The Importance of Economics in the Framework of Climate Issues
Professor Christopher Essex
Good afternoon it’s a pleasure to once again speak to you in the plenary sessions at Erice. I am co-chairing this session on climate, with Professor Zichichi and Lord Monckton. This session follows directly from the presentation made this morning by President Klaus in which climate and economics were central topics.
Whenever I co-chair or organize such a session I like to spend a few minutes briefly framing it with explanations as to its broader significance. In this case, because this session, and President Klaus’s session this morning, are both facilitated through the climate PMP, the question arises as to why we are discussing economics and not just climate. Economics can seem quite remote from the physics, chemistry, or mathematics of climate, and yet there is an entire field known as climate economics. Indeed, when I was a student I would never have imagined that I would spend as much time with economists as I have in recent years. Although I am not one of them, for the most part my time among them has turned out surprisingly well. So I will attempt to explain why economics matters on the fundamentally physical issue of climate.
Central to popular and policy interest in the science of climate is concern over projected deleterious changes in climate, particularly any potential deleterious changes caused by humans that are preventable by humans. Of course there are academics who would be interested in climate even if there were no risk or danger, but the broader society cares more about the risk and danger and less about the natural wonder. The obvious human response to such fears is to alter actions, in hopes of sparing us all of the potential negative outcomes. But, alas, it is not that simple. Not only are the negative outcomes difficult to nail down, but so are climate and climate change highly problematic and elusive in terms of rigorous physical thinking. I have found over the years that if you present this unambiguous reality in detail to people involved with this topic, many will respond by raising the “precautionary principle.”
In case you don’t know what that is, I will attempt to explain. The precautionary principle is a policy doctrine for facing the unknown, and what better fits into the category of the “unknown” than topics of scientific research, of which climate is surely one. If you have two paths, where one is safe and the other potentially dangerous, the precautionary principle calls on people to choose the safe path, unless it can be proven that the novel one is safe too. Pretty straightforward, isn’t it? Uncertainty, particularly scientific uncertainty, then is faced by practicing risk avoidance.
Of course simple risk avoidance is not a realistic, let alone effective, policy. To illustrate how the real world can intrude I will provide a couple of examples, not from grand policy issues, but from real individual lives:
- Near the end of the cold war, a Canadian living on the west coast of Canada was concerned about the risk of nuclear war. He applied the precautionary principle to the problem (without using the term, I imagine). He concluded that western countries were potential targets, and so resolved to personally avoid the risk by moving as far from them as he could. The southern hemisphere was about as far away as he could go. He would further insulate himself from the risk by finding an island far from potential land targets. So in accordance with his application of the precautionary principle, he set himself up as a sheep farmer in the Falkland Islands only to find himself in the middle of a real war and not just a hypothetical one.
- When I was with the Canadian Climate Centre’s general circulation modeling group, one of my colleagues revealed that he came to Canada to avoid military service that might require him to fight in a war. After arriving in Canada as a young man, he wanted to become a scientist. He liked physics but he was afraid of how physics had become embroiled with politics. So as a precautionary measure he deliberately chose to study a field that he could not imagine would ever be of political interest: meteorology and climate.
While it may or may not have useful legal applications, the precautionary principle simply cannot stand as the basis of coherent policy toward the unknown of real events if for no other reason that it presumes to know of a pristine road through the unknown that is risk free. That is it copes with the unknown by presuming to know the unknown.
It is easy to decide which way to go if one path is known to be dark, dangerous, and foreboding, while the other has only butterflies, rainbows, sunshine, and unicorns to offer. But in the real world things can go wrong on either path, while there may also be unique advantages to either. The only rational way to decide which road to take is to have a way to compare the risks and advantages.
An engineer’s classical way of discussing risk is in terms of probability. What are the odds, say, that a bridge will fail, or a building will collapse? The relative risk, in this picture, between seemingly unrelated things can be compared on a number line of the relative likelihood of desirable or undesirable events.
It is true that probability in the real world is not quite like the clean probability you may have learned about it school, where you select, say, black or white marbles from a bowl. In the real world probabilities are hard to know formally, and they are conditional in complicated and devilishly subtle ways, leading to many famous paradoxes like the prisoner’s paradox or the Monty Hall problem. I have seen knowledgeable people get into huge disputes over such things. I would love to tell you about the look on the face of a classically trained probabilist meeting a Bayesian probabilist for the first time. I have seen this. There are also some great jokes about probability that arise from such things. But in the interest of time, we will not pursue these things today. I will of course be willing to share probability jokes with anyone who is interested at another time.
So then, assuming that probabilities can be well-defined and determined, we can compare the risk of getting struck by lighting to the risk of being bitten by a dog, to a dam breaking or even to the likelihood of winning a prize. But what this picture lacks is a sense of magnitude. A dam breaking is in a different league of calamity than being bitten by a dog, although you may be less affected personally in a particular realization of the former than the latter.
We say these things have different “magnitudes” but different magnitudes of what? These events are not one-dimensional in a common physical quantity. They are qualitatively different from each other, and yet at the human level we have an intuitive sense of rank ordering. Fortunately humans long ago devised an index to compare the human significance of things that may be physically qualitatively quite different from each other. And that index is of course known as money.
At the human level for every event we may assess a value in terms of money. That means that every event can be assigned a positive or negative monetary value and a probability, placing all events in this context into a two-dimensional space rather than a one-dimensional number line. This is depicted in figure 1.
In this case the probability, p, of a deleterious event is along the horizontal axis while the cost represented as L, for losses, is along the vertical axis. Lines of constant risk in the classical engineering picture would be vertical lines. But if we bring the issue of cost into the picture, the lines of constant risk look qualitatively quite different.
Risk in this picture is measured in terms of total dollars paid out, or received. Thus it’s clear that a rare but costly event, A, can actually be riskier in terms of losses than a common, but less expensive, event B. Risk becomes the product of the probability and the cost. Lines of constant risk then become hyperbola’s rather than vertical lines. It makes an event in the upper left of the diagram equal, in terms of risk, to events in the lower right. It also means that risk increases upward and to the right rather than horizontally. I think it’s fascinating how introducing the valuation of an event completely changes the shape of lines of constant risk. That shows us that how one determines the meaning of the various quantities involved has a significant effect on how we will make decisions.
And that is exactly what economics concerns itself with: not just the costs of doing something but also the costs of not doing something. You may feel safe hiding in a closet, but you lose out on all of the benefits that you might gain by going out into the world from your closet. You may also find unanticipated risks from staying in the closet. Making a full assessment of these, such as may be possible, is the kind of thing that economists do. In this framework the precautionary principle is completely superseded for the purposes of sound policymaking. So while economics is not primarily concerned with climate, the importance of climate for humanity must ultimately involve economics. And that is why we find ourselves talking about climate economics today.
We may worry about the consequences of producing carbon dioxide in large enough quantities to affect climate change. But it is not correct to presume that there are no consequences to not producing carbon dioxide. Rational decisions about what we should do ultimately then have to weigh the economic consequences against the climatological consequences that we may imagine. Among economists there is more than one school of thought on this as one might naturally expect. We have attempted to represent this to a limited extent. We did invite Lord Stern, who is a well-known protagonist for one pole of the spectrum of views, but as you can see he is not present today. I am grateful to our own Dr. Bruce Stram who has kindly agreed to represent that side of the picture.
What I hope you’ll pay close attention to in all of the talks is that we are not dealing with the case of action versus doing nothing, as contemporary demagoguery continues to offer us, but the relative costs and benefits of different scenarios. I would also like you to bear in mind that extreme (implausible) economic scenarios are not trivial. They can be every bit as apocalyptic as extreme (implausible) scenarios for climate change. In either case extreme scenarios call for narrow focused efforts which tend not to be robust against the unknown.
1