Once a year, I blog about the Lucas Critique. Here is my blog post from 2016. Yesterday, Brad Plumer published an important NY Times piece that discusses new research that provides county by county estimates of how climate change will hurt the U.S economy in the year 2080. As you can imagine, this is an ambitious exercise.
First, let me celebrate the "Paul Revere" effect. The authors of this study are talented econometricians who hope to protect the future U.S from suffering real damage from climate change. By alerting us to the real possibility of these future losses, the authors seek to influence public policy (i.e raise support for a carbon tax ) and to encourage adaptation. The net effect of such mitigation and adaptation would be that their estimates vastly over-state the future losses that we actually suffer.
Now, permit me to make some technical points. An econometric research team follows the following recipe. First, it takes historical data and estimates how weather conditions correlate with economic conditions. For example, when it is extremely hot in a county --- do we observe based on past data that the county's per-capita income is lower than usual. The research team takes these past correlations and takes a climate change model (that tells you a guess of what will be future climate conditions by county) to predict future economic outcomes under the assumption that the historical correlation between weather and economic outcomes persists into the future.
This bold writing violates the Lucas Critique. Robert Lucas is one of the University of Chicago's greatest economists. I was not one of his greatest students but I learned from him that as the "Rules of the Game" change that forward looking decision makers re-optimize. He studied this issue in the context of government counter-cyclical macro policy (i.e tax cuts during recessions) but the same point applies in the case of climate change.
Let me explain;
Suppose it has always been 90 degrees in Phoenix in April but moving forward it will now be 105 degrees on average in Phoenix in April because of climate change. This is what I mean by a change in the Rules of the Game. The key stochastic process' core parameters have changed. The climate scientists estimate such relationship using geocoded time series data. They spread their findings (through the New York Times and through wild bloggers such as Joe Romm).
Investors (those who invest in durable buildings, businesses, families) who live and work in a specific area such as Phoenix have strong incentives to take pro-active actions to reduce their exposure to hotter Aprils. They have thousands of adaptation strategies (and richer people have even more). One of the points I argue in Climatopolis is that induced innovation will take place because of Paul Revere style forecasts of hotter summers. Demand creates supply! I haven't even mentioned government at the local, state or federal level. While many adaptation strategies are private goods (think of air conditioners), there are also public goods (sea walls, air cooling centers). If government changes its investments because of the new "Rules of the Game", then the poor's well being can improve in the face of a changing climate even if they can't afford any of the private adaptation strategies. We are not passive victims here. The greatness of capitalism is that the set of alternatives we have to choose from keeps growing due to innovation and product differentiation. Each of these private and public goods helps us to individually and collective adapt.
As these changes takes place, the historical correlations between climate and economic losses are attenuated. This is why I don't have much confidence in the predictions reported in the new Science Paper.
A final thought experiment. JFK was our President in October 1963. He was a very smart man. If you had asked him about the U.S economy in the future in July 2017; I bet that he would have talked about manufacturing and farming. I doubt that he would have talked much about women's labor force participation. Neither JFK nor RFK's wives were that active in the labor market at that time. He wouldn't have anticipated Google, Twitter and Apple or AI or robots. The direction of technological advance cannot be ignored. Without a model of directed technological change, it is difficult to even begin to think about the shape of the U.S economy in the year 2080 let alone to consider how our incomes will be affected by future climate conditions.
Since the U.S is an urbanized economy and since the U.S covers so much geographic area, I am highly optimistic that we can identify "higher ground" and build our future cities there. Of course, there will be losers (i.e think of those who own land in places that will flood or that become too hot). But, such logic ignores the Ricardian point that other land will grow in value as it proves to be more resilient in the face of new climate risks. Don't forget general equilibrium when thinking about the net effects of a changing climate. The more interesting economics question relates to adjustment costs. Given the capital stock we now have, what will it cost us to transition to the "right capital stock"? Who will gain and lose in the process of making this adjustment?
A quick half-joke; we are looking for new work for less educated U.S workers. If we must rebuild our cities, a construction boom will unfold. Opportunity to relieve misery are two sides of the same coin --- yet this logic does not appear in the new Science Piece.
Environmental Economics has made great progress in recent years but it has locked into the "atheoretical labor style" of focusing on reduced form credible identification and this hinders the inference and the policy implications of such research.