Monday, July 19, 2010

Economists waive any responsibility on climate

Julia Gillard's stop-gap substitutes for Labor's abandoned emissions trading scheme is unlikely to produce much reduction in emissions or be cost-effective. I reckon just about every economist would agree with that proposition, just as they'd agree with its corollary: the key to reducing emissions is to put a price on carbon.

Yet the nation's economists were neither unanimous nor active in supporting the Rudd government's carbon pollution reduction scheme.

Why weren't they? Why do so many economists behave in such an uninterested and even disinterested way on the subject?

Dr Martin Parkinson, the secretary of the Department of Climate Change, observed in a recent speech that, unlike with other, earlier economic reforms, ''there has not been a broad consensus within the economics profession on the merits of action to reduce Australia's greenhouse gas emissions, nor on the general approach to how it should be implemented''. With a few notable exceptions, he said, it had been surprising ''how little serious engagement we have seen from economists in the carbon pollution reduction scheme debate''.

Economists' preference for a carbon price signal was where agreement among economists ended. ''There is disagreement on the detail required for practical implementation, such as the timing, level and nature of the mechanisms that should be used to provide a carbon price signal, and in some cases disagreement on whether action should be taken at all,'' he said.

So why is there this lack of broad consensus and engagement by economists? Parko suggests four possible reasons.

First, some economists see climate change as an environmental problem rather than a multi-disciplinary problem. If it's an environmental issue, it's probably being dominated by environmentalists who are interventionist and anti-growth. In truth, the policy response to climate change is based on work coming from scientists, not greenies.

Note that Parkinson is a former deputy secretary of Treasury and has a quite a few ex-Treasury people around him. Emissions trading is an ''economic instrument'' and it was being designed and implemented by highly orthodox economists.

''When it comes to climate change science and projections, it is probably reasonable that economists without expertise in the relevant scientific disciplines should let scientists be the professional experts in this area,'' Parko said.

Even where some economists are genuinely sceptical of the scientific evidence, ''it has been surprising that some economists have resisted serious consideration of the professional application of the precautionary principle - that is, that taking action on climate change today is a form of insurance''.

Second, economists usually deal with marginal issues and have little experience with issues having potentially catastrophic outcomes. To a neo-classical economist trained in ''marginal analysis'', marginal doesn't mean of little importance, but quite the reverse. All the interesting things happen on the margin.

But climate change has the potential to involve a complete change in the state of the world, including the possibility of catastrophic outcomes. Economists have little experience in dealing with ''non-trivial'' (that is, worth taking seriously) probabilities of such outcomes occurring, or the related application of the precautionary principle and need for risk management.

This is the ''fat-tailed'' or ''black swan'' problem that's very difficult to assess using economists' conventional ''expected-value'' risk analysis: that is, a tiny probability of an unthinkable event.

The third reason economists have failed to provide strong support may be that, though they understand ''externalities'' in principle, in practice they have a strong preference for leaving things to the market.

The existence of market failure doesn't automatically justify government intervention in the market. You also have to be satisfied intervention will do more good than harm, otherwise all you end up with is ''government failure''.

This highlights the cost of inaction, which both Britain's Stern report and our own Garnaut report have shown is very high. This being so, the chances are high that, without guidance from economists, governments will pursue remedies involving high efficiency costs.

Parko's fourth possible explanation for economists' lack of support is that they prefer to be pure in their proposed solutions to problems and are suspicious of politically negotiated outcomes and transitional assistance.

Academic economists in particular love an ''elegant'' solution to a complex problem, but policy action is a messy, compromised business, that never starts with a clean slate and involves building coalitions around concrete policy proposals.

No sooner had the Rudd government fixed on an emissions trading scheme than economists came out of the woodwork arguing a carbon tax would be better. That trading schemes had long been the centre of international efforts to achieve a co-ordinated reduction in emissions troubled them not a bit.

''These proposals are generally put forward at a conceptual level, where they may be models of elegance and simplicity, untrammelled by questions of practical implementation or political reality,'' Parko said.

As for the objection to transitional assistance, ''no one ever suggested that tariff reform wasn't worth doing because it was implemented gradually and with generous transitional assistance packages - yet despite the careful attention paid to preserving the abatement incentives and ensuring that assistance is provided for a transitional period only, this is exactly what many are saying about the carbon pollution reduction scheme''.

Parkinson concludes that economists' lack of agreement on key implementation questions renders their preference for a carbon price signal largely meaningless in practice. In fact, it undermines public support for least-cost solutions. Well done.