Economics of climate: Step back from ideology

What is economics, in essence?

It is an optimization problem. You choose your measure of interest and make it as good as possible.

From there, opinions vary. What is your measure of interest? Some say growth – the rising tides raise all boats crew (they have never had a leaky boat). Others say equity – inequality they say is not an acceptable price for growth. Sustainability is another measure: it is all very well to pursue maximum growth, minizing inequality, maximizing access to quality health and education or whatever other goal you seek if, in the long run, everything falls apart.

The optimization problem and the hazard of local maxima.
Assume your score of interest is good if it is big. At points
A and B, getting better takes you to a place that is not the best
because you have to first pass through a point where things

look worse

 

There are two difficulties with simplistic markets-vs-socialism comparisons. First, not everything is an economic good. A social good may not have a monetary value and also may not be promoted by pure economic growth. Another problem is that a market is good at finding local maxima, and disadvantages players willing to endure short-term pain to reach a more optimum point.

Markets favour local optimization

Check out the picture.

Assume you are in an industry where players have achieved efficiencies that put them at point A or B. If they are under competition pressure, their best strategy is to move to the “local maximum” because moving in that direction makes them more competitive. If they attempt to move to the point marked “best?” they first have to move through a stage of getting worse.

This is in very generic terms – to make it concrete, if a totally new way of operating is proposed that is way more efficient than traditional practice but it takes a big investment to implement, anyone adopting the new concept goes through a period where they incur extra costs in making this investment. They therefore move away from the local maximum and head down the “worse” slope. Then, once the new investment starts to pay off, they need to make improvements to get ahead of the competition who is still playing in the “local maximum” space.

Social vs. Economic Foods

Some things either do not have a monetary value or are too important to leave to the possibility that the markets will fix them. One example is health. Up to a point, you can trade being healthy for having more money but debilitating or life-threatening conditions are things you would rather fix the best way possible that worry about the cheapest option. More broadly, a healthy population benefits society. Essential work is not left undone because someone is sick, etc. Much the same can be said for education. Though being educated confers personal advantage, society as a whole benefits from a more educated population.

Can markets alone optimize social goods? No. Because access to resources does not neccessarily correlate with ability. The stupidly rich can benefit from education even if they have very little potential. If the extremely poor get ill, they cannot be expected to work extra time while still sick to pay medical bills.

A borderline case is negative externalities, costs that do not fall on a producer but that cost society. These are economic costs but are not well-suited to the market model as the cost can be passed on to society. Examples include pollution and depletion of natural resources.

Climate Change

Where does climate change fit into all of this?

First, the cost is a negative externality, something that the markets demonstrably do not handle as they have not fixed the problem. Second, it is a social cost as it damages the poor disproportionately and generally will damage those not responsible for the problem. Third, it illustrates the problem of local optimization neatly. While it is increasingly plausible that renewable energy in the long run will cost less than fossil fuels – particularly when cheap sources deplete – in the short term the “worse” cost scenario has to be covered somehow, otherwise renewables cannot build to the sort of scale needed.

Some fundamentalist libertarians argue that climate science is flawed because it requires a large-scale government intervention. I argue the opposite. Their economic philosophy is flawed because it cannot remedy a situation like this. So instead of allowing someone else to fix the problem, they deny.