Wednesday, January 19, 2011

Discount Rates Hole

In which Management moves a rather contentious set of comments about the possibility of negative interest rates to it's own hole. Now one has to carefully distinguish between such things as the cost of funds, the discount rate and the social discount rate, something that the bunnies have not been very careful at, but this is not the first time that such a discussion has occurred, for example this post and the comments (read the post AND at least the first comment). Positive discount rates ALWAYS value the present over the future and are an assumption.

There have been long periods when global growth decreased although not recently, for example, between 1100 and 1300, and others where it remained roughly constant, again, for example between 200 BC and 400 AD. The triple threats of nuclear war, species extinction and climate change pose such a threat, and IEHO if we do not meet those challenges today it will be grim.

And so to the tape
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John Mashey said...

I am impressed to hear that the GDP/capita in developed world will be $400K ... those people will be *rich*.

[Ayres & Warr still make me nervous that the ~3% discount rates come from a century of cheap fossil fuels, and while I've asked often, no one has yet to give me a a clear reason why the discount rate should overall be positive for 2100. it would be awfully nice of the part of economics that seems to want to be physics had cosnervations laws and similar things to help reality checks.]

18/1/11 12:04 AM
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Anonymous says
Marlowe J asks " more stuff on climate policy/economics please.
Glad to Marlowe

Boy oh Boy, is this a beehive of stupidity or what.

John Mashey says:

[Ayres & Warr still make me nervous that the ~3% discount rates come from a century of cheap fossil fuels, and while I've asked often, no one has yet to give me a a clear reason why the discount rate should overall be positive for 2100. it would be awfully nice of the part of economics that seems to want to be physics had cosnervations laws and similar things to help reality checks.]

I mean this in the nicest possible way. I can’t believe after reading the Mash’s comment how he could have possibly been senior technology scientist at a technology company. But I remind myself that it went into chap 11 and feel more at peace.

Mash, you total economics ignoramus, what the hell has discount rate have to do with (your words) “heap fossil fuels”? What the damn hell is going though you mind when you said:

“Ayres & Warr still make me nervous that the ~3% discount rates come from a century of cheap fossil fuels”

For crying out loud.

He then asks possibly the stupidest rhetorical question I have ever seen on a blog let alone a blog post trying to attack an economist. He asks himself why should a discount rate that should logically give value to present goods over future ones be positive. The Mash reasons it should be negative! Negative! FFS

This can only leave me with one option, which is to request a loan from the Mash.

Mash, please give me $100,000 today only on condition you pay me 3% a year for 100 years. I take it that’s a deal.

The Mash then has the audacity to suggest reality check.

I can’t believe Eli has allowed that comment to go through without deletion or perhaps even banning him for not being ummmmm, up to scratch. At the very least Eli should ask the Mash to lift his game/ or perhaps we forgive him for being a Californian. 18/1/11 7:22 AM
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J Bowers said...
Anonymous -- "How can a case be made to take from the poor (present generation) to give to the rich (future generations), "

Ask any parent or grandparent.
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Anonymous said...
Bowers:
Your little comment is emotive and doesn't make any sense as to why we should take from the poor to give to the rich.
In fact, if you really thought about your comment some more instead of emotive babble you would realize that the actors in your example are the richer (parents and grand parents) giving to the poorer (the kids).It in no way negates the point I made and in fact supports it.
18/1/11 9:01 AM

---------------------------

Martin Vermeer said...
J Bowers, Anonymous: a better example would be a soldier dying in combat, or a dissident rotting in jail, so his children may be free.

Sometimes the bell just tolls.
---------------------------

Much more follows, some of it, not nice

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John Mashey said...

Please, somebody convince me that the discount rate to 2100AD is positive....

And will the various anonymice prove they can read and follow Eli's clear admonition:

"Dear Anonymous,
Some of the regulars here are having trouble telling the anonymice apart. Please add some distinguishing name to your comment such as Mickey, Minnie, Mighty, or Fred."

Please pick a pseudonym and at least stick with it for a discussion, otherwise my motto is:
IUOUI = Ignore Unsupported Opinions of Unidentifiable Individuals

Perhaps Eli can send more anonymous posts to the Rabett Hole, which might be considered the 11th circle...

18/1/11 5:07 PM
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Anonymous said...

"Please, somebody convince me that the discount rate to 2100AD is positive...."

How can we convince you the earth is flat, Mash.

Here, this may convince you.

Lend me 1,000,000 and pay me 3% for doing so. If you don't agree to the deal which I'm happy to offer security double the value you're simply a bullshit artist.

When do we sign up Mash?

18/1/11 5:16 PM
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Anonymous said...

John Mashey, I'm deadly freaking serious, man.

If you think we should use a negative discount rate I am prepared to borrow any amount of money you can offer me and I will give you double security. I'll even throw in a small NYC apartment as part of the security to sweeten it up. (Not in Crooklyn of course).

And you pay me 3% for the privilege.

Best anon.

18/1/11 5:52 PM
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Anonymous said...

This is a truly bizarre debate...

If people believe in negative natural interest rates, they are beyond hope and in turn anti economics and anti conservationist – they are intellectual dropkicks. They are discounting time value of money entirely. In fact, the message is to consume as much as humanly possibly right now, and not give two craps about the environment.

18/1/11 6:35 PM
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EliRabett said...

Anon, yes, negative discount and interest rates exist. On the monetary side, Switzerland has on occasion offered negative interest rates to discourage foreign investment in SF. Folks bought anyhow because of the perceived safety of the investment.

Real interest rates can easily be negative if inflation is higher than the interest rate.

In both cases it ain't pretty, but it does happen.

A discount rate reflecting economic growth, assumes that the economy grows. The proper discount rate for 1928 - 1935 would be what? Berry, berry negative. Worse even for the period after Rome fell. The argument for a positive rate is that historically over the past century and a half (with brief periods of contraction) the global economy has grown, but there are sadly exceptions such as Somalia, where a negative discount rate would apply.

So no Virginia, there is no guarantee. Social interest rates are a whole other entire ball of wax.

18/1/11 8:40 PM
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Anonymous said...
"Anon, yes, negative discount and interest rates exist. On the monetary side, Switzerland has on occasion offered negative interest rates to discourage foreign investment in SF. Folks bought anyhow because of the perceived safety of the investment. "

It was a technical abberation caused by the structure of Bretton Woods when money was pouring into Switzerland across the border. The Swiss were using that regulation to dissuade this form of portfolio capital flows. It wasn't market driven, as the exchange rate was fixed and was also a regulatory imposition.

Finally Eli, you are basically referring to short term interests and certainly there was never any attempt to change the 100 year time preference e en in switizerland, as you're implying.

Yes, there there negative real rates that show up at times and there were also negative long bond rates when interest rates and reserve requirements were controlled by the Fed under Regulation Q, but that was placed back in the draw in 1978(ish) when the Fed abolished interest rate controls.

"....but there are sadly exceptions such as Somalia, where a negative discount rate would apply".

Not true.

You are actually suggesting that you could find someone that would happily give you local currency as a loan and would also happily pay you interest to get that money back in the future.

I challenge you to offer up proof. 18/1/11 9:21 PM

----------------------

Eli will interject here. Anon is confusing the interest rate with the discount rate especially the discount rate appropriate to intergenerational transfers (see link at the top of this post). It is perfectly rational to value the future more than the present under some circumstances, especially if one values those who might follow us. Moreover, as Eli has shown, there are cases where both negative interest rates (when you are interested in preserving disappearing value)

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Anonymous said...

There is no such thing as negative natural interest rates. The payoff decision criteria for lenders is not symmetrical. Furthermore, in cases of recession where there isn't a liquidity crisis, financial institutions still demand positive real returns, as do less senior creditors, who demand a higher positive rate, with or without recession.

"Social" discount rates ought to reflect the market real rate of capital costs. Like actual discount rates. They are meant to represent the value of capital investment forgone. Otherwise they represent nothing and you also begin to engage in double counting.

It is simply amazing we have so called conservationists believing in a price signal which would tell us all to consume everything now and ignore the consequences.

"The argument for a positive rate is that historically over the past century and a half (with brief periods of contraction) the global economy has grown..."

No. That is just part of it. Furthermore, the current century should have a higher growth rate than the 1900s, as the trend and antecedents suggest.

18/1/11 9:54 PM
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Anonymous said...

There is no such thing as negative natural interest rates. The payoff decision criteria for lenders is not symmetrical. Furthermore, in cases of recession where there isn't a liquidity crisis, financial institutions still demand positive real returns, as do less senior creditors, who demand a higher positive rate, with or without recession.

"Social" discount rates ought to reflect the market real rate of capital costs. Like actual discount rates. They are meant to represent the value of capital investment forgone. Otherwise they represent nothing and you also begin to engage in double counting.

It is simply amazing we have so called conservationists believing in a price signal which would tell us all to consume everything now and ignore the consequences.

"The argument for a positive rate is that historically over the past century and a half (with brief periods of contraction) the global economy has grown..."

No. That is just part of it. Furthermore, the current century should have a higher growth rate than the 1900s, as the trend and antecedents suggest.

18/1/11 9:54 PM
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Jakerman said...

Shorter anon (who is now repeating Tol worshiping claims made by Fred Knell):

"Its is good economics to lose 20% of GDP in order to preserve 1% of GDP."

Try harder Fred, you might convince yourself.

18/1/11 10:46 PM


-----------------------------

Martin Vermeer said...

Stern was more of less suggesting we use 1% of
> the growth rate to mitigate. ... as the growth
> rate trajectory falls to 3.5% growth rate

Nope. Not "more or less", not at all. Read the Executive Summary page xiii.

Resource cost estimates suggest that an upper bound for the expected annual cost of emissions reductions consistent with a trajectory leading to stabilisation at 550ppm CO2e is likely to be around 1% of GDP by 2050.

There is no reason this 1% should be taken off the growth rate. That is your choice. It could be taken off consumption instead, in which case by 2100, the available GGDP would be $3,152 trillion - 1% = $3,120.5 trillion, well over the alternative of $2,522 trillion.

I hope this is unsophisticated enough ;-)

18/1/11 11:23 PM
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Anonymous said...

Vermeer Says:
You can take 1% off consumption LOl.

How do exactly do that when consumption is 60% off GDP. How do you mange removing 1% a year off the rate of consumption without lowering living standards? And who gets it?

Your comment isn't unsophisticated it's dumb. It's about as stupid as Mashey suggesting we apply negative time preference rates.

18/1/11 11:36 PM
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Martin Vermeer said...

I've see John Mashey do this before, and it's fun to watch. Plant some simple idea, lean back, and watch crazy creeping out of their nooks...

Negative GDP growth rates produce negative discount rates naturally; any "economist" not grasping this should go demand their tuition fees back. A simple example is the following.

We are writing the year 2060AD, the economy is stagnating, teetering on the brink of collapse. Inflation is running 10% per annum, and no productive investments can be found promising even as much as 1%.

One John Mashey Jr. has $1000,000 that he doesn't know what to do with. Out of the blue comes one Anomymous Jr, offering to borrow the money and pay 1% per annum for doing so, with impeccable securities. Mashey Jr. of course takes him up on the offer -- 1% isn't great, but it beats keeping it under your mattress.

Now the point is, that the real interest rate that Mashey Jr. sees, is -9%. This is the proper discount rate to consider. Simple!

18/1/11 11:42 PM
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Anonymous said...

Martin V Says:

"There is no reason this 1% should be taken off the growth rate. That is your choice. It could be taken off consumption instead, in which case by 2100, the available GGDP would be $3,152 trillion - 1% = $3,120.5 trillion, well over the alternative of $2,522 trillion."

The 1% GGDP is the cost of mitigation. That’s a reasonable estimate how much big government directed mitigation would cost as a baseline figure that can be expressed any way you want but it has a dollar amount and the accepted norm on how to express it is over GGDP.

No mater how this is spun and dried the cost of mitigation is 1% of GGDP. If you wish to base the measure on Global consumption rates the cost will simply be a function of the consumption component of GGDP. There’s no getting around it, Hercules.

---------------------------

Martin Vermeer said...

> How do exactly do that when consumption
> is 60% off GDP.

Well, you take 1% off so it becomes 59% of GDP.

> How do you mange removing 1% a year off the rate of consumption

Not 1% a year. 1% period, every year anew, off that year's consumption -- there is no such thing as a "rate of consumption". Read the fscking report... perhaps after brushing up on your English reading comprehension.

18/1/11 11:51 PM
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Martin Vermeer said...

There’s no getting around it, Hercules.

Sigh, someone else with reading comprehension issues. Use the formula Luke: the 1% is 1% of GGDP. Taken off the consumption part of GGDP. Rather than eating up the seed grains, so to speak, which most farmers will tell you is not a good idea.

18/1/11 11:58 PM
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Anonymous said...

"I've see John Mashey do this before, and it's fun to watch. Plant some simple idea, lean back, and watch crazy creeping out of their nooks..."

If it’s as stupid as the idea he would lend me money and pay interest to the borrower. If he really did that people would end up laughing at the economic illiterate. No wonder you like his scrawls.

"“Negative GDP growth rates produce negative discount rates naturally; any "economist" not grasping this should go demand their tuition fees back. A simple example is the following.

We are writing the year 2060AD, the economy is stagnating, teetering on the brink of collapse. Inflation is running 10% per annum, and no productive investments can be found promising even as much as 1%.”"

This isn’t time preference, you moron. You’re discussing economic events.

"One John Mashey Jr. has $1000,000 that he doesn't know what to do with. Out of the blue comes one Anomymous Jr, offering to borrow the money and pay 1% per annum for doing so, with impeccable securities. Mashey Jr. of course takes him up on the offer -- 1% isn't great, but it beats keeping it under your mattress."

No, that’s not what the Mash has said. The Mashster suggested negative time preference. In other words he would lend money now and pay the borrower for the privilege. If you think that is a good idea, you’re stupider than he is.

"Now the point is, that the real interest rate that Mashey Jr. sees, is -9%. This is the proper discount rate to consider. Simple!"

What’s is simple is seeing a liberal arts grad from a so so college pretend he understands econometrics and in your case even basic economics for that matter.

19/1/11 12:15 AM
-----------------------------------
John Mashey said...

Martin: yes, it is simple, and having talked about the effect of energy on GDP/capita with Ayres (a very sharp guy) over dinner, I get nervous. By coincidence, here's an Economics blog post from a few days ago, on Oil shocks and economic recessions. As Hamilton (UCSD Econ Prof) writes:

"Every recession (with one exception) was preceded by an increase in oil prices, and every oil market disruption (with one exception) was followed by an economic recession."

Anon is very much in the style of Fred Knell, as in 19/1/11 12:32 AM
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Richard Tol said...

@Martin, Anonymous
Stern's estimate of the cost of emission reduction should be read as follows: GDP in 2050 with climate policy is 99% of GDP in 2050 without climate policy.

Roughly, that means that both consumption and investment are 1% lower. It does NOT mean that the growth rate of the economy is 1 percent-point lower.

19/1/11 12:19 AM
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Anonymous said...

If the estimate of large scale mitigate cost is 1% a year of GGDP then it doesn't really matter where that 1% is lifted from if it's also compounding at the annual sum of compounding GDP. It changes nothing.

As far as Stern explanation goes.. he's playing semantics. 1% of consumption and investment is 1% of GDP. How he can pretend to remove

government + (exports- imports) is rank nonsense. Who is Stern trying to kid as you can't remove mitigation costs from G or Ex - Im in a full blown mitigation environment.

Definition:

GDP = consumption +investment + govt (ex- imp).

19/1/11 12:37 AM
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Anonymous said...

Richard:

If the estimate of large scale mitigate cost is 1% a year of GGDP then it doesn't really matter where that 1% is lifted from if it's also compounding at the annual sum of compounding GDP. It changes nothing.

As far as Stern explanation goes.. he's playing semantics. 1% of consumption and investment is 1% of GDP. How he can pretend to remove

government + (exports- imports) is rank nonsense. Who is Stern trying to kid as you can't remove mitigation costs from G or Ex - Im in a full blown mitigation environment.

Definition:

GDP = consumption +investment + govt (ex- imp).


19/1/11 12:37 AM
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Jakerman said...

Anon (aka Fred Knell Or Frustrated potty mouth):

Let me repeat using Tol's terms (with slight improvment):

Sterns 2006 finding: GDP in 2050 with climate policy is 99% of GDP in 2050 without climate change.

And GDP in 2050 without climate policy is 80-95% of GDP in 2050 without climate change.

Sorry that keep getting things wrong Fred. I can see where your frustration arises.

19/1/11 1:00 AM
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Jakerman said...

BTW Fred, it was sweet of you to give us this line:

""I'm a ignorant dick".I can't try harder with you, jakerman, as you're too stupid to understand."

But even sweeter that you did so just to get this smack down from your idol:

"It does NOT mean that the growth rate of the economy is 1 percent-point lower."


19/1/11 1:15 AM
----------------------------
Anonymous said...

Jerkerman:

I'm not Fred, so stop it with the blind punches. If you don't like him, Fred has to be a good guy.

Do you even understand what you're saying? I don't think so.

Okay, His Lordship (stern) says:

1. There is minimal climate change damage in 2050. 1%.

2. The bulk of the damage will be felt beyond that and by 2050 the world will experience AGW damage of around 15 to 20% of GGDP.

3. Other current mitigation estimates are 1% of GGDP from now on.

I used roughly these parameters in my earlier comment, so what's your point? Do you think that by wasting pixels it will somehow raise my estimates of your comments. No they won't primarily because you're a fool, and ELI aside, this thread has attracted a large number of economic illiterates and fools.

I blame it on the liberal arts colleges.

Are you Californian too, because Mash is.

19/1/11 1:23 AM
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Anonymous said...

"It does NOT mean that the growth rate of the economy is 1 percent-point lower.""

No, Tol doesn't because he's being professional and exacting with what His Lordhship (Stern) said.

But if you see above I understood exactly what Tol is doing/saying and I explain it without the niceties, as I don't believe His Lordship deserves any.

Anyone who says (like his Lordship) that there will be AGW damage/mitigation effects on consumption and Investment which make up the bulk of GDP but avoids the effects on G + (ex -Im) is a bullshit artist.

19/1/11 1:31 AM
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Jakerman said...

Anon (aka Fred Knell) I can see why you'd want to distance your Fred persona from your comments in this thread, and the last thing I'm goinng to do is take your word for it. Compare your claims and language and Tol worship in this thread to yours over at Deltoid.

While it matters little little to me I think you are Fred Knell.

Fred continues:

"I used roughly these parameters in my earlier comment, so what's your point?"

That you got it wrong, when you based your argument on this false premise:

"Stern was more of [sic] less suggesting we use 1% of the growth rate to mitigate." And then you took this further to make more false claims. And you made your error delicious by telling those who corrected you that they were "stupid" and "ignorant dicks".

19/1/11 2:10 AM
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Tim Worstall said...

Just to be annoying: say that mitigation will indeed cost 1% of GDP each and every year.

In the UK that's £14 billion (1% of the £1,400 billion economy).

We already pay £14 billion (and a lot more in fact) in mitigation, higher energy prices, pigou taxes etc.

Thus the UK has solved climate change.

Or, as an alternative, Stern's insistence that mitigation will only cost 1% of GDP per annum is incorrect.

And here's the problem: those arguing that the UK must do much more are, by so arguing, insisting that Stern's cost estimates are wrong.

19/1/11 3:49 AM
------------------------------------

Martin Vermeer said...

Roughly, that means that both consumption and investment are 1% lower.

Richard, indeed. And doing the sums for that, it means that the rate of GGDP growth will also be 1% lower: 0.99*4.5 = 4.455% per annum. And GGDP will be

60 trillion * (1.04455)^90 = 3032 trillion

instead of 3152 trillion. A 4% shortfall.

19/1/11 4:01 AM
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guthrie said...

No, Neil Craig always uses his own name, and uses different words.

There seems to be some problem here - Tim is saying we're already paying 14 billion cost for AGW mitigation, whereas I was under the impression mitigation was a matter of spending that 14 billion on a new energy production system, better housing, sea walls and suchlike.

19/1/11 4:06 AM
----------------------

Jakerman said...

Tim writes;
"Thus the UK has solved climate change."

Slightly premature Tim. You need to keep mitigating, its not even 2050 yet.

Also, Sterns 2006 figures were pre AR4 and dependent on strong early global action. Although the UK rolled up its sleeves working towards pulling its weight, laggards like Australia and USA etc dragged the chain.

Strong early global action described by Stern in 2006 is not looking likely for a few years. In 2008 (post AR4) Stern recognized higher rate of emissions and up graded the costs of mitigation to 2% of GDP, but also recognized the higher risks associate with our higher emissions rate.

19/1/11 4:19 AM
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Anonymous said...

Martin V:

You seem to have a serious problem with rudimentary math.

The expression of 1% of GDP is just that it's an expression or a short-handed way of saying it will cost $6 trillion from a global economy that produces $60 trillion of GDP.

So each year the economy grows either 3.5% of 4.5% both those sums operate off the new compounded base, so it doesn't matter if it is expressed at a reduction off the growth rate, the consumption rate or the cost of beer ratio. What matters is the amount it represents.

Do you understand that now, you ignoramus?

There's nothing worse than liberal arts majors skulking around trying to sound all knowledgeable about these things except IT majors. Stick to the Iliad and let the grown ups speak.

19/1/11 4:23 AM
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a_ray_in_dilbert_space said...

Wow! Troll cleanup, aisle 1. All I know is that anyone who can say, "Ecology is for an innumerate pretending they are doing science when it's nothing of the sort these days," is an ignorant ass of monumental proportions. Ecology is one of the toughest of the sciences. I've been a physicist for 30 years. I'm no lightweight when it comes to bringing order to complicated studies. And yet I am astounded at the way ecologists manage to make sense out of their discipline. Sure there are bad ecological studies, but hey, G&T got published, too! There is a lot of very good work being done.

Our troll has contributed jack so far. He's given no evidence of being numerate himself, and his ejaculations are unworthy of any serious debate.

Back on topic. How can you do a study of mitigation before you have managed to bound the risk?

19/1/11 6:04 AM
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Anonymous said...

Dilbert:

If you think ecology hasn't been hijacked and is now a course in extremist environmental propaganda then it would lead me to think you're a pretty miserable physicist because you know or understand jack shit.

"How can you do a study of mitigation before you have managed to bound the risk?"

Easy. For a physicist to ask that question astonishes me.

We take an average of predictions of people in that specific field and then try to work for there with a cool headed approach (not like Stern who also took the effects of climate change on gender inequality into account). Pleazzzee.

Reasonable estimates of heavy handed top-down mitigation are around 1% of GGDP (and even that would be an under estimate as it wouldn't be taking into account the graft, corruption and rent seeking that would be going on like we've found in Europe since they introduced their abortion of a cap and trade.

My personal estimate? 2% of GDP for 100 years of growth getting hidden in a much lower growth trajectory.

19/1/11 6:19 AM
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a_ray_in_dilbert_space said...

On discount rates, let us amend the proposed deal. You can borrow up to $100 for any amount of time and will be paid 3% per year. Unfortunately, we will have to drop you into an airtight tank and the money you are borrowing is the money that would have gone for oxygen for the tank and the price of oxygen goes up by the second. We will be happy to buy the oxygen as soon as you pay us back the money and throw in however much additional we must pay for oxygen. If you survive, we'll be happy to refund the amount you've earned in interest. We look forward to your reply.

19/1/11 6:22 AM
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a_ray_in_dilbert_space said...

Anonymous, At the risk of stating the obvious, if you have not bounded risk, then how do you know that the money you spend to mitigate risk will not be wiped out by the unbounded risk you haven't bothered to consider. This is absolutely basic. Anyone who has ever worked on mission assurance or even properly considered an investment portfolio ought to know this.

19/1/11 6:26 AM
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Anonymous said...

Dilbert:

You astonish me. You boast about your qualifications as though physics is supposed to impress me to no end (It doesn't really). You now try and beef up Mash's economic illiteracy by posting gibberish on the site in troll like way.

The Mash said that he would like to see a negative time preference being used for mitigation. If the Mash prefers negative time preference I am happy to take a loan of any amount and I will offer him 100% security while he pays me 3% interest each year.

You don't even seem to understand the argument yet you're asking for people to be thrown off the thread? You're a clown.

19/1/11 6:32 AM
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Anonymous said...

“if you have not bounded risk, then how do you know that the money you spend to mitigate risk will not be wiped out by the unbounded risk you haven't bothered to consider.”

You can’t know, as we’ve never had any experience in assessing this form of risk before. Therefore we can only work with estimates of risk and find where the mean is on the curve and account for size of variance.

"This is absolutely basic".

Well actually it's not.

"Anyone who has ever worked on mission assurance or even properly considered an investment portfolio ought to know this".

Not true. There are volatility calculations one can perform on a portfolio and VAR. But you cannot insure for black swan events or can only do so by taking off risk from the portfolio. In terms mitigation that would basically mean de-industrializing.

Again, you astonish me with your last comment.

19/1/11 6:41 AM
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a_ray_in_dilbert_space said...

Anonym-Ass,
OK, we'll put you down for an "utterly clueless" when it comes to risk mitigation. If you care to learn, here is the procedure you go through for any risk mitigation:

1)Understand the risk
2)Bound the risk
3)Mitigate the risk

Without a bound on the risk, it is impossible to say whether 1)you are overpaying to mitigate the risk or 2)any amount you invest to mitigate risk will be wiped out when unanticipated risk swamps your investment.

This is precisely what happens in an insurance company when they do not take into account the thick tails of the risk in coverage or an investment. Perhaps you could tell us exactly what portion of it you don't understand.

19/1/11 6:42 AM
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Anonymous said...

"First, I think I've been pretty substantive and on topic throughout the discussion. I certainly think it is a reasonable to question how you can discuss mitigation before you've bounded risk even for the known uncertainties (and Tol has not)."

I nicely explained to you before that the only thing one can do with this is to set up a risk table supported by the risks in temps rise (scientists claims and therefore deriving the mean).

We have no real history of being able to make any other assessment of the risk, as there's been no previous experience. This is why it is different to insurance risk, as firms there are able to interpolate some historical data in what they insure.

You figure out the cost of mitigation up the prob curve and determine optimum.

At this stage if you look up at my claim earlier there is no case for top heavy mitigation efforts as the cost does not warrant a wealth transfer.

"And John's question is quite relevant. If climate change decreases ROI in the future, then the discount rate could well be negative--that is money spent now could significantly increase return down the road."

You're an ass. Time preference cannot be negative.

"Put another way: Would the discount rate for strengthening levies in New Orleans in 2000 have been positive or negative?"

There would never have been a discount rate figured out for such a thing by itself as it would form part of something else.. What an economist would do is prepare an cost benefit analysis while a discount rate would have have a part of the overall study. Time preference would have been positive.

You really don't understand this stuff, do you?

19/1/11 9:07 AM
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John Mashey said...

a_ray_in_dilbert_space said...

And John's question is quite relevant. If climate change decreases ROI in the future, then the discount rate could well be negative--that is money spent now could significantly increase return down the road.

Actually, that wasn't my argument. My argument is that GDP/capita is fairly strongly related to energy*efficiency/capita (at least up to a point), and that the general idea that people will be 14X richer in 2100AD might be in jeopardy given Peak Oil+Gas.


Put another way, fossil = energy capital; it might be good to ivnest more of it into asserts that produce energy income, for when the capital is much less. Silicon Valley companies usually learn that if you have a a hot product, you'd better be investing some ofthe profits into R&D for the next one, rather than just partying.

19/1/11 9:20 AM
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Anonymous said...

"And John's question is quite relevant. If climate change decreases ROI in the future, then the discount rate could well be negative--that is money spent now could significantly increase return down the road."

Jeez lord.

Time preference would NOT be negative in such an example. it would look like a firms cap ex. They are cap spending, expecting capture higher future returns than what is available. They would apply a positive discount rate, not negative.

You people need to understand the basics.

Have to go, enjoy yourselves no doubt at my expense and I will return later this afternoon to explain exactly what a firm would do and correct the "stupidities" that would no doubt show up.

19/1/11 9:27 AM
-----------------------------------

a_ray_in_dilbert_space said...

OK, I can see we have to go back to really basic ideas for our anonymous clownshoe.

OK, consider two possible scenarios. 1)Money invested now in mitigation cannot be invested in other profitable activity. This situation yields a positive discount rate. However, it presumes that there are other investments that will yield a profit. 2)If we do not invest in mitigation now, we damage the economy to the extent that positive ROI is not possible. In this case, the discount rate is negative. If we do not mitigate,all future investments yield lower returns. That really isn't so hard, is it?

The latter situation is quite possible in the case of climate change. Why? BECAUSE YOU HAVEN'T BOUNDED THE FRICKIN RISK!

Look, Clownshoe, I would consider a scenario in which 99% of species on the planet die to be one in which economic opportunities are seriously degraded. Richard, by his own admission, cannot rule that out.

We have been arguing about settled science for 20 years. We should have done something 20 years ago, and would have except for assclowns like you.

19/1/11 9:29 AM
---------------------------------

this appears to have run it's course

27 comments:

Kooiti MASUDA said...

You have moved John Mashey's comment referring to Ayres and Warr, so this comment of mine should belong here, though it is not directly about discount rates. (I wanted to pursue the notion that the growth rate of GDP may be negative.)
---------------------------
Kooiti MASUDA said...
I think that the works of Robert Ayres, mentioned by John Mashey, deserve more prominent attention than a short mention in a comment about the works of Richard Tol.
http://en.wikipedia.org/wiki/Robert_Ayres_%28scientist%29
http://www.insead.edu/facultyresearch/faculty/profiles/rayres/
19/1/11 2:17 PM
---------------------------

By the way, the interest rate is conceptually not the same as the discount rate. The interest rate actually prescribes duties of borrowers. The discount rate is a more theoretical concept used in projectionss and plans. But many economic projections equate these two (I have not examined whether Richard Tol did that). When (but only when) we accept their framework, we do not need to distinguish them.

EliRabett said...

Glad to insert your comment into the text.

One of the problems in all this is that the normal practice is to base the discount rate on the cost of capital. This can be seen in the first link
-------------------
The real rate of interest is the appropriate discount rate for benefit cost analysis. Market interest rates should be used for discounting because they reflect the rate at which those in the economy are willing to trade present for future consumption. Market rates reflect social preferences. Nominal market interest rates are equal to the sum of the real rate of interest (i.e., the rate of return on capital) and inflationary expectations. Most variations in nominal rates are due to changes in inflationary expectations since the rate of return on capital (e.g., factories, equipment) is fairly stable over time. The real rate of interest is equal to the market interest rate minus inflationary expectations.
------------------------------
and the objection to this is in the first comment there
---------------------------
I think there are other issues to consider with the discount rate and the environment. Because the environmental problems are usually of very long term, using even a very low discount rate on a future environmental benefit makes it worthless today.
-----------------------------
and this is also an important comment

Richard Tol said...

Climate-change-induced negative consumption discount rates are a real possibility. See

http://ideas.repec.org/p/sgc/wpaper/3.html

http://ideas.repec.org/p/sgc/wpaper/83.html

http://ideas.repec.org/p/esr/wpaper/wp276.html

http://ideas.repec.org/p/esr/wpaper/wp348.html

Jakerman said...

Richard Tol writes:

"However, there is a small chance that climate change reverses economic growth in some regions. In that case, the discount rate becomes negative and the net present marginal benefits of greenhouse gas emission reduction becomes very large. So large, that its variance is unbounded."

Thank you for providing this analysis.

Richard, you found "a small chance that climate change reverses economic growth in some regions" and did so using a model that assumes that extinction rates are relatively insensitive to the scale of warming.

What other adjustment to assumptions might might turn this into something larger than a small chance?

Anonymous said...

Apropos of ecology and economics see this from Nature:

http://www.nature.com/nature/journal/v469/n7330/full/nature09659.html

Systemic risk in banking ecosystems
Andrew G. Haldane & Robert M. May


Cheers,
Chris S.

Richard Tol said...

@Jakerman
In FUND, its lack of water (rather than species extinction) that would drag down the economy.

Jakerman said...

Richard, thank you for clarifying this point of sensitivity in your FUND model.

Anonymous said...

I don't think everyone is using the same of the several meanings of "discount rate". Why not check, just in case?

Pete Dunkelberg

Tim Worstall said...

"I think there are other issues to consider with the discount rate and the environment. Because the environmental problems are usually of very long term, using even a very low discount rate on a future environmental benefit makes it worthless today. "

Indeed: and that's a fault with us humans, this hyperbolic discounting thing. But it's still true that the economists (Tol among them) are attempting to measure what humans measure things at.

As to negative doscount rates: sure, if the economy shrinks then these are possible. But we almost certainly shouldn't use such in discussing climate change. For in the SRES (the assumptions about future economic and population growth that all of the IPCC work is based upon) we have already assumed that there will be strong economic growth this century. Global GDP will rise from the $50 trillion (1990 ish) to $250 (B2 I think) to $550 trillion (A1).

So we cannot assume negative discount rates at some point, driven by a shrinking economy, when our very calculations used to show that there is a climate change problem (which of course there is) make the opposite assumption, that there will be continuing economic growth which will cause the climate change problem we're all trying to solve.

John Mashey said...

I only looked at the abstracts Richard, but they certainly do discuss negative discounts, as in this one, a succinct comment:

"It is well-known that the discount rate is crucially important for estimating the social cost of carbon, a standard indicator for the seriousness of climate change and desirable level of climate policy. The Ramsey equation for the discount rate has three components: the pure rate of time preference, a measure of relative risk aversion, and the rate of growth of per capita consumption. Much of the attention on the appropriate discount rate for long-term environmental problems has focussed on the role played by the pure rate of time preference in this formulation. We show that the other two elements are numerically just as important in considerations of anthropogenic climate change."

John Mashey said...

A question for Tim:
Let me pose a thought question.
Suppose we magically instituted a worldwide tax per barrel oil such that the effective price (averaged over 5-10 years to avoid noise):

a) Was at least 2X higher in 2050.
b) Was 5-10X higher in 2100.

1) Do you believe this would have any effect whatsoever on the GDP/capita in 2100AD?

2) If so, in which direction?

3) And if negative, would it be noticeable enough that the figures used in Stern, IPCC, etc, for GDP growth might be a bit high?

4) Would you be in favor or opposed to such a tax?

Richard Tol said...

@Tim
What happens in the model is that climate change drives a few regions to economic ruin while other regions continue to grow and emit.

Jakerman said...

Tim writes:

"So we cannot assume negative discount rates at some point, driven by a shrinking economy, when our very calculations used to show that there is a climate change problem (which of course there is) make the opposite assumption..."

Tim, because of the long lag time I've cited several times (decades for temperature equilibrium following a forcing change, and longer for ecosystem effects, we can indeed expect a both a shrinking economy and climate change problem. The climate change problem is set up in advance (ie with our current economy) then we pay for it for later. [We pay for decades later if it the impact is very strong, and we pay for Millennia if AGW has a low to moderate effect.]

Anonymous said...

Re: Tim Worstall: The SRES scenarios are the underpinning of much of the IPCC's analysis of future climate scenarios, but they are not the be-all and end-all of our climate change understanding. It is true that the higher the economic growth, the more likely it is that we have higher emissions, and therefore more likely high temperature change and damages. So, there is a correlation between rich futures (presumably better able to adapt, and with higher discount rates) and higher emissions scenarios leading to higher temperatures.

However, 3 caveats:

1: emissions is not perfectly correlated with economic growth. Population is a key factor, and technology improvement another (often approximated as AEEI - autonomous energy efficiency improvement index): so even among the SRES scenarios there are rich but low emissions futures and dirty, poorer high emissions futures. (though none of the SRES scenarios are actually poor, and they mostly all have assumptions about convergence such that the poorest countries today start catching up to the richest by the end of the century in almost all the SRES scenarios... this choice was considered less than optimal by many economists but rumor has it was guided by political considerations such as not wanting to point out the possibility that some dirt-poor countries might remain dirt-poor given their lack of advances over the past several decades)

2: the SRES scenarios do not take into account the effects of climate change. So what starts out as a rich, high emissions future could run into massive climate changes and turn into a poor future.

3: outside of SRES, one could get a high temperature, poor future if emissions didn't drop until the 2nd half of the century, given climatic inertia: eg, the economy booms until 2060, we hit peak-fossil-fuel or whatever, and everything crashes... but warming continues.

-M

Majorajam said...

Some good thoughts here, but people need to distinguish between background growth rates in the absence of global warming and global warming damages. If the reason d'etre for this thread is people wondering 'what would happen to study results if we were  underestimating damages from warming', which seems to be the thrust of many comments here including Richard Tol's, that does not belong in a discussion about the appropriate discount rates to use in an evaluation of the economic merits of mitigation. 
 
That topic belongs on the old thread, in a discussion of how to assess damages writ large, (and thus returns to mitigation), and most particularly given the focus of readers here and at Deltoid, damages to the biosphere (remembering that Weitzman has shown that uncertainty exists at all levels of this problem, from emissions, to temperatures, to damages, to discount rates- with each independently capable of blowing up otherwise nicely behaved numbers).
 
On the other hand, the question of whether we are overestimating background rates of growth, (and I would argue that we are for several highly OT reasons having to do with the breakdown of civil society, though even I would find negative background growth rates over hundreds of years difficult to justify short of 100 year wars and the like), does indeed have massive implications for the appropriate discount rate to use in studies of this ilk. **
 
Note however that it's not clear to me how sensitive the results of these models are to different background growth rate assumptions. Remembering that we're talking about an integrated assessment model here, so in addition to a lower or even negative discount rate that dismal growth forecasts could project, they would also imply lesser damages for the same temperature change and lesser emissions, thus lesser temperature change. I would still assume the background growth assumptions relate inversely to the attractiveness of mitigation, just not perhaps as strongly as people here seem to believe.
 
This helps to explain why the real controversy over discount rate inputs focuses so much on the pure rate of social time preference, which regardless of how specified is actually a small component of the nominal money discount rate in absolute terms (tiny in Stern's formulation, not so Yohe/Tol... and how. Hey, they're not authoritarians, just honestly reflecting the revealed preference for extending a big middle finger to future generations). The reason is that the prtp affects only the way in which we discount the future relative to the present, without all the other implications that background growth rates imply.
 
** Writing this made me think of a possible way to summarize the sentiment here, (which of course involves, stop the presses, another gaping hole in these economic analyses). I personally have no idea, but can any of the expertise here weigh in on the extent to which mitigation of carbon emissions reduce other non-climate change related stresses on the biosphere? What are those worth? (think on a first order basis ocean acidification, but also other many other fossil fuel driven travesties e.g. deepwater horizon). Because I'll bet you dollars to doughnuts those benefits do not find there way into economic models of climate change such as Richard's.

Majorajam said...

John Mashey-
 
A fossil fuel centric view of growth rates strikes me as highly myopic. First of all, energy is a lesser constraint on production and distribution capability than popularly imagined. Note that the moon shot in petroleum prices of the past few years did not derail economic growth- wayward underwriting practices did. 
 
Of course, oil prices it did make vast stores of hard to reach deposits profitable, much less Canadian tar sands. So I really wonder how constrained oil production will be any time soon. But lets assume that by some miracle, some day, there is global carbon rationing. What then? I hardly think that drives such huge changes in lifestyles.
 
There are literally hundreds of technologies at various states of development from artificial photosynthesis to continuous solar thermal at the cost of natural gas to sophisticated demand management electric grids to transmission and storage technologies, etc. etc. These are all steadily conspiring to reduce further the energy constraint on output, and to overthrow fossil fuel's dominance of energy production as part of the 'peak oil' processes that are driving its cost curve in the other direction. Resource economics, not to mention history, tells us that there will be at some point a crossover. It has happened before.
 
I personally can tell you that in the last ten years, alternative energy deals have started to look a lot more like traditional energy deals by metrics that matter quite a lot, but that aren't often discussed in a still neoclassical thinking world (things that are meaningful to financial institutions with legal, regulatory, and liability considerations- not to mention whose principals are exposed to career risk- such as useful lives, warranties and insurance, maintenance, lease residuals, etc.). It is the tip of the iceberg.
 
I know this is a hot button issue, and I know how sensitive people are to the price at the pump as they say, but I don't find the hypothesis convincing.

Jakerman said...

"they're not authoritarians, just honestly reflecting the revealed preference for extending a big middle finger to future generations)."

Or they are using assumptions that things will get better and better based on wishful thinking about things for example like Tol's bizzare temperature insensitivity of extinction rates.

Anonymous said...

This is lots saner than the other thread (not to deny room for improvement).

As the discussion hinges on future economic productivity, I'll throw Hsiang 2010 into the picture: Heat and other severe weather cut productivity in non-agricultural sectors.

It is especially hard to be productive when flooded.

Economists answer: "But there will be a construction boom afterward so GDP will be good."

Oh Goody. It's all right then.

Floods, heat and drought cut agricultural production. If these increase, what are the odds of either a major world wide famine in the 2050's (or a series of lesser population reductions between now and then?

Tol: "But some countries will manage to increase production anyway."

What a relief that someone has the answers to all these problems.

Pete Dunkelberg

John Mashey said...

Majorjam:

Please read Ayres 2005 and perhaps you can find a copy of Ayres and Warr 2008. As Masuda-san says, these deserve more than an offhand mention.

As it happens, I reviewed a draft manuscript, and Ayres seemed to like comments enough to ask for a blurb and we have had various discussions, including over dinner.

I would be sleep better if someone could convince me Ayres was wrong, via logic, data, citations.

Many people are convinced that he is wrong or at least unconvinced he is right. Sadly, most such people have not carefully studied these materials or some of the other papers.

Tim Worstall said...

Suppose we magically instituted a worldwide tax per barrel oil such that the effective price (averaged over 5-10 years to avoid noise):

a) Was at least 2X higher in 2050.

I expect this to happen anyway...assuming by "effective price" you mean adjusted for CPI inflation.
b) Was 5-10X higher in 2100.

1) Do you believe this would have any effect whatsoever on the GDP/capita in 2100AD?
Over that time span, no, not a lot. There's a hell of a lot of flexibility in an economy over 89 years. We're going to replace the entire energy generation sector at least twice over that time, the global transport fleet (ships and planes n' trains) two or three times and the personal transportation system perhaps 5 times.

If it happened tomorrow (or taxes were raised so that it did) then we'd have huge disruption. But over 39 and 89 years? Not much either way I would have thought.
2) If so, in which direction?

3) And if negative, would it be noticeable enough that the figures used in Stern, IPCC, etc, for GDP growth might be a bit high?

4) Would you be in favor or opposed to such a tax?

My long standing suggestion is the Nordhaus proposal (he's the clever chap who came up with it, I'm just a random bloke on the internet supporting it). Low taxation now with a credible plan to raise it over the decades. Perhaps $5 or $10 a tonne CO2 now rising to $240 around 2040.

I prefer this to Stern ($80 or $120 now, depending upon which version you take) for that very point above, the turnover of the capital stock. Very little of what we will use in 2050 and almost nothing of what we will use in 2080 exists now. It's all stuff that is going to be built in the coming decades. So what we really want is serious pressure on those who will be doing the building in the future to build low emissions stuff. Curtailing the use, or even insisting upon the premature destruction, of the capital stock that we currently have has a synonym. "Making us poorer".

This does depend, of course, on the thought that we're not facing an imminent crisis. But then I don't think we are: we've got a long term and chronic problem to deal with, not something that we've got to have sorted by Tuesday at 3 pm.

Precisely why it is a problem in fact, humans aren't very good at solving chronic and long term problems.

Hank Roberts said...

Eli, how many different IPs are posting as "Anonymous" in this thread?

Is this gush from a firehose, or a sprinkler system?

Anonymous said...

RE: Marjoram's question as to the extent to which mitigation measures reduce other stresses on the biosphere.

It looks like the big one is direct benefits to human health. - see series of papers in the Lancet: http://www.thelancet.com/series/health-and-climate-change. Valuation of just the benefits of reduced air pollution averages about $50/tCO2 (Nemet et al, Env. Res. Letters, 2010).

These are not factored in to most economic analysis (including FUND) the only apparent exception being Stern, who did it in a rather minimal manner. Given that these benefits are near-immediate, and equal or bigger then the much more debatable estimates of damage costs of climate change, or most suggestions for a carbon tax - this seems a bit of an oversight, no?

Hank Roberts said...

> direct benefits to human health

And lost income to industry to the extent those health problems are reduced, and increased cost to the individual in the free market who'd rather buy stuff without paying for the pollution involved. Gotta be cynical enough, hard as it is.

John Mashey said...

Wearing my {private equity investor, occasional VC-helper, ex-corporate executive} hat, a whole lot of VCs, local governments, and business people (especially around Silicon Valley and SF Bay Area) would be ecstatic to have a long-term plan for rising carbon taxes.

Nobody wants an instant high tax, but of course, the numbers actually have to work, not just keep shoving the problem future-ward.

I think Tim is more sanguine than I am about the speed with which energy and transport infrastructure is naturally rebuilt. Big power plants last longer than people expect, roads and railroads are where they are, and in some places take a long time to build.

But in any case, it probably doesn't take taxes.
We're into the Peak Oil plateau, it's a pretty good guess the world oil production will down to .5Peak by ~2050, and to .1Peak by 2100. Sensible people use the high-EROEI energy sources first, but overall EROEI is going down fairly quickly. No longer does one just stick a straw into Texas, one has to do Deepwater Horizons. Likewise, in California (which people often forget is still actually a serious oil state), we're a long time past "There Will Be Blood".


See The Oil rum, specifically "The Curse of Shrinking EROEI" and Figures 11-12. i.e., these are Charlie Hall's EROEI balloon diagram and his "cheese slicer" Sankey diagrams from this presentation.
There, flip through pp.61-66 the by-year pages to see the effect, especially on discretionary spending.

So far Ayres&Warr, Hall, and other biophysical economists make way more sense to me than neoclassical economics that seem to divorce GDP growth from energy. But then, I've actually studied their work and met them. I would love to be convinced (with citations, data, not just opinions) they are wrong...

because it is all too easy for us to consume our one-time energy capital without investing enough of it into long-term energy income, and not only dump a lot of CO2 into the atmosphere, but build a great deal of infrastructure that makes sense only with cheap oil.

(For example, I would suggest that major new airport expansions, especially in expensive-to-build places like near Heathrow, better have a good model of future oil prices. I once looked at justification for the 3d runway, and it accounted for oil prices, but kept them at a ludicrously low level.)


Of course, I'd be happy if we used all the oil&gas there is ... if we could shut coal down. But we can't, any smart coal guy should do everything possible to get more coal plants built, to avoid a gradual transition away from them. It is far better for them if people are indefinitely faced with "shut coal off and you turn the lights out." Places like France or California are anathema to coal.

All this is orthogonal to the ecological impacts topic, but is not irrelevant to any computations claiming that mitigation or adaptation costs X% of GDP. The IPCC models different emissions scenarios. I'd sure like to see more modeling of different GDP scenarios, including the ones that think (energy supply) affects GDP, not just the reverse. Interested people might go rummage around Nordhaus's DICE/RICE models and see if they can find that. I haven't looked carefully of late, but I couldn't find it there a few years ago.

Tim Worstall said...

"a whole lot of VCs, local governments, and business people (especially around Silicon Valley and SF Bay Area) would be ecstatic to have a long-term plan for rising carbon taxes."

Quite....some of them are even my customers (my day job is in wholesaling the weird metals that many of these new technologies need).

Hank Roberts said...

Psst, any chance of pushing the -- more -- break up higher in this thread? Issss way long on your main page.

Kooiti MASUDA said...

I want to continue discussion about that GDP growth rate will not always be positive, but it seems to be more apt to move to the thread of Post-Growth Progress of Michael Tobis's blog, where I have tried to explain Ayres and Warr.