Monday, July 03, 2006

Copenhagen consensus - wrong question leads to wrong answer on climate change

In theory, it would be good to prioritise resources for global do-gooding by asking what is the best use of an additional $50 billion,and weighing costs and benefits of different approaches. The Copenhagen Consensus Center, headed by Bjørn Lomborg author of the Skeptical Environmentalist and bête noire of the greens, attempts to address this sort of question. In doing so, they've created a list of 40 possible global interventions and asked workshop participants drawn mostly from UN represenatives (China, India, Pakistan, Tanzania, Thailand, the United States, Vietnam and Zambia) to rank them. The ranking they came up with places climate change at the bottom and tackling communicable diseases at the top. There are several flaws in this superficially attractive approach. These are:

  • The climate change measures listed are really 'efficiency' measures... ie. an "optimal carbon tax", meaning that the carbon externality is reflected in energy prices. Not to do this is inefficient. A carbon tax doesn't cost anything: it represents redistribution of the tax burden to pollution and away from other tax bases, like employment or investment. Most of the other measures are 'equity' approaches, and involve transfers from one group to another. Measures taken for efficiency reasons should be done anyway, and not compared with measures taken for equity reasons. The question is badly framed in this critical respect.
  • The choice as framed is artificial - not disimilar to asking someone if they would spend all their money on health care or on fire insurance. Most people, and most governments, establish a portfolio of responses designed to manage risks of very different types and timetables. The climate risks are long-term, potentially disasterous but uncertain in magnitude and form, and likely to be irreversible. It is difficult to compare these in isolation with more immediate risks.
  • The choices made may reflect indifference to intergenerational equity consequences by those seeking equity-driven transfers for the current generation - ie. most of the participants. It is true that societies have tended to under-provide for and over-exploit the resources of future generations... and this is likely to be the case for climate change. If there are going to be transfers, the case for transfers to future generations is unlikely to be made convincingly by those that want transfers to them now. However, in deciding on priorities for transfers for equity reasons, principles of justice need to be applied (usually by the donors, which must also strike a bargain with their own taxayers over altruistic use of funds). They should not just respond to the aggregated expressed preferences of those representing current generations at a workshop. A type of 'Rawlsian veil of ignorance' could have been drawn over the exercise and participants asked to imagine they did not know when in the next 200 years they were living or who they were serving.
  • The responses of participants may reflect a general belief in the underprovision of aid and global public goods. There may well have been different choices made for the marginal $50 billion if we had been more effective in securring efficient level of provision of global public goods.
Having said all this, I welcome Lomberg's approach and wish there was more of this sort of challenge and debate - though with a more thoughtful approach to what is a transfer for equity reasons and what is an attempt to deliver efficient provision of public goods and internalisation of externalities.

4 comments:

Anonymous said...

I think the main point here is quite simple: the choice of social discount rates is the key single driver of long-term investment appraisal.

The Copenhagen Consensus uses a discount rate of 5%. So, for example, a benefit of £50bn in 100 years' time would justify a cost today of up to £380m (0.76%).

The UK uses a long-term discount rate of 2.5% for such time periods. This would justify a cost today of £4.2bn (8.46%), eleven times more than the under the higher discount rate.

Of course, determining the right discount rate is no technocratic exercise: really it's goes to the heart of our personal social and philosophical preferences, particularly for potentially catastrophic events and where the costs are highly inequitably distributed across generations, national borders, and social groups.

Clive Bates said...

Hello anon - excellent point!

First thing to say is that I think the difference between efficiency and equity is important too.

But on your main point, I think discount rate is really a proxy for the broader concept of 'time preference' - usually falsly implying some objective rationale. for what is really a subjective idea. As you say, there is no single answer to the correct time preference, as each person asked will have a differet view. Not surprisingly, the representatives of the countries invited to the Copenhagen Consensus table for this exercise have a very aggressive time preference for money that would flow to them. But that doesn't mean they are the right people to determine what the appropriate time preference is.

Governments use discount rates lower than the private sector precisely because they believe there are public goods or other non-market reasons to use time preferences other than those determined by the aggregation of market participants.

So I don't think it is that the Copenhagen Consensus has chosen the 'wrong' discount rate per se, just that they've failed to think about whose time preferences they are aggregating and why that is or isn't valid.

Doctapaul said...

What if man made things mean nothing to Nature?

Chris Yiu said...

Yes.

Capital markets provide a mechanism for aggregating individual rates of time preference (whether they are fully efficient is another debate).

If we think there are market failures to be addressed then this should go into the cost/benefit analysis, not directly modify the discount rate chosen.

Similarly how we think about uncertain (and potentially catastrophic) future events is about our/society's taste for risk. The more risk averse we are, the more we should be willing to pay to mitigate future risk. But this is not about discount rates either.

Clive - I think employing a veil of ignorance is an excellent suggestion for future exercises. But how would you enforce it?