Price of global warming

Price of global warming
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First Published: Tue, Apr 08 2008. 10 21 PM IST
Updated: Tue, Apr 08 2008. 10 21 PM IST
The climate change debate is far from settled. Or at least that’s the impression one gets when visiting a new website called www.climatedebatedaily.com. The home page is split vertically down the middle, with global warming enthusiasts and sceptics ranged against one another. One recent academic article on the sceptical side of the fence says that the world should be concerned about global cooling rather than global warming.
So, should we sit back and wait to see what happens?
This is where I think the climate change sceptics get it all wrong. One of the most common arguments they put forward in defence of their scepticism seems convincing at first glance. They argue that forecasting the future of any complex system such as the climate (or the economy) is terribly difficult. The margin of error is huge—and hence we must take the predictions that regularly hit the newspaper with a pinch of salt.
But that’s just the point. Forecasters may be erring on both sides because of the uncertainty involved. The world may not heat as much as expected. Or it may heat many, many times more than what we have been told to expect.
“Although greater uncertainty means climate change might be less bad than we fear—for example, an ‘iris’ effect means increases in cloud cover may slow global warming—it also means it might be much worse,” writes Paul Klemperer, a professor of economics at Oxford University, in a recent article. He draws parallels between the financial models that failed last summer and the climate change debate. “Only last summer, hedge fund managers found their stock market models’ predictions were, in their own words, ‘25 standard deviations’ from the outcomes, just as the Nobel Prize-winning economists who advised LTCM believed the probability that the fund would lose more than half its money was way below a billionth (until, that is, they lost almost all their money).”
In short, the uncertainty about the future course of global temperatures means that it is sensible to buy some insurance against 25 standard deviation climatic outcomes.
How? There are no easy answers to the problem of climate change, which could be the biggest externality the world economy has ever faced. As with the design of most economic policies, the trick is to identify the trade-offs and incentives involved. Economists need to be part of the solution.
The Indian government seems to have got the point. There has been some criticism of the fact that the 13th finance commission has been asked to look at “the need to manage ecology, environment and climate change consistent with sustainable development”. That’s not the job of a finance commission, which traditionally tries to figure out how tax revenues should be shared between the Centre and states. But, the new finance commission could help frame the Indian debate on what economic policies are needed to mitigate the effects of climate change. And that will be a big step forward.
The International Monetary Fund (IMF), too, has jumped into the fray in its new World Economic Outlook (WEO) that has been released this month. It seems like a strange decision at first glance. Shouldn’t IMF leave the climate change issue to scientists and focus more on the global economic slowdown and the spurt in inflation? But climate change could be a huge risk to the global economy.
WEO also has a box on the possible impact of an abrupt climate shock on an illustrative South Asian country that is heavily dependent on agriculture. Think India. There are several possibilities. The dislocations to agriculture and industry will pull down productivity as farmland is lost, industry is relocated and labour is retrained. Foreign demand for this country’s products will be hit “due to reduced competitiveness of the new industries in which the country is forced to specialize”.
The government will be forced to respond through a higher deficit and lower interest rates. These will reduce national savings and increase the current account deficit. The deterioration in the country’s economic performance will drive up risk perceptions and borrowing costs. These higher interest rates will squeeze investment and improve the current account balance.
The questions pile up. By how much should the price of carbon be increased to bring down emissions over the long run? How should the burden of cleaning up be shared between our generation and the coming generations? What part of the task should be left to private markets and what part should be tackled directly by government policy? How should the bill be shared between the rich countries that have been responsible for most of the carbon pumped into the atmosphere till now and the developing countries that will be the world’s biggest polluters in the future?
Economic reasoning needs to supplement climate change forecasting.
Your comments are welcome at cafeeconomics@livemint.com
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First Published: Tue, Apr 08 2008. 10 21 PM IST