Saturday, March 31, 2007

Can $15 Per Ton Be The Right Price?

The figure commonly thrown about for damages from global warming is roughly $15 per ton of carbon. This startlingly reasonable number has left me wondering whether our methods of damage estimation are correct.

I haven't scrutinized these exact estimates but typically we do damage estimation by calculating either the willingness-to-pay to avoid the externality or the willingness-to-accept to live with it.

That is, we figure out either how much people would pay, if they could, to get rid of the problem of global warming or how much we would have to pay them so that they would rather take global warming and the money than be without either.

This is all very normal and accepted.

The problem comes in when the people who are creating the externality and the people who are going to suffer from the externality are radically and systematically different. In this case the United States is the world's largest producer of carbon emissions and also happens to be the wealthiest nation in the world. On the other hand by many account Bangladesh will suffer some the worst consequences of global warming and is among the poorest nations in the world.

All else being equal the more money you have the higher your willingness-to-pay to avoid externalities will be, this is in part because rich people have more time to be concerned with these types of things, but more importantly its because rich people simply have more money to pay.

Before my economist readers pooh-pooh this line of reasoning as being dealt with by Kaldor-Hicks let me weave a story that I think is important.

Suppose we continue with the example of the US and Bangladesh. The US is emitting carbon which we will assume has little to no impact on the quality of life in the US but will potentially kill roughly 10 Million Bangladeshis because of the rise in sea levels.

Now we could say - Look America, the Bangladeshis have a right to life and property which you are infringing upon. Please cease and desist. By many accounts this would be fair. I don't have the right to fire bullets into a crowd or start uncontrollable fires in my backyard because I could be taking other people's lives. Why does the US have the right to pump carbon into the atmosphere? The fair thing to do would be to make America stop.

Economists rush in, however, and say - Look, it may or may not be fair but it is certainly not efficient. No particular Bangladeshi will die with certainty in the floods and many risk death every day from other things. I think some of them would rather have money which they could use to buy food and medicine for their families and then just chance the flood.

So, we figure up how much medicine we'd have to give the Bangladeshis to make them indifferent to global warming and we call that the damages. If we just charge that to the US then by the miracle of markets we've managed to make the Bangladeshis whole and reduce the cost to the US to a mere fraction of what it would be if we stopped carbon all together.

The problem with the story is this - The miracle was possible in large part because Americans had to give up very little happiness in the form of money to make the Bangladeshis very happy with medicine.

In other words here, the major gain is that in this example there are huge gains from trade between the United States and Bangladesh. That gain, however, is only realized if in fact we trade with Bangladesh. If we keep the tax money and use it to reduce our own income taxes we haven't taken advantage of that gain and so the calculations we used to come up with the marginal damages are invalid.

Another way to think about this, suppose that each human being has the right to produce a given amount of carbon, a personal carbon permit. Bangladesh would have about half as many permits as the US but a fraction of the carbon. They would gladly trade some of their permits in exchange for life saving resources.

America, in desperate need of permits would take the exchange. However, in the end this transaction involves two parts. A given reduction in US carbon emissionas and an increase in medicine in Bangladesh. The first part does not make sense without the second.

If we aren't going to give the money to Americans then we have to ask another question. What would an American pay to avoid the consquences the average Bangledeshi is going to experience. My guess is that that number is significantly higher.

hat tip to mankiw

16 comments:

Chris said...

I have a completely unrelated question, but I don't see a link to e-mail.

I am for free trade. I wish everyone was. However, I do wonder if unilateral 'disarmament' of trade barriers is akin to unilateral military disarmament?

In both cases, government's are spending money in a non-productive fashion (at least, not directly) to protect local production.

In both cases, it would be better if everyone disarmed, but it would also be better if each country was slightly better armed than everyone else.

thoughts? please tell me I'm wrong.

Karl Smith said...

Chris, good question. The short answer is that in general the analogy is false - protectionism doesn't even help the country that is doing the protecting.

However, I'll try to get a more complete answer posted by tomorrow.

mk said...

Neat, very nice explanation Karl.

Just to get it clear myself, the problem doesn't seem to have anything to do with the two groups (the polluters and victims) being radically different. Rather, the problem is that Kaldor-Hicks efficiency is too theoretical-- you're not helping the world out unless you really send those tax revenues to bangladesh.

Do I have this right?

It seems that what is called for here is some criterion, not quite Pareto (too strict) and not quite Kaldor-Hicks (too theoretical) but rather something like "if you're only helping yourself out a marginal amount, and yet you're totally shafting these folks over here, that's worse." Even just adding everyone's utility together would work for this case.

I'm sure there's a rich literature on how to define this criterion, which not being an economist I know nothing about...

Karl Smith said...

^

So, the problem with Kaldor-Hicks is that it doesn't count redistribution.

It says that damages are damaages no matter who they occur to.

This is bad because I ask a Bangladeshi - what would it take for you to be willing to risk the flood. He says well, $100 to get all my children vaccinated would be wonderful. $10,000 to send them all to school would be fantastic.

If I were to ask an American the same question she would say - Well probably $2 million.

The big difference is because the Bangledeshis are a lot poorer.

So when I ask one group what the damages are, but then apply it to another group that is much wealthier there is a disconnect.

That would be ok it the American's were in fact giving the money to the Bangladeshis. But sense they are not I am effectively devalueing Bangladeshi life by the difference in average income between the nations.

It is a complex concept that I find it hard to explain even to other economists. I hope I am doing okay here.

mk said...

Yes, but if we actually give that money to Bangladesh, then Kaldor-Hicks turns into Pareto and everything's great, no?


In other words, things unfold like this:

1) We estimate the costs of pollution by asking some Bangladeshis how much we need to pay them;
2) That cost is pretty low because they're poor;
3) We tax the polluters to recover that cost;
4) We don't actually send the revenues to Bangladesh.

This scenario is "bad", which in this case I am defining as "not Pareto optimal."

But it is also not Pareto optimal if:

a. (2) is not true, and Bangladesh is very rich so the taxes are really high.
or if...
b. Americans are the victims instead of Bangladeshis, so the costs are set according to what Americans would be willing to pay to avoid the flood. These costs are much higher. However, as before, the government does not literally pay the affected Americans using the tax revenues. Instead, it builds a Mars probe, or something.

I guess what I'm questioning is the assumption that the government will take the marginal revenues and "pay them back" to Americans in a roughly Pareto-like way. This is because:

1) Every American suffers either a lot or a little from pollution. It can vary from person to person;
2) The pollution tax's revenues get dispersed back out to Americans in some random other proportion; according to what is being subsidized, where the tax credits go, who is getting income assistance, etc.

So basically, throwing more money into "the government" is not a targeted enough way to get Pareto optimality.

On the other hand, you might just say, ah, that's a separate problem. The government ought to be giving out its money to the most needy people, if it does that, Pareto optimality is assured.

I am also not sure if I am being clear ;) nevertheless, this helped me get a little clearer on what I mean...

mkayser said...

Whoops, I just wrote:
The government ought to be giving out its money to the most needy people, if it does that, Pareto optimality is assured.

Sorry, elementary mistake. Pareto optimality really is only assured if revenues are totally earmarked for the victims. So that's the problem. As long as you really earmark the revenues for the victims, everything's fine. Even if the victims are in Bangladesh.

(But if Pareto is your bag, clearly Americans are going to suffer too, so being more realistic, you have to interview some Americans too.)

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tm said...

So- have you guys not heard?

"Global warming" as a result of human action is a myth.

Thirty thousand+ scientist agree that the small(but disproportionately vocal) minority of AGW advocates are not only wrong but are, in fact, actively TRYING to push the deception that it the "global warming" fraud.

This whole issue is a Trojan Horse for wealth redistribution. Not surprisingly your posts confirm that fact. What ever happened to intellectual honesty?

I, personally, am highly disappointed that such well-educated people would be foolish enough to think that mankind has more impact on his environment than weather does.

Mankind's TOTAL OUTPUT to date is only a tiny fraction of a percentage point of the effects of a small volcanic eruption. Mt. St. Helens released exponentially more CO2 than all the industry of man in all of history.

So- tell me again why I should pay for "carbon credits"?

Seriously: see the IPCC controversey if you doubt the fact that *certain* "scientists" are propagating falsehoods about AGW.

Apologies if I seem overly assertive but this talk of carbon taxing and cap-and-trade is bordering on a full frontal assault on everything affecting global economy.

Think for yourself; don't blindly swallow Captain Planets' nonsense.

Please. For ALL our sakes.