Uncertainty Can Go Both Ways
By David Henderson
In the latest issue of Regulation magazine is a symposium on carbon taxes. The lead article is by Bob Litterman and then four authors, including me, responded. Here’s an excerpt from my piece.
On two other issues, I disagree with Litterman.
The first is the issue of the economists’ consensus. He writes, “There is no disagreement among economists on the benefits of pricing carbon emissions.” That is simply false; there is disagreement. I’m an economist and I am not sure of the benefits of pricing carbon emissions; in what follows, I say why. Perhaps he accidentally overstated his case because in the same paragraph, he writes, “Relying on prices to allocate scarce resources is vastly superior to the command-and-control approaches of current policies, which rely on public subsidies and mandates to use particular alternatives to fossil fuels.” That is true, but to say that A is better than B is not to say that there is no disagreement on the desirability of A.
The second issue on which I part company with Litterman is the role of uncertainty, which is the main focus of his article. He admits that his reasoning about uncertainty does not lead to any firm conclusions about carbon policy. He writes, “The fundamental problem, of course, with the insights provided by the economics of risk management is that the answer depends, at its core, on something unknowable.” And yet, in his last paragraph, he reaches a strong policy conclusion. He writes:
I believe that given that uncertainty, a cautious approach that weighs the cost of catastrophic outcomes above the potential benefits of hedging future economic growth is justified. It would be best to get started immediately by pricing carbon emissions no lower, and perhaps well above, a reasonable estimate of the present value of expected future damages, and allow the price to respond appropriately to new information as it becomes known.
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.
I also express my caution about the political system:
I am cautious not only about the science of global warming, but also about the political system. If the government imposes a tax, that tax will be difficult to end if our later information tells us that it should end. Some interest groups will lobby to keep the tax in place. Which groups? Perhaps the producers of alternative, non-carbon-based energies, a group that has shown particular power in recent years. Economists who pay any attention to the way laws are made and to the contents of those laws should be among the first to be cautious about advocating new programs and/or new taxes.