David R. Henderson  

Uncertainty Can Go Both Ways

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In a recent response to Byran Caplan on global warming, Yoram Bauman rested part of his argument against cost/benefit analysis on the issue of uncertainty. Bauman wrote:

Reason #1 is that CBA has trouble dealing with uncertainty: if there's a (say) 1% chance that climate change will be catastrophic and a 99% chance that it will be no big deal, how do you account for that in CBA? I don't think anybody who knows the St Petersburg Paradox (and Marty Weitzman's related work on "fat tails") has a good answer here.

I dealt with this issue a year ago in an article in Regulation that I highlighted in a post about a year ago.

Excerpt from my Regulation article, titled "Uncertainty Can Go Both Ways":

I think that Litterman would be hard pressed to justify that conclusion. It seems to be more of a hunch than to be something he has established in his article.

But there is a more fundamental problem. For Litterman, the uncertainty is all in one direction. Go through his article and, in every case where he discusses uncertainty, it's about how bad the consequences of global warming will be. Will they be just moderately bad or will we have a catastrophe? Notice what's missing: He doesn't even entertain the possibility that global warming could be good. Nor does he entertain the possibility that not only could it be good, but also it could offset the potentially catastrophic damage that could result from global cooling. I am not a climate scientist, so I don't know how likely global cooling is. But I am enough of an analyst to know that if we are uncertain, as Litterman admits we are, then we need to entertain that possibility.

Notice that I'm not addressing directly whether uncertainty makes it hard to do CBA. Rather, I'm saying that uncertainty does not mean that the case for a carbon tax is stronger than otherwise.

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COMMENTS (16 to date)
Ari Tai writes:

I'd meet them halfway. Acknowledge catastrophe (both human and natural) is guaranteed, especially our own personal end-of-the-world (our death). But it's guaranteed unknowable. So what empirically is the best way to insure the largest number of souls survive? Compare Bangladesh to, say, Homestead Florida, to New Orleans after Katrina (and buses underwater).

We can agree that wealth and power (usually motive (to get out of the way), but also including weapons and ability to generate our own electricity) under our own, our families' or our neighbors' control are overwhelmingly more important than (the best) governance and policy.

So we need to adopt policies that increase wealth and power of all kinds under an individual's control. Means uninhibited growth (even if it arguably increases the odds of a certain catastrophe - Holland's dikes - or worse, seas fall (because the mile thick glaciers of the past return to the mile-high Antarctic plateau given heat and moisture are needed to lift the water to that altitude) and there are now new homes in front of the Kennedy estate).

To say nothing of how I'll be royally pissed when the reactionaries, luddites and anti-progress people slow medical innovation to the point that whatever would have prevented my own personal end-of-the-world emerges the decade after I die (my sense is we're now at least two decades behind where we could be wrt medical innovation given unfettered competition and opportunity (and suppressed guilds) - which leads to attempting to estimate the desired (for maximum) progress experimental death rate). But sins of omission are near impossible to measure. Perhaps China will show us how it's done. It's already the only place to do uninhibited DNA and related research. If only because in WW2 the Japanese had a chembio project focused on a humanicide that targeted the Han.

Which suggests that the precautionary principle is a synonym for choosing an early death. To say nothing of the foolishness of believing that a dollar spent today will be valued by the future at even today's value. Try to list just 10 items where $10 invested today is worth $10 the next century. It's impossible. Save maybe being god-like and omniscient and assassinating future Stalins and Hitlers before they gain power (how do you totally waste the efforts of several billions of lifetimes? Eliminate price-signals). Whatever the effects of slightly warmer higher altitudes in the northern and southern hemisphere are, they'll be cheaper to deal with at that time than today.

JLV writes:

You seem to be imagining a scenario where there are two unknown states of the world - one in which global cooling kills off a billion people with some small p1>0 if we engage in emission reductions, and one in which catastrophic global warming kills off a billion people if we don't engage in emission reductions, again with some small p2>0.

I think you'd need p1>=p2 for your critique to have any teeth, right? In which case you need to make the case for p1>=p2.

Dan JJ writes:

What about cost benefit of billions of dollars in transfers via govt coercion?

gofx writes:


They are also myopic with respect to other potential catastrophes. There is also uncertainty in the probability of other catastrophic events and how resources should be allocated against all these "threats". I raise this question all the time with these folks. What about asteroid defense? Catastrophic volcano eruptions? Earthquake protection? These events may have higher probabilities and more negative consequences than what they fixate upon. Of course the response is usually, "yes we should do all that too!"

MikeP writes:

Engaging in emission reductions and not engaging in emission reductions are not symmetric.

In particular, the former is more costly to the economy than the latter, and the latter will therefore leave the world with more wealth as well as more technological and institutional capital to deal with whatever threats exist a century hence -- be they catastrophic warming or catastrophic cooling or megavolcanos.

The opportunity cost of spending wealth today to deal with a risk that is predicted to arrive decades in the future is not having the wealth for a different risk that actually does arrive decades in the future.

Curtis L. writes:

Let's forget CBA based on uncertainties (a truly silly endeavor -- I agree). What if we approach climate change merely from a market externality standpoint? Carbon emissions, and much more, are externalities. Let's internalize them. A carbon/Pigovian tax is one solution of, I assume, many.

Don Boudreaux writes:

Cass Sunstein's 2005 book, Laws of Fear, is actually quite good on this matter. Sunstein explains very clearly why the "precautionary principle" turns in on itself, and thus rendering it not at all a firm basis for the policy conclusions that those who invoke this principle imagine it to be.

Handle writes:

Bauman evades the critical question, "How do we evaluate whether the costs of any particular policy is worthwhile?"

So, for example, let us assume that we can estimate that if the the US unilaterally reduces power plant CO2 emissions per kilowatt-hour by 30%, it will cost 0.1% of GDP and it reduces the chance of catastrophic climate disruption by 2100 from 0.05% to 0.04%.

Ok, now what? Worth it or not?

When emissions reductions advocates abjure CBA, what they are really saying is that CO2 is evil and reducing emissions is sacred and any policy that reduces any amount of CO2 at any cost is justified, because you can't put a price on catastrophe reduction.

Well, that's ridiculous and irrational. All they are trying to do is neutralize the most salient, material, and powerful objection to any of their proposals by putting it outside the bounds of debate.

That's decent evidence that someone is bluffing and holding a weak hand.

Daublin writes:

To expand gofx's comment, it's also conceivable that CO2 is more harmful than the IPCC predicts.

In such a case, CO2 controls will not be adequate to the challenge, and we'll still have to do something else to survive, anyway. Thus we see, CO2 controls are only helpful in a narrow band of effects of CO2: CO2 has to be bad enough that it's warth the pain of controls, but also benign enough that controls will be enough.

It's much better insurance to attain a high degree of resources and technology. Wealth is insurance against *all* catastrophes.

ThomasH writes:

An asteroid strike is another low probability - high cost event that I think we should be investing in avoiding, like global climate change. But even without taking into consideration possibly catastrophic events, I think conventional cost benefit analysis would show that investing in reducing CO2 emissions makes sense and if so a carbon tax would be the most efficient way to achieve the reduction and which reduces growth by the least amount (or even increases it if the revenues were used to offset other distorting taxes like the corporate income tax). And investing in growing richer in the future is another strategy for dealing with the uncertain costs of climate change.

Yancey Ward writes:
An asteroid strike is another low probability - high cost event that I think we should be investing in avoiding, like global climate change

How, exactly, are we to avoid global climate change? Even if we reduce human carbon dioxide emissions to zero, the climate is still going to change, and in essentially unpredictable ways.

MikeP writes:

Curtis L.,

How do you suppose one determines the price of the externalities without CBA?

Curtis L. writes:


CBA is useful in making decisions, not prices. The market is still (usually?) the best option for setting prices. But all externalities must be accounted for in order to set a true price. I don't see where CBA is necessary for that.

David R. Henderson writes:

I’m not sure what your first sentence means but the problem with your last two sentences is that to account for externalities, you need to know their size and value. This is part of what we do in CBA.

Curtis L. writes:

We agree fundamentally on how prices are determined then.

MikeP writes:

We agree fundamentally on how prices are determined then.

Specifically for the case of carbon abatement, the price of carbon that is charged as a carbon tax is determined by CBA, and the price of carbon that is charged as carbon credits in a cap-and-trade market is mediated by a supply of credits determined by CBA.

So why do you think CBA is unnecessary?

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