Economist Hubris

Last November, I wrote a couple of blog entries entitled, “Everything We Know Is Wrong,” which were based on a presentation I made last year at the Decision Analysis Affinity Group (DAAG) conference. I’m going to be giving an updated version of that presentation at the American Association of Petroleum Geologists (AAPG) conference in Pittsburgh on May 21^st as the keynote speech at the Division of Professional Affairs and Association of Women Geoscientists luncheon.

One of the points I make in the talk is that the most common measure of value in business – Net Present Value, or NPV – discounts distant future benefits down to such a small number as to render investments which benefit future generations worthless. One of my colleagues – an academic whose perspectives and opinions I very much respect – told me that quite a bit of research had been done on the issue of how to find a discount rate which appropriately balances the wants and needs of future generations with those of the current generation.

He advised me to read a book entitled Discounting and Intergenerational Equity, edited by Paul R. Portney and John P. Weyant. It is a compilation of papers written as part of a 1999 conference to collect the thoughts of a number of prominent economists around the question of how to appropriately value very long lived projects – ones that span multiple generations. They used the global warming problem as a specific example, since the costs associated with combating global warming would primarily be borne by the current generation, but most of the benefits would be realized by future generations.

The book is every bit as riveting as the title would indicate. Most of the papers center around the question of whether one should use today’s discount rate (usually the current cost of capital) indefinitely into the future, or a lower discount rate for projects which span more than, say forty years. J.K. Rowling has nothing to worry about when it comes to sales records being broken.

However, after reading a half-dozen of these papers, a frightening realization dawned on me: these people actually believe that everything in the world, from pollution to destruction of ecosystems to causing a mass extinction event – everything is just a matter of economics. I was reminded of a comment made by David Stockman (Director of the Office of Management and Budget under President Reagan) when acid rain was becoming a major issue in the early 80s: he couldn’t see how the value of “a few fish in the Adirondacks” compared to the value of having cheap electricity from coal-fired power plants. It was obvious that he had no idea of the ramifications of destroying entire ecosystems. Stockman was incapable of thinking outside his own sphere of expertise.

The same is true of most of these economists. They truly seem to think that if we just settle this pesky issue of the discount rate, we will be able to calculate the appropriate course of action.

Here is an excerpt from one of the papers:

“Global warming might cause a rise in sea level, which in turn could cause flooding in low-lying cities if they were not walled off and pumped out. But if and when this event happens two centuries or more into the future, it’s not such a big deal because a very modest savings program started now would accumulate enough bricks and metal and so forth that we could easily afford to build the walls and pumps and everything else we would need….”

This is inane in more ways than I can count. This is like saying that Beijing shouldn’t bother to clean up the city’s air because it would be so much cheaper to issue surgical masks to everybody. It completely ignores all the other problems (beyond sea level rise) that would result from an increase in average global temperatures of more than a couple of degrees Celsius. Also, we are talking about a global rise in sea level, not a local one; how far up and down the shoreline are you planning to build these walls? It takes a fair amount of brick and steel to wall off entire continents.

More to the point, this isn’t just about money; there’s an ethical issue here. Would you say that it’s “not such a big deal” if I burn down your home, provided I’m willing to buy you a new one? These future people have a right not to have their city flooded by our actions, regardless of whether we’re willing to pay for walls and pumps.

Reading this book was like listening to a group of art historians describe World War II solely in terms of the art which was lost, damaged or stolen. You find yourself thinking, “Uh, guys – there’s a lot more to it than that.” It is painfully obvious that these enormously accomplished economists have no idea what the real-world effects of rising global temperatures may be. Yet they feel absolutely qualified to weigh in on the question of what to do about a problem that is completely outside their area of expertise.

Mercifully, there were two exceptions. The fifteenth paper (out of seventeen) was written by William D. Nordhaus of Yale University. Among other eminently sensible things, he says:

“…conventional benefit-cost analyses are rules of thumb for decision making. They simplify calculations and reduce the dimensionality of a problem. But they cannot substitute for judgment. When the implications of the calculations are ethically unacceptable, or where the underlying assumptions are questionable, we must step back and ask whether there are implicit assumptions in the decision criterion that are flawed.”

I wept with joy when I read these words. An economist who understands something beyond economics! As we at Decision Strategies often tell our clients, “You cannot calculate a strategy.” Dr. Nordhaus concludes, “The best approach will generally be to identify the long-term objectives and to take specific steps to override market decisions or conventional benefit-cost tests so as to achieve these long-term goals.” I couldn’t have put it better myself.

The other ray of hope was the final paper, written by Robert C. Lind of Cornell University, whom the editors acknowledge to be the original Wise Man of the discount rate dilemma. He says, “…these models and this mode of analysis cannot tell us what the optimal policy with regard to climate mitigation is….” He adds, “…each policy decision positions us to make the next policy decision later. Policy action is akin to buying an option to facilitate future action. The case for immediate action is generated by the existence of irreversabilities….this type of sequential analysis and decision making is … critical for analyzing investments that span centuries.” Wise Man, indeed.

Finally, let it never be said that economists don’t have a sense of irony. One of the contributors opened his paper with a quote from John Maynard Keynes: “If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid.” I wish more of these contributors had taken that message to heart.