Letter to FT on Lomborg's false dichotomy

The following letter was published in the Financial Times today (20 December, 2010), in response to this article by Bjorn Lomborg (from the FT, 9 December, 2010).

Sir,

In the article “Time for Europe to show real vision on climate” (FT, 10^th December), Bjorn Lomborg argues that "We will never succeed in making fossil fuels so expensive that no one wants them [...] Instead, we should make green energy so cheap that everyone wants it". There is an inherent inconsistency in this line of reasoning, as the decision to switch from burning fossil fuels to some alternative depends on the relative prices of each.

The figures quoted in the article seem to suggest that emissions reduction is very expensive, while developing green tech alternatives would be relatively cheap. These cannot be simultaneously true. If cheap alternative energy sources are developed then emissions reduction becomes cheap as a consequence. Incidentally, it is notable that no reference is made to the assumptions and uncertainties inherent in the types of estimates to which the author refers.

As regards his policy recommendations, Lomborg advocates supply side solutions to climate change without specifying how the necessary investment might be stimulated. Does he envisage governments giving large-scale subsidies to the green energy sector? Such schemes are unlikely to be cheap.

Private sector investment in green energy alternatives is constrained partly by uncertainty, which pushes up the risk premium required by investors. One way of reducing this uncertainty - and thus stimulating greater investment - is to formulate more coherent climate policy, something which Lomborg seems to think is no longer worthwhile.

The simple, but false, dichotomous interpretation of the available policy options presented in this article may be a good way of getting media attention, but it is not a good way of thinking about complex socio-economic or scientific policy issues.

Yours etc.

Tom McDermott & Stefano F. Verde, Trinity College Dublin

Tim Laing, LSE

and Aurelie Mejean, CIRED, Paris

Update: Lomborg's response to our letter is here.

Learning our Lessons

Letter to the Irish Times, 5 December 2010 (not published)

A chara,

Stephen Collins makes the now standard error of blaming wide swathes of Irish society for our current woes ("Bailout teaches what we should have learned years ago", 4 December). We will be living with the consequences of decisions taken by a reckless minority in this country for many years to come. However, we should be very clear about one thing: this bailout and the concomitant loss of sovereignty, has been precipitated by the actions of private banks - both Irish and others - actions which our present government and it's European 'partners' now expect Irish people to take responsibility for.

Is mise,
Tom McDermott

Breaking down the "bailout"

Phoenix magazine had a very clear breakdown of the "bailout" in its most recent issue. (I couldn't find it online - you need a subscription - so I'll just quote some of the key points here)

Total borrowing involved in bailout: 60.5bn euro (the remainder comes from Ireland's own funds - pension reserve and whatever cash the NTMA has stored up).

Of this:

- 22.5bn is from IMF at interest rates of around 3-4%

- 17.5bn from the European Financial Stability Facility

- 22.5bn from the European Financial Stability Mechanism

EFSF is mainly German and French money. It's a special vehicle set up to fund EU members in need of restructuring funds. It operates in conjunction with the German Debt Management Office.

According to the framework agreement which set up the EFSF, the interest rate to be charged is "intended to cover the cost of funding incurred by EFSF and shall include a margin [ie a profit] which shall provide remuneration for the guarantors". On top of this there is a service fee to cover operational costs and various fees, which is charged upfront at 0.5% of the total loan (ie 88m).

The rate applied is based on "the rates corresponding to swap rates for the relevant maturities" (today approx 2.7%) plus "a charge of three percent for maturities up to three years and an extrra one percent per year for loans longer than three years" (ie 6.7% - making a profit for the EFSF of 4bn over the lifetime of the, ahem, "bailout"!!!).

It gets worse.

"The anticipated margin that would accrue on each loan to its scheduled maturity date shall be deducted from the cash amount to be remitted to the borrower in respect of loan. The service fee and the net present value of the anticipated margin ... will be deducted from the cash amount remitted to the borrower in respect of each loan but shall not reduce the principal amount of such loan that the borrower is liable to repay and on which interest accrues under the relevant loan". [that quote also comes from the framework agreement].

(ie they take their 4bn of the 17.5bn they are lending us before the money ever gets to Dublin, while charging interest on the full amount!).

EFSM money will be charged at 5.7%, if we draw down the full amount. (Greece paid 5.2%).

Ireland's so-called "bailout"

What's happening now is a variation on what I complained about previously (in my unpublished letter to the Irish Times, posted here). Rather than using the "we all partied" line (and what a gem that is -

http://www.youtube.com/watch?v=YK7w6fXoYxo) the line now is this crap about the state running out of money, having no alternative etc., with Fianna Fail taking some culpability for some mistakes somewhere in the distant past (but sure the others would've done the same anyway), and ultimately we should be grateful to our Euro "partners" for bailing us out of this fine mess we've gotten ourselves into.

This is all a web of lies, deception etc. The only reason markets stopped lending to Ireland in the last few weeks is because of the bank debt that has been nationalised. WE CANT AFFORD TO REPAY THIS. The markets know this. Our banks have been shut out of international markets - because their losses on property etc. have been rising beyond any "worst case scenarios" previously envisaged, and because they had become entirely reliant on money from the ECB (this is its role remember: CB = lender of last resort to the financial system, so let's not feel too grateful/ashamed for requiring this facility either). Then the markets got really spooked when Merkel started talking about making bondholders share the pain without giving any details.

So Ireland was pressured into taking the bailout in an attempt to "stuff" the banks with cash (over-capitalise them is what Gov Honohan called it) and convince markets this was the end of it so they would start lending to our banks again. The whole point was to avoid "contagion" to the other Euro countries in trouble. This hasn't worked. Big surprise. The bit about using this money to fund the Irish state is a total sideshow.

We do need to make a big "fiscal correction" over the next few years, but that is totally doable.

So, yes I believe we do have an alternative. As David McWilliams has been saying, what we need is a new "bank resolution" law (I don't think any such legislation currently exists in Ireland, so creating an entirely new one should be straightforward). The law would simply state that in Ireland, when a bank becomes insolvent (the Irish CB could be allowed to decide when this is so) that bank's bondholders must share the burden. Specifically we would create a debt-equity swap mechanism. Bondholders who are owed money by an insolvent bank will have their debt converted into equity (or shares in the bank). The bank doesn't disappear. In fact the bank is now significantly healthier as it has rid itself of debt. Depositors would have to be protected by some sort of insurance. (The Irish government already guarantees anything up to EUR100k. I'm not sure if we would need European cooperation to guarantee bigger deposits.)

The bit about all the medium sized firms imploding in such a scenario is probably exaggerated. Our banking system wouldn't disappear over night. As it is, small firms are having a really hard time getting credit because whatever money goes into the banks is being used to pay down their debts and/or build up these extra capital requirements that are supposed to make them look like good banks again.

So the banks' bondholders would suffer losses. But they expect this, because it will become European law in 2013. Anyway, even if we piss off some investors, so what?! Would the markets ever lend to Ireland again? Of course they would. The 'markets' are not a single entity with some sort of institutional memory. They are made up of lots of different investors all over the world. Investors do not generally hold grudges. They make decisions based on future prospects of risk/return. Even if some of the specific individuals that get burned in this scenario did decide to take it personally and never lend to Ireland again it wouldn't matter. Ireland is small. So are our funding needs by international standards. There are plenty of more investor fish in the sea, so to speak.

An Irish state that is rid of its bank debt obligations would represent a very attractive investment (especially at the kind of rates we are paying for this so-called "bailout"). We will still have low taxes by European standards (even after we get our fiscal house in order). We have a young, well educated workforce. We have a hugely successful manufacturing and internationally-traded services sector, with highly profitable divisions of some of the world's biggest companies based here. We have a lot going for us. Yes this course of action involves some reputational damage, but would that really be worse than the reputational damage already done by fiscal and economic mis-management? And the reputational damage of having to be "bailed out"?? Distinguishing between the Irish state and the Irish banks might actually be a good way to begin restoring our damaged reputation overseas. Anyway, a damaged reputation (and some bruised egos) is a lower price to pay than the costs associated with this bailout and our continued commitment to pay for whatever losses are accrued by our reckless banks.

An open letter on Ireland's proposed Climate Change Bill

A chara,

Climate change is a real and significant threat to human welfare, particularly in the poorest parts of the world. While an effective 'solution' to this threat will require global cooperation over a sustained period of time, this is no excuse for not acting now to begin the process of reducing our dependence on carbon-intensive activities.

Ireland has a great record of leading the world in initiatives aimed at reducing global poverty. This work should be complemented and reinforced by action on climate change. Ireland could take the lead in demonstrating to other rich countries (and the rapidly developing 'emerging economies') that reducing carbon emissions can be achieved without jeopardising economic or social welfare. In fact, these goals can be enhanced by such initiatives. This is not only the morally right thing to do, it is also in our interests. Such leadership would help to restore Ireland's image internationally, which has been so tarnished by the excesses, greed and corruption of our recent economic boom and bust. At the same time, intelligent climate legislation could provide an additional source of revenue for government, while potentially improving our competitiveness over the long-term.

Unfortunately, the proposed Climate Change Bill produced by The Oireachtas Joint Committee on Climate Change and Energy Security (and due to be debated in the Dail today, Thursday), will not achieve any of these worthy goals. The proposed bill would legislate for ambitious emissions reduction targets, with the Taoiseach responsible for ensuring that these targets are achieved. The Taoiseach would also indicate what levels of emissions he/she expects each year. How is the Taoiseach to predict annual emissions levels or to enforce any such medium to long-term targets? This is equivalent to imposing legislation that requires the Taoiseach to predict levels of economic growth each year, or somehow to enforce medium to long-term economic targets.

Unless this legislation envisages an entirely new, centrally-planned economic system in this country, I do not see how its objectives can be achieved.

Legislation of this nature will do two things:

1) It provides a convenient sound-bite for politicians to hide behind. It is relatively easy to say "we have proposed/introduced legislation that will force emissions to fall by x% by 2050" etc. without actually specifying how such targets will be achieved (i.e. without having to stand up to various interest groups who may stand to lose from specific climate-related legislation).

2) Such a law obliges the presiding government to make various interventions to attempt to reduce GHG emissions. Crucially, however, it leaves the choice of specific interventions as a purely political decision. How will the government of the day decide how and where to reduce emissions? On what basis? We surely should be sufficiently well chastened in this country by recent experience of political interventions in the property sector (in the form of tax breaks etc.) to understand what a dangerous scenario this type of legislation will create.

We should not allow politicians the convenience of meaningless targets to hide behind, or the opportunity to use climate change legislation as a means of making themselves and their friends better off in the next round of crony-political-economy.

Setting ambitious long-term targets might sound good, but in reality this does not provide any greater certainty to businesses, investors, or consumers, simply because such targets are purely aspirational and are not credible without specific measures to achieve them.

The optimal climate change policy from both an equity and an efficiency perspective is to place a tax on carbon emissions, and allow people to choose the best way for them of reducing carbon dependency. This would obviously have revenue raising potential - revenue that is so desperately needed right now - while any potential threat to vulnerable people could be mitigated by using part of the revenue raised to provide reimbursements to those on low-incomes. Taxes are never popular, but the people of Ireland are acutely aware right now that taxes must rise. In every crisis there lies opportunity. If only we had the courage to embrace this one.

Is mise,

Tom McDermott

Update: A version of this letter was published on the irisheconomy.ie blog on 11 November 2010.

Our happiness is inextricably linked with that of those around us

"Says one time he went out in the wilderness to find his own soul, an' he foun' he didn' have no soul that was his'n. Says he foun' he jus' got a little piece of a great big soul. Says a wilderness ain't no good, 'cause his little piece of a soul wasn't no good 'less it was with the rest, an' was whole.

...

"Two are better than one, because they have a good reward for their labour."

(Tom Joad, quoting the preacher, Casy, The Grapes of Wrath - John Steinbeck).

Winning the battle with climate change skeptics?

The following post came out of a debate I was having with my brother about the role of "skeptical" views on climate change in the climate policy debate ...

The likely (and worst) effects of climate change in poor countries are almost indistinguishable from the effects of being poor.* The idea that (in the short term at least, and based on current expectations) money would be better spent on pursuing development goals rather than mitigation efforts (from poor countries' perspective), has often been made in the academic literature on climate change and development (see for example this article by Richard Tol).

For example, malaria represents a "winnable battle" (although "winning" is not as straightforward as some authors have suggested, see this article by Jeffrey Sachs & Pia Malaney), and deserves more attention and money. However, there is a very important and subtle distinction that some of the climate "skeptic" commentary seems to have missed (or intentionally omitted). That is, climate change will make these so-called winnable battles much harder to win. Furthermore, unmitigated climate change will have - almost certainly - disastrous consequences (especially for poor countries and poor people everywhere).

Business as usual is not a good option (as argued in this RealClimate post and this Economist article). The projections now being made about what unmitigated climate change will look like are startling, and scary (see for example this article by Andrei Sokolov and colleagues, and the report from the Hadley Centre in the UK, as reported here in The SundayTimes). The debate needs to be about how much mitigation is optimal, when and how to pursue it, and how to balance resources devoted to mitigation with those devoted to adaptation (from a poor country's perspective this essentially means development).

This is a very worthwhile debate, and should not be stifled by those who use the ugly term "climate denier" and make personal attacks on anyone 'silly enough' to be skeptical about climate change - or the proposed policy responses to it. (Ironically, this is exactly the sort of small-minded condescension that environmentalists and other 'social crusaders' have had to put up with for years).

One thing that is dangerous about the skeptics' approach - and the headlines they generate in some sections of the popular media - is that people are very willing to believe a voice that tells them "everything is fine, everything is going to be ok". We fundamentally prefer the easy option (psychologists term this "cognitive fluency"). We find it very difficult, on the other hand, to take a threat seriously if we have difficulty imagining it happening (people are a lot more frightened by the idea of being attacked by a shark than killed by falling debris from a plane, but apparently that is irrational - the latter being 30 times more likely! This is the so-called 'availability bias' - see this article by Oliver Burkeman, writing in the Guardian).

Climate change, and its potential consequences definitely fall into this category of being difficult to imagine.

As a footnote to this discussion, I'm not sure what is meant by saying that climate change is an 'unwinnable battle' (as I think has been suggested by some of the skeptics who, although not explicitly doubting the existence of climate change - and the contribution human activities are making to it - have challenged the rationale for attempting to prevent it through emissions reductions). There is a strong degree of irreversibility in climate change. However, the level of warming/change is still up for grabs - the irreversibility aspect makes precautionary emissions reduction now, although expensive, all the more justifiable (as the Economist also argues, in the article cited above). If the 'unwinnable' aspect is the contention that we will never change people's behaviour, then I think that is very naive. People will respond to the right incentives (a tax on carbon being the best way to create those incentives), and will change behaviour very quickly when the alternative becomes economically more rewarding. Not easy to get this right, but hardly 'unwinnable'.

*Note: That is, excluding the potential for inundation leading to the destruction - or at least forced relocation - of entire communities or even nations. In fact, this has already happened to the Charteret Islanders of Papua New Guinea.

Easter Island

The economy of Easter Island collapsed as a result of resource exploitation: trees were felled to use as sleds and rollers for moving giant stone statues. This led to soil erosion and a collapse of the economy. (As described in this article from the IT, Friday 8 January, 2010).

The only economist who got it right...

... Marx of course! (see Deaglan de Breadun's article in the Irish Times).

Forever blowing bubbles

Hyman Minsky's model of the credit cycle includes five stages: displacement, boom, euphoria, profit-taking, and panic. See this article "The Minsky Moment" from the New Yorker (February 4, 2008).

Paul Krugman has also written a nice piece, entitled "The Ice Age Cometh" on the evolutionary psychology behind irrational asset price bubbles.

Race and prisons in America

The New York Review of Books published an article by David Cole on America's prisons in November 2009. Some of the statistics jump out. For example; the US incarcerates more people per capita than any other nation on earth (its rate of incarceration is 40% higher than its nearest 'rivals' Russia and Belarus); while african-americans make up just 13% of the US population, they represent over 50% of the prison population (together with Latinos, the two groups account for over 70% of US inmates); blacks are 8 times more likely to end up in prison in the US than whites.

The article notes that "For an entire cohort of young black men in America's inner cities, incarceration has become the more-likely-than-not norm, not the unthinkable exception". This observation has the hollow ring of familiarity to anyone that has read Malcolm X's autobiographical account of the young black man's experience of life in the ghetto suburbs of major American cities during the pre-civil rights era years of the '40s and '50s. (Or for that matter watched The Wire, or read Jay-Z's account of how he got involved in selling drugs).

Up to 1975 the US incarceration rate had been steady at about 100 per 100,000. Since then, the rate has ballooned to 700 per 100,000.

According to the article:

"Drug convictions alone account for more than 80 percent of the total increase in the federal prison population from 1985 to 1995. In 2008, four of five drug arrests were for possession, and only one in five was for distribution; fully half of all drug arrests were for marijuana offenses."

Blacks make up about 14% of monthly drug users, around the same proportion they represent of the total population. However, the statistics on drug crime are hugely disproportionate:

"37 percent of those arrested for drug offenses are black as well as 56 percent of those in state prisons for drug offenses. Blacks serve almost as much time in prison for drug offenses (average of 58.7 months) as whites do for violent crimes (average of 61.7 months)."