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Krugman almost gets ‘Economics of Catastrophe’

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"Krugman almost gets ‘Economics of Catastrophe’"

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Paul Krugman has a blog post about one of my favorite economists, Marty Weitzman. He has the central point right, which is that “on any sort of expected-welfare calculation, the small probability of catastrophe dominates the expected loss.”

But Krugman’s general lack of understanding of global warming — and his willingness to believe anything Bj¸rn Lomborg says — undermines his entire analysis:

Bjorn Lomborg … says that climate change will reduce world GDP by less than 0.5%, so it’s not worth spending a lot on mitigation.

Weitzman’s point is, first, that we don’t actually know that: a small loss may be the most likely outcome given what we know now, but there’s some chance that things will be much worse. (Marty surveys the existing climate models, and suggests that they give about a 1% probability to truly catastrophic change, say a 20-degree centigrade rise in average temperature.)

… Suppose that there’s a 99% chance that Lomborg is right, but a 1% chance that catastrophic climate change will reduce world GDP by 90%. You might be tempted to disregard that small chance — but if you’re even moderately risk averse (say, relative risk aversion of 2 — econowonks know what I mean), you quickly find that the expected loss of welfare isn’t 0.5% of GDP, it’s 10% or more of GDP.

Well, ‘yes’, on the final point, but ‘no’ on every other point.

Indeed, a 20°C rise in average global temperature — which translates to perhaps 50°F warming over much of the inland U.S. — is “James Lovelock” territory where “the Earth’s population will be culled from today’s 6.6 billion to as few as 500 million.” Catastrophic climate change is anything significantly over 3°C, which is not a 1% chance, but a near certainty if we don’t reverse greenhouse gas emissions sharply and soon (see “Is 450 ppm politically possible? Part 0: The alternative is humanity’s self-destruction“).

Lomborg, of course, does not have anywhere near a 99% chance of being right that “climate change will reduce world GDP by less than 0.5%.” Indeed, if we actually followed Lomborg’s do-nothing prescription, then he has precisely a zero chance of being right. He is a pure disinformer (see “Lomborg skewers the facts, again” and “Debunking Bj¸rn Lomborg — Part III, He’s a Real Nowhere Man“).

Weitzman’s analysis is, however, very important for traditionally economists — and everyone else — to understand, so let me reprint my September post, Harvard economist disses most climate cost-benefit analyses, below:

Harvard economist Martin Weitzman has a new paper in which he points out that the vast majority of conventional economic analyses of climate change should carry the following label:

“WARNING: to be used ONLY for cost-benefit analysis of non-extreme climate change possibilities. NOT INTENDED to cover welfare evaluation of extreme tail possibilities, for which a complete accounting might produce ARBITRARILY DIFFERENT welfare outcomes.

In short, if you don’t factor in plausible worst-case scenarios — and the vast majority of economic analyses don’t (this means you, William Nordhaus, and you, too, Bj¸rn Lomborg) — your analysis is useless. Pretty strong stuff for a Harvard economist!

fat-tail.gifThe extreme or fat tail of the damage function (click on figure at right) represents what Weitzman calls “rare climate disasters,” although as we’ll see, they probably aren’t that rare. For Weitzman, disaster is a temperature change of > 6°C (11°F) in a century, as he explains in an earlier paper on the Stern Review on the economics of climate change:

With roughly 3% IPCC-4 probability, we will “consume” a terra incognita biosphere within a hundred years whose mass species extinctions, radical alterations of natural environments, and other extreme outdoor consequences of a different planet will have been triggered by a geologically-instantaneous temperature change that is signi…cantly larger than what separates us now from past ice ages.

Weitzman says the IPCC Fourth Assessment gives the probability of such an “extreme” temperature change as 3%, and that “to ignore or suppress the signi…cance of rare tail disasters is to ignore or suppress what economic theory is telling us loudly and clearly is potentially the most important part of the analysis” — more important than the discount rate.

For me, what is especially alarming about Weitzman’s analysis is that I have argued there is far greater chance than 3% that we will have a total warming of 6°C or more in a century or so if we don’t reverse emissions trends soon. That’s because failure to act quickly means carbon cycle feedbacks will kick in by mid-century, escalating greenhouse gas concentrations and temperatures well beyond standard IPCC projections. Put another way, if we don’t stabilize below 500 ppm of carbon dioxide emissions (we are at 380 today and were at 280 pre-industrial), we will probably soar to at least 800 ppm in a century, if not 1000 ppm or more. Losing either the permafrost or the Amazon are sufficient to take us to 1000.

Weitzman’s paper “Structural Uncertainty and the Value of Statistical Life in the Economics of Catastrophic Climate Change,” is not for the general reader. His discussion of the Stern Review, however, covers many of the same points and is, I think, accessible to anyone who took an economics class or two in college, especially if first you read John Quiggin (here and here).

It is worth noting that while Weitzman is critical of how Stern chose the key discount rate parameters, he still thinks that Stern is mostly right for the “wrong reasons” — because the “the implications of large consequences with small probabilities” — like the many scenarios of catastrophic climate change (ice sheet instability, tundra melting) — matter more than the choice of discount rate.

That said, the mainstream economic policy think tank — Resources for the Future (RFF) — wrote a major report, “An Even Sterner Review,” that concluded, “we find no strong objections to the discounting assumptions adopted in the Stern Review” (a point I have made, also, based on Quiggin). It also concluded Stern could have used “rising relative prices” from future scarcity to get the same result. The RFF report pointed out:

If we were to combine the low discount rates in the Stern Review with rising relative prices, the conclusions would favor even higher levels of abatement. This would in fact lead us to consider some of the levels of carbon content that Stern deems unrealistic, that is, aiming for a target of less than 450 ppm CO2 equivalents.

Now what I would like to see is a cost-benefit analysis combining a moderate discount rate with RFF’s rising relative prices AND Weitzman’s “extreme climate change possibilities.”

I’m sure that such a comprehensive economic analysis would vindicate Stern again and drive us toward a target of 450 ppm or lower — which means we must peak in global emissions by 2020. The time to act is now. Economics demands it.

UPDATE: Let me be clear that a 3°C to 4°C total warming from preindustrial levels — which takes us to the same temperature the planet had the last time sea levels were 80 feet higher — would be an unmitigated catastrophe for the planet — that is Hansen’s point. My point in this post is just that if we get that warm, the feedbacks will probably take us to 6°C warming a few decades later.

UPDATE2: Weitzman has toned down the piece in his next draft, so you won’t see his strong warning. Oh well. I guess I’ll have to dis Lomborg and Nordhaus myself! Stay tuned.

Hat tip out to Mark Shapiro.

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13 Responses to Krugman almost gets ‘Economics of Catastrophe’

  1. Lamont says:

    100 million of the worlds poor dying of hunger, starvation, flooding, etc over the course of a decade or two would have a fairly negligible impact on global GDP.

    I’m not sure I agree with the measuring stick which is being used here.

  2. Andy says:

    80′ higher? I think that is 80m higher or about 270′. Goodbye Florida and Louisiana and Texas is going to come out of that a hell of a lot smaller. Illinois will have ocean front property. A paper was just published that found such temperatures totally take out the Antarctic Ice Sheet.

    http://earthobservatory.nasa.gov/Newsroom/MediaAlerts/2008/2008072827309.html

  3. Paul K says:

    Joe,
    Good to see a more scholarly post. Weitzman’s paper is 35 pages long. It’s not that tough a read if you have a dictionary and take notes. So far I’ve read the abstract and the conclusions. Paragraph two of the conclusions is especially cogent.

  4. Peter Wood says:

    Weitzman’s paper is a very important contribution.

    Unfortunately some of the low-probability high-impact catastrophes are not so low-probability anymore. If we think of the IPCC AR4 version of the science as a “prior” distribution of the costs, and the latest science as a “posterior” distribution of the costs, then in my opinion the posterior distribution is in the dangerous tail of the prior distribution. This is what I would call a “Bayesian” way of thinking about the problem.

  5. Carol says:

    Are you sure that Krugman is “willing to believe” Lomborg, or was he using Lomborg’s figures to show that even non-denying deniers really are miscalculating the effect of global warming? That was how I read it.

  6. tidal says:

    For those that want some more on Weitzman, this is a repost of something I contributed earlier over @ env-econ.net.

    Weitzman’s paper is seminal, with major implications for policy in the near future. I am surprised it doesn’t get more interest when you blog about it.

    Weitzman does an excellent job of presenting his concepts in the video of this conference: Rethinking Climate Policy. The video “controls” are sometimes rather uncooperative, but you should be able to skip ahead to Weitzman’s presentation directly (@ 2:13:19). His main presentation gets cut off due to time constraints, but then in the Q&A later (@ 3:03:18), it’s almost all Weitzman and he continues to elaborate. Rather passionately as well, which is refreshing. Highly recommend those two video clips.

    And whilst I am ad-hoc reviewing, I thought that much of the closing remarks by Schelling were out-of-touch and embarrassing.

    The video is from an AEI-Brookings joint seminar on the topic. As Weitzman states in his initial remarks, if you really want to “get” his paper, you should read it, but his commentary does a very good job of cutting to the key issues. Again, I recommend the Q&A.

    Joe notes that Weitzman appears to have “toned down” the final paper from earlier drafts. What the reason for that is, I am not sure. For what it is worth, I am going to include some commentary that used to be in the introduction to the drafts of this final paper:
    At least potentially, the influence on cost-benefit analysis of fat-tailed structural uncertainty about climate change, coupled with great unsureness about high-temperature damages, can outweigh the influence of discounting or anything else… (1) because of deep structural uncertainty about the prospects for disastrously large temperature changes, there is a strong prima facie case that the relevant probability density function (PDF) of climate change catastrophes has an extreme tail that is heavy with probability; (2) when these heavy tails are combined with very unsure high-temperature damages, this aspect can dominate the discounting aspect in calculations of expected present discounted utility (even at empirically plausible realworld interest rates); (3) all of this translates into placing severe limitations on the reliability of policy advice coming from standard cost-benefit analysis (CBA) of climate change; (4) the conventional climatechange policy ramp is an extreme lower bound on what is reasonable rather than a best estimate of what is reasonable;
    (5) removing the artificial limitations on conventional CBAs that comes from excluding veryhighimpact disasters is capable of shifting a more inclusive economicwelfare analysis strongly away from the gradualism of a climatechange policy ramp.”
    (By the way, in trying to relocate that quote, I stumbled on this rather good, succinct summary of Weitzman’s draft which was submitted to the Garnaut review here.

  7. Dano says:

    I read the piece how Carol read it.

    Nonetheless, Joe’s

    For me, what is especially alarming about Weitzman’s analysis is that I have argued there is far greater chance than 3% that we will have a total warming of 6°C or more in a century or so if we don’t reverse emissions trends soon

    is cogent, IMHO.

    I personally think the likelihood of 3+ degrees is around 50%.

    Of course, there is no precedent for these temps so this will flip not only ecosystems but human societal systems. I suspect the cost will be far, far, far more than .5% of GDP. Of course, ecologists have been saying this for years but our discipline doesn’t distill into a 2-paragraph blurb for popular consumption.

    Best,

    D

  8. Dano says:

    And to build on Tidal’s implicit point, what kind of morality do we promulgate that we are willing to risk hundreds of millions of lives by negating the non-negligible risk?

    Can you imagine an actuary at, say, Swiss Re who neglects a 1% risk for a $10B investment? How quickly would they be shown the door?

    Best,

    D

  9. David B. Benson says:

    As I understand the climatology principles which go in the reasoning that

    3 K leads irreversibly to 6 K

    this process would take a long time, not just a few decades but many centuries, possibly even many millennia.

    Still, all of it needs to be avoided.

  10. Lamont says:

    +20C is just a stupid number.

    The swing between hothouse and icehouse Earth climates is only about 10C, which is the most which is likely reasonable to talk about. You might as well discuss the possibility of a +5000C climate change. Against that number a +3C swing in climate seems pretty reasonable, doesn’t it? +3C is only 0.06% of the way to turning the Earth’s surface into a plasma gas (which would really knock back the ol’ global GDP).

  11. David B. Benson says:

    I’ve read, quickly, just once, Martin Weitzman’s paper.

    So I’ll point out that even a 1% chance is much, much, much too large to ignore.

    His Dismal Theorem is deeply dismal.

  12. danny bloom says:

    Why isn’t anyone here at all discussing, even in theory only, the possibility that we might need lifeboats, polar cities, Lovelock Retreats, to house survivors of global warming disaster events in 2500 or so? Is the idea of adaptation so far fetched that nobody wants to talk about it? Just as a what if scenario?

  13. David Lewis says:

    I tried posting a critique of Krugman’s “Economics of Catastophe’ column on his blog. He won’t put it up. Its moderated for abuse, it says, but he seems to be moderating to make sure he doesn’t look bad.

    I compared his reasoning to someone who says well, there is Bozo who says there is a layer of clowns in the atmosphere called the bozone layer etc, and then there is Weitzman, as if they were two poles in a debate. I said Lomborg, in terms an economist might understand, is saying all the Nobel Prize winning economists of the last twenty years don’t have one clue, listen to me, I’ll tell you about economics – I said that’s how Lomborg looks to anyone who knows climate science.

    Anyway, its a good thing Krugman is writing about Weitzman, even if he had to package it up adding a shred of legitimacy to Lomborg. At some point we can expect Krugman to actually look a bit harder at climate science.

    I don’t find Weitzman’s analysis particularly alarming though. Hansen’s is the elephant in the room. Weitzman seems to be applying common sense, although I don’t claim to be able to understand much of the language he is using, by extending out these projections to 2050 that don’t stabilize things, to 2100 and beyond and talking about what it means for then. His scenarios end up to be wild just because his timeframe is so long. There have always been the doom scenarios and I’ve never understood how people can rule them out and talk like they don’t exist. Just because you can run a computer projection doesn’t mean you can predict the future the first time an atmosphere on a planet is altered at this rate.

    Hansen on the other hand is telling us there is no timeframe left. There is too much greenhouse gas in the atmosphere already. He’s calling for returning the atmosphere to 350 ppm. He’s saying if economists can’t understand that transforming the planet to one that is completely different than the one we were born on, that has no stable shoreline on any timeframe meaningful to human beings, on top of wholesale climate change the consequences of which could only be exceeded by nuclear war at some point in the future, well maybe he’s not saying what I say next, which is then its time to get rid of economists. How hard is this to understand? They aren’t going to be able to predict the future to compare present costs with future damage.

    All this talk about the economics of it sound to me like similar talk would have been when civilization faced Hitler. It was a matter of survival, and economics was just used as a tool like anthing else they could find, mass produced warplanes, millions of troops, nuclear bombs, whatever it takes. How is it that a country like the US could suddenly reorient its entire economy after the 1941 Pearl Harbour attack, gather up its 18 year olds by the millions to throw them in front of guns on the battlefield, change most of its industrial production to things that would be thown at the enemy in battle and would be useless after the peace, then emerge a few decades later in a burst of prosperity no society had ever known? Can some economist tell me why that makes sense in some economic theory? What were the debates like prior to 1941? Lets see… OK Hitler takes over the world, enslaves us, kills all the Jews, gays, etc, builds his thousand year Reich, OK, (sound of an adding machine) hmm, now present costs would be.. let’s see, hundreds of thousands of war planes, millions of dead troops, I guess we’d better delay because we can’t quantify how much damage a 1,000 year Reich would do.