Thursday, September 9, 2010

Assault of Thoughts - 9/9/2010

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- A little while ago, commenter stickman recommended I read Thomas Sterner and U. Martin Persson paper An Even Sterner Review, which discusses the alleged dependence of the original Stern Review's results on a low social discount rate. I, like Sterner and Persson, think a very low social discount rate is quite justified. But Sterner and Persson argue that modeling relative price adjustments (that basic point of mircoeconomics that Mario Rizzo thinks Keynesians don't think about, FYI) produces optimal carbon paths comparable to Stern's. The idea is that what they call "environmental goods" - clean water, presumably food, anything we think might be conceivably impacted by global warming directly - are imperfectly substitutable with other goods. This means that as production of these environmental goods becomes more costly, prices respond more substantially than consumption, and environmental goods take up an increasing share of income, crowding out other goods.

- Menzie Chinn has an interesting graph of government employment. When you take out temporary census workers it is declining. This is not surprising if every three months you eagerly await the new BEA NIPA tables. It is surprising if you only follow people who repeatedly tell you about the explosion of government. As with the budget, the federal/state split is going to look a little different - and that's disconcerting for me, of course, as I've stated repeatedly on here. But the overall trend in government spending and employment is not what many would like you to believe.

- Incredible Wampum, a libertarian student's blog, googles "libertarians are..." and gets some interesting results. This, the author says, is what motivates her to call herself a "classical liberal". This is pretty sad - the internet can be a very antagonistic place, and I sympathize with her and totally see where she's coming from. Out of curiosity I googled "Keynesians are..." and got many of the same results that she did! One thing I got that she didn't was "...are witch doctors". The anonymity (or as Evan likes to add, "pseudonymity") of the internet can make it nasty sometimes - it is what it is I suppose.

- Mark Thoma has an excellent post on the relationship between views on regulation and population density, specifically the way he views regulation coming from a small town environment. He keeps it simple, but he's essentially discussing what you might call the asymmetry of "asymmetric information". Or, as Adam Smith tells us, "the division of labor is limited by the extent of the market". In small markets, the division of labor is low. That has it's costs but one cost that it keeps low is transactions costs. It's a trade-off, of course, which gets into Krugman's economic geography and the economics of agglomeration. But it also helps to explain differential views on regulation. This, of course, is also a substantial argument for robust federalism.


  1. Well, that's great. I'd like federal employment figures to return to the level of say 1790.

  2. Anyway, having grown up in a small town I can largely agree that yes, regulation is largely silly due to reputational, etc. mechanisms. However, the notion that government regulation is a substitute of any kind for that in large metropolitan areas is something I do not buy into at all. The state at best does a piss poor job of such and of course is not some neutral arbiter of the matter.

  3. Daniel,

    Glad you read the Sterner and Persson paper. Again, I'd reiterate my belief that it is a great paper for anyone interested in the broad economic issues involved in climate change. IMHO, the introduction of relative prices – the (imperfect) substitutability between manmade and natural capital - also goes a long way towards formalising the intuitive concerns that many people have regarding climate change effects; i.e. the broader ramifications of destabilising natural systems that we are intimately dependent on. A nice paragraph to illustrate:

    "[G]lobal agriculture is said to represent 24 percent of global GDP (Stern Review, p. 67). A 1-percent loss of agricultural output might be estimated to reduce global GDP by.24 percent. Basic logic, however, tells us that a 50-percent loss of agricultural production would reduce global GDP by much more than 12 percent, and a 100-percent loss would reduce GDP by more than 24 percent of GDP. The mechanism behind this would be escalating food prices: As food became more and more scarce, its relative price would rise so fast that the dwindling food supplies would crowd out everything else and approach 100 percent of total GDP."

    To extend upon your comments above, the most interesting outcome of the S&P paper for me is that it shows strong, early emissions reductions (such as those proposed by The Stern Review) can be economically justified even in the presence of high discount rates. In other words, being cognisant of relative price effects helps to overcome some of the more arcane and subjective debates over the discount rate, which currently cloud the timing of climate policy.

  4. PS - For those interested in this climate change issue: A series of similar - though more technical - arguments have recently been put forward by the ever-impressive Christian Gollier. E.g. "Ecological Discounting" in the Journal of Economic Theory:
    (Apologies for the hideous URL; I'd hyperlink if I could... Gollier actually goes some way to merging the relative price concept with Martin Weitzman’s "fat-tail" argument (i.e. the problem of uncertainty surrounding catastrophic climate effects), before arriving at separate discount rates for biodiversity (1.5%) and consumption (3.2%)... The former being pretty much on par with Stern’s chosen discount rate of 1.4%.)

  5. All good stuff.

    But let's keep front and center that these are not alternatives to a low discount rate. People's discount rates hit a floor because the fact is, we're only mortal. And as Jefferson said, the Earth belongs to the living. So our mortality should be no excuse for an implicit discount rate that binds our descendants.

    All these things, to me, say "even if you don't buy my low discount rate schtick this is a real problem".

    If you buy it, (which you should!), then it just means that all this stuff on top of a low discount rate makes it even more important to do something about than even Stern suggested.

    The uncertainty is immense - this is true. I'm not an Al Gore doomsdayer. But for the time being we've only got one shot at this. If we could all pick up and move to Mars, it might be a different story.

  6. As for Thoma's discussion about small towns and the attitude towards regulation; yes, I think his basic point is well made and easy to agree with. Of course, it is hardly a revolutionary concept... But I like the way he framed it.

    As someone that has been much influenced by the "norms and institutions" school (a la Elinor Ostrom), I'd always support these "organic" institutions as a first-win where possible. Unfortunately, there have to be a quite specific set of factors at play for communal management of resources to work effectively; not least a small number of participants. Those trumpeting Ostrom's work as proof of broad "anti-regulation" ignore the scope of her implications and, in doing so, rather miss the point I fear.

  7. "But let's keep front and center that these are not alternatives to a low discount rate. People's discount rates hit a floor because the fact is, we're only mortal. And as Jefferson said, the Earth belongs to the living. So our mortality should be no excuse for an implicit discount rate that binds our descendants."

    Yes, but bear in mind that a number of economists would hit back by saying that future generations will [i]benefit[/i] from our productivity now (especially in poorer areas). Or, alternatively, they could ask: Why should we care if future generations two hundred years from now are "only" 13 times richer than us than 15 times richer? You need to have serious counters to these arguments if you want to convince people of your position.

    I agree and sympathise with many of the ethical arguments proposed by Stern... but it's a fact of life that disagreements over the discount rate will always have an impact on what we perceive to be an efficient emission path.

    From my perspective, the most powerful result of papers by S&P, Weitzman, Gollier and the like is to demonstrate formally how wealth will not increase uniformly, or anywhere close to the level typically assumed.
    That's why the major conclusion of these studies remains so important: Policies which call for decisive mitigation against climate change now can be economically justified even in the presence of high discount rates.

    That's a critical first step to reach agreement on... And, indeed, the way in which these insights allow us to (partly) abstract from the intrinsic subjectivity of the discount debate is a major reason why I keep bringing them up.

  8. Last thing: Daniel, you previously mentioned your interest in reading the original 1928 Frank Ramsey paper, where he derived his famous discounting equation (now the primary reference in climate change economics):

    r = δ + η.g

    As a follower of Keynes yourself, you may be interested to hear that Ramsey was something of a Keynesian protégé. Keynes certainly influenced his decision to branch out from pure mathematics*, also acting as Ramsey's benefactor in some instances. They did, however, have their disagreements (e.g. on the application of probability theory).

    Another interesting aside (particular to the issues we've discussed above) is that, like Stern, Ramsey himself was strongly against pure time preference discounting (δ). There's a famous passage in which he decries it as “ethically indefensible”, going on to say that the assumed preference for current enjoyments over future ones “arises merely from the weakness of the imagination”.

    * All in all, Ramsey made a number of seminal contributions to mathematics, economics and philosophy... These contributions are more remarkable for the fact that he died at the age of only 26.

  9. I read enough of the beginning to notice the frequent Keynes references - thanks!

    I hadn't realized he died that young! What a waste. I can only imagine what he would have become if he had survived.


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