Saturday, June 07, 2008

How Neo-Classical Economics Sucks As A Tool For Tackling Global Warming (And How Economists Are Trying To Make It Suck Less)

A wonderful short piece from Scientific American on the pseudo-scientific roots of neoclassical economics (Someone alert Andrew Coyne!):

The 19th-century creators of neoclassical economics—the theory that now serves as the basis for coordinating activities in the global market system—are credited with transforming their field into a scientific discipline. But what is not widely known is that these now legendary economists—William Stanley Jevons, Léon Walras, Maria Edgeworth and Vilfredo Pareto—developed their theories by adapting equations from 19th-century physics that eventually became obsolete. Unfortunately, it is clear that neoclassical economics has also become outdated. The theory is based on unscientific assumptions that are hindering the implementation of viable economic solutions for global warming and other menacing environmental problems.

The physical theory that the creators of neoclassical economics used as a template was conceived in response to the inability of Newtonian physics to account for the phenomena of heat, light and electricity. In 1847 German physicist Hermann von Helmholtz formulated the conservation of energy principle and postulated the existence of a field of conserved energy that fills all space and unifies these phenomena. Later in the century James Maxwell, Ludwig Boltzmann and other physicists devised better explanations for electromagnetism and thermodynamics, but in the meantime, the economists had borrowed and altered Helmholtz’s equations.

The strategy the economists used was as simple as it was absurd—they substituted economic variables for physical ones. Utility (a measure of economic well-being) took the place of energy; the sum of utility and expenditure replaced potential and kinetic energy. A number of well-known mathematicians and physicists told the economists that there was absolutely no basis for making these substitutions. But the economists ignored such criticisms and proceeded to claim that they had transformed their field of study into a rigorously mathematical scientific discipline.

Keep reading for the whole list of nasty theoretical side-effects, but the most important one is that:

The costs of damage to the external natural environment by economic activities must be treated as costs that lie outside the closed market system or as costs that cannot be included in the pricing mechanisms that operate within the system.

As a result:

[Neo-Classical economics] constitutes one of the greatest barriers to combating climate change and other threats to the planet. It is imperative that economists devise new theories that will take all the realities of our global system into account.

I rather think, however, that author Robert Nadeau has missed some of the most interesting recent work in the economics of climate change. I and other's have written about the developing consensus among economists that seems to have followed on the heels of the climatological consensus. Richard Tol, for example, has come around and now supports a carbon tax. And if any single paper by any single researcher can be said to have triggered this emerging consensus, it is On Modeling and Interpreting the Economics of Catastrophic Climate Change by Harvard economist Marty Weitzman.

I cannot confess to being able to follow Mr. Weitzman's math, and you probably can't either, because it strains the limits of the professionals. But the For Dummies version seems to be roughly as follows (here is another attempt at the FD version):

AGW may give rise to any number of "high-impact low probability" disasters (melting Greenland ice-sheets, for example) the results of which would be so catastrophic as to confound the economist's standard cost benefit analysis (you can't really predict how many points having to abandon a flooded New York City will knock of the GDP).

And while these events have a low probability, their destructive effects are so extreme as to justify immediate action against them as a form of insurance policy. (In particular, high enough to set the price of carbon at $50 per ton U.S.)

13 comments:

Dante said...

I can find no reference that lists his economic credentials. That may mean he doesn't have any.

If you understand what he is saying, perhaps you can point to an economic system that would work.

Please don't start citing Trotsky and how his system would have worked had Lenin not distorted it. I've heard way to much of that garbage.

bigcitylib said...

I've linked to his CV. Or you could simply google his name and something like "climate change economics". Or you could follow the links to the other climate change pros I ref.

Ti-Guy said...

I can find no reference that lists his economic credentials.

This was always the other part of the problem; although all of us have a very fundamental stake in economics -- indeed, if we simply stopped participating in the market, the whole thing would collapse -- only those who are credentialed are authorised to speak on the issue.

Quite often these economic High Priests offer goods (intellectual ones in the forms of theories and principles) and services (predictions, advice, etc.) that are exempt from valuation in the open market, or at least, not with an immediacy that everything is supposed be valuated. A tenured economist at a publicly-funded university or occupying a sinecure at a think-tank can be wrong for decades and suffer no economic consequences.

I don't think we need new theories. The problems with economics in a free market are largely due to imperfect information; we make better choices when we have better information. The work of economists would then be predicated on observing a higher number of more rational economic transactions (buying, selling, consuming, wasting) that would lead to better predictive models and more rational policies.

The dilema with laisszy-faire/crony capitalism is that it promotes unjustifiable concentrations of wealth and power and the abuses those entail, the biggest being the control and manipulation of information.

Please don't start citing Trotsky and how his system would have worked had Lenin not distorted it. I've heard way to much of that garbage.

If some people don't get on the stick quick, those who don't understand the free market very well and end up suffering the most from its distortions (while others, directly responsible for those distortions, get off scott-free or end up thriving even...on the public dime, no less) will find Marxism (and worse) appealing again.

Fred said...

Here's some economic advice for all you Believers.

Trust in science, trust in real, not massaged data and buy some long underwear 'cause its getting colder and it will be a long cold spell if the astrophysicists are right.

Maybe we could call it it the Gore Minimum, just so we can all be reminded of the great fraud and the great fraudster. In Canada, we could nickname it the Suzuki Minimum, to remind us of Gore's #1 sidekick.

3,2,1 "Launch Ti-Guy".

And Ti-Guy has cleared the tower and is foaming at the mouth.

Dante said...

The dilema with laisszy-faire/crony capitalism is that it promotes unjustifiable concentrations of wealth and power and the abuses those entail, the biggest being the control and manipulation of information.

Not that I don't believe that unjustified concentrations exist. Of course they do. I just believe it exists in all areas of social construct.

At least is this system people sell themselves into slavery opposed to the state making us all into slaves.

Paul S said...

Oh boy. Nadeau is a leftover Marxist spouting nonsense and little more.

"Neo-Classical economics] constitutes one of the greatest barriers to combating climate change and other threats to the planet."

Oh really? Next he will be saying democracy is the greatest obstacle of all to action. I really dislike these writers who blather such nonsense without a trace of shame.
But it's Saturday, so this site need some filler. ;)

Richard Tol said...

Maria Edgeworth was a novelist. The economist is Francis Ysidro Edgeworth.

I've supported a carbon tax since 1992 or so. The recent paper of Weitzman had nothing to do with that. (His 1974 paper did, though.)

bigcitylib said...

"Maria Edgeworth was a novelist. The economist is Francis Ysidro Edgeworth."

I suppose somebody will mention this to Mr. Nadeau eventually.

Ti-Guy said...

I just believe it exists in all areas of social construct.

It's not the power, it's the abuse of power. The free-flow of quality information is vital for healthy systems; the market, the democratic process and society as a whole.

bigcitylib said...

Richard, So what was the New Scientist article on about?

Richard Tol said...

Maria Edgeworth was Francis' aunt actually.

I told the journalist of New Scientist that Weitzman's catastrophe paper may be a reason for increasing the carbon tax, but my starting point was not zero.

rabbit said...

This is a ridiculous hatchet job. Economists would fall over in laughter over some of the assertions made here.

So far as externalities, that problem has been recognized in economics for at least a century. There is considerable literature, and many solutions have been proposed over the decades.

This is not to say that the problem of externalities is closed, but to present it as some newly discovered dilemna in an attempt to discredit neo-classical economics is ridiculous.

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