The Hindu Business Line : From probability to certainty

There’s this to be said about economists: they go where the money is. When poverty studies had the funding, they went there; now that climate change has it, they are herding there. Their studies on poverty made no difference to poverty, except their own; their studies on climate change will make no difference to the climate, either.

As Dr Brijeshwar Singh, an economist and officer of the IAS, who is currently NHAI chairman, points out, climate change is a mega thing, while the tools of economics are for micro changes at the margins. To look to economics for solving climate problems is like breaking boulders with a goldsmith’s hammer. There is another problem that economists duck which is equally serious. It concerns uncertainty and, therefore, probability. It is not that they don’t study the effects of uncertainty. They do, copiously and continuously. They also study probability. But not, alas, in the context of climate change.

Making policy requires a reasonably accurate assignment of likelihoods to the various outcomes that the uncertainty inherent in human behaviour induces. This is where economists cop out, implicitly and conveniently assigning a probability of one — certainty — to events. They then proceed to prescribe policies.

Probability ignored

And they are now applying the same technique to climate change because it is assumed by them not only that the climate will change, but it will change by global temperatures going up by exactly 2 degrees in the next 100 years. So, policy prescriptions are based on this ‘certainty’.

In fact, the precise definition of climate change was quite different and has now been almost forgotten. It was the probability of average global temperatures rising by 2 degrees over a hundred years. Somewhere in the last decade, the ‘probability’ part was given a quiet burial and the two degree rise is now taken to be a certainty.

This is crucial because if the probability is not one — that is, it is not completely certain that global temperatures in 2110 will, on average, be two degrees higher than they are now — the policies that need to be adopted, and therefore the costs that have to be incurred now, are radically different.

This has serious implications for funding these costs, whatever they may be. Since the costs will have to be met only through higher taxation, and as people will resist paying for something that may or may not happen 75-100 years from now, the rate of taxation is absolutely critical.

So, cut right down to the bone, the proposition is as follows: the higher the probability of global temperatures being two degrees more than they are now, the higher will have to be the current tax rate, and the reverse also holds.

But by assuming the probability to be one, or as close to it as to not matter, economists require the current tax rate to be impossibly high, as did the Stern Review. This is never going to work, whichever way the tax is imposed — lower growth rates for India and China; front-loaded costs for the US, the EU and Japan in the form of more stringent emission norms in the first 20 years; contributions to technology funds paid for by direct taxes or a cess, and so on.

Big contradictions

Not just this: there is another huge contradiction in the approach, even if a lower rate is adopted. Economists say if you devise the proper incentives, the problem will be solved. So you tax carbon so that firms use less of it.

But, as many studies have shown, a carbon tax is regressive even in the developed countries, leave alone the poor ones. That is, it leaves the poor worse off than the rich. Shareholders in a company benefit from a carbon tax but not anyone else.

To get round this tricky issue, we get to the idea of ‘stakeholders’ which says “you may not benefit now but please think of your children and grandchildren.” OK, but then a carbon tax gives a double benefit to shareholders — a pecuniary one now in the form of higher dividends and a non-pecuniary one in the form of a better climate for one’s descendants, for which everyone except the shareholders paid.

I have asked scores of economists, including three Nobel Laureates, about this problem. Not one had an answer because, in fact, there is no answer. And it should be noted: this has nothing to do with the idea of a social rate of time discount.

One of them said “Look at the tax as an insurance premium”. All right, but then why ignore the actuarial aspects, as embedded in probabilities, when calculating premia, or, in this case, the tax rate? Actuaries have never been asked to apply their skills to working out a fixed tax or premium rate applicable to everyone over the next, say, 50 years based on different assumptions about the likelihood of global temperatures in 2110 rising, on average, by 2 degrees. Thus, what would be the premium (or tax rate) if the probabilities were 0.25, 0.75 and 0.90 respectively?

It should be evident from this that it is impossible to work out anything that is even remotely sensible. And the reason for that is that economics is not the right intellectual tool to apply to the perceived problem of climate change. The answer lies in changing the energy base of the world. That needs science and technology, not economics.

( blfeedback@thehindu.co.in)

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