On Discount Rates

RFF has published an article by Cameron Hepburn who confuses pure rate of time preference with consumption discount rate. It's troubling that this confusion still keeps popping up among academics. Hepburn says:

In contrast to Stern’s prescriptive approach, previous research tended to be “descriptive” in assumptions about discounting, focusing on what we actually do, rather than what we ought to do from an ethical point of view. The focus was on market interest rates, which reflect the sum of many individual choices. Historic market interest rates (ignoring past and present financial crises) have averaged around 6 percent, so most previous research applied consumption discount rates at roughly this level.

In finance, pure rate of time preference can be calculated from historical real market returns, or if you will, estimated by using the capital asset pricing model for future flows. However, in economics you have (1) the pure rate of time preference (PRTP), and (2) the consumption discount rate, which is PRTP plus the elasticity of marginal utility of consumption multiplied by the growth rate of consumption. In economics, it's not whether PRTP should or could be about ethics; it is about ethics. It's about the value of future, not the value of a future cash flow to you. It's about intergenerational justice, and if future generations were treated equally to us, PRTP should be zero.

Hepburn continues:

Also, if our ancestors had adopted Stern’s perspective, they would have had to devote more resources (by way of savings and investment) for our benefit, reducing their own consumption, and hence also their welfare. This seems unfair given that our ancestors were significantly poorer than we are today.

If our ancestors had known how rich we'd be, they certainly would've not saved more than they did. The reason why Stern chose a lower growth rate than historically, is because there's uncertainty whether that growth can be maintained. In a GHG world, growth is a random variable, and the left tail of probability distribution is thickened by possible impacts of climate change.

Lastly, Hepburn says:

by assuming the probabilities are themselves uncertain, further bridges the divide between the discount rate of the Stern Review and higher market interest rates. Also, it may be consistent to apply high discount rates for aggregate consumption, and low discount rates for (increasingly scarce) natural capital

And there is no connection between the two? For example, would you expect aggregate consumption to go up, if climate change wiped out a significant portion of all arable land? The consumption discount rate can be positive, zero or, in extreme case, negative.

According to Paul Krugman, Prescott had once boasted that Keynes was never mentioned in their graduate programs. I'm afraid that both Cameron Hepburn and William Nordhaus may have been asleep when Frank Ramsey was mentioned in theirs.

Self-fulfilling Prophecies

Angela Merkel on Friday:

It is realistic to say that in Copenhagen we will not be able to conclude a treaty

Guardian, yesterday:

"Nobody thinks we will get a full treaty," said a spokesman for the Department of Energy and Climate Change (UK)

...

Lars Løkke Rasmussen, prime minister of Denmark, said: "We do not think it will be possible to decide all the finer details for a legally binding regime."

Hanne Bjurstroem, Norwegian cabinet minister and chief climate negotiator, told Reuters: "I don't believe we will get a full, ratifiable, legally binding agreement from Copenhagen."

Our climate negotiators desperately need psychology 101 before heading to Copenhagen.

While waiting for the results from the vote on Waxman-Markey

Read this posting by the Earth Institute's blog on turning CO2 into a solid carbonate. Having the first large-scale demonstration facility come online in September is a huge thing. Let's hope it works.

Who wants some limestone?

Message from Detroit to Capitol Hill

Jim Oberstar, the chairman of US House Transportation and Infrastructure Committee has proposed a higher fuel tax, making many Democrats nervous about what is "too much" in these difficult times. Obama also opposes the tax hike. I'm inclined to question the logic behind the opposition, whether it's populism or domestic realpolitik.

Dave McCurdy, President of the Alliance of Automobile Manufacturers was on EETV today talking about Detroit's challenges on the path to lower car emissions. He said one thing the Obama administration should take heed of:

But I think there has to be price signals, whether it's legislation or whether its regulation. Price signals are important. If you look at the history it's very clear, a year ago this current time frame, we were starting to see four dollar gas. We saw what four dollar gas did. Four dollar gas changed consumer behavior and consumer wishes. We dropped from selling about 55 percent light-duty tracks compared to 45 percent cars to completely the opposite, to 45 or trucks, then the 55 to cars. Now back at $2.50 gas, guess what, it's flipped back the other way.

This comes from the automakers. There's still another, much more powerful lobby group opposing a higher fuel tax, but policy makers should realize that it's the most effective (and by lowering taxes on labor and capital at the same time, the most efficient) way to decrease emissions from transportation. Moreover, the Highway Trust Fund (which is funded by fuel tax revenues) is going broke for the second consecutive year, and the rumor is the US treasury wouldn't mind the extra revenue, either.

No matter how inefficient taxes may be, taxing "bads" (with corrective Pigouvian taxes) is always preferable to taxing goods (such as capital and labor). By off-setting one with the other, the cost is at most zero, if not negative. The only difference is the deadweight loss of the fuel tax and the deadweight loss of the tax (say labor) it replaces, and the distributional effects relate only to those differences. In short, there are no excuses for not taxing economic activities with large negative externalities (here meaning driving Hummer H2s and the like); at least not as long as labor and capital are taxed instead.

People who get us into trouble

I found this latest piece by Robert J. Samuelson via Paul Krugman, who nails some of the most disturbing fallacies in the column:

I don’t think there’s a single thing there that’s right. What on earth do business cycles have to do with it? The models may assume growth based on past trends, but they DO ask whether emissions policy would greatly slow growth — and the answer is no. Consumers aren’t assumed to “quickly” use less — the time frame in these models is decades long. And new supplies don’t “magically” appear — they respond to price incentives, which is what economics usually says.

I don’t especially mean to pick on Samuelson, but this column exemplifies a strange thing about the climate change debate. Opponents of a policy change generally believe that market economies are wonderful things, able to adapt to just about anything — anything, that is, except a government policy that puts a price on greenhouse gas emissions. Limits on the world supply of oil, land, water — no problem. Limits on the amount of CO2 we can emit — total disaster.

Funny how that is.

Ultimately, however it's Samuelson himself who deconstructs his own arguments most accurately:

The selling of the green economy involves much economic make-believe... Actually, no one involved in this debate really knows what the consequences or costs might be. All are inferred from models of uncertain reliability. Great schemes of economic and social engineering are proposed on shaky foundations of knowledge.

Funny because economic make-believe and shaky foundations of knowledge would've probably been the exact words I'd chosen to describe Samuelson's writing with.

The Paradox of Plenty

Ok, it's been some time since my last post. I'll try to get back to speed with shorter posts on what's happening. Interaction Quarterly of Stanford recently published an article, which reminds us that NOCs (national oil companies) have often neglected new exploration investments, and the oil revenue is rather used for other government expenditure (a recent exception is Brazil's Petrobras). The "sovereign" or political risk in the oil producing countries is often too high for non-NOCs to do exploration solo. There's still plenty of oil in the ground; it's just harder to get to, and new investments are lagging behind because of poverty, corruption, and war. NOCs are instant cash machines, as David Victor calls them.

Why is it so important to get to as many conventional oil sources as possible? Well, because each barrel of conventional oil left in the ground is likely to be replaced with a barrel of non-conventional oil. That's bad news both economically and environmentally, and there's no "paradox of plenty" with regards to either of the two.

IEA's Roles

It's been almost two weeks since I wrote my last post. I've asked myself why, and there's a really simple logical causal chain. As everyone else, I've been preoccupied with the global economic crisis. I've wanted to comment on the effects of the economic crisis on the energy sector. However, my best source for global energy market statistics is the International Energy Agency, which will publish its 2008 energy statistics sometime in 2010. Hence, the best I can do is to speculate what the effects of the current crisis are.

I understand that not all countries follow or assemble their energy statistics as quickly as others, notably as quickly as the US (EIA). What I don't get is why doesn't the IEA provide up to date summarized statistics for the countries that do publish that data in a timely manner. It can be argued that IEA's purpose is not to offer timely statistic data of the global energy markets. Rather, it's primary role is to provide advice on energy policies. Whether or not you think they've succeeded in that, I think we need an institution that offers timely information of the global energy markets. There are several statisticians at the IEA, and they could be separated from the agency to form a new public agency that serves that purpose. That way the OECD tax payers could get a bit more bang for the buck.