Wednesday, January 31, 2007

More nicotine for your dollar from the merchants of death

The Harvard School of Public Health have published a study showing that the nicotine content of cigarettes has increased in the US by 11% during the period 1997-2005. Nicotine is the primary agent that makes smoking addictive.

As I recently suggested it is inappropriate to define smoking in terms of the number of cigarettes consumed. Smoking is a nicotine delivery vehicle. Consumers change their smoking practices in response to such things as changed prices – with price increases they puff harder and inhale longer to achieve desired nicotine concentrations in their brain. This has significant effects in offsetting the effects of higher cigarette prices on health. It is also well-known that smokers who switch to low nicotine cigarettes increase their smoking intake to maintain nicotine levels.

Judge Kessler in the US District Court for the District of Columbia has also made it clear that tobacco companies modify nicotine levels to sustain addictions. Indeed these companies ‘…can and do control the level of nicotine delivered in order to create and sustain addiction’. Sworn evidence by ex-industry insiders in a number of other legal cases (cited in the Harvard study) make it clear that firms manipulate nicotine levels to maintain addictions.

The Harvard study shows that tobacco companies have increased nicotine yields per cigarette by 1.1% annually from 1997-2005 and by 1.6% annually from 1998-2005. This occurred in all types of cigarettes – mentholated, full-flavour, ultra-light – the lot. It occurred by increase nicotine concentration in the ‘tobacco rod’, by reducing the effectiveness of the filter on cigarettes and by reducing the cigarette burn rate which encourages more puffs per cigarette and hence more nicotine intake. More nicotine is delivered per puff and ceteris paribus per dollar.

The effect of these measures is to make it easier to get addicted to smoking. It also enables low income consumers to maintain their addictions in the face of rising cigarette prices.

Tuesday, January 30, 2007

Defending paternalism

I have been rereading Milton Friedman’s Capitalism and Freedom – one of the books that have most influenced me. I am particularly interested in Friedman’s views on paternalism which probably determine my own and which torpedo some of the extreme claims of libertarians and those who see any attempt to limit self-destructive or irrational behavior as an unwarranted attack on individual freedoms. It need not be. Friedman argues:
‘Freedom is a tenable objective only for responsible individuals. We do not believe in freedom for madmen or children….Paternalism is inescapable for those who whom we designate as not responsible…

The clearest case, perhaps, is that of madmen…It would be nice if we could rely on voluntary activities of individuals to house and care for the madmen. But I think we
cannot rule out the possibility that such charitable activities will be inadequate…For this reason, we may be willing to arrange for their care through government…

The paternalistic ground for government activity is in many ways the most troublesome to a liberal; for it involves the acceptance of a principle – that some shall decide for others – which he finds objectionable in most applications…

Yet there is no use pretending that problems are simpler than in fact they are. There is no avoiding the need for some measure of paternalism….’

The difficult question here is what a ‘responsible individual’ is. Definitions of ‘responsible’ include the idea of being able to make rational or moral decisions on one’s own and therefore being answerable for one’s behavior. I suppose the question then is whether a 20 year old who decides to use heroin or smoke cigarettes is being responsible in this sense. I am unsure whether the behavior is immoral but it doesn’t seem rational, except in an uninteresting tautological sense. How do you judge whether paternalism makes sense in this situation. Friedman says that the issue is determined by a debate not by some abstract philosophical principle:
‘There is no formula that can tell us where to stop. We must rely on our fallible judgment and, having reached a judgment, on our ability to persuade our fellow men that it is the correct judgment, or their ability to persuade us to modify our views. We must put our faith, here as elsewhere, in a consensus reached by imperfect and biased men through free discussion and trial and error.’

Conserving biodiversity in the face of climate change

A framework is provided for designing adaptation policies for conserving Australian biodiversity in the face of climate change.

Uncertainty about climatic effects and the resilience of biodiversity are intrinsic as are ‘species loss’ and ‘sunk cost’ irreversibilities, nonlinearities in damage responses, long policy maker time horizons and ambiguities in objectives.

Policy insight can be gleaned from the economics of information and using ‘real options’ models that account for possible catastrophic risks.

The Natural Resource Ministerial Council provides an ‘action plan’ that can be used in this setting. The case for investing in information and for pursuing a range of safety-first policies and insurance options is emphasised.

1. Introduction. Most scientists accept that environmentally-damaging, anthropogenic, global warming has been a reality over the past century and that, unless societies reduce their greenhouse gas emissions, warming will become a more serious global concern over the next 50-70 years. Even with active greenhouse gas management policies it is also widely agreed that global warming will continue because of lags in climate generation. This has led to policies being developed which seek adaptation to the effects of global warming as it is expected to unfold. These policies accept that future global warming is a reality and seek to learn to live with it.

Adaptation policies are of particular concern to individual countries whose greenhouse gas emissions contribute in only a minor way to aggregate global emissions. While such countries can, and should, seek international cooperative agreements to manage emissions, they only exert a marginal impact on aggregate global emissions and it is this global ‘public bad’ that will impact on the climate change likely to be experienced in their country.

One class of adaptation strategies, of concern to Australia, relate to biodiversity resources. Biodiversity has intrinsic value since citizens value species and habitats that exist per se. Biodiversity also has instrumental value in improving the quality of life of citizens who consume the direct service flows stemming from its existence and, indirectly, through biodiversity’s role in insuring a reliable supply of agricultural, water resource and other outputs.

This paper shows how to determine economically efficient public policies to reduce climate change’s impact on the range and richness of Australian biodiversity. It emphasises issues of limiting species extinctions to advance the community’s intrinsic demands for conservation. However avoiding extinctions, by itself, is a narrow conservation perspective. More generally we think of policies to improve the resilience of Australian biodiversity to climate change. How does one design an response to climate change when costs and benefits of dealing with the problem are uncertain as are physical and environmental effects, when there is controversy over the discount rate to be used and when damages associated with biodiversity destruction are highly nonlinear, involve important irreversibilities and when policy makers must address events over distant time horizons.

This is a complex policy design task because of the interaction between risk and the irreversibilities. But economic theory suggests approaches to analysing such issues using ‘real options’ theory: See Pindyck (2007).

Section 2 below provides background information on the biodiversity conservation problem posed and articulates factors complicating its resolution. Section 3 examines policy developments in Australia in relation to this problem and articulates an approach based on that proposed by the Natural Resource Ministerial Council (2004). Section 4 makes final remarks.

2. Global warming and biodiversity conservation. Most of Australia will warm by between 1-6o C by 2070. Annual rainfall is likely to fall in the south and southeast where population and agricultural production are concentrated and evaporation will increase. Some sparsely-populated inland and north western areas will have moister summers. To provide perspective, with a 4-6oC increase in temperature, Melbourne’s climate would resemble that of Moree in northern NSW. Forecast climatic effects are not necessarily marginal – they could be very significant. Globally a 6oC average temperature matches the temperature increase experienced since the last ice age.

2.1 Climatic uncertainty. Precise climatic effects are complex and difficult to forecast. Meteorological science shows the relation between greenhouse gas concentrations and climate is highly uncertain. There is substantial uncertainty concerning effects on climate of measures to control emissions and the high natural variability of climate masks slowly evolving induced climate trends. Furthermore, Australia spans regions from the tropics to the mid-latitudes and already has a highly variable climate because of the El Niño Southern Oscillation (ENSO). This brings about Dorothy Mackellar’s description of Australia’s climate as one of ‘droughts and flooding rains’, particularly in eastern Australia. Climate change can intensify extreme climatic outcomes with increased intensity and frequency of droughts, heavy rains, floods and cyclones. With higher temperatures too there will be more heatwaves and fewer frosts. Impacts on specific average rainfall patterns are highly uncertain with reduced rainfall in the southwest but with either uncertain rainfall effects in northern and eastern Australia. Pittock (2003), (2005, 256-257) provides further information.

Finally, while climate change is recognised to be generated by global greenhouse gas emissions its effects will differ widely by region and even by continent: See Wolfson and Schneider (2002, 36-40). But while information on general trends in a broad region are often useful, species conservation concerns often involve analysing specific habitats. Indeed, endangered species may occupy very narrow geographic regions that may be subject to anomalous climatic and environmental experiences. Conservation biologists will therefore be forced to place considerable weight on aggregated, uncertain climate forecasts.

A major initial observation is therefore a simple one: The effects of climate change in Australia are geographically diverse and hence exceedingly complex. They are also highly uncertain in terms of both specific temperature and rainfall effects.

2.2 Environmental uncertainty. While analysis has focused on the impacts of climate change for human life, a growing literature addresses consequences for non-human life and particularly for biodiversity. Flora and fauna face difficulties in adapting to, or migrating from, changed climates, even with gradual climate change, due to the human fragmentation of landscapes. If, as expected, substantial climatic changes occur over a short period, such as 50-100 years - on a geological timescale this is abrupt - effects will be severe.

A possible extreme environmental consequence of climate change is an ensuing wave of species extinctions globally and a destruction of biodiversity values. Thomas et al (2004) estimate that, in regions covering one fifth of the earth, 15-37% of plant and animal species could face extinction by 2050 should a middle-of-the-road scenario for increased emissions eventuate. If emissions are on the high side, the range jumps to 21-52%. Note the wide range in these estimates and their sensitivity to assumptions regarding mitigation responses.

The Stern Review (2006) endorsed these estimates. A warming of 2oC was expected to leave 15-40% of the world’s currently extant species extinct.

In Australia, the Climate Change Network, at their website, identifies 90 Australian species at risk from climate change - for the most part species identified at this site are currently threatened species. What is required is an indication of the sensitivity of various species and habitats to climate change – on their resilience - and, on this, there is only partial information.

For example, Hughes et al. (1996) examine the distribution of 819 species of Eucalyptus the major tree type characterising the Australian landscape. The majority of these individual species occupy small discrete regions defined by narrow temperature zones. More than 200 species have ranges spanning 1oC while 82 span just 2oC. Should Australia’s temperature rise by 3oC this century half of Australia’s Eucalyptus would grow outside their current zone. How well they would adapt to this is uncertain but there is potential for sensitivity.

Clearly knowledge of climate change effects on biodiversity is limited partly because of uncertainty about the effectiveness of natural adaptive responses, the role of geographical fragmentation of landscapes and the assault that might be launched on certain areas by invading exotic and natural species. Most of the information that is available is individual species and habitat specific. Given ecosystem complexities and the partial nature of information, uncertainty is intrinsic to analysis of the effects of climate change on biodiversity and to assessing species and habitat resilience in the face of climate change. As Pittock (2003, p. 168) states:

‘…there is relatively little specific information about the long-term capacity for and rates of adaptation of ecosystems in Australia that can be used to predict likely outcomes. Therefore, a large degree of uncertainty inevitably exists about the future of the Australian natural ecosystems under climate change.’

Our second major observation is also simple. The specific effects of climate change on biodiversity are highly uncertain.

2.3. Policy objective uncertainty. Finally, it is important to clarify what policy objectives are with respect to conserving biodiversity. These are complex because the idea of ‘biodiversity’ is itself complex – it is a pseudo-cognate concept (Gaston (1996, 1)) with different users of the term having distinct concepts in mind but using it as if it had a common meaning. It is difficult to formulate policies towards a loosely-defined notion.

Even ignoring definitional niceties, the development of biodiversity conservation strategies in Australia, as in most countries, has been partly ad hoc and partly based on delivery of sound conservation outcomes. It is acknowledged, for example, that land with high agricultural value has been under-supplied for conservation purposes.

With respect to biodiversity conservation per se, specific objectives of policy are diffuse and numerous: See Environment Australia (2001). Policies sometimes seek to limit extinctions and sometimes to retain representative habitats. In seeking strategies to deal with exogenous climate changes we are not addressing simple objectives.

Moreover, as benefits and costs from biodiversity conservation are distributed into the distant future the inter-temporal valuation issue of choosing a discount rate arises in choosing between conservation options. There is disagreement and uncertainty in assigning discount rates which becomes crucially important in problems with long-term time horizons. One can argue that if discount rates are anything other than very low and if costs of acting are borne now while benefits accrue in the distant future then, on the basis of cost-benefit analysis, the best policy is to do nothing – since discounted benefits then may not justify costs. Thus if conserving a species provides a $1 billion benefit in 200 years that is worth only $58,000 today at a discount rate of 5%. Moreover, intergenerational arguments - placing significant weight on the environment we hope to transfer to our children - suggest discounting at a low rate. Pindyck (2006) shows that being uncertain about the discount rate means itself that the rate used should be set at less than the expected future discount rate in the absence of uncertainty with the difference increasing as the planning time-horizon increases. For long-term planning, a rate close to zero is not implausible.

2.4. Irreversibilities. Inter-temporal aspects of any plan to address effects of climate change on biodiversity make the task complex and, again, uncertain.

Finally, important irreversibilities impact on policy-making. These pull in opposite directions in terms of desired policy intensities and the timing of interventions and substantially complicate policy planning.

(i) Species loss effects – in particular species extinctions - are irreversible. This creates incentives to adopt active management policies early even if benefits from doing so fall somewhat short of costs. The existence of the possibility of a future benefit from not allowing a species to go extinct provides an ‘option value’ rationale for species protection that reflects the irreversible loss of options that extinctions imply – indeed this is the core idea of the ‘real options’ approach to irreversible investments under uncertainty: See Dixit and Pindyck (1994). The existence of option values provides a bias towards early adoption of policy and for greater policy stringency.

(ii) Sunk cost effects also arise however because policies to deal with climate change problems impose sunk costs for society. For example, investing in captive-breeding programs or the translocation of species are expensive discrete investments that are not recoverable should the investments prove unwise because uncertain policy costs and benefits turn against such provisions. For example, if long-term conservation costs should turn out to be higher than expected while long term benefits are lower. This provides a motivation to wait for better information before investment in biodiversity protection is undertaken. Cost benefit analysis which accounts for this value of waiting, will be biased toward postponing adoption of such policies and for reducing policy stringency.

This is an important summary point. Irreversibilities combined with uncertainty can sometimes increase and sometimes decrease both the timing and extent of desired conservation effort. Without good empirical evidence – and this is lacking to this point – there is no way of making a simple qualitative judgement a priori. It is necessary to assess the relative size of ‘species loss’ and ‘sunk cost’ effects. Some literature – based it must be acknowledged on plausible though invented data - suggests ‘sunk cost’ effects are relatively strong implying a case for deferred and reduced intensity investments rather than pursuit of high intensity conservation policies now: See Pindyck (2000), (2002).

2.5 Nonlinearities and thresholds. The case for emphasising ‘sunk cost’ irreversibilities is tempered by the prospects for non-linearities in the damage response of the environment to climate change when uncertain critical thresholds occur: See Pittock (2005, 99-105). Such non-linearities can be accounted for by allowing for the prospect of a catastrophic risk of a substantial damage response. A biodiversity example might be widespread species extinctions while at the climate level catastrophic risks include possible rapid deglaciation of the polar ice sheets or collapse of the conveyor belt circulation in the North Atlantic. Note that given the complexity of environmental systems, catastrophic risks could also take the form of currently unanticipated consequences: See Grant and Quiggin (2006). In this case previously undiscovered consequences of climate change for biodiversity may be discovered in the future and events previously regarded as impossible may turn out to be possible. We may also find out that we know less than we thought we did.

Clarke and Reed (1994) show that, if the degree of risk of catastrophic collapse is strongly related to the extent of policy intervention, so a critical level of lack of conservation effort can bring about a wave of costly extinctions, greater stringency in control is sought. In simple terms this provides a case for pursuing ‘safety first’ options. If, however, greater risk is expected that is unrelated to the extent of policy intervention then, by a familiar triage argument, less should be expended on protecting species since their value has unalterably fallen.

Intuition suggests that a case for early action is also motivated by standard arguments emphasising the increasing value of natural capital relative to person-made capital as society advances. With technical progress, person-made capital can be augmented and replaced while natural capital cannot. Also, with increasing wealth if it is supposed that demands for biodiversity conservation are a luxury good, so more is demanded with increased affluence, there is again an argument favouring early adoption of adaptation policies to improve biodiversity resilience: See Krutilla (1967).

2.6 Summing up. There is uncertainty about the scale of climate change, climate change impacts on biodiversity and about what the impacts of an adaptive policy should seek to achieve. There are also significant irreversibilities that add complexity to the planning task. Formal economic model building can help sort out the qualitative role of these complicating factors and can suggest sensible policies.

As a general matter, the high uncertainty in analysing this policy task suggests a need to invest in providing information on the extent of climatic effects and consequent biodiversity impacts. It also suggests a case for monitoring the environment’s response to climate change. Finally, the high risks suggest that a policy focus with emphasis on a narrow range of policy options is inappropriate. A number of policy responses need to be sought and backup ‘insurance’ options pursued lest major policy responses should fail. For example, with respect to endangered species protection, one might simultaneously seek to strengthen the protection accorded to that species in its current environment, seek to translocate that species to new environments and perhaps also seek a captive breeding response as insurance.

Uncertainty needs to be incorporated into formal decision models by attaching probabilities to the various anticipated outcomes with account taken for possible surprise events. Probabilities should be assigned using expert judgement even if the costs and benefits assigned to outcomes reflect policy-maker or community values.

The general policy prescription involves increased investment in biodiversity conservation to reflect the increased risk that this valuable community asset is exposed to. In part this investment reflects the fact that species will endogenously migrate as climate change proceeds. Thus investment effort will need to be devoted to improving the resilience of existing conservation efforts, the adaptability of new areas a receptor sites for new species and to preventing unwanted species invasions.

3. A policy framework. Australian governments have prepared an ‘action plan’ for addressing climate change impacts on Australian biodiversity: See Natural Resource Ministerial Council (2004). The NRMC’s intention is for each state and territory to undertake specific initiatives to implement this plan and for the commonwealth to coordinate efforts. The plan splits into three types of undertaking that are broadly consistent with the framework set out above. They involve investment in information, investment in minimising biodiversity impacts and integration of policy designs into pre-existing conservation planning and policies for managing new efforts. Suggestions are now made to develop this framework using economics. The economics of information and investment provide the main conceptual and practical guidelines to conservation planning where risk and irreversibility play a major role.

3.1 Increasing knowledge. This NRMC objective seeks to improve knowledge of the impacts of climate change on biodiversity over time horizons where adaptation planning is sensible; to improve understanding of adaptation responses and to increase the capacity to assess costs and benefits of different policy responses. These objectives also need to be augmented to include improving knowledge of the specific likely extent of climate change. The NRMC also emphasise the need to transmit these types of information to policy makers and the broader community.

The economically desired investment in information depends on the extent of uncertainty faced, costs of acquiring information and the benefits consequent to having better information. As emphasised above, there is substantial uncertainty regarding effects of global warming and on the resilience and adaptability of biodiversity to climate change. Information about climate change is in some respects a global public good that will be underprovided by private markets partly because it can be drawn on at low cost. Hence, unless costs are prohibitive, there is a case for public investment in long-term meteorological and climate research to gain information. A basic question is the extent of likely climate change given plausible assumptions about global mitigation responses.

Information on the adaptability of Australian biodiversity is, in the main, a local public good that must be generated primarily in Australia. This is likely to be much more expensive than climatic information as it will need to be site and species specific. Such informational investments inevitably call for prioritization since exhaustive characterisations are impractical.

Climatic and biological information accrues through time with experience of climatic change, through observing the adaptability of ecosystems and through independent science-based learning. Given learning possibilities there are incentives to monitor developments and to delay acting on developments until information quality improves. While the need to ‘wait’ is a standard incentive in dynamically-evolving uncertain systems, significant effects of climate change will occur short-term, over perhaps 30-70 years.

Moreover, it might be expected that adaptation strategies could become both more expensive and less effective as the pace of climate change increases. As with the climate change issue as a whole, there are incentives to act promptly on the basis of imperfect information rather than to wait for much more accurate information. This means that policy responses should be closed-loop feedback rules reflecting the current state of knowledge and which evolve as knowledge evolves.

A particular information concern is to identify ‘at-risk’ species and to list them as threatened under threatened species legislation. This makes sense if high costs are associated with species extinctions. Moreover, addressing the extinction issue enables policy authorities to simplify one of the key irreversibility constraints namely the species conservation constraint.

A final specific information concern is to identify climate change effects on the distribution of new and established exotic as well as native invasive species. While some species will be damaged by climate change the survival prospects of others may be improved thereby damaging the survival prospects of competitive species.

3.2 Minimising biodiversity impacts. These impacts are classified into different categories by geographic area and actions sought to minimise the harmful effects of climate change. One focus is on impacts on hydrological cycles and consequent impacts on inland aquatic and semi-aquatic species. Another looks at impacts on marine, estuarine and coastal ecosystems. A third focus looks at terrestrial systems. Concern also focuses on minimising the impact of invasive species whether they are exotic or native species.

Clearly there are a range of adaptation investments that can improve the resilience of biodiversity. For the most part NRMC emphasise investments building on current conservation efforts. These fall into several areas.

Policies designed to increase the environmental resilience of existing conservation zones. This includes policies for increasing conservation reserve size, measures to improve and restore streams and aquatic environments, limiting land degradation and invasive pest species and to provide appropriate fire management regimes. For many conservation efforts the general prescription for policy responses is for more active management.
Investments in new reserves that seek to strengthen the capacity of the reserve system as a whole to act as refuges for vulnerable species that migrate in response to climate change. This might include investments in wildlife corridors that facilitate migrations and the translocation of particular threatened species. An important aspect is to develop partnerships between government and landowners to facilitate linkages and stepping stones to assist biodiversity adaptations.

Efforts should be devoted to protect species whose existence is threatened by climate change. These species require investments as discussed above but might also call for conservation in captive-breeding programs, zoological and botanical gardens and/or germ-plasm/seed banks.

If a pessimistic assessment of the likely success of adaptation measures is taken insurance policies can be adopted to reduce the probability of extinctions. The NRMC suppose captive breeding and translocation strategies are expensive compared to adapting current conservation policies. They may however make sense as fallback insurance options that imperfectly realise conservation objectives should more general programs fail.

Translocation policies require specific analysis since they are complex and expensive.
The radical strategy of assisted migration involves moving species to climatic zones where they have improved survival prospects. This policy triggers strong, mixed feelings from conservation biologists because the procedure is risky even though not undertaking the strategy may condemn species to extinction. Parmesan (2006) reviewed studies on the ecological effects of climate change and concluded that many plant species are already now budding earlier in the spring, animals migrate earlier and the ranges of many species are shifting to higher latitudes, as they track climates that suit them. So migrations are already occurring.

These adjustments have occurred over the past 2 million years as the planet has swung between ice ages and warm periods. But the current warming is different as the earth was already relatively warm when it began. It will also be more difficult for some species to move since, when the planet warmed at the end of past ice ages, retreating glaciers left behind empty landscapes. Today’s species face obstacle courses of cities, farms and other human settlements. Animals and plants will also have to move quickly if they are to keep up with relatively quick climatic changes.

Many conservation biologists believe alternatively that conventional strategies may help combat extinctions from global warming. Bigger reserves and corridors connecting them, could give species more room to move. McLachlan, Schwartz and Hellmann (2007) examine this debate.

Assisted migration may be the only way to save some species but biologists need to do it safely and effectively. The basic question is: Which species to move and where to take them? If numerous species face extinction then prioritization is inevitable. Those selected need to be relocated to regions where they can survive in a warmer climate. Simply moving a species is no guarantee it will survive since many species depend on other species for survival. Finally, a transplanted species is an invasive one which might start to harm other species. Will some migrant populations need to be controlled or eliminated?

Some argue that assisted migration should be a measure of last resort used sparingly. But further species migrations will occur and, as species shift their ranges, some will push into preserves that are refuges for endangered species.

3.3 Incorporating strategies into current practise. Finally, the action plan examines the integration of thinking about impacts of climate change into current biodiversity planning. The premise is that these programs exist so one can build on the knowledge of them. But in addition, new land use strategies might need to be developed to accommodate adaptation to climate change planning.

To make current conservation efforts responsive to climate change issues:

Existing conservation strategies must incorporate climate change into monitoring and reporting systems and use this information to provide policy advice on climate change-induced effects on conservation. A particular concern is with rural adjustment policy and links between the action plans for biodiversity and that for agricultural adaptations: See NRMC (2006).

Major issues concern how the national reserve systems can be linked to provide corridors for species migrations in the face of climate change. Specifically how can such measures be linked to agricultural land reclamation programs and what are the cost and benefits of such programs?
There is a need to review new land use and reserve planning policies to account for climate change and to make provision for species adaptations. Again there is the need to provide policy advice on these issues.

To include impacts of climate change on decision-making associated with listing threatened and endangered species and to develop recovery plans for such species. While emphasis should be on planning at habitat or biome level, flora and fauna species checklists should be used to determine vulnerable species not protected by broader conservation efforts.

These developments belong prior to the derivation of specific investment policies. Their articulation and refinement is the major output of attempts to address climate change impacts using economics.

Directing policy towards pre-existing conservation efforts is sensible also from the perspective of offsetting the effects of uncertainties by emphasising win-win options. Such efforts are useful if anticipated climatic outcomes eventuate but, in so far as they strengthen current programs, they will advance conservation objectives even if climate change impacts are less severe than expected. Win-win options can also be encouraged by thinking about synergies with the agricultural sector through enhanced conservation and water resource management policies. Again payoffs will eventuate even if anticipated climatic changes are unrealised. These win-win payoffs have the incidental benefit of helping to secure community support for addressing impacts of climate change on non-marketed biodiversity.

4. Final comments. A major issue in biodiversity conservation in the face of climate change is the interaction between high risk and irreversibility. The existence of risk provides incentives to invest in information and provides consequent conflicting incentives to wait for additional better information. However irreversibilities can drive an emphasis on dealing promptly with a problem before it becomes severe.

In this setting utilising adaptation policies to ameliorate climate change effects makes sense. These policies can be both passive reflecting observed changes in biological systems and anticipatory adaptation: See Schneider & Kuntz-Duriseti (2002). Proactive policies involve strengthening the resilience of biological systems now to deal with climate change impacts in the decades ahead.

As a general proposition it makes sense to rely on a range of policy responses and to view policy as adaptive or closed-loop rather than an open-loop response. It also makes sense to err on the side of caution in predicting longer-term effects of climate change on biodiversity.

Unless one believes in science fiction, biodiversity losses are irreversible so it is sensible to be prepared to deal with the worst that can happen. This suggests assigning higher than expected values to biodiversity losses to reflect their option values and to prepare worst-that-can-happen policy responses to climate change effects. Most importantly it also implies the need to devise back-up plans involving species translocations and captive breeding.

With these uncertainties it makes little sense to seek to develop a comprehensive national conservation response a priori. Test runs should be devised using case studies of a representative sample of conservation sites as the basis for a more comprehensive plan. The test runs should include a focus on conservation efforts in Australia’s single conservation hotspot namely south west, Western Australia, in Alpine habitats such as the Victorian Alps or the Snowy Mountains, in the rainforest habitats of northern Queensland, in coral reef habitats such as the Great Barrier Reef and in the rangeland areas of southern Queensland or central Western Australia. The costs and benefits of various adaptation policies need to be measured and species loss and sunk cost effects identified in each of these settings. The likelihood of catastrophic risks should be examined and their possible implications for policy intervention identified.

The case studies should assess the economics of conservation efforts at the various sites, examine existing plans for dealing with climate change and, where necessary, look at cost-minimising options for improving resilience as discussed above. The options examined should include ‘doing nothing’, investing in improved resilience onsite and, as a limiting policy, arranging species translocations. The ‘doing nothing’ option is relevant for species whose viability is unthreatened and, using triage arguments, for species whose extinction is inevitable.

Given the information and management expertise possessed and the existence of existing conservation resources it makes sense, as the NRMC review suggest, to base an adaptation strategy around existing conservation efforts. This will reflect the existing reserve system and pre-existing efforts to promote conservation on private land, including wildlife corridors. But conservation priorities could change in regions most affected by climate change and this needs to be reflected in planning.

Along with attempts to strengthen existing conservation efforts there needs to be a critical emphasis on where existing efforts are vulnerable and possibly made redundant by climate change impacts. As the NRMC note, to the extent that climate change causes changes in agricultural land values, there are both problems and opportunities for new approaches to planning.

The significant contribution economics can make in helping to understand the impact of climate change on biodiversity is to provide a framework for assessing objectives and the scope of policy. Cost benefit analyses, adapted to account for information acquisition issues under risk, can be used to prioritise conservation options. The emerging literature on cost-benefit analysis under uncertainty, where significant irreversibilities are involved, shows the structure of the policy design task.


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S.H. Schneider, A. Rosencranz & J.O. Niles (eds), Climate Change Policy: A Survey, Island Press, Washington, 2002.

C.D. Thomas et al, ‘Extinction Risk from Climate Change’, Nature, 427, 2004, 145-148.

R. Wolfson & S.H. Schneider, ‘Understanding Climate Science’, in S.H. Schneider, A. Rosencranz & J.O. Niles (eds), Climate Change Policy: A Survey, Island Press, Washington, 2002, Chapter 1.

Monday, January 29, 2007

Coalition to be returned?

Some interesting posts at the oz politics blog on the next Federal election.

I’ll stick to my previous views that the Coalition will scrape back in with a reduced majority. Interest rates should fall this year, inflation is moving lower, unemployment is low and the economy is in great shape. Howard will wait until Rudd’s honeymoon period comes to an end when I think the electorate will go for more of the same.

Labor’s policy on industrial relations is Neanderthal, on nuclear fuels crazy and, right-or-wrong, Australians won’t be comfortable with committing to desert our major ally, in Iraq. Labor’s industry policy – as stupid as it is – will get a few votes but my guess not enough.

Saturday, January 27, 2007

A case for biofuels

Guest post by Sir Henry Casingbroke

The Howard government's winner-picking is clearly bad for the environment, dishonest, smacks of crony capitalism and in the case I am about to quote, inimical to the long-term aim of turning down the flow of petrodollars to islamofascists of the Wahhabi kind.

A budding biodiesel industry is being nipped in the bud in Australia because the Howard government has decided not to extend the diesel subsidy to biodiesel.


Yet, biodiesel is a brilliant interim tech and makes sense in Australia for the following reasons:

1. It requires very little energy to process it, unlike petroleum-based fuels

2. Diesel engines run on it without any modificationso we could in theory start using an alternative fuel in current technology cars and trucks, and trains and power stations.

3. It is comparatively easy to make, indeed you could make it at home, see link

4. It has relatively low carbon emissions, not as low as burning natural gas or LPG but lower than petro-diesel, petrol and of course coal, which is a real nightmare in this respect

5. Exhaust is clean: it is particulate (soot) free eliminating the black smoke of worn diesel engines

6. The oil for making biodiesel can be grown from plants. Australia's climate is ideal for such large-scale agronomy. Oil plants are many and various, and yields vary too. Candlenut and coconut are among the highest but have a long lead time. But best of all are oil-producing algae, which can reach a yield of around 95,000 L/ha (Compared to flax/linseed of 478L/ha!). See wiki article with a table link

7. Algae will grow very well on salinised land, or better still, brackish water. Especially genetically modified algae - hey wouldn't that put the tree huggers in a spin! This could be a great boost to the farmers in the WA eastern wheatbelts who have lost much of their acreage to salt. (For more on extent of the salinity problem see my article in Australian Geographic issue 72).

8. To grow, algae needs, yes! carbon dioxide, lots of it. Geosequestration is useless, diverting carbon dioxide to algal fields situated on land around coal fired power stations would make sense and allow the coal users to obtain carbon-tax credits and then use the resultant biodiesel in adjunct diesel generators running them into the grid without any need to create new infrastructure.

9. It would improve Australia's balance of payments situation by lessening the need for imported petroleum products.

10. Finally, the main criticism levelled against biodiesel is that it would require too much real estate and would thus "eat" into the land available for food production. This of course is total self-serving bullshit. Apart from the fact that oil can be grown on land too damaged even for crudest fodder for sheep (saltbush), there has been some good, serious work done on this, see link and link

In the wake of Australia Day

I had a quiet Saturday making yet another attempt to grow Kangaroo Paws from seed. A few years ago I did the whole thing carefully - first soaking the pots in bleach and cooking the seeding mix for 30 minutes at 180 degrees C to kill bugs - and had brilliant success with dozens of healthy plants germinating.

So this year I meticulously did everything according to the book. I planted some mixed colour Anigozanthos flavidus and some of the short-lived, red and green Anigozanthos manglesii seed.

Of course KPs are West Australian plants so this exercise fails to reach my intent of planting only local native species. But the KPs that I have grown in the past were not so good this year because of Ink Disease that blackens the leaves, and because some of the species I grew only last for a few years anyway.

I’ve just learned that KPs regenerate from points below ground level so that the best way to get healthy plants is to cut them right back to this level once they have flowered.

Another thrilling Saturday in suburbia!

Friday, January 26, 2007

Savvy investors don’t like polluting firms

I put up a rather dull post a few days ago showing how water restrictions were having some obvious market effects that would enhance water conservation. For example, households have incentives to invest using use grey water for their gardens or covers to prevent evaporation from their swimming pools.

More importantly concerns over high fuel prices and climate change are having intriguing effects on equity markets. The Bulletin (subscription only, 30/1/07) has a piece by Giles Parkinson ‘Emission Impossible’ (I’ll attach a link if one becomes available) arguing that savvy investors are avoiding companies that pollute.

For example Citygroup have slashed their valuation on BMW even though the firm has forecast a 20% increase in sales. The reason? BMW is heavily exposed to likely new carbon emission regulations. On the other hand firms like Peugeot Citroen, the ‘small car kings’ and firms like Toyota and Honda are being heavily backed because of their heavy investment in fuel-efficient technologies.

Concern for the environment is not only a moral issue – the big polluters are just high risk firms that are a bad bet for savvy investors..

Citigroup have just compiled a study on ‘Climate Change and the ASX’ which studies the implications of global heating for the 100 top ASX companies in Australia. The presumption is that 2007 will see a major turnaround in thinking on climate change – the IPCC release their 4th assessment report on February 2 – and markets will adjust accordingly.

The Australian Investor Group on Climate Change, which manage $200 billion, surveyed 150 local companies (report here) and got responses from 57%:
  • 94% recognise the potential for climate change related issues to impact future earnings, liabilities or firm risk profiles.
  • 83% recognise the physical risks associated with climate change (eg. drought, extreme weather events) that impact upon their businesses.
  • 31% have established clear internal accountabilities for climate change.
  • 9% fully disclosed their emissions profile from owned and controlled entities (including 3rd party verification).
  • 9% have established formal GHG emission reduction targets with clear timelines.
  • 9% provided total energy costs and demonstrated a clear understanding of potential impact on profitability of changes in energy pricing.
So what are the good and bad equity buys? Well of course you want to avoid stocks with heavy carbon imprints such as traditional energy stocks and choose those without. Citicorp’s rankings were:
  • Possible winners: Investa Property, Origin Energy, Sims Group, Lend Lease, AGL, GPT Group, DB Reef, Macquarie Office, Stockland, AMP.
  • 'At risk' stocks: Rio Tinto, OneSteel, Iluka, Bluescope Steel, BHP, Woodside, Transurban, Toll Holdings, Santos, QBE, Centro Properties.
I’ll leave you to ponder these using Google since my interest here is to show that this investment advice is being given rather than to help you make money.

Finally, Goldman Sachs has launched a mutual fund KLD Global Climate 100 index which selects firms which show leadership in handling climate risk and the ability to prosper in a carbon-constrained environment.

These are interesting developments. Consumers have incentives to avoid goods that they expect to be subject to hefty restrictions on use or carbon taxes. Investors with foresight have incentives to place low valuations on firms that produce such products and these low valuations restrict the ability to grow and expand.

Pursuit of the almighty buck helps to drive yet another socially worthwhile outcome.

Tim Flannery

Well I missed out on a best blog posts award last year and was omitted from the Australia Day honours list today. All those wasted emails and postage on nominations and letters of support!

But I was delighted that Tim Flannery was given the Australia Day, Australian of the Year award. I’ve read several of Tim’s books (The Future Eaters, Throwin Way Leg, The Weather Makers) and enjoyed, as well as learnt from them all. I set some as reading for my environmental economics classes. He is a passionate, though relatively moderate, environmentalist and a skilled writer.

He has gone straight to the point today on the Government’s inaction on the climate change issue. He has also attacked the rushed proposal to develop northern Australia as an agricultural zone. Tim has the skills to argue a case well and the position to help make 2007 the year that Australians take climate change, as well as water resource, problems seriously.

Thursday, January 25, 2007

Climate change & climatic extremes: forecasts

One prediction is that with global heating (James Lovelock’s term that emphasizes that humans are cooking the planet) we will be hotter and there will be more climatic disasters. More droughts, floods, cyclones, extremely hot days and so on.

Australia’s climate is dominated by El Nino, and hence those ‘droughts and flooding rains’ that Dorothy Mackellar wrote about are already an integral part of our climate. Hence I thought we might really cope it in terms of increased climatic extremes when things get globally hotter. I also believed that Australia would cop it bad simply through above-average, average temperature elevation effects.

According to recent forecasts provided in the current New Scientist Australia is likely to get 6-7o C hotter – indeed the whole globe gets hotter - but the climatic extremes experienced and the extent of warming will be more moderate than those experienced in many other parts of the world. An exception is the area around Perth which will have a more extreme climate – Perth already faces a looming water supply crisis and is destined to be a climate change 'hotspot' (see R. Hensen, The Rough Guide to Climate Change. Roughguides 2006). Maybe that will finally deflate the booming Perth property market.

Globally the areas that are really hammered in terms of extreme climatic variability are the Amazon rainforest, the Congo Basin and a fair bit of China. These areas are also hammered in terms of the sheer extent of temperature gain - temperature increases will range up to 11 degrees C. The result for China is of particular interest since, although its per capita energy consumptions are low, it already emits 15% of the world's Greenhouse gas emissions. It has a stake in cutting carbon emissions to secure its own future viability!

Michele Battig provides a nice visual graphic of where things get much hotter here. She published her co-authored research in Geophysical Research Letters.

Howard's bold move on water

The Howard Government's proposal to give the Commonwealth control of the Murray-Darling River system is welcome news. The government will spend $1.5 million paying farmers to reduce their water usage - $500 million to reduce evaporation and seepage, about $500 million on improving river flows and $500 million will be given to the Bureau of Meteorology to do a national water audit.

The Murray-Darling system crosses four Australian states, including the three most densely populated states. State government control of these major rivers is inefficient because it has primarily reflected state interests and ignored the effects of individual state water comnsumption decisions on other states. A review of the issues is here.

The South Australian and Victorian Governments have already protested the moves. The Victorian dills want ‘co-operation’not a takeover while the South Australians are worried that the Howard Government is the pocket of industry interests. South Australia has the most to gain from this reform so Mike Rann’s comments are particularly foolish, if predictable. I have not yet seen a response from the other states but can take a good guess what the brainless, grinning, toothy, media-tart Beattie will have to say. My guess is populist fluff that appeals to a parochial interests but which leaves us all worse-off. The States are governed by Labor and will put party-political interests ahead of the national interest.

While the states have constitutional control over water the Howard Government is confident it can achieve a takeover. I hope so. It is a bold move and good news.

Update: (26/1/07). Things move a long way in a day. The bill for the projected water reforms has gone up to $10 billion over 10 years and the political response of the states has been muted and in the case of NSW positive. Kevin Rudd has endorsed the plan. This is a surprising but very welcome outcome. Only rightist ideologues could criticize this plan as overly centralist – how can any solution to the Murray-Darling problem not be centralist given that 4 state governments are involved?

There is some criticism of the ‘handout’ component to the scheme because water rights to farmers will be purchased. It is important to understand that current water usage in the Murray Darling is inefficient. This means that the total money value of the water benefits from the MD are less than they could be. Buying out water rights involve transfers that, ignoring deadweight losses of taxes used to fund them, are not losses to society as a whole. If the final water allocations drive water into higher-valued uses we benefit from these transfers.

Tuesday, January 23, 2007

Assisted migration for biodiversity

This article in the NYT deals with one of the biodiversity conservation options I have been thinking about as an adaptation policy for dealing with the effects of climate change. The radical strategy is assisted migration - moving species to climatic zones where they have a better chance of survival.

This triggers strong, mixed feelings from conservation biologists because the procedure is plagued by risk. Yet not undertaking the strategy may condemn species to inevitable extinction.
The average temperature of the planet is 1.6 degrees F higher than in 1880. Dr. Camille Parmesan, reviewed hundreds of studies on the ecological effects of climate change in this month's Annual Review of Ecology, Evolution, and Systematics. Many plant species are now budding earlier in the spring. Animals migrate earlier as well. And the ranges of many species are shifting to higher latitudes, as they track the climate that suits them.

These adjustments have occurred over the past 2 million years as the planet has swung between ice ages and warm periods. But the current bout of warming may be different as the earth was already relatively warm when it began. It’s also going to be more difficult for some species to move since when the planet warmed at the end of past ice ages, retreating glaciers left behind empty landscapes. Today’s species will face an obstacle course of cities, farms and other human settlements. Animals and plants will also have to move quickly if they are to keep up with relatively quick climatic changes.

Many conservation biologists believe that conventional strategies may help combat extinctions from global warming. Bigger reserves and corridors connecting them, could give species more room to move.

McLachlan, Schwartz and Hellmann lay out the debate in a paper to be published in Conservation Biology. Assisted migration may be the only way to save some species but biologists need to answer many questions before they can do it safely and effectively. Some questions:

Which species to move? If thousands are facing extinction, it will probably be impossible to save them all. Conservation biologists will have to make decisions about which species to try to save. Some species threatened by climate change, including polar bears and other animals adapted to very cold climates, may have nowhere to go.

Where to take them? Conservation biologists will have to identify regions where species can survive in a warmer climate. But to make that prediction, scientists need to know how climate controls the range of species today. That information is lacking. Simply moving a species is no guarantee it will be saved since many species depend on other species for their survival. In addition, a transplanted species would be an invasive one which might thrive so well that it would start to harm other species.

Perhaps assisted migration should be a measure of last resort that is used sparingly. But species migrations will occur anyway and, as species shift their ranges, some will push into preserves that are refuges for endangered species. Will some new migrants need to be eradicated?

None of these questions are simple and all are relevant.

Greenhouse policies in a complex world – some analytics

How do you design an appropriate response to anthropogenic climatic change when the costs and benefits of dealing with the problem are uncertain? The physical and environmental effects of climate change are uncertain, there is controversy over the discount rate to be used and damage functions are highly nonlinear, involve important irreversibilities and policy makers must address very long time horizons.

Robert Pindyck’s ‘Uncertainty in Environmental Economics’ discusses these issues for environmental problems with emphasis on climate change issues. I specialise his discussion to the design of adaptation policies for preventing species extinctions in the face of global warming – a topic that holds my current interest.

Meteorological science shows that the relation between greenhouse gas emissions (GHGs), temperatures and climate patterns is highly uncertain. We don’t know the exact effects on climate of measures to control emissions. Nor do we know the effects of climate changes on ecosystems or of the effects of policy measures that seek to improve the survival of species. We are therefore uncertain about the adaptability and resilience of different species both now, and in the longer-term, in the face of climate change and an adaptation policy response.

These uncertainties have implications for the design of adaptive policies. Hybrid policies make more sense than dedicated uniform policies in settings where policy makers choose between ‘price’ and ‘quantity’ instruments and the same will probably be true if the policy task is to select among various ways of helping biodiversity to adapt to climate change. Strengthening existing conservation programs might make sense as might providing translocation sites and, perhaps, captive breeding programs. The optimal policy hybrid will depend on the extent of the uncertainties.

The effects of uncertainty on the intensity of policy response are complex. Without irreversibilities uncertainty often leads to lower policy intensities – here less conservation effort. This would be the case if conservation benefits are an increasing concave function of investment in reserves and so on and if conservation costs are convex in the extent of conservation. But irreversibilities are fundamental so this special case is not robust or particularly useful.

Pindyck also suggests there is substantial discount rate uncertainty in GHG problems. In my view this can be exaggerated since, if discount rates are anything other than very low, the policy answer is simple – do nothing – the discounted benefits then won’t justify the costs. Moreover, intergenerational arguments suggest we should discount at a low rate. Pindyck’s response would be that being uncertain about the discount rate means itself that the rate that is used should be set at less than the expected future discount rate with the difference here increasing as the time-horizon for planning increases. Indeed, for long-term planning, a rate close to zero is not implausible.

Climate change issues do indeed involve very long time horizons. This exacerbates the uncertainties associated with estimating future costs and benefits particularly if a low discount rate is used.

It is also plausible to suppose damage functions defined on adaptation conservation effort are highly non-linear with highly uncertain ‘tipping’ or ‘threshold’ points. An insufficiently large effort might tip the environment towards a catastrophic state where many species become extinct.

In addition, there are significant irreversibilities that pull in two opposite directions. These substantially complicate policy planning.

(i) Species loss effects – in particular species extinctions - are irreversible. This creates incentives to adopt active management policies early even if benefits from doing so fall short of costs. The existence of the possibility of a future benefit from not allowing a species to go extinct provides an ‘option value’ rationale for species protection that reflects the irreversible loss of options those extinctions imply. This provides a bias towards early adoption of policy.

(ii) Sunk cost effects however also arise because policies to deal with GHG problems impose sunk costs for society. For example, investing in captive-breeding programs or in translocating species are discrete investments that might prove unwise should uncertain policy costs and benefits turn against such provisions. For example if long-term conservation costs should turn out to be high and long term benefits low. This provides a motivation to wait for better information before investment in species protection is undertaken. Cost benefit analysis which accounts for the value of waiting for better information, will be biased toward postponing adoption of such policies.

Thus irreversibilities combined with uncertainty can sometimes increase and sometimes decrease desired conservation effort. What a pity! There is no neat analytical result! Without good empirical evidence – and this seems lacking to this point – there is no way of making a simple qualitative judgement. One needs to assess the relative scale of species loss and sunk cost effects.

On this issue some of the literature suggests a reduced level of control and waiting as opposed to early action: see Pindyck (2000), (2002). One can ask if this story is changed when allowance is made for the prospect of a catastrophic risk of widespread species extinctions. In a paper I wrote with William Reed in 1994 we show that if the degree of risk of catastrophic collapse is strongly related to the extent of policy intervention – so for example a critical level of lack of conservation effort will bring about a wave of very costly extinctions - that greater stringency in control is sought.

My intuition too is that the case for early action is motivated by standard arguments that emphasise the increasing value of natural capital relative to person-made capital as society advances. With increasing wealth person-made capital can be replaced but natural capital cannot be. Also with increasing wealth and supposing that demands for biodiversity conservation are a luxury good – more is demanded with increased affluence – there is again a ‘preference’ argument favouring early adoption of adaptation policies for improving the resilience of biodiversity.

The AEI-Brookings Joint Centre for Regulatory Studies has a range of readable economic papers at its website – including this excellent paper by Robert Pindyck. I’ve attached the site to my blogroll.

Reference: Harry Clarke & William Reed, ‘Long-Run Consumption Pollution Tradeoffs in An Environment Subject to the Possibility of Pollution-Related Catastrophic Collapse’, Journal of Economic Dynamics and Control, 18, 1994, 991-1010.

Monday, January 22, 2007

State public sector wages bills gallop away

We have Labor governments in each of our states and territories. According to the AFR editorial this morning (subscription only) the expenses of these governments in recent years have risen by an average of 7.5% per annum.

Most of this has gone on extra wages for public employees. In 2006-07 wages growth in Queensland will be 12.4% while in NSW and Victoria it will be 5.5% and 4.4% respectively. Teachers, nurses and police account for a fair portion of this increase but burgeoning bureaucracies add their share.

These trends reflect ties between the Labor Party and the union movement. You can see this in NSW where an election is due in March and where the police association are demanding another 3000 members. Against Treasury advice the NSW Government will provide an extra 750 police at an annual cost of $69 million. The nurses and teachers are always after more members and higher wages divorced from productivity gains. Indeed the ratbag Victorian teachers union has demanded a 30% increase in wages over 3 years without - of course - performance testing.

Of course governments should award such hefty gains only when unions agree to substantial workforce reform. But to quote the AFR this is not happening:

'State governments also cause themselves problems by resisting the concepts behind the federal government's WorkChoices policies and legislation. While the commonwealth wants to emphasise the contribution that individuals make to the workplace, state ministers - under the influence of unions - prefer to treat all workers equally, even though the value added by individual employees differs markedly.'

The states and territories have the capacity to squander the benefits of the current resources boom just as the commonwealth can. The Labor Party dinosaurs running state and territory governments are currently held in check by the commonwealth. What a disaster it will be if a Labor victory federally meant Rudd-style support, for an antiquated industrial relations system, was to give additional licence to the spendthrift states.

Sunday, January 21, 2007

Sound economic analysis made me a tree-hugger

Over a decade ago I wrote a paper (‘Forest Rotation and Streamflow Benefits’, Australian Journal of Forestry, 1994) that looked at optimizing the total water supply plus timber benefits from logging in a water catchment – specifically the Thomson River catchment.

When trees are of intermediate size and growing fast they cut into water yields simply because they drink a lot. When they are small their small absolute size means that their drinking has little effect while when they are old they don’t drink much because they are not growing quickly.
Thus if you are thinking about harvesting trees you want to avoid having forest stands that lie in an intermediate age group. Either cut them very young or leave them alone and don’t cut them at all to gain sustained water supply benefits. (I always enjoyed obtaining this result just by drawing a few graphs using Excel and tree growth-water yield data – the optimization task itself is a complicated, non-concave problem so drawing graphs turns out to be the simplest and best approach). Generally I favored not logging at all in the Thomson.

According to The Sunday Age this morning the solution I suggested seems right.

‘MELBOURNE is losing out on a million litres of drinking water every year [as reader ChrisL points out this is a ludicrously low, presumably a typo] from continued logging in the city's main catchment area. And it comes at a cost to the taxpayer of at least $147 million — the difference between the royalties paid by the logging industry to the State Government and the value of the lost water, according to economic consultants commissioned by Melbourne Water.
As the city heads towards stringent stage 4 restrictions, a host of scientific studies indicate the Thomson Dam, which supplies about 60 % of Melbourne's water, is losing up to half the potential run-off in the highest rainfall area owing to effects of logging……
It is estimated that if logging was stopped, water yields in the catchment would increase by 20,000 megalitres within two decades.
Despite the existence of studies dating to the 1950s, in 2004 the Bracks Government decided to conduct more research into the reduced water yields
caused by logging. It is scheduled to be completed in May 2008.
All the scientists spoken to by The Sunday Age questioned the need for further studies, saying the numerous existing reports, many of which were commissioned by the Kennett and Bracks governments and on which this article is based, were sufficient’.

Of course the Bracks Government seeks further studies because it is fearful of the electoral implications of giving the forest industry a well-deserved kick in the rear-end. In the meantime we continue to face costly water restrictions, lose beautiful forests of mountain ash and other species and pay a huge implied subsidy to the forestry industry.

Saturday, January 20, 2007

Neuroeconomics of being a spendthrift or tightwad

Why do people run up excessive debt? Why are many in the population tightwads? The Economist reviews an article in Neuron (by Brian Knutson, Scott Rick, G. Elliott Wimmer, Drazen Prelec and George Loewenstein) which provides a possible neuroeconomic explanation.

Economics assumes humans are rational beings so price is a signal that helps decide the combination of choices that suits best. But evidence suggests that decision-making draws on the emotions along with reason.

The role of emotions in traditional tasks such as obtaining food and mates, and in dealing with threats can be explained by neural mechanisms which weigh up pros and cons to produce an optimal outcome. Emotions help prod animals towards optimal outcomes. Then neuroeconomics and economic theory predict the same outcomes. But this may not apply to less traditional choices. Perhaps modern shopping subverts the decision-making machinery and encourages some people to run up debt.

The authors asked 26 volunteers to decide whether to buy various products that were flashed on a computer screen one after another. In each round the researchers first presented the product and then its price, with each step lasting four seconds. In the final stage, which also lasted four seconds, they asked the volunteers to select a product. To make the task realistic two randomly selected sales were real—paid for out of a $40 credit from which the volunteer got to keep the change.

The researchers scanned the brains of volunteers using functional magnetic resonance imaging (fMRI) which measures blood flow and oxygen consumption in the brain, as an indication of brain activity. Different parts of the brain were involved at different stages of the test.

1. Product virtues. The nucleus accumbens—known to be involved in processing rewarding stimuli such as food, recreational drugs and monetary gain, as well as the anticipation of those rewards—was the most active part when a product was being displayed. The level of activity correlated with the reported desirability of the product.

2. Immediate product costs. When the price appeared, however, fMRI reported more activity in other parts of the brain. Excessively high prices increased activity in the insular cortex, a region linked to expectations of likely immediate pain, monetary loss and viewing of upsetting pictures. There was greater activity in this region when the subject decided not to purchase an item.

3. Balancing virtues against costs. Price information also activated the medial prefrontal cortex which is involved in rational calculation and in balancing expected and actual outcomes of monetary decisions. In this experiment its activity correlated with a volunteer's reaction to both product and price, rather than to price alone. The sense of a good bargain evoked higher activity levels here and often preceded a decision to buy.

What is interesting is the separation of a product’s assessment (by the nucleus accumbens) from the assessment of its price (by the insular cortex) though the two are then synthesised in the prefrontal cortex. Rather than weighing the present good against future alternatives, as economics suggests, people balance the immediate pleasure of the prospective product with the immediate pain of paying for it.

That makes sense as an evolved mechanism for trading. If one useful object is being traded for another or for cash, the future utility of what is being given up is embedded in the object being traded. Emotion is then as capable of assigning value as reason.

But buying on credit might be different. The abstract nature of credit cards, coupled with the deferment of payment that they promise, may modulate the ‘con’ in the insular cortex side of the calculation in favour of the ‘pro’. This will be particularly true among spendthrifts who may have lazy insular cortexes!

Further work might test whether people with different spending behaviour, such as miserliness and extravagance, experience different amounts of pain (or show different patterns of brain activity) in response to prices. They will also assess whether, in the same individuals, buying with credit cards eases the pain compared with paying by cash. If it does, then credit cards may have to join the list of things such as fatty and sugary foods, and recreational drugs, that subvert human instincts in ways that are pleasurable at the time but have an adverse aftertaste.

A related nice read from the NYT is here. Spendthrifts have a lazy insula cortex while in tightwads have an overactive one. But tightwads behave irrationally too by uncoupling the comparison of current benefits and financial pain from their rational thinking.

Friday, January 19, 2007

No sour grapes ex this buttercup

So the best blog posts of 2006 have been selected by Ken Parish at Troppo with assistance from a committee including Ken Parish, Nicholas Gruen and Helen Dale. Having co-operated in producing a shortlist, Ken then chose the best blogs with Nicholas acting as a ‘sounding board’.

I didn’t get a prize – indeed I didn’t get a nomination - so I’ll try again this year. I’ve already run off copies of the winning posts and I’ll try to imitate their style, humour, depth and lack of snarkiness.

The committee gave awards to, well, themselves (Ken Parish 1, Nicholas Gruen 1, Helen Dale 1). Others from Troppo such as Rex Ringschott and Don Arthur also got prizes. There were no prizes to anyone on the conservative side of politics except for Helen Dale – and yeah, she too was on the committee!

At the ANU in 1975 I recall a mathematician who described one of his earlier papers in a later paper as a ‘seminal contribution’. I always wondered whether this is the type of complimentary remark you best hope others will make of your work.

But blogging is a bit more free-for-all so I assume that the Troppo moves are proper – if you are a good blog poster you just got to be a good judge of what else is good out there, otherwise you would not have the power of judgment. Or something like that.

Indeed, I’ll try to mimic this process myself during 2007. If others would like to join me on a ‘best blog post’ selection committee I promise that they’ll get at least one award. But they do have to satisfy my strict selection criteria and agree to vote for at least a few of my posts. Maybe, 2007, I should also circulate a best blog posts of the week feature just so you all know what you must read in the lead-up.

By the way I did glance through the Troppo award winners and a few were worth the megapixels. Apart from one by Robert Merkel however they did not overflow with specificity and content. They were (if anything) artistic rather than informative with one really bitchy feminist rant about how awful it is to get up the duff.

The debate rages on in an anarchic way at Catallaxy.

Thursday, January 18, 2007

Puff harder, the price went up

An attractive paper by Jérôme Adda & Francesca Cornaglia in the September 2006 American Economic Review (a preprint here) re-examines popular accounts of the price-sensitivity of the demand for cigarettes.

Smoking can be defined as a process by which agents give their brains a nicotine hit. Nicotine is a psychoactive stimulant and one of the most addictive drugs around. Cigarettes are an efficient nicotine delivery device – once inhaled nicotine can reach the brain’s pleasure centres in less than 10 seconds where it increases the release and delays the metabolism of dopamine. It is this dopamine release that smokers seek.

This suggests that if the price of cigarettes rises because of a tax increase that consumers might endeavour to increase the nicotine they gain per cigarette by smoking each cigarette more intensively. This might occur by puffing harder, increasing the number of puffs, inhaling for longer periods and blocking ventilation holes on the cigarette filter. If this is true then the conventional findings that the demand for cigarettes is reasonably responsive to price (elasticities of the order of -0.4) in the short-run and a higher elasticity in the long-run (perhaps -0.7) might overstate the health benefits from smoking.

Adda and Coraglia build on work by William Evans and Matthew Farrelly (1998) and Jeffrey Harris (1980) in confirming such compensatory behaviour particularly among heavy smokers. They find that a 1% increase in taxes causes a 0.4% increase in smoking intensity. Smokers not only cut their smoking with a tax increase but compensate by smoking more intensively.

Smoking more intensively has the additional health cost of causing cancer deeper in the lung – see Michael Thun et al. (1997) – an adverse effect from a health perspective. This suggests that the value of excise taxes on cigarettes as a means of improving health has, in the past, been overstated.

The US engagement in Iraq as a behavioural quirk

I have no dispute with the idea that agents have optimism biases and an aversion to cutting one’s losses and that these insights may have application to military conflicts and the proclivity to be a hawk as Daniel Kahneman and Daniel Renshon have recently argued.

Optimism biases make sense in optimistic positive-thinking societies where ‘having a go’ is important. Also ‘not admitting mistakes’ is important in organisations where you are punished for making them. Optimism biases can also arise because those prosecuting wards ignore the opportunity costs of staging a war as William Nordhaus and others (most recently David Leonardt) have pointed out.

But applying this analysis to the specifics of the war in Iraq, as John Quiggin and Kahneman-Renshon have done can amount to dressing up your own political views with a bit of jazzy behavioural economics. Maybe the US went into Iraq because it believed in the existence of potentially enormously dangerous WMDs and because it sought to get rid of Saddam. Maybe it believed this would be a straightforward process that would involve few casualties. That these beliefs tuned out to be in part false has little to do with the strength of ex ante convictions at that time. Even the Nordhaus paper approvingly intriguingly quote on the possible enormous costs of nuclear and biological weapons by Iraq:

‘In spite of some defector claims, it seems doubtful that Saddam has even one nuclear weapon. The same, however, is probably not true of biological and chemical weapons and a radiological weapon is possible. Iraq may also have enough components to assemble as many as 25 Scuds, has shorter range missiles, can modify drones and combat aircraft to act as “cruise missiles,” and has significant capability to smuggle weapons of mass destruction out of Iraq and deliver’. (Anthony H. Cordesman, Iraq’s Military Capabilities: Fighting A Wounded, But Dangerous, Poisonous Snake (Washington, D.C.: Center for Strategic and International Studies, 3 December 2001), 8).

While one can assume the worst about George Bush’s intentions in sending in an additional 21,500 troops it is not clear that this amounts to a ‘double-or-nothing’ bias. It may be that the actual loss of US prestige in accepting defeat in Iraq would be a serious cost to the international fight against terrorism – what signal would it send?- and Iraq would descend into a violent bloodbath even more serious than the current dire situation.

It’s a cunning way of advancing your political agenda of opposition to the war but logically invalid to argue that the Iraq intervention derived from some quirk in making decisions in a risky situation.

Tuesday, January 16, 2007

Markets resolve a hi definition DVD standards war

Have you been waiting to choose one of the new generation of high-definition DVDs and disc players? I have because there are two rival formats (Blu-ray and HD DVD) and because I don’t want to be left with a format that eventually is rejected by the market as was the Betamax videocassette. Consumers generally are unwilling to open their wallets while there are two incompatible formats if they assume one might dominate eventually but don't know which one.

A decade ago, I bought a laserdisc player plus a collection of $80 laserdisks only to find they were essentially made redundant by the DVD – I am not going to get burned again!

The choice of a format is referred to in economics as a ‘standard’ choice. There are ‘standards wars’ as firms compete to be the dominant technology format.

A famous example of a war was fought by Adobe Systems which invested heavily in developing a ‘page description language’ called PostScript for desktop publishing. Adobe realized that no one would invest the time necessary to learn PostScript unless it was the clear ‘standard’. So the firm deliberately allowed competitors to clone its language to create a competitive market in PostScript interpreters.

Adobe’s strategy paid off: several competitors emerged (including one that gave its product away) and PostScript became a widely-used standard for desktop publishing. Adobe kept a few things proprietary – for instance techniques for displaying fonts at low resolution – and managed to dominate the high end of the market. Ironically, Adobes’s market success was due to its ability to encourage entry by its competitors!

With respect to the high definition DVD format issue, 2 business responses to the ‘standards’ problem have been developed and were announced at the recent Las Vegas Consumer Electronics Show.

1. South Korea’s LG offered a DVD player which will, at modest additional cost, accommodates both high definition formats. It sells for about $1200US. Consumers then can buy a player and be confident that it will be useful if only one of the two formats endures. It also boosts the demand for complementor disk products.

2. Warner Bros plans to release a disk that will compete in either type of recorder with a Blu-ray movie on one side and a HD DVD format version on the other. This can be demanded by users of either type of player thus expanding its market. Moreover such disks will remain useful longer-term even if one of the formats fails to be a standard. It boosts demand for complementor DVD player products even those that deliver in only one of the two formats.

Each of these moves are interesting attempts to cash in on the standard war dilemma and each provides benefits to different complementor products. Of course the development does not ensure an unending lifespan for any of the products since it is very likely new ways of delivering high definition content are about to appear. Amir Majidimehr, corporate vice president of consumer technology at Microsoft has said that:
‘…the lifespan of both formats would also be less than the current DVD format. It has lasted 10 years with great success but …the technology would be superseded by developments in online delivery of hi-def content’.

Libertarian paternalism & drug policy issues

I got a buzz from reading the Becker-Posner blog on libertarian-paternalism. Their argument is in part a criticism of C. Sunstein & R. Thaler’s ‘Libertarian Paternalism is Not an Oxymoron’ .

Sunstein & Thaler claim it is both possible and legitimate for private and public institutions to affect behaviour while respecting freedom of choice because people's preferences are ill-formed and their choices are influenced by behavioural quirks such as default rules, framing effects, and starting points. Equipped with an understanding of behavioral findings of bounded rationality and bounded self-control, libertarian paternalists seek to steer choices in welfare-promoting directions without eliminating freedom of choice. This view, in turn, was responded to by Daniel Klein’s ‘Status Quo Bias’. This debate has impacts on the sorts of arguments posed for restricting smoking or the intake of obesity-causing foods.

Libertarians believe individuals should be allowed to pursue their own interests unless their behaviour negatively impacts on others. So individuals should be allowed to buy the food they want but drunk drivers should be constrained because they harm others. But modern research shows that individuals may not have enough information to effectively pursue their interests so, it is argued, government regulations and rules might help guide them to the better pursuit of interests they would have if they had additional information. A libertarian paternalist accepts these information arguments for government regulation but also stresses considerations such as bounded rationality and self-control.

Consider a person who smokes, but has an internal conflict between his stronger ‘self’ who wants to quit, and his weaker ‘self’ who continues to smoke when he feels under pressure or in social situations. The weaker self does not stop smoking because of limited self-control. Paternalism here seeks to help the more dispassionate self gain control over the choices made by the conflicted individual because of his dual selves. Such paternalism might take the form of high cigarette taxes, so that weak selves would not want to smoke so much or of ordinances to limit smoking in restaurants, bars, and other social situations to protect weak selves from temptation. The argument is that individuals are ‘happier’ if given a helping hand to exercise self-control. They might even be happier with high cigarette taxes though Posner notes smokers never lobby for higher taxes!

But Posner notes that libertarianism does not assume adults always know their interests or even are always able to act on their interests when they know them. It does assume that adults know their own interests better than government officials or professors. In addition being able to make mistakes through having the right to make one's own choices leads to more self-reliant, competent, and independent individuals. For example prisoners often lose the ability to make choices for themselves after spending many years in prison where life is rigidly regulated. Thus libertarians claim is that the ‘process’ of making choices leads to individuals more capable of making good choices.

Also it is difficult to distinguish libertarian paternalism from unadulterated paternalism because it is difficult to decide with objective criteria where ‘bounded rationality and bounded self-control’ are important and where they are not? Posner claims that models of rational addiction do as well if not better than models of bounded self-control when applied empirically to smoking behaviour. Why adopt models of bounded self-control in this case?

Take another illustration: Is the obesity problem due to bounds on rationality and control? If so, why did it not happen earlier, or why is the gain in weight so much greater in certain countries? If it cannot answer these questions is not libertarian paternalism simply substituting an intellectual's (or bureaucrat's, politician’s) beliefs about should be done for the judgment of others. Libertarians recognize the temptation in us to control choices made by others and so are in favour of allowing people to make their own choices unless there are external effects. Moreover, even well-intentioned government officials are subject to the cognitive defects that are supposed to affect choices by others. Can one have confidence that they will promote individual interests better than these individuals do themselves?

Posner therefore believes that the case for classical libertarianism is not weakened by the literature motivating libertarian paternalism. Indeed, when similar considerations are applied to government officials and intellectuals the case for classical libertarianism is strengthened!

Posner’s arguments go to the heart of the case for government intervention in certain markets to restore self-control. The key issues are:

1. Are individuals better placed to make sound consumption decisions than others can for them? 2. Does assigning people freedom of choice lead to better decision-making?
3. Do models of rational choice account for behaviour better than models of self-control?
4. Are those making policy judgements subject to the same behavioural defects as citizens subject to self-control problems?

My answer to 1. is certainly ‘no’ for young individuals whose brains are still developing. Most decisions to initiate smoking arte taken when smokers are young but most smokers wish they had never initiated the habit. My response to 2. is ‘not necessarily’. Addictive consumption choices need not lead to better longer-term decision-making. Certainly though, making individuals responsible for their choices, will overcome the ‘moral hazard’ implications of offering ‘treatment’ and ‘care’ to those who make poor consumption choices. To be clear here I favour such care and treatment options because of their moral hazard costs.

I think point 3. is incorrect. The existence of substantial self-control problems is evident throughout the addictive consumption and obesity literature. To take Thomas Schelling’s famous example – rational choice theory cannot explain why a cocaine addict will agree to sign a document admitting use of illegal drugs and give this document to the manager of a drug treatment clinic with the instruction that if cocaine is detected in his urine the document is to be forwarded to the police. Closer to home – as an ex-smoker - I find it fantastic for anyone to claim that individuals do not struggle to quit smoking even though they seriously want to.

Point 4. has value. Some anti-drugs crusaders do suffer from cognitive defects but many are scientists and doctors who do have good knowledge. The case against smoking is motivated by abundant medical evidence and the self-control issues that smokers face are documented in a vast body of neurobiological evidence. Its playing a silly game to claim it is wrong to believe that ‘experts’ are always right. Of course they are not always right – nor are they inevitably wrong or less well-informed than others.