Europe looks considerably closer to the United States, emerging Asia has not caught up as much, and many developing countries are further behind. Each component we introduce plays a significant role in accounting for these differences, with mortality being most important.
(W)hat proportion of consumption in the United States, given the US values of leisure, mortality, and inequality, would deliver the same expected utility as the values in France? In our results, lower mortality, lower inequality, and higher leisure each add roughly 10 percentage points to French welfare in terms of equivalent consumption. Rather than looking like 60 percent of the US value, as it does based solely in consumption, France ends up with consumption-equivalent welfare equal to 92 percent of that in the United States.
(i) GDP per person is an informative indicator of welfare across a broad range of countries: the two measures have a correlation of 0.98. Nevertheless, there are economically important differences between GDP per person and consumption-equivalent welfare. Across our 13 countries, the median deviation is around 35 percent—so disparities like we see in France are quite common.
(ii) Average Western European living standards appear much closer to those in the United States (around 85 percent for welfare versus 67 percent for income) when we take into account Europe’s longer life expectancy, additional leisure time, and lower inequality.
(iii) Most developing countries—including much of sub-Saharan Africa, Latin America, southern Asia, and China—are substantially poorer than incomes suggest because of a combination of shorter lives and extreme inequality. Lower life expectancy reduces welfare by 15 to 50 percent in the developing countries we examine. Combined with the previous finding, the upshot is that, across countries, welfare inequality appears even greater than income inequality.
(iv) Growth rates are typically revised upward, with welfare growth averaging 3.1 percent between the 1980s and the mid-2000s versus income growth of 2.1 percent. A boost from rising life expectancy of more than a percentage point shows up throughout the world, with the notable exception of sub-Saharan Africa. When welfare grows 3 percent instead of 2 percent per year, living standards double in 24 years instead of 36 years; over a century, this leads to a 20-fold increase rather than a 7-fold increase.
Bailouts, Time Inconsistency, and Optimal Regulation: A Macroeconomic View: A common view is that bailouts of firms by governments are needed to cure inefficiencies in private markets. We propose an alternative view: even when private markets are efficient, costly bankruptcies will occur and benevolent governments without commitment will
bail out firms to avoid bankruptcy costs. Bailouts then introduce inefficiencies where none had existed. Although granting the government orderly resolution powers which allow it to rewrite private contracts improves on bailout outcomes, regulating leverage and taxing size is needed to achieve the relevant constrained efficient outcome, the sustainably efficient outcome.
Long-Run Risk Is the Worst-Case Scenario: We study an investor who is unsure of the dynamics of the economy. Not only are parameters unknown, but the investor does not even know what order model to estimate. She estimates her consumption process nonparametrically…and prices assets using a pessimistic model that minimizes lifetime utility subject to a constraint on statistical plausibility…[A] way of interpreting our results is that they say that what people fear most, and what makes them averse to investing in equities, is that growth rates or asset returns are going to be persistently lower over the rest of their lives than they have been on average in the past.
An interesting discussion about the failures and lessons for broad scale retraining programs.
My own thought is that we need to buy out the homes of displaced workers at the higher of either their purchase cost or the assessed value to facilitate moving to a new job location.
For example, most condemned what they called “crony capitalism,” by which they mean big corporations getting sweetheart deals from the government because of lobbying and campaign contributions…The more conversations I had, the more I understood the connection between their view of “crony capitalism” and their dislike of government. They don’t oppose government per se. …Rather, they see government as the vehicle for big corporations and Wall Street to exert their power in ways that hurt the little guy. They call themselves Republicans but many of the inhabitants of America’s heartland are populists in the tradition of William Jennings Bryan.
I actually think Donald Trump is really an embodiment of blue-collar frustration with what are really a bipartisan elite consensus on a number of issues that Republicans and Democrats in Washington agree on. One is free trade, and you see Donald Trump and Bernie Sanders taking similar positions there reflecting frustration. Another is immigration, where Donald Trump is an ardent opponent of letting more immigrants into the country. And I think you see the far left and the far right coming together on that issue. And so Barack Obama is certainly an embodiment of elite Washington opinion, but it’s really, I think, frustration among the grassroots of both parties about issues, really, that Republicans and Democrats agree on and where they feel they are not getting a hearing.
The first question is what is at the heart of the frustration among the white middle-class that is at the core of the Tea Party, and support for Donald Trump. Essentially the white middle class sees that the social compact that guaranteed a comfortable life style with little uncertainty by simply working steadily has come apart. The Great Recession accelerated a trend that was already gaining steam as unemployment and underemployment for older white men increased. Job security for a group that historically has enjoyed the greatest job security is disappearing. And they’re angry about it.
The next question is what is at the core of this trend. First a digression into what we do for “work.” Typically we can divide up what we work on into three areas: making things used by other people, directly serving people, and creating ideas and concepts that people can enjoy or use in the other two work areas. There are physical limits on the value that any one worker can create either in manufacturing or in services. A factory worker can produce only one car at a time and a consumer can buy and use only one car. A coffee barista can serve only one customer at a time, who in turn can only drink one coffee at a time. Nobel Prize winner William Baumol identified this “cost disease” 50 years ago, but he was focused only on services versus manufacturing. He observed that technology could help the factory worker make a car faster, but it wouldn’t be much help for a coffee barista. But he hadn’t considered the role of workers who create ideas and concepts, simply because this wasn’t a big part of the economy then.
With the advent of computers and the Internet, along with other mass media, it’s now possible for a “worker” such as an entertainer, an athlete, an investment banker, or an app programmer, to create a “product” that can be consumed by millions with no limitations on how many can buy and use that product at one time. Distribution of the product is now almost costless. As a result, a single worker can create huge amounts of economic value single-handedly. That’s not the case with either manufacturing or services. The workers in the ideas and concepts industries can now command extraordinary salaries. Bay Area tech workers are earning an average of $176,275!
Who are these tech workers? Not older white middle class men with a high school education or less. Instead economic value is accruing to the younger, college educated (particularly in STEM fields) and the “middle class” is disappearing. The supporters of the populist causes and the demagogues who exploit those opportunities are those being left behind by this radical transformation of the economy.
The same thing happened at the turn of the twentieth century as the nation moved from an agrarian economy with a 38% of its population on the farm to an industrial powerhouse. William Jennings Bryant thrice ran for President as a populist, in his time railing against the gold standard and calling for “free silver.” His supporters were the farmers being left behind by rapid economic change.
As was the case then, the older dominant labor force working in traditional, stable industries today are not well equipped to adapt to the coming of disruptive changes. They have been extolled as the core of a virtuous workforce, as was the case with farmers then, so they have become part of the American pantheon. Just watch any pickup truck commercial. They understood the social compact as putting in a 40-hour week being sufficient to deliver a comfortable lifestyle. These workers understood that they wouldn’t have to change their careers or learn new skills to live the “American dream.” Unfortunately, that was a false promise. (We can’t really expect that everyone should understand how the economy works–at least not without major changes in our education and media systems.)
Now they look for “easy solutions” of the type long offered by politicians, and they are not disappointed by the offerings. Blocking immigration, imposing trade restrictions, and creating opportunity are all buzz word solutions without real substance or a likelihood for success in solving their problems (and may make the problems worse.)
The change a century ago led to economic benefits that few would dispute improved the well-being of most Americans; we would not have wanted to freeze the proportion of the U.S. economy devoted to agriculture. The final question then is what should be the appropriate policy responses to mitigate these harsh effects on a group that long enjoyed a favorable position in our economy while allowing for another beneficial economic transformation?
A post by Tim Brennan at RFF on the uncertain foundations of benefit-cost analysis. (Another RFF post explores the question of whether policies should influence preferences.) The bottom line: that we can’t rely on a cut-and-dried economic analysis to define the “most efficient” policy action.
His conclusion is that we need to turn back to policymakers to decide, rather than relying on the “high priests” of economists:
The best alternative may be to use a fair and open democratic process to choose those who would change (or ignore) revealed preferences. This sounds more radical than it is; we do it all the time. We elect officials who directly or indirectly make choices according to noneconomic values based on ethical rights or distributive justice. Moreover, we also cannot forget that though economics takes preferences as given, they have to come from somewhere. Manipulating preferences is already part of public policy, most notably using education to inculcate preferences to be good citizens as well as to acquire useful skills. Although the puzzles mentioned here are real, we may not have the choice to ignore them, much as we might prefer to do so.
Maximillian Auffhammer at UC’s Energy Institute @ Haas focuses on the issue of exporting coal from the Port of Oakland, but he turns to the issue I highlighted recently–the path to accomplishing environmental objectives should travel through compensating those who are worse off from such policies.
Source: Leaking Coal to Asia
Matthew Kahn at UCLA lists his research addressing why voters and politicians in low-energy cost / high-carbon emitting areas oppose GHG reduction policies. He shows how protecting the status quo is in their interests, including for lower-income suburban dwellers. Proponents of climate change policies should consider how to compensate the range of “losers” from adopting these policies. Using carbon tax revenues to offset other taxes or as income-based rebates is one type of solution. I’ve pointed out previously that ignoring the need to compensate those who have reduced welfare from a policy choice both improves economic efficiency and reduces political opposition.