Uncertainty Can Go Both Ways
By David Henderson
In a recent response to Byran Caplan on global warming, Yoram Bauman rested part of his argument against cost/benefit analysis on the issue of uncertainty. Bauman wrote:
Reason #1 is that CBA has trouble dealing with uncertainty: if there’s a (say) 1% chance that climate change will be catastrophic and a 99% chance that it will be no big deal, how do you account for that in CBA? I don’t think anybody who knows the St Petersburg Paradox (and Marty Weitzman’s related work on “fat tails”) has a good answer here.
I dealt with this issue a year ago in an article in Regulation that I highlighted in a post about a year ago.
Excerpt from my Regulation article, titled “Uncertainty Can Go Both Ways”:
I think that Litterman would be hard pressed to justify that conclusion. It seems to be more of a hunch than to be something he has established in his article.
But there is a more fundamental problem. For Litterman, the uncertainty is all in one direction. Go through his article and, in every case where he discusses uncertainty, it’s about how bad the consequences of global warming will be. Will they be just moderately bad or will we have a catastrophe? Notice what’s missing: He doesn’t even entertain the possibility that global warming could be good. Nor does he entertain the possibility that not only could it be good, but also it could offset the potentially catastrophic damage that could result from global cooling. I am not a climate scientist, so I don’t know how likely global cooling is. But I am enough of an analyst to know that if we are uncertain, as Litterman admits we are, then we need to entertain that possibility.
Notice that I’m not addressing directly whether uncertainty makes it hard to do CBA. Rather, I’m saying that uncertainty does not mean that the case for a carbon tax is stronger than otherwise.