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Why can’t we confront climate change? Behavioural economics explains

Why can’t we confront climate change? Behavioural economics explains

The devastating storms in America have kept the issue of climate change firmly in the public mind.

But so far, it has proved very difficult for politicians to persuade electorates to change consumption patterns in ways which many scientists would like to see.

More expensive air travel, steeper energy bills – these are not very popular.

People are being asked to accept lower increases – or even outright reductions – in their living standards now, in exchange for escaping potentially large costs in the future.The problem is easy to state. But it raises some difficult issues in economic theory.

An obvious one is how to analyse uncertainty. Suppose, for example, you are offered odds of four to one on a horse in a particular race. You can then judge whether you think the true probability of it winning is more or less than the odds suggest.

But the uncertainty around the whole climate change issue is much trickier to deal with. It is as if you are offered these odds on a horse, but you do not know which other horses it will be running against.

A simple illustration is given by Geoff Heal of Columbia University in a paper in the latest Journal of Economic Literature. We face both scientific and socio-economic uncertainty: uncertainty about the underlying science of climate change, and about the economic and social impacts of an altered climate.

Heal points out that scientists working on climate change take it almost for granted that a rise in global temperature of two to three degrees would inflict massive costs on our societies.

However, he goes on to say that “nothing in the emerging econometric studies of the impact of climate on economic activity confirms these dramatic concerns”.

So even the different groups of experts disagree.

A second challenge is that people value benefits received and costs incurred in the present and the immediate future more than they do the same benefits and costs in the more distant future.

The Bank of England is rock solid and has never defaulted. So when it issues debt, you can be as certain as possible that you will get your money back. But the Bank still has to offer you interest – more money in the future – to persuade you to buy it now.

A key question is then: how do people discount the future? What rate of interest do they use when they think about it?

Behavioural economics has provided a large amount of evidence on this question. It is not at all good news for climate change activists. In the jargon, people often use “hyperbolic discounting”. Translated, this simply means they place far more weight on small rewards or costs which occur now than on much larger ones in the more distant future.

A non-obvious implication of this is that they make choices today that their future self would prefer not to have made, despite knowing the same information.

Economics cannot solve the problem of climate change. But it can explain why electorates are so reluctant to do anything about it.

As published in City AM Wednesday 13th September 2017

Image: Hurricane Irma Rescue by US Air Force is licensed under CC by 2.0
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Valuing the Future. Why Climate Change Agreement is Hard

Valuing the Future.  Why Climate Change Agreement is Hard

The two week long Paris conference on climate change seems to drag on interminably.  There are obviously many reasons why such summits find it difficult to reach meaningful agreements.  But a fundamental one is that the electorates of the West are being asked to bear substantial costs right here and now, in return for a stream of benefits which will only become apparent well into the future.  Closer to home, we see similar issues with major infrastructure projects such as the new airport runway in London and the high speed rail project HS2.  We pay for them upfront, and the gains appear later.

Economists have a way of analysing this problem.  They even, as usual, have their own special phrase to describe it, namely ‘social time preference’.  The Treasury publishes the Green Book, which describes the methodology to be used in the appraisal and evaluation of the use of public funds in investment projects.    A substantial part of it is devoted to how to compare the value of costs incurred now and benefits received in the future.  If you are offered the choice between being given £100 today or £100 next year (inflation adjusted), you will naturally prefer to have the money in your hand immediately.  But how much more would you need to be offered to persuade you to wait?

The Treasury calculates, citing some impressive academic work, that the rate to be used on public projects is 3.5 per cent a year.  So if an investment yields a benefit of £103.50 next year, this is essentially the equivalent of receiving £100 today.  The impact cumulates strongly, so that a benefit of £100 in twenty years’ time is only the same as £50 today.  The numbers for Crossrail, for example, were ground through the same process, and came out positive.  The scheme was calculated to be worth building despite the high initial costs involved in money and disruption.

In the case of climate change, the predicted benefits of taking action now stretch hundreds of years into the future.  But the impact of the social time preference rate is ruthless.  Very long term benefits become worth more or less nothing when translated into today’s value.  Yet people in the West are being asked to bear the costs now.

This was the problem faced by Lord Nicholas Stern in his famous review written for Gordon Brown in 2006, the Economics of Climate Change.  His advocacy of spending 1 per cent of the world’s GDP immediately to combat climate change has been very influential.  But to get the numbers to stack up, he had to set the rate of social time preference close to zero.

Martin Weitzman of Harvard wrote an important paper nearly 20 years ago arguing that the discount rate should be reduced for the ‘far distant’ future.  The Treasury do acknowledge this, and their 3.5 per cent rate only applies for the next 30 years.  Even so the basic dilemma remains.  Pay now, and your grandchildren might benefit.  No wonder democratic politicians struggle to sell the idea.

As published in City AM on Wednesday 9th December

Image: To change everything we need everyone by Alisdare Hickson licensed under CC by 2.0. 

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