Making economic (non)sense of climate change

Here’s a joke about economists in a letter last week to the Economist magazine:

“When I considered taking a degree in economics almost 50 years ago, I was told that the exam questions would be the same from year to year but that the correct answers would differ each year.”

Here’s a not-so-jokey letter from the same issue: “The current head of the Congressional Budget Office co-wrote a paper a few years back titled: ‘Can Financial Innovation Help to Explain the Reduced Volatility of Economic Activity?’ ”

Actually, the brilliant 1990s-2000s financial innovations hugely increased economic volatility. They caused of a financial shock of epic proportions that has wrecked multitudes of ordinary folks’ lives.

Sometimes economics has the air of unreality of late-1960s love-in pop music, commemorated this weekend in the fortieth anniversary of the Woodstock outdoor concert, remembered by one baby-boomer last week as “sloppy, chaotic, bewildering, drenched, uncertain, sometimes excruciating, sometimes ecstatic”, in the end no match for “everyday human nature or the pragmatic workings of the market”.

So why has the government made so much of economists’ projections in defending its 2020 greenhouse gas reductions target?

It is not that the general equilibrium models, as they are known in the trade, give certainty. They cannot see round corners. And there will be corners between now and 2020 as there were from 2000 to now.

Moreover, what you get out of the models depends on what you put in and what you leave out.

Different prices for “carbon” (the shorthand for greenhouse gas emissions) yield different costs. Whether you allow purchases of offshore credits or not affects the carbon price. The model the government used did not incorporate the Kyoto protocol starting point. It ignored exogenous change such as new technology which might reduce the net cost.

So don’t take Nick Smith’s $30 a week cost for each person in 2020 as gospel. It is the economist’s equivalent of (sophisticatedly) throwing a dart at a (sophisticated) dartboard — it might be right but it almost certainly will be wrong and no one can tell you in which direction. Read the Economist’s recent severe critique of macroeconomists.

So should you take the 10-20 per cent target as a given? Even the 10 per cent depends on five conditions being at least partially met. They won’t be fully met, so there is large wriggle room for the government to settle at the bottom end of the range or even do nothing.

But there is reason to think enough of the conditions will be met for at least the 10 per cent target to come into play.

A “comprehensive global agreement” at Copenhagen in December is all but off the cards. But a “framework” is probable then, which will keep negotiations alive. The Kyoto protocol doesn’t run out till 2012 — time for the “framework” to be fleshed out into something that looks enough like an agreement to trigger the 10 per cent.

And officials at the Bonn negotiations this week say other countries are starting to take seriously New Zealand’s long-running and intensive efforts to inject sense into the Kyoto rules on land use, land use change and forestry.

Officials in Bonn also say that other countries have volunteered to them that the 10-20 per cent position is creditable. The non-government American-based Pew Centre for Climate Change has also said so.

So Smith has met one condition: initial international acceptance. New Zealand is not the pariah Greenpeace and the Greens have been warning of (at least not yet).

Those are the critics Smith and colleagues have been fending off. He is much less bothered about the other side, the climate change deniers and the business lobbies for a low or no target. In fact, apart from Federated Farmers which is in a universe of its own, business reaction ranged from muted to supportive.

And that is despite the Treasury, working on an equal-cost-to-GDP basis, pushing a range of plus-15 per cent to minus-7 per cent. The cabinet can claim to be have been adventurous.

The next step is to make policy to achieve the target. As the Greens have pointed out, the government has done next to nothing and there is much it could do, at limited cost, to reduce gross emissions.

It has dawdled while the select committee reviewed the emissions trading scheme (ETS). That committee is due to report late this month. Then business — especially the forestry sector, which has been in limbo, at a cost to us all of carbon sinks foregone — gets some certainty and can either invest or pack up.

One likely change is to have the ETS prices administered by the planned Environmental Protection Agency, at arm’s length from the government. Also a focus will be how much sectors’ entry into the scheme will be delayed and their free allocation phasedowns softened — not much, nods and winks say.

And then the question is: will the new ETS be durable? Economic modellers will be no help in answering that question. That is for politics.