Saturday, October 17, 2009

More evidence the risk-return tradeoff in climate change action is being underdiscussed: Stephen Levitt

Nobel Prize winning economist Paul Krugman in a post today makes essentially the same point I made in my Blog Action Day post on Thursday:
Weitzman pointed out, however, that we are highly uncertain about the impact of greenhouse gas emissions — and that the form of this uncertainty is such that there’s a significant risk of utter catastrophe if we don’t act. This risk of catastrophe, he argued, is what should drive policy — and it argues for quick, decisive action rather than a gradualist, wait-and-see policy.

This argument convinced me; it’s one of the main reasons I’m a strong advocate of moving quickly on climate.
With my training and work mostly in finance, I put it in finance terms:
The risk-return tradeoff says that the higher the risk of an investment, the higher an average rate of return you will, or should, require. But it also says, conversely, that the lower the risk of an investment – or the more risk decreasing an investment – the lower an average rate of return you will happily accept.

What average rate of return do people happily accept for fire insurance for their home? A negative one, not just a low one, a very negative one. People even accept a very negative return for insurance on their car.

So what return would you accept for fire insurance on the planet you, and your children, and your grandchildren will live on? Scientists aren't that sure what exactly will happen with global warming. The feedback effects could get out of control and devastate the planet.

Stern's study justifies large spending on global warming even using positive rates of return (or discount rates). But when you use a negative, insurance like, rate of return, then clearly it becomes far more than worth it to spend at least moderate sums combating global warming, sums much greater than anything that's currently being discussed.
Krugman's post today justifiably severely criticizes Stephen Levitt. In his new book Superfreakonomics, he "quotes Weitzman, which cites his [tail] probability of utter catastrophe as if it were a reason to be skeptical of the need to act." When a full economics professor at a prestige school misses, or doesn't acknowledge, the argument that the risk of devastating losses justifies low, or negative insurance like, discount rates, it's evidence that we are not getting this message out enough in at least the professional media and blogosphere, and in fact, it's a message that I personally seldom hear, at least explicitly and clearly, in a great deal of reading of this media.