Tuesday, December 08, 2009

Copenhagen and International Carbon Politics

I have been trying to follow the Copenhagen news stories such as this LA Times piece but I must admit that I do not have a good grasp on how nations actually negotiate with each other on such carbon mitigation issues. Nations know their current carbon emissions (so the USA is at 20 tons of co2 per year per-capita) and we know how to multiply numbers. If carbon dioxide has a price of $35 a ton then the average American will face a $700 a year bill to continue to live his "status quo" lifestyle while the average person in China would face a $140 bill. Now, what we don't know is what would be the medium term and long term effects of this pricing on economic growth and carbon mitigation technologies.

Don't count on the economists to have a good "Computable General Equilibrium" model to yield valid estimates of how each nation's economy will evolve in the presence of a carbon tax. If we introduced uncertainty into our models the confidence intervals would be huge. But today a group of economists are getting rich peddling their "scientific" models as truth in predicting very difficult policy counter-factuals.

The modern economics profession has made great progress estimating partial equilibrium relationships. See almost any NBER applied micro paper to get a taste of this. We have made much less progress on multi-sector dynamic general equilibrium models with endogenous innovation, irreversibilities, learning and uncertainty. Introduce all of these bells and whistles and you have the issue of climate change. Now economists like to be quoted and we are self confident but if we currently do not have good answers to policy questions should we follow the Nobel Laureate Robert Lucas and modestly say; "I don't know"? If we follow this path, we are well aware that some bozo out there will fill our place offering the politicians an even sillier answer. So, we must pick our poison.

The politicians want to believe that the scientific economists have a kosher model for predicting carbon policy counter-factuals but at least as of right now, we don't. So how do we identify and rank "good public policies" in the face of such modeling uncertainty?

I would prefer a more modest approach in which we economists admit what we currently do not know but suggest a series of statistical indicators for benchmarking how our evolving economy is adapting to climate pricing.

UPDATE: Here is Tom Friedman in today's New York Times

"If we prepare for climate change by building a clean-power economy, but climate change turns out to be a hoax, what would be the result? Well, during a transition period, we would have higher energy prices. But gradually we would be driving battery-powered electric cars and powering more and more of our homes and factories with wind, solar, nuclear and second-generation biofuels. We would be much less dependent on oil dictators who have drawn a bull’s-eye on our backs; our trade deficit would improve; the dollar would strengthen; and the air we breathe would be cleaner. In short, as a country, we would be stronger, more innovative and more energy independent.

But if we don’t prepare, and climate change turns out to be real, life on this planet could become a living hell. And that’s why I’m for doing the Cheney-thing on climate — preparing for 1 percent."

Will our life on this planet become a living hell? In 2010, I will publish a new book that will take a close look at this claim. Beware the conventional wisdom.