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Climate change and growth ? Nordhaus and Romer
« on: October 10, 2018, 06:33:19 AM »
Climate change and growth ? Nordhaus and Romer

by Michael Roberts

It is both appropriate and Ironic that, on the day that William  Nordhaus should get the Riksbank prize (also called Nobel) for his  contribution to the economics of climate change, the top scientific  body, the Intergovernmental Panel on Climate Change (IPCC), should  release its latest update on global warming.  The report sets out the key practical differences between the Paris agreement?s two contrasting goals: to limit the increase of human-induced global warming to well below 2?, and to ?pursue efforts? to limit warming to 1.5?.

The IPCC says that if we are to limit warming to 1.5?, we must reduce  carbon dioxide emissions by 45% by 2030, reaching near-zero by around  2050. Whether we are successful primarily depends on the rate at which  government and non-state bodies take action to reduce emissions. Yet  despite the urgency, current national pledges under the Paris Agreement are not enough to remain within a 3? temperature limit, let alone 1.5?.

Rapid action is essential and the next ten years will be crucial. In 2017, global warming breached 1?.  If the planet continues to warm at the current rate of 0.2? per decade,  we will reach 1.5? of warming around 2040. At current emissions rates,  within the next 10 to 14 years there is a 2/3 chance we will have used  up our entire carbon budget for keeping to 1.5C.  Global emissions of  carbon dioxide, methane and other greenhouse gases need to reach net  zero globally by around 2050. By 2050, 70-85% of electricity globally  will need to be supplied by renewables. Investment in low-carbon and  energy-efficient technologies will need to double, whereas investment in  fossil-fuel extraction will need to decrease by around a quarter.

Although the Paris Agreement aims to hold global warming as close to  1.5? as possible, that doesn?t mean it is a ?safe? level. Communities  and ecosystems around the world have already suffered significant  impacts from the 1? of warming so far, and the effects at 1.5? will be  harsher still. Poverty and disadvantages will increase as temperatures rise to 1.5?. Small island states, deltas and low-lying coasts are particularly vulnerable, with increased risk of flooding, and threats to freshwater supplies, infrastructure, and livelihoods.

Warming to 1.5? also poses a risk to global economic growth, with the  tropics and southern subtropics potentially being hit hardest. Extreme  weather events such as floods, heatwaves, and droughts will become more  frequent, severe, and widespread, with attendant costs in terms of  health care, infrastructure, and disaster response.

This is where William Nordhaus, a professor of economics at Yale University, comes in.  He pioneered the economic analysis of climate change.  He is also a leading proponent of the use of carbon taxation to reduce  emissions, a policy approach preferred by many mainstream  economists.  Nordhaus? contribution was to develop a model that could  supposedly gauge the likely impact on economies from climate change.   Nordhaus constructed so-called integrated assessment models (IAMs) to  estimate the social cost of carbon (SCC) and evaluate alternative  abatement policies.

And this is where it becomes ironic.  Nordhaus? IAMs have flaws that  make them close to useless as tools for policy analysis. The IPCC  pointed out  that estimates of losses resulting from a 2 C increase in  mean global temperature above pre-industrial levels ranged from 0.2% to  2% of global gross domestic product.  It admitted that the global  economic impacts are ?difficult to estimate? and that attempts depend on  a large number of ?disputable? assumptions. Moreover, many estimates do  not account for factors such as catastrophic changes and tipping points  ie where global warming gets out of control and damages economies much  more quickly and deeper than forecast.

Most IAMs struggle to incorporate the scale of the scientific risks,  such as the thawing of permafrost, release of methane, and other  potential tipping points. Furthermore, many of the largest potential  impacts are omitted, such as widespread conflict as a result of  large-scale human migration to escape the worst-affected areas.

IAMs are also used to calculate the social cost of carbon (SCC). They  attempt to model the incremental change in, or damage to, global  economic output resulting from 1 tonne of anthropogenic carbon dioxide  emissions or equivalent. These SCC estimates are used by policymakers in  cost?benefit analyses of climate-change-mitigation policies.

Because the IAMs omit so many of the big risks, SCC estimates are often way too low. As the IPCC acknowledged2,  published SCC estimates ?lie between a few dollars and several hundreds  of dollars?. These values often depend crucially on the ?discounting?  used to translate future costs to current dollars. The high discount  rates that predominate essentially assume that benefits to people in the  future are much less important than benefits today.

These discount rates are central to any discussion. Most current  models of climate-change impacts make two flawed assumptions: that  people will be much wealthier in the future and that lives in the future  are less important than lives now. The former assumption ignores the  great risks of severe damage and disruption to livelihoods from climate  change. The latter assumption is ?discrimination by date of birth?. It  is a value judgement that is rarely scrutinized, difficult to defend and  in conflict with most moral codes.

The other role of IAMs ? to estimate the costs of climate-change  mitigation ? also suffers from major shortcomings. The IPCC?s mitigation  assessment concluded from its review of IAM outputs that the reduction  in emissions needed to provide a 66% chance of achieving the 2C goal  would cut overall global consumption by between 2.9% and 11.4% in 2100.  This was measured relative to a ?business as usual? scenario. But growth  itself can be derailed by climate change from business-as-usual  emissions. So the business-as-usual baseline, against which costs of  action are measured, conveys a misleading message to policymakers that  fossil fuels can be consumed in ever greater quantities without any  negative consequences to growth itself.

The discount rate used to calculate the likely monetary damage to  economies is arbitrary.  If we use a 3% discount rate, that means the  current rise in global warming would lead to $5trn of economic damage  (loss of GDP), but the cost in current money of global warming would be  no more than $400bn, about what China spends on hi-speed rail.  So, on  this discount rate, global warming causes little economic damage and  thus the social cost of carbon (SCC) is only about $10/ton, so  mitigation action can be limited.  This is what Nordhaus uses in his  model.

But why 3%?  Nicholas Stern, of the famous Stern Review on climate  change, took Nordhaus? data and applied a 1.4% discount rate.  The SCC  then rises to $85/ton ? meaning that it costs economies $85 for every  ton of Co2, or closer to $3trn now!  If you take a median range discount  rate on likely damage, the SCC is probably about $50/t.  But the  current carbon price is about $25/t.  So the social cost is not being  ?internalised? in any market prices.

The argument about the discount rate exposes the argument about the  future.  The IAMs assume that the world economy will have a much larger  GDP in 50 years so that even if carbon emissions rise as the IPCC  predicts, governments can defer the cost of mitigation to the future.   And if you apply stringent carbon abatement measures eg ending all coal  production, you might lower growth rates and incomes and so make it more  difficult to mitigate in the future.  Yes, that is what Nordhaus? IAMs  can lead us to conclude.

These models exclude the obvious and now empirically backed evidence  that slower growth actually leads to less global warming.  Tapia  Granados points out that ?the evolution of CO2 emissions  and the economy in the past half century leaves no room to doubt that  emissions are directly connected with economic growth. The only periods  in which the greenhouse emissions that are destroying the stability of  the Earth climate have declined have been the years in which the world  economy has ceased growing and has contracted, i.e., during economic  crises. From the point of view of climate change, economic crises are a  blessing, while economic prosperity is a scourge.?  Inexorable march toward utter climate disaster [f] (1)

And IAMs also exclude the feedback ? namely that global warming leads  to more natural disasters, droughts and floods and thus to massive  disruption and migration of affected populations and thus a sharp  reduction in GDP growth rates.  The world will not be much ?richer? in  the next generation if global warming goes unchecked. Finally, as with  all these neoclassical growth accounting models of which the IAM of  Nordhaus is one, there is no allowance for recurring crises of  production in capitalism or rising inequality of income and wealth.

Growth accounting is the mainstream version of explaining long-term  economic growth.  Neoclassical theory assumes perfect competition and  free markets and it assumes what it should prove that capitalist  economic expansion will be harmonious and without crises as long as  markets are free and competition is operating.

Applying these microeconomic assumptions to long-term growth was the province of factor productivity models, originating with Solow and Swan in 1956.   Based on marginal utility theory, each factor of production (capital  and labour) contributed to growth according to its marginal  productivity.  The problem with this factor accounting model was  two-fold.

First, the nature of ?capital? could not be defined or measured ?  what was it: numbers of different machines or the present value of the  interest rate for borrowing ?capital??  This led to the so-called Cambridge controversy, where the neoclassical school was confounded by those who showed that  you needed a common measure of value (labour?), otherwise the definition  of capital was circular (namely its marginal productivity was the rate  of interest on borrowing, but the amount of capital was the present  value of the rate of interest!).

The second problem was that adding up the marginal contributions of  capital and labour factors to GDP growth would lead a ?residual?; which  was designated as ?technical innovation?, the productivity growth of all the factors.  This appeared to be ?exogenous? i.e. from outside the  market system of marginal productivity.  Mainstream economics had no  explanation for technological innovation!

This is where the contribution of Paul Romer comes in.  He developed an ?endogenous growth model?,  where long-run economic growth is determined by forces that are  internal to the economic system, namely the ?knowledge? incorporated in  the workforce of an economy. Technological progress takes place through  innovations, in the form of new products, processes and markets, many of  which are the result of economic activities. Thus there are constant or  increasing returns to factors, not diminishing marginal ones.  This  theory became popular with many reformist economists and politicians ?  apparently, former adviser and minister in the British Gordon Brown  Labour government, Ed Balls, was a keen promoter.

Actually Romer was not the first to come up with this ?endogenous? model.  That honour goes to the recently deceased Kenneth Arrow, the doyen of neoclassical economics.  Arrow recognised what any fool could see: that supply was affected by  demand but also demand was affected by supply.  Innovation did not come  out of the sky but from the drive of companies to grow (or in the case  of Marxist theory, to make more profit and reduce labour costs). Of  course, the mainstream version of growth theory did not consider  profitability relevant to innovation but instead looked at aggregate  output.

However, the endogenous model is little better (and may be even  worse) than the exogenous model in explaining and accounting for  long-term growth in economies.  Romer argues that the explanation for  why some countries grow faster and get richer than others is not more  investment in machines, or more labour power and skills; but more  ?ideas?. Whereas the old exogenous model predicted that growth would  slow as new investment in skills and capital yielded diminishing  returns, Romer?s New Growth Theory opened the window onto a sunnier  world view: a larger number of affluent people means more ideas, so  prosperity and population expansion might cause growth to speed up.

This is nonsense, of course.  Capitalism does not work like that.   ?Ideas? or innovations become the property of individual capitalist  companies; IPRs, patents etc are applied.  The general distribution of  innovation only takes place through the rough and tumble of competition  and the battle for profit and market share.  Innovation under capitalism  depends on profitability and if that is low or not there, or to be  given to all, then it won?t be applied. As one critic has pointed out,  Romer was very much a profit-making ?entrepreneur? himself, having  founded and sold on an online economic teaching company ? so no open  spillover of ?ideas? there.

In a way, Romer recognises market forces and argues that governments  need to intervene to foster technological innovation, for example, by  investing in research and development and by writing patent laws that  provided sufficient rewards for new ideas without letting inventors  permanently monopolize those rewards.  Thus we must correct and manage  the competitive struggle.

Romer is a professor of economics at New York University, but  recently he became chief economist at the World Bank for a short and  chequered period.  It was a surprising appointment for an organisation  that is supposed to help poor countries end their poverty.  That?s  because one of the conclusions that Romer took from his endogenous model  of ?knowledge? was that developing countries would benefit from  creating pockets within urban areas that are administered by a more  advanced country, so-called ?charter cities?. The advanced country would  develop a small part of the country by introducing ?good institutions?  and the benefits of development will spill over into the rest of the  economy.

Romer?s ideal example was Hong Kong. Rather than seeing Hong Kong?s signing away to Britain as unjust or humiliating for China, Romer saw it as an ?intervention?  that has done much more to reduce poverty than any aid program and at a  much lower cost. Therefore, he concludes that the world needs more Hong  Kongs.  The whole approach is that a country would gain from giving up  sovereignty to a more advanced nation that can better administer its  affairs.

But has China?s phenomenal growth over the last 40 years, taking 800m  people out of World Bank-defined poverty, needed ?charter cities? and  ?knowledge? kindly administered by ?advanced ? economies like the US.   Indeed, keeping imperialism out of China is part of the reason for  China?s growth success.  Romer actually persuaded the government of  Madagascar to apply his development plan.  It led to massive popular  uprisings against the President after he agreed to lease a part of  Madagascar to a South Korean corporation for 99 years!

Both the long-term growth models of Nordhaus and Romer rest on neoclassical free market theory.  As Ben Fine pointed out nearly 20 years ago in his analysis of endogenous growth theory, it has ?nothing  to do as such with an economy as a whole, other than in the trivial  sense of requiring at least two economic agents in order for exchange to  arise. Indeed, often implicitly and sometimes explicitly, the  literature takes a microeconomic theory and simply interprets it as  macroeconomics?In short, endogenous growth theory is heavily implicated  in the traditional and strengthening microeconomic foundations of  neoclassical economics.? Romer himself has recognised the failure of mainstream economics in his paper The trouble with macroeconomics, In that paper he goes on to trash all macroeconomic models for being unrealistic in their assumptions.

Both Nordhaus and Romer start with neoclassical theory and apply it  to analyse long-term growth.  Their contributions are therefore stunted  for that reason.  Factor of production models do not explain growth ?  they leave ?residuals? and they cannot account for the nature of  ?capital? ? it?s either just things (machines) or accumulated interest.   And there is no connection between these models of growth and the  reality of capitalist accumulation for profit and the recurring crises  in investment and production in capitalist expansion.

Nordhaus and Romer are aware of these contradictions at the heart of  capitalism. They know that ?free markets? bring pollution and global  warming; and ?markets? will block innovation if left alone. But their  answer is to manage capitalism and try to persuade governments to do so.  As the world gets hotter faster, and growth gets slower, good luck with  that.
Source: Climate change and growth ? Nordhaus and Romer