Chinese equity market drives world equity markets

It will be a nervous day for traders on the Australian stock market today after a 400 point fall on Wall Street after a 9% decline in Chinese stocks. The US fall was the worst since the first day of trading after September 11, 2001. The Chinese decline was due to expected tighter monetary conditions as the Chinese government attempts to rein in a ballooning economy. The Chinese market has grown strongly and erratically over the past year and investors are starting to doubt the sustainability of the Chinese boom. In the US a decline in the demand for durables by US consumers suggests the consumer-driven expansion may be ending and that the US might be entering a 'low growth' phase.

It is interesting of course that a Chinese capital market correction drives a worldwide capital market correction. The world has changed.

The International Herald Tribune suggested the US plunge could also be attributed to former Fed Chairman Alan Greenspan’s remarks, a day ago, that the US may be headed for a recession this year. In addition, median US home prices fell for a 6th straight month. Finally, there has been recent upward pressure on oil prices which makes controlling inflation more difficult.

Wall Street, has had a big run-up since October and was due for a correction anyway. Hong Kong's Hang Seng Index dropped 1.8%, Malaysia's Kuala Lumpur Composite Index fell 2.8%, Japan's Nikkei fell only 0.52%, but European markets were rattled — Britain's FTSE 100 lost 2.31%, Germany's DAX index dropped 2.96% and France's CAC-40 fell 3.02%.

Update: At 10-32 am this morning the Australian All-Ordinaries had fallen 3.4%. This is a big reaction. By 2-54 pm the fall was 2.7% with large sustained falls in the Chinese-oriented mineral exporters like BHP-Billiton.

Public vs. private school funding again

Since 1996 state school enrolments in Australia have risen 1.2% while independent and catholic school enrolments have increased 21.5%. As argued in an earlier post these trends could reflect a move to quality or a move by aspirational parents to give their kids a 'leg up'.

Our ratbag teacher unions (the lot who want vastly higher pay without any merit or performance component) offer an unhelpful input. The Australian Education Union's Victoria branch president Mary Bluett said the shift was in part a result of reduced federal funding for government schools. ‘Last year the federal funding share for Victoria was $920 per government school child and $4339 per non-government student … so I think it is influencing this trend’.

But what about total government grants to government and non-government schools? In 2003/04 governments in total (Commonwealth and State) contributed almost twice the amount to educating a student in the government schools ($10,000 on average) compared with educating a student in the non-government schools ($5,600 on average). Private households picked up the gap, paying on average $8690 for an average secondary independent school compared to amounts from households to a government secondary schools of $390 and to catholic schools of $3600.

Parents sending their children to independent schools are not drawing excessively from the public purse as Bluett suggests. Those sending their children to private and independent schools are heavily cross-subsidising the costs of children in the public system and enabling a better quality education and higher teacher salaries than would otherwise obtain.

Combating domestic terrorism

The Age editorializes that the system of placing air marshals on planes to combat terrorism is an expensive failure. In 4 years the scheme has cost the government $106 million – about $26 million per year. The actual ticket cost of travelling – the marshal’s fly business class – is absorbed by the airlines and is an additional component of social cost. The Age points out that the marshals during the past 4 years have apprehended only 1 person with a small knife on a flight between Sydney and Cairns.

The national secretary of the Liquor, Hospitality and Miscellaneous Workers Union, Jeff Lawrence, said ‘There's just no evidence it's had any benefit.’ This might be so but that does not mean the scheme is wasteful. If the objective is deterrence it will be difficult to assemble evidence of effectiveness? Virgin Blue are also unhappy about the measure.

Federal Justice Minister Chris Ellison defended the use of marshals saying that every day without an incident was a successful day for aviation security. ‘It's like saying that because you have an armed guard outside a bank, and the bank is not robbed, the guard is unnecessary’. But Ellison is not right either unless he has evidence he does not present. One cannot assume attacks have been deferred by the marshals.

Some rough empirics however suggest that the use of marshals is unlikely to be excessively costly so Senator Ellison is partly right. Suppose the marshals deter just 1 terrorist attack on a plane every 10 years, an attack would have led to the deaths of 50 people. Supposing the value of each life lost is $5 million (this is conservative) there is a total human cost of $250 million which, including property damage costs, would cover current costs of the marshal program.

Of course the key issue is whether the same level of enhanced security might be provided more cheaply. Reinforcing cockpit doors, arming pilots with handguns and providing more effective passenger screening procedures (including computer-based selective screening of high-risk ethnic/religious groups linked to terrorism) prior to boarding will also deter terrorists. So too will surveillance of suspect groups including suspect religious groups to inform on those linked to espousing terrorist rhetoric.

Australia should also monitor the immigration and refugee program to limit entry of those ethnic/religious groups who pose greatest terrorist threat. The humanitarian program should be redirected towards Asia where we can address humanitarian concerns at lower risk to ourselves.
Determining whether marshals are a waste involves assessing risks as well as the costs and benefits of these alternative measures and whether it is best to go for a narrow or broadly based defense measures.

A terrorist attack in Australia is almost an inevitable consequence of our role in fighting terrorism in Afghanistan and Iraq and of our efforts in East Timor. This attack might be directed at aircraft, our ports or our mass transit systems.

Effective ways of addressing terrorism need to be systematically analysed using economics and operations research (an excellent survey with references is here) not on the basis of glib editorials that ignore the real threats we do face.

Dolphin slaughter in Japan

I am not a vegetarian although I have sympathies with the animal rights movement. Animals have rights that should be protected by humans. This is a plausible ethical position. That almost all humans recognize such rights is implied by the near universal aversion civilized people feel regarding deliberate cruelty to animals. This suggests that animals have at least some rights - the only arguable question is the extent of such rights. Exercising this logic suggests if we are going to kill animals for food then the killing should, at least, avoid unnecessary suffering. That is not a sufficient condition to guarantee legitimate animal rights but it is necessary.

Unnecessary suffering is not avoided in the case of the tragic slaughter of dolphins in Japan. Please take a look. You might also want to look at this whaling clip - killing whales too is not only about limiting their conservation - it is also about inflicting unnecessary suffering.

J.M. Coetzee compares the treatment of animals in a slaughterhouse to the holocaust. This view causes distress to people who lost relatives at the hands of the Nazis, or just to those who appreciate the scale of the Nazi evil. But aspects of Coetzee’s argument make sense.

‘In the 20th Century, a group of powerful and bloody-minded men in Germany hit on the idea of adapting the methods of the industrial stockyard, as pioneered and perfected in Chicago, to the slaughter – or what they preferred to call the processing of human beings.

Of course we cried out in horror when we found out what they had been up to. What a terrible crime to treat human beings like cattle – if we had only known beforehand. But our cry should more accurately have been: What a terrible crime to treat human beings like units in an industrial process. And that cry should have had a postscript: What a terrible crime – come to think of it, a crime against nature – to treat any living being like a unit in an industrial process.’

Coetzee states that children offered the brightest hope, he wrote: ‘It takes but one glance into a slaughterhouse to turn a child into a lifelong vegetarian.’ He claims that our hypocrisy in relation to the slaughter of animals is revealed by our attempts to hide the reality of slaughtering animals out-of –sight.

‘Therefore they arrange their lives in such a way that they need be reminded of farms and abattoirs as little as possible, and they do their best to ensure their children are kept in the dark too, because children have tender hearts and are easily moved’.

Coetzee seems to be wrong at least about some Japanese and their children. The sight of a Japanese school kid walking with indifference past an animal writhing in agony in the video is distressing as is the attitude of workers who, while hacking into live dolphins obviously writhing in pain, seem unconcerned that school kids are viewing what is going on.

If you feel like attaching your signature to a petition to the Japanese Prime Minister regarding the dolphin slaughter do so here. You might be able to help shame the Japanese Government into stopping such practices although I have no idea how you change the cultural attitudes of people who see such behavior as reasonable and benign.

Wasteful backyard water conservation efforts

Investing in a backyard water tank is one way of escaping the effects of water restrictions. But it is much more expensive than supplying water to households by investing more in the water supply system. This is hardly suprising given the enormous economies of scale economics identifies in the processes of storing and distributing water.

My former colleague Rob Dumsday pointed out to me that the rural newspaper, Weekly Times (17/1/07, page 5) estimates the capital costs per ML saved of various new water supply options for Melbourne are approximately:

1. Hume corridor pipeline $7,250 per ML.
2. Eastern Water Recycling pipeline $17,266.
3. Big River pipeline and tunnel $10,750.
4. Goulburn and Black Rivers pipeline and tunnel $13,257.

But a household water tank with capacity of 4,500L and with installation cost of $1,500 in Melbourne would cost 1,000,000/4500 = $333,000 per ML saved. Focusing on capital costs alone it seems that government subsidies designed to encourage householders to install such tanks are encouraging people to engage in unwise investments.

This would not be of concern if households correctly anticipated the costs and if they had access to water at the marginal cost of supplying it. But with water restrictions in place householders may still rationally make such foolish investments as a way of thinking they can profitably escape the effects of the restrictions.

They can in some circumstances but it remains mighty expensive water. Suppose, for example, that a water tank can be filled completely 3 times per year and the water collected, 13,500 L in total, is used on the household garden. For many families this will be at the upper end of the scale for which such water is required – in the main it will be sought in summer months when the natural supply of water from rainfall is scarce and 3 complete refills followed by usage is an optimistic estimate. The value of water supplied from the mains to realise this level of supply would be about $13-50. Assuming the water tank lasts forever and never requires maintenance this would be viable only at discount rates of less than $13.50/1500 or less than 0.01%.

In the absence of water restrictions such an investment will not make sense unless the water uses are very high-valued.

Climate change and agriculture

I am developing an interest in the effects of climate change in the Murray-Darling Basin. What types of adaptation policies should be adopted in this important component of Australian agriculture? There is already an ‘action plan’ for addressing climate change issues generally in Australian agriculture. There is quite a bit of other literature. A global perspective is provided here while an early comprehensive report is here. An overview of US problems is here. Some additional Australian materials on the general problem facing agriculture are here and here (see also their specific report including MDB forecasts here). Analytically some of the issues being discussed in these reports have a similar structure to work on climate change and biodiversity.

Projections, first published by CSIRO in 2001, showed that by 2070, temperatures could rise between 1 °C and 6.5 °C during spring and summer in the MDB. More refined work since shows that, without explicit efforts to reduce emissions of CO2, inland regions show warming in spring and summer of between 0.5 °C and 2.0 °C by the year 2030, and warming between 0.8 °C and 6.5 °C by 2070. So the range, if anything, has slightly expanded.

Rainfall predictions are even more highly uncertain and could decrease by as much as 60% or increase by 40% by 2070 in the MDB. The changes more likely in the northerly areas are to become hotter, especially in spring. The southern and coastal parts of the MDB show less warming and a decreased shift in rainfall. It is fairly vague stuff.

There might be a payoff to the further research (now occurring) into climatic effects that pins down forecasts.

A group of UQ economists (including John Quiggin) have a paper on dealing with climate change in the MDB. They get around the problem of the range in the climate forecasts by supposing temperatures do change a lot and that rainfall decreases. I am just beginning to think about the issue but maybe this is a sensible approach. This might still yield ‘no regrets’ or ‘few regrets’ advantages even if the climatic predictions prove unnecessarily pessimistic.

Maybe too there is the need to think about the issues more generally. Clearly there is a need for water and land use reform in the MDB anyway but the prospect of climate change can raise the stakes. Supposing reforms occur (no small feat!) what types of anticipatory adaptation policies are called for to deal with a probability distribution of prospects for climate change and how far do you need to think ahead?

If static externality issues are resolved how far can free market forces be allowed to drive entry and exit from agriculture in the MDB without any need for being anticipatory?

In building up environmental resilience my hunch is that there are important synergies with efforts to conserve biodiversity.

I’ll get informed about these issues over the coming weeks (I am not pretending I am yet) and will report back. Comments, references and good hyperlinks would be appreciated.

Pipe dream?

I have tried in the past few weeks to suggest profit-making opportunities from climate change. I wonder if having a share market punt on pipe manufacturers makes good sense given our dire water supply situation and Mr Howard’s plans to improve irrigation piping efficiencies in the Murray-Darling Basin.

Even if Howard's plans don’t come off because of foolish self-interest on the part of the States, the issue of more effectively using water in our urban and rural communities remains.

Recall that Richard Pratt identified both the need and commercial potential for more extensive use of plastic piping in the past.

One firm I noticed was the Crane Group whose share price has doubled since April last year. There are others but many are not listed.

Asteroids, global warming & planning for catastrophic risk

According to stargazers an asteroid (called 99942 Apophis) with a 1 in 45,000 chance of hitting the earth in 2036 should be targeted for ‘deflection’ by a ‘gravity tractor’ space vehicle mission organised by the UN. The cost of a direct hit by the asteroid on earth is estimated at $400 billion. The expected damage cost today – the expected benefit of avoiding a collision, ignoring discounting - is a shade under $8.9 million. It is $5 million if a discount rate of 2% is used.

Defecting an asteroid would require a substantial space investment program – I doubt investments in the range $5-$8.9 million would pay the cafeteria costs of such an enterprise! The cost of putting a person on the moon today would be $127 billion!

In fact, the costs of dealing with the asteroid depend on the degree of desired deflection. These increase dramatically after 2029 as the cost of deflecting the asteroid rises strongly – certainly faster than the discount rate. Thus if it isn’t worth doing now it probably won’t be in the future - at least if you respect the expected value criterion – and rely on expected value calculations.

Of course if the catastrophic event was the extinction of humankind you would need to rethink your analysis. That’s a harder issue I am not prepared to argue at this time.

The ‘asteroid problem’ sounds analogous to the theoretical paradigm for dealing with global warming by accounting for catastrophic risks that I have commented on before. Indeed, one commenter on my earlier discussion raised the specific issue of a meteorite (rather than an asteroid) strike. In my response to his comment I got it wrong by denying there was much one can do about such a strike (I had not heard of the ‘deflection’ option) so that the prospect of catastrophe inevitably reduced the value of future human existence. It suggested we should ‘have a party’ rather than waste our money trying to prevent the inevitable.

One twist that is different about the ‘asteroid problem’ is that, if tagging of the asteroid can be done quickly enough, the decision to intervene in planning a defection mission can be postponed until the likelihood of a hit is known with certainty. The idea that catastrophic outcomes associated with climate change can be deferred until their likelihood is known with certainty is implausible.

Another interesting reflection on catastrophic events is posed by the analysis of ‘unknown unknowns’ in John Quiggin’s post on dead zones in the ocean, where life is extinguished. The cause of such zones is uncertain - they are proximately linked to changes in ocean currents which are in a complex way linked to climate.

‘The known (but uncertain) possible consequences of doing nothing add a lot more to the expected costs than do the known (but uncertain) possibilities of adaptation and so on producing lower-than-expected costs. Even more important, the ‘unknown unknowns’, that is, the possible consequences of which we are not yet aware, are dominated by nasty surprises that await us if we continue changing the climate rapidly.’

Sounds plausible. Seeking to maintain the climate status quo through adaptation will leave us less exposed to ‘unknown unknowns’ than will the uncertain consequences of doing nothing and allowing the climate to change.

It is only sensible to apply the ‘asteroid problem’ logic if you can delay taking strong and expensive policy actions to deal with the potentially catastrophic effects of climate change until you know for sure that it will occur. As argued this is questionable. Given the pace of climate change and the extent of uncertainties the time for anticipatory action is right know.

Bracks no grinning angel

The Fitzgerald Inquiry into Queensland Police Corruption recommended that the State Government premier and police minister should only meet police union officers when the Chief Police Commissioner was present. The intention was to keep the police union at arm's length from government - to keep the process honest. These principles apply particularly to the Victorian Police now because it is recognised as having significant corruption problems currently being investigated by the OPI.

But Victoria’s Premier Bracks and his then police minister, Tim Holding, secretly met Head of the Victorian Police Association Paul Mullett, in the absence of Chief Commissioner Nixon, during last year's state election campaign.

The Premier's wanted Mullett's support. He obtained this by means of a 6-page ‘record of commitments’ that provides agreement on many union demands. This deal makes a farce of the current enterprise bargaining talks between Nixon and Mullett since a secret pay increase. as well as other union demands. had been agreed to 3.5 months ago. Bracks has also underwritten the legal bills of officers being investigated by George Brouwer of the OPI. The OPI itself read of the Mullet-Bracks deal in the press - as the rest of us mug taxpayers did.

This was relevant information to voters since it is taxpayers who will fund the cost of prosecuting and defending suspected corrupt cops. The complete transcript of the document is here. It is well worth reading, testimony to Mullet’s bargaining skills and to assessing Steve Bracks’ integrity.

In the election lead-up, Mullett declared war on Labor. But, after the deal, Mullett campaigned strongly for Labor and derided the Liberals, despite the Opposition offering more police recruits.
How will leftwing blogs pursue this? They probably won’t in general though John Quiggin has made a useful post here. They have, for the most part, been silent on the Brian Burke fiasco and Bracks’ efforts will be ignored too. Imagine the negative publicity if Jeff Kennett had done what Bracks has just done.

Labor is now involved in corrupt and dishonest dealings around Australia. Child sex, drugs, corrupt payments to property developers and corrupt king-makers, lying to parliament and now secret deals with a police force where corruption is a serious and acknowledged problem. The sleeze issue is a difficult one for Labor linked to Labor’s factional structure and its time-honoured traditions of handing out of favors to buy support. Integrity doesn’t play a part.

Facts on smoking - incidence & health issues

This post contained some data errors. I have reposed the whole thing with corrections here.

Financial incentives to induce healthy behavior

An insidious externality in our comprehensive health cover system is that poor health risks, even if induced by negligent individual behavior, are borne as costs by the community rather than those who create them. This is moral hazard. Consumers have inadequate incentives to look after their health since their health costs are partly borne by others.

Business Week’s Get Healthy - or Else shows how private profit incentives in the US can improve health outcomes – health insurance costs can be reduced and health outcomes improved. The same incentives will work with our private health schemes in Australia.

Firms in the US often pay a proportion of their employee health care costs. As health is expensive this is a rising cost and firms have encouraged employees to bear a wider range of costs themselves through higher premiums and co-payments. This doesn’t work well because health costs are still shared threough pooling of health risks. Hence firms are starting to force employees to take preventative measures to improve their health and even firing them if they don’t. Firms provide discounts on health club memberships, free weight-loss and smoking-cessation programs, gratis gym memberships, counselling for emotional problems and prizes for health achievements like vacations or points that can be redeemed for gifts. These schemes prevent employees from driving up costs simply because they are unwilling to address their health problems. The schemes save firms money and employees who respond to such incentives get healthier. It is a good deal all round and should be duplicated here in Australia where health insurance firms and the State, rather than private firms, provide most health cover.

It should be possible to lower health care costs in Australia by encouraging consumers to signal to private health funds and to Medibank that they are taking measures to improve their health or to prevent its deterioration. This is not the same thing as offering reduced premiums to those with good health – I am not suggesting free competition for clients and indeed, I favour the current universal health care system. What I am proposing is that individuals be offered incentives to encourage them to take care of their health.

For example many chronic conditions such as Type 2 diabetes can be largely self-regulated by controlling diet and by exercising. One way of encouraging self-regulation is to first help people understand that they have the condition – screening is very inexpensive requiring only a glucose tolerance test. The main costs associated with the condition are associated with not dealing with it, rather than treating it, and thereby incurring catastrophic conditions such as blindness, limb amputations, heart attacks or strokes. As I have previously reported:

‘Average annual health costs/per person of the disease (diabetes) were $5360 in direct costs. Health care costs contributed 79% of costs with medications accounting for only 30%. The complications mentioned, which occur only in a relatively small number of DM sufferers, were the main driver of diabetes costs. Annual costs without complications were $4025, $7025 for those with only microvascular complications, $9055 with macrovascular complications and $9645 for those with both.’

It would be sensible for the Australian private health funds and perhaps for Medibank to subsidise testing for such conditions and, where relevant, to offer health insurance rebates to those who do successfully manage the condition by regulating diet and by taking exercise. It would be a sound investment that would encourage better health care practices and reduce our health bills. Moreover, this would in no way threaten the system of universal cover for health costs that we enjoy.

I have taken the chronic Type 2 diabetes condition as an example but the general approach would apply to other conditions such as obesity. Private health schemes should be able to provide financial rewards to those who take care of themselves and offer subsidies for screening abnd other forms of treatment where such incentives reduce health insurance costs and improve health outcomes.

Denialism will harm the Liberal Party

Nick Minchin is someone in the Liberal Party I respect so I am puzzled about his remarks urging caution over the claimed case for anthropogenic climate change.

Nick is correct that we should maintain a healthy dose of skepticism regarding the likely extent of climate change given underlying climatic uncertainties. We should keep an open mind and be prepared to revise our views as knowledge accumulates. But as I read Nick’s argument he is also saying we should not take determined action to deal with climate change because really disastrous scenarios envisaged might not eventuate. That does not seem sound. As I argued last week, even if there are relatively low probabilities of disastrous scenarios developing we should still take action now if the costs associated with disasters are large enough.

Moreover, Nick’s claim that Australia should not take decisive action to control carbon emissions because our aggregate emissions are a small proportion of total global emissions is not a sensible claim. In 20 years China will be the world’s largest carbon emitter. We need to be among bthe developed countries that can apply moral pressure on China to address this issue. Hypocrisy will not help in this regard.

In practical political terms Nick is opposing any carbon trading scheme for Australia. He sees attempts to get such a scheme off the ground as letting political pressure drive decisions on environmental policy when the stakes for the Australian economy are too high. He states: ‘There is never a finality to almost anything in the scientific world. Even the most hardened advocates of (global warming) accept that the world's climate is the most complex system imaginable. I doubt you could ever say the matter will be settled.’ This complexity of the climatic system is acknowledged but the last statement might be wrongly taken as implying there is wiill never be a case for taking action.

Many conservatives will probably vote for the Liberal Party because they dislike Labor. But climate change is a serious concern that rises above politics. Many conservatives will have serious problems maintaining traditional allegiances if the Liberal Party went into the next election campaign without a convincing, definite position of being committed to deal with climate change. Business and consumer groups - even some coal workers favor taking action.

Moreover, disgruntled conservatives have options for registering a protest vote against the Liberal Party. They can give their first preference to the Greens. This might not harm the Liberals much in the next Federal election, as they will give their second preference to the Liberals, but it won’t help the Liberals much in what looks like a difficult election campaign for them.

Advantages of private schools?

Have people lost faith in public schools because of their unsound educational practices? Or is it just that, with rising incomes, aspirational parents seek to give their children a ‘leg up’ by investing more intensively in education by sending children to private schools?

Investing in a private education does provide tertiary educational advantage. The Age today shows that state school students are under-represented at Victorian universities, with 70% of Melbourne University students recruited from private or academically selective government schools. Half of first-year students were from independent schools, with 35% from government schools and 17% from Catholic schools. At Monash University, 43% of students were from government schools, 33% from independent and 25% from Catholic schools.

But overall, in Victoria, 58% of year 12 students went to government schools, 22% to Catholic schools and only 20% to independent schools.

In part, popularity of vocational programs in public and Catholic schools explains their low representation in elite universities but high university entry scores are also a barrier to public school student. Private schools deliver much higher entry scores.

Parents who send their children to expensive private schools will earn above-average incomes partly because they received good educational opportunities themselves. This solid educational background will influence their children directly. Such parents will also often be educationally-ambitious and confident with respect to their children. Moreover, children at private schools enjoy positive externalities by interacting with other children who have well-educated, academically ambitious parents. These factors will drive self-fullfilling, successful academic outcomes in private schools even if these schools do not provide a better education.

This does not prove that the independent schools are not outperforming public schools but it is a plausible hypothesis. I’d like to see evidence on these issues. I am reading Kevin Donnelly’s Dumbing Down to become better informed on the views of the public school critics.

In my case I attended a public school because my parents were not in a position to pay for a private school. My own 3 children have attended private schools and have (so far) done academically well. But I am unsure whether, it is environment or parenting that has generated most of these outcomes. I am very aware of the externalities generated by putting children among others with academically ambitious parents.

One factor that has been highly influential in encouraging me to choose private schools for my own children is the large number of Labor-voting school teachers I know who express support for the public school system but who send their own children to private schools.

My younger colleagues at work ask me whether I think private schools are worth it and I generally respond by suggesting the question is stupid. Unless you are very wealthy the cost of a private education is a major burden. In many years more than half of my disposable income has been spent on school fees. I’d have to be more crazy, than even my most severe critics would claim, to be involved in such an investment without a belief that there is a private school payoff.

But I am uncertain about the size of the payoff and whether, with the same parenting input, much the same outcomes would have occurred with a public education. After all, ignore my gruff good looks and my occasional overindulgence in booze, and look at the outstanding citizen I have become!

Certainly the size of the educational investment must be assessed. Unless family incomes are huge, funding private school education means foregoing other forms of education derived from, for example, family travel. Paying for private education is also a long-term commitment that creates the need for working parents to ‘moonlight’ and which also creates an excessive concern for money that has negative externalities within the family. This concern to pay school fees arriving as a huge bill every 4 months can extend to cover half of the average parent’s working life.

Even if private education is all that it is claimed to be parents must balance their own welfare against the altruism they feel for their children.

Conservation news - the Night parrot

Australia has a poor record of conserving mammal species but quite a good record for, at least, not allowing bird species to become extinct.

22 Australian mammals have become extinct since white settlement. A few extant species survive only on offshore islands where they are protected from introduced predators such as cats and foxes. Many survive in small numbers in very narrow habitat ranges on the mainland - only about 30 Gilbert's potoroo survive at a single location, Two People's Bay near Albany in Western Australia.

On mainland Australia (i.e. Australia excluding its offshore islands) only a single bird species has almost certainly become extinct since white settlement - the Paradise parrot has not been seen since 1927. One cannot get too excited about this, or exaggerate our conservation success, since many bird species have suffered a really dramatic contraction of their ranges and, taking a populational rather than classical species viewpoint, our record has not been that good.

One of the rarest and most mysterious birds in Australia - the Night parrot - had long been considered very close to extinction. Then, in 1990, a road-killed specimen was found in north-west Queensland - the first sighting since 1912. Then, in 1996, a pair of live Night parrots were observed at a secret location on Newhaven Station in the Northern Territory. Now it is reported that a further dead specimen has been found in far western Queensland. This suggests strongly that the species does still survive over a very large range but probably with exceedingly low population density. Forshaw's book Australian Parrots surveys all the claimed sightings - Forshaw conjectures that the Night parrot might even be reasonably common but, as I say, spread over a huge range at low density. Despite this, very little is known about the species.

It is good news that an interesting Australian bird seems not to have been wiped-out. It is the only Australian parrot species that is active and feeds at night and is hence a uniquely valuable part of our natural heritage.

Lorne

Staying in Lorne, Victoria for a couple of days. Lorne is a coastal resort about 140 kms south of Melbourne. Its a work-related visit but hopefully can visit the Otway National Park and have a swim at the Lorne beach. If I do swim it will be my first at a Victorian beach for quite a few years. The luxury of growing up near great Sydney beaches like Dee Why and Long Reef has left me with a prejudiced view of beaches in the rest of Australia. I'll have to adapt!

Thinking about alcohol policy

I've taken a bit of flak for what are claimed to be my illiberal, paternalistic views on drugs policy. Last October I presented a paper to the Australian Professional Society on Alcohol and Other Drugs Annual Conference in Cairns. This provides what I think is a fairly liberal position that pretty much reflects my views. Comments are very welcome.

Abstract: A liberal economic perspective for thinking about alcohol policy is provided. This is based on ideas of market failure rather than on paternalistic public health approaches of minimizing the gross costs of alcohol consumption. Apart from avoiding paternalism, the liberal approach helps to design effective alcohol regulatory policies. It emphases information, self-control and externality motivations for policy. Proposals to levy taxes in this setting, based on alcohol content rather than value, face limitations when there are possibilities to substitute other intoxicants. There are also equity issues that reflect the fact that it may be poor people with alcohol dependencies and inelastic demands who purchase low-value, high-alcohol content beverages.

Introduction

This paper examines the policy case for intervening in alcoholic drink markets. It also analyses the form that interventions should take. The perspective rejects paternalistic wowserism which opposes drinking alcohol because of its claimed high gross costs. To the contrary, the liberal approach adopted supposes that alcohol yields consumption benefits in terms of its taste and effects, as well as costs, and that society’s objective is to maximize the difference between all benefits and all costs. Consuming alcohol is, for the most part, assumed to be a social, recreational activity - one way of dealing with the pressures of the day and of enhancing the enjoyment of life. The presumption is that, for most people, using alcohol is an informed, rational individual choice. In most cases this choice has relatively harmless implications for the consumer but, even if substantial harm is caused, that is not in itself taken as a necessary indication that use of alcohol should be restricted. The presumption is that individuals are generally the best judges of their own welfares. Thus, provided the potential for harm is recognized by users, and costs of such harms are borne by consumers themselves and assessed rationally by comparing benefits obtained to costs at the margin, restrictions are redundant. In short, the analysis starts from the presumption that alcohol consumption provides net benefits to most adults who drink based on informed individual choices.

Moreover, alcohol is a drug that, for most adults, is both legal to consume and socially accepted. It is also consumed by a significant proportion of the population in diverse settings.

The analysis recognizes that the consumption of alcohol has important costs, particularly when consumed at high levels or when consumed in a risky way. Alcohol consumption has seriously harmful physical and mental health effects, can lead to anti-social and even dangerous behavior such as drink-driving and violence, particularly within the family unit. These costs become important to an economic liberal if they are not borne by the individual alcohol consumer.

There are numerous government policies devised to regulate and restrict the terms under which alcohol is purchased and consumed. This paper provides a framework where such restrictions can be assessed in a consistent setting.

Medical and Non-Economic Approaches to Policy

Much of the community’s focus on alcohol consumption looks at the adverse health and neuro-psychiatric consequences of drinking alcohol. This is the gross ‘cost of illness’ approach to estimating the costs of alcohol consumption: see Godfrey (2004). There is concern with the health costs of excessive drinking either when this occurs on a regular basis or episodically and with alcoholic dependence. There is also concern with social problems associated with drinking, in the workplace and in the home, with violent crime and intentional cause of injuries associated with drinking and with drinking on inappropriate occasions such as immediately prior to driving a vehicle. Particular interest is directed at drinking among youth: see e.g. RACP (2005), WHO (2004).

This work is valuable in articulating health cost implications of alcohol consumption and is often used to support a dramatic headline that points to the costly consequences of drinking alcohol. But this recognition does not help much in designing policy. To what extent should alcohol consumption be restricted? What are the costs, in terms of foregone benefits, of restricting consumption?

That drinking alcohol is risky behavior does not in itself suggest much about the desirability of drinking or the extent to which it should be restricted. This involves assessing the costs and benefits of alcohol consumption and making an evaluation of the case for restrictions based on these. The question is how to value the costs and benefits. Economics does this by assigning monetary values to the costs and benefits individual consumers experience through alcohol consumption as well as any costs and benefits that spillover to society as externalities because of this consumption. Policy analysis then seeks regulations and interventions which maximizes the difference between social benefits and costs.

Free market exchange by rational private consumers will maximize this difference between social benefits and costs if there are no external costs or benefits. Rational individuals then choose to consume whatever maximizes their welfare and advance society’s welfare. If there is a net external cost, however, free market exchange will not achieve this maximization since rational individuals, in making their consumption decisions, consider only the private costs they face. A restriction to reduce consumption to the point where net social benefits are maximized then makes sense provided the cost of the policy restriction is less that the net benefits lost by not employing it. This establishes a case for policy activism with respect to alcohol consumption. Moreover, looking at things in this way provides a conceptual and quantitative guide to the desired extent of the restriction.

From a liberal perspective, if consumers are aware of risks and costs of activities (whether they are drinking alcohol, smoking cigarettes, driving a car or bungy-jumping) there is no a priori case for restricting an activity unless there are net external costs. Simply identifying that costs and risks are associated with the consumption of alcohol does not suggest anything about the case for restrictions if one assumes that individuals are best equipped to make the choices which drive their welfare. Focusing on gross costs suggests only extreme, prohibitive policies.

One can reject the hypothesis that people make their consumption choices rationally on the basis of good information. Indeed some people may be viewed as having self-control problems in relation to alcohol consumption and may fail to identify harmful consequences of consumption. In part these are arguments for providing people with better decision-making skills and with access to better information.

Use of economics can help with policy design. Simply to recognize that consumption of a substance causes social harms does not in itself suggest efficient ways of addressing or reducing such harms.

Rationale for Intervention

There are three main market imperfections that create a case for restricting alcohol consumption. A fourth motivation for policy, paternalism, is a real-politic reason.

1. Information. Efficiency in market exchange requires that the purchaser of a product understands fully the characteristics of that product. With respect to alcohol an issue is whether consumers understand that ethyl alcohol is a neurotoxin - it destroys brain cells – with, in fact, very few health benefits, see Fillmore et al. (2006). It is also unclear whether consumers understand the genetic basis for alcohol self-control problems.

The information difficulties are compounded by advertising and promotion of alcohol which links consumption to sporting and social prowess. There is strong evidence that such advertising has strong effects on consumption, particularly for youth (Saffer and Dave (2003)).

Finally, there might be particular age, ethnic or socio-economic groups in the community that have poorer information than other groups.

The failure to provide good information about the negative consequences of drinking alcohol is a market failure since information is a public good. Markets will develop to promote alcohol consumption since this benefits particular industry groups but there are no such private incentives to provide information that presents the negative consequences of consumption.

On the other hand there is some evidence that some young people overestimate some risks associated with alcohol consumption – particularly the risks of becoming alcoholic. This overestimation leads to less drinking than would occur were the risks accurately perceived: See Lundborg and Lindgren (2002). The same result has been observed with respect to smoking – smokers tend to overestimate the adverse health consequences of smoking: See Viscusi (2002). To the extent this is true public information campaigns that seek to encourage accurate perceptions of health costs should be oriented towards calming people’s fears of the consequences of drinking rather than attempting to heighten their awareness of health risks.

2. Self-control issues. Alcohol consumption can be addictive and people may have problems curtailing their consumption. There are high levels of alcoholism in the community and evidence that people take efforts and expend resources trying to control their alcohol consumption.

Self-control problems can be triggered or initiated by impulsive behavior and those who do have persistent problems controlling their alcohol consumption may have demands reignited by advertising and other cues.

There are particular issues of self-control among young drinkers who have high impulsiveness and those who have particular genetic predispositions to smoke.

3. Externalities. Alcohol consumption creates private costs for individuals and more general social costs for those close to alcohol consumers and the broader community. Drink driving is a serious cause of traffic accidents (a good discussion is Phelps (1997, chapter 15)) and violent behavior by those intoxicated is a serious issue in the broader community.

Other alcohol-linked externalities include fetal alcohol syndrome and generally the damages caused by a drinker to family members. In some situations economists ignore intra-family costs on the basis that family units are regarded as making consumption decisions. This is clearly not the case with most alcohol consumption so family costs should be regarded as a third-party impact.

In addition, in countries like Australia with a publicly-funded national health scheme the medical costs of alcohol consumption are nor borne only privately by the individual. Above-average medical costs will be met partly from the public purse. For this reason alone there can be a public interest in restricting use of alcohol.

4. Paternalism. Finally, although it does not at all fit into the liberal, ‘market failure’ category of reasons for intervention in alcoholic beverage markets, it must be admitted that there are strong moral and emotional arguments against excessive alcohol consumption. Some would oppose certain levels of alcohol consumption even if well-informed consumers, without self-control problems, did bear all the costs of their consumption.

This could result in alcohol taxes being set above their externality-correcting levels to reduce alcohol consumption. It could also motivate public health campaigns to be launched to decrease alcohol consumption not because external costs are being generated but simply because reduced alcohol consumption is a social objective.

For policy design purposes such arguments do not help. They do not take one far in considering a rationale for policy. On the basis of paternalism, alcohol consumption is opposed because one group in the community – doctors, scientists, religious leaders - assesses it to be undesirable. On the other hand considering paternalism might be a useful descriptive way of understanding some actual government regulatory policies – perhaps inefficient policies - that do operate.

Policy Interventions

Given the ‘market-failure’ reasons for seeking to restrict alcohol consumption what are the policy options for regulating alcohol use?

1. Information-related policies. The public sector may need to intervene to provide accurate information about the negative consequences of consuming alcohol and to restrict advertising that emphasizes inaccurately optimistic positive consequences of consumption.

The negative consequences of alcohol consumption include information on self-control issues and on genetic information that might suggest possible future problems.

A difficulty here is that there might be disagreement about the health consequences of consuming alcohol. The debate over the possible health benefits of consuming alcohol in reducing heart disease is a case in point: see Fillmore (2006a). Apart from providing accurate information on health consequences there is also then a case for investing in the provision of improved knowledge on the health consequences of consumption.

In addition, as already mentioned, the case for warning people of the health risks of alcohol consumption is weakened if people already exaggerate the risks. If particular at risk groups or particular health concerns arise then these should be targeted rather than general alcohol health warnings given.

2. Self-control policies. Policies for improving self-control include helping to demonstrate that alcoholism can be a consequence of recurrent drinking. There can also be provision of means for individuals to improve their self-control by promoting such things as personal rules or heuristics that consumers can use to control their drinking behavior. In particular, since problems with alcohol consumption primarily stem from excessive consumption, personal rules relating to the number of ‘standard drinks’ one consumes per week, numbers of alcohol-free days that should be pursued per week or, in some cases, the pursuit of total abstinence can be useful. These are primarily information policy issues.

Self-control can also be improved by restricting the availability of alcohol in various ways – by limiting the availability of alcohol outlets, by restricting trading hours and by limiting the promotion of advertising that might trigger cues to drink. Such policies also increase the non-price user costs of consuming alcohol.

For particular age groups who are prone to excessive alcohol consumption there can be a case for outright bans on consumption. Minimum age laws or restriction of the availability of alcohol to people with particular ethnicities such as Australian aborigines in particular locations are candidate policies.

With respect to drink-driving issues the installation of ignition interlock devices can be understood as a technique improving the judgment and self-control of drinkers in their ability to safely drive after consuming alcohol.

Finally, those with self-control problems should be made aware of the existence of treatment options and of self-help groups such as Alcoholics Anonymous.

3. Externality policies. Economists focus on externalities as a primary source of social costs in relation to substance abuse. The most standard economic prescription is to levy a tax which internalizes these external costs.

Externalities such as drink-driving induced accidents cannot be dealt with by a simple tax directed toward alcohol consumption since the externality here stems from the combined activities of drinking and driving. Moreover, we know that the probability of an accident, given a certain level of alcohol consumption, increases with age: see Phelps (1997, p. 516). Inevitably highway patrols and booze buses are used to detect drink driving with alcohol-involved driving being penalized by fines and penalties rather than taxes on alcohol consumption.

It is only if alcohol-related externalities are related to the overall level of a population’s alcohol consumption (the ‘populational health’ view, see Young (1998, p.115) that simple uniform tax policies make sense. The theory is described in the graph below.



Here the market demand for alcohol q is illustrated along with the private marginal costs of consuming different amounts of alcohol. The demand curve measures the marginal benefits from alcohol consumption for all alcohol consumers. The private marginal cost curve c(q) includes the internalized private health costs, the costs of traffic accidents borne by the drinker, the alcohol purchase costs and so on. The social marginal costs of consumption are also illustrated. These comprise both the private marginal costs borne by consumers and the external social costs generated including the health costs borne by other people, the traffic accident costs born by others and the cost (in dollar terms) of violence and anti-social behavior to others. With a free market operating consumers will consume to the point where their private marginal benefits equal their private marginal costs – they operate at q2 and pay price p2 for their consumption. Because social costs exceed marginal benefits over the range q1 to q2 consumption this imposes net social costs or deadweight losses (DWLs) to the community from drinking equal to the dollar value of the area ABC.

The standard economic prescription in this situation to remove these costs is to levy a Pigovian tax t which raises the price of alcohol consumption to p1 and leaves alcohol consumption where marginal private benefits equal marginal social costs.

Determining the size of this tax depends on assessing the scale of the unpaid for social costs and how these are linked to consumption at the margin. It also depends on the elasticity of demand of consuming alcohol – the more responsive demand is to the tax the smaller the tax can be. Selvanathan et al. (2004) provide price elasticity estimates of -0.3, -0.4 and -1.3 for Australian beer, wine and spirit consumption respectively. For alcoholic beverages as a whole the estimated price elasticity is -0.6 suggesting that a 10% increase in price would cause a 6% reduction in consumption.

Clearly if the social costs are related to the alcohol content of drinks then it should be designed to reflect this fact – it should be a volumetric tax related to the alcohol content of particular types of alcoholic beverage and not an ad valorem excise levied on the value of the alcoholic products sold. Light beer in Australia is already taxed at a lower rate that full-alcohol-strength beer in accord with volumetric principles (Commonwealth of Australia (2005, chapter 5)).

The distinctive feature of this economic approach is that it does not focus on the gross costs of consumption, GC. Thus it does not focus on the total medical, road accident costs and so on that can be attributed to alcohol consumption. In the figure these would be represented as the area 0q2BE. Nor does it focus solely on the non-internalized net costs less benefits (NC) of alcohol use – the medical or road accident costs not borne by alcohol consumers less consumption benefits as given by the area ECB. Instead the economic approach recognizes that alcohol consumption yields benefits to consumers that are given by the area under the demand curve.

The approach seeks to enforce a tax-inclusive price and a level of alcohol consumption that maximizes the net social advantage here the value of the benefits consumers derive from alcohol consumption less all the costs consumers impose irrespective of whether they are internalized or not.

Conclusions and Final Remarks

The economic approach to the costs of alcohol use focuses on the external costs of consuming alcohol not gross costs. The approach recognizes that alcohol provides benefits to consumers and that those costs of consuming alcohol borne by consumers themselves are irrelevant from the viewpoint of society. The economic approach to alcohol policy is based on the utilitarian precept that alcohol consumers should bear the full costs of their consumption and, given this, that society should then maximize net social benefits from consumption.

The advantages of this approach are that it implies a clear guide to policy design. Information should be provided to consumers so they correctly assess the costs and benefits of alcohol consumption including the self-control problems that can develop with alcohol consumption. Self-control difficulties themselves can be addressed with appropriate policies for treating such difficulties and by adjusting measures of the benefits from alcohol consumption. With such adjustments alcohol pricing can force the price of alcohol towards its full social cost (Godrey (2004)).

Despite the strong theoretical reasons for adopting the economic approach it has, in fact, only rather seldom been applied. The main studies are for the United States (Manning et al. (1989), Pogue & Sgontz (1989), Heien & Pittman (1993)) and New Zealand (Barker (2002)). Anderson and Braumberg (2006, p. 68-69) in reviewing these studies comment on the difficulties of implementing them given the problems of defining what are external costs and particularly in recognizing the private component of health costs in a country with a public health system:

‘…externality studies …evidently omit any consideration of the broad range of costs borne by the individual drinker, and are more useful when conducted alongside rather than in place of more common social cost studies. This is particularly true given two contentious results of the assumptions in many externality studies – first, that any harm within the household (such as to the drinker’s partner, or children) is counted as a private cost; and second, that drinkers are both fully rational and fully informed of the risks when they decide to drink’.

This is a political criticism that rejects the liberal ethic underlying the economic approach. The claim that harm within the family needs to be included as a private cost is rejected in this paper as families don’t make drinking decisions, individual consumers do, so there is no reason to treat such costs as private. The second point suggests that a group of non-drinkers can better judge what a consumer wishes to consume than the consumer themselves. This might sometimes be so but clearly not always. To a liberal it is a questionable basis for public policy.

References

P. Anderson & B. Braumberg, Alcohol in Europe: A Public Health Perspective, Institute of Alcohol Studies for the European Commission, 2006. http://ec.europa.eu/health-eu/news_alcoholineurope_en.htm.

F. Barker, ‘Consumption Externalities and the Role of Government: The Case of Alcohol’, Working Paper 02/25, 2002, New Zealand Treasury, http://www.treasury.govt.nz/workingpapers/2002/twp02-25.pdf

L. Cameron & J. Williams, ‘Cannabis, Alcohol and Cigarettes: Substitutes or Complements?’ Economic Record, 2001, 77, 236, 19-34.

D. J. Collins & H.M. Lapsley, Counting the Costs: Estimates of the Social Costs of Drug Abuse, Commonwealth Department of Health and Aging, Canberra, 2002.

Commonwealth of Australia, Review of the Schedule to the Excise Tariff Act, Industry Discussion Paper, Canberra, 2005.

K. Fillmore, T.R. Stockwell, W. Kerr, T. Chikritzhs & A. Bostrom,. ‘Has Alcohol Been Proven to be Protective Against Coronary Heart Disease? Response to Eight Commentaries’. Addiction Research & Theory. (In Press) 2006a.


Fillmore, K., T.R. Stockwell, W. Kerr, T Chikritzhs, & A. Bostrom, ‘Moderate alcohol use and reduced mortality risk: systematic error in prospective studies’. Addiction Research & Theory, 14, 2, 101-132. 2006.


C. Godfrey, ‘The Financial Costs and Benefits of Alcohol’, Paper presented to the European Alcohol Policy Conference: Bridging the Gap, Warsaw 16-19 June 2004 (available at http://www.eurocare.org/btg/conf0604/papers/godfrey.pdf).

D.M. Heien & D.J. Pittman, ‘The External Costs of Alcohol Abuse’, Journal of Studies on Alcohol, 54, 1993, 302-307.

P. Lundborg & B. Lindgren, ‘Risk Perceptions and Alcohol Consumption Among Young Adolescents’, Journal of Risk and Uncertainty, 25, 2002, 165-183.

W.G. Manning, E.B. Keeler, J.P. Newhouse, E.M. Sloss & J. Wasserman, ‘The Taxes of Sin: Do Smokers and Drinkers Pay Their Way’, Journal of the American Medical Association, 261, 1989, 1604-1609.

C.E. Phelps, Health Economics, Addison-Wesley, 1997.

T.F. Pogue & L.G. Sgontz, ‘Taxing to Control Social Costs: The Case of Alcohol’, American Economic Review, 79, 1, 1989, 235-243.

Productivity Commission, Australia’s Gambling Industries, Volume 1, Melbourne 1999.

E.A. Selvanathan & S. Selvanathan, ‘Economic and demographic factors in Australian alcohol demand’, Applied Economics, 36, 2004, 2405-2417.

T. Kue Young, Population Health, New York, Oxford, 1998.

Royal Australasian College of Surgeons, Alcohol Policy: Using Evidence for Better Outcomes, RACP, Sydney, 2005.

H. Saffer & D. Dave, Alcohol Advertising and Alcohol Consumption by Adolescents, NBER Working Paper No 9482, National Bureau of Economic Research, 2003.

W. Kip Viscusi, Smoke-Filled Rooms, University of Chicago Press, Chicago, 2002.

J. Williams, R. Pacula, F.J. Chaloupa, H. Wechsler, Alcohol and Marijuana Use Among College Students: Economic Complements or Substitutes? Health Economics, 13, 9, 2004, 825-843,

World Health Organisation, Global Status Report on Alcohol 2004, World Health Organisation, Geneva, 2004.

Developing countries & climate change policies

I have been thinking about climate change issues in developing countries like China. The following notes provide some preliminary thoughts. I'd welcome comments.

Developing countries like China have low per capita energy consumptions, low efficiencies of energy use and, because of their population size, high aggregate greenhouse gas emission levels. They are also experiencing rapid economic growth. Currently they are not bound to control their carbon emissions by the Kyoto Protocol or other regulations. Indeed these countries are subject to low levels of environmental regulation generally.

What this suggests is that energy consumption and carbon emissions will be subject to two influences as these countries develop. Improved energy efficiencies will tend to reduce per capita consumptions and emission levels while increasing incomes are having stronger effects in driving both consumptions and emissions higher. China has already stated it will attempt to control carbon emissions by seeking to pursue ‘no regrets’ options of improved energy efficiency. But in the longer term we would expect that higher living standards will drive per capita energy levels towards levels enjoyed in developed countries. The short-term pursuit of ‘no regrets’ options is a sensible strategy since it both enhances cost efficiencies and reduces pressures from short-term emission growth. Longer-term developing countries can develop or purchase from developed economies less polluting coal or other electricity generation technologies as developing incomes increase and the capacity to employ less pollution technologies increases.

An obstacle to better longer term emission policies in developing countries is that currently these nations enjoy comparative advantages in a number of manufacturing areas because of the combined role of their low wage costs and the low prices they levy on use of the environment. As their economic development proceeds and wages increase, and as environmental restrictions in developed countries become more stringent, there will be increasing pressure on developing countries to rely on their low priced environments to preserve their comparative advantages. Indeed, it is in their self-interest to seek stringent environmental regulation in developed countries but to retain a lack of environmental controls for themselves.

While one can criticise the environmental stance of countries like the United States for not ratifying the Kyoto Protocol and for generally permissive policies towards carbon emissions eventually governments in the United States must respond to local public opinion. But neither local consumers nor international public opinion will have the same role in limiting pollution in countries like China if there continues to be a lack of accountability through the democratic process. While local environmental conditions are among the worst of any country the benefits of economic growth are being consistently favoured over the environment.

This is potentially a very dangerous outcome since within 20 years China will be the world’s biggest emitter of greenhouse gases. Moreover, China is one of the countries that will be most adversely affected both by generalised global warming and the direct harm it is carrying out on its citizens through local pollution.

Finally, the failure of China and other developing countries to implement effective carbon management policies reduces the incentives of industrial firms to practise effective carbon management in developed countries. Rather than investing in research or in new less-polluting technologies manufacturing businesses are encouraged to relocate in countries without stringent carbon controls. This has a global impact of reducing the international community’s ability to adjust to climate change or, equivalently, it increases the costs of adjusting to such change.

Countries like China, Australia and the United States which do not tax or limit their carbon emissions are imposing an external cost on the international community. An enforcement mechanism that countries could develop to pressure these countries to address the issue of climate change would be a countervailing tariff administered by the WTO similar to that proposed by Stiglitz on all goods that involved a significant carbon content. Countries that imposed a globally determined carbon tax would be exempt from such tariffs on their exports and could use the revenue as a significant source of income.

Under-valuing catastrophic risk

Tim Flannery reacted to the recent 4th IPCC report by claiming that its middle-of-the-road forecasts ignored the potential for very steep temperature rises of 6 degrees C (with probability 0.1) and for very rapid melting of the Arctic Ice Cap in 5-15 years. In short he claimed the IPCC understated the possibility of catastrophic risks. Flannery was dismissed as an alarmist (and worse) by right-wing commentators.

But Tim is worth listening to for 2 reasons:

1. In dealing with uncertainty in a global warming context it makes sense to look at extreme catastrophic outcomes that might happen. Even if there was only a small probability of a catastrophic climate outcome that devastated the world that would be an event that should be taken very seriously by decision-makers. Extreme events must be accounted for if their expected costs are very high because society is more concerned with extreme climatic events than averages. For example, we are much less interested in knowing in average temperature will rise by 3 degrees C than in knowing whether we will experience extreme heat waves, droughts or storms.

In other words, we should not only be trying to nail down forecasts of temperature ans sea level changes but also look at the probability distributions od such forecasts with an emphasis on long-tailed events.

2. There is increasing evidence from various sources that the IPCC report was conservative in undervaluing catastrophic outcomes. New Scientist this week voices several concerns. Generally the IPCC emphasized rigorous research so research deemed controversial or not yet incorporated into climate models was excluded.

The political benefit was to leave little room for the climate change sceptics but there was, simultaneously, the dangerous cost that legitimate findings may have been frozen out with many of the more scary scenarios for climate change - those that scientists discuss among themselves - 'being left on the cutting room floor’.

Climate scientists came together 2 years ago to discuss ‘dangerous’ climate change at a conference organised by the UK government in Exeter. They identified potential positive feedbacks and ‘tipping points’ not included in current models of the earth's climate system that could accelerate global warming or sea-level rise. These included:

• the physical collapse of the Greenland ice sheet,
• rapid melting in Antarctica,
• a shut-down of the Gulf Stream in the Atlantic,
• the release of CO2 and methane from soil, the ocean bed & melting permafrost.

Yet last week's IPCC report largely ignored these possibilities.

One concern is that the ice sheets of Greenland and Antarctica could disintegrate causing sea level rises of metres. But the IPCC restricted itself to noting that sea levels are rising 3.1 centimetres a decade - still twice the rate of the early 1990s. Current climate models assume that the ice sheets will melt only slowly, as heat works its way down through ice more than 2 kilometres thick.

But many glaciologists believe ice sheets fracture as they melt, so water can penetrate to the bottom within seconds, warming its full depth so break-up of the ice sheets happens long before thermal melting. Indeed, the rate of ice loss in Greenland has unexpectedly doubled in the past decade and the permanent Arctic sea ice is contracting by 7% each decade.

Moreover, there is research showing that world sea levels are rising 50% faster today than predicted in the last IPCC report in 2001 This could be the first sign of a dramatic acceleration of sea level rise as ice sheets disintegrate. But the IPCC last week reduced its estimate of worst-case sea level rise in the coming century from 88 to 59 centimetres. Controversy over such forecasts continues at Deltoid.

Researchers at the UK's National Oceanography Centre, Southampton also felt overlooked. In 2005, they reported that the Gulf Stream slowed by 30% 1957-2004. But the IPCC summary insists that ‘there is insufficient evidence to determine whether trends exist’.

Water vapour is increasing in the atmosphere, the IPCC says thanks to more evaporation from the oceans. Weather systems are changing, with more intense droughts and tropical cyclones at low latitudes. Rainfall, when it occurs, is heavier because the warmer air holds more moisture. However, the IPCC fail to take up warnings made of ‘carbon-cycle feedbacks’ - the release of greenhouse gases from warmed soils, forests, permafrost and sea beds. It does note that CO2 is accumulating at a rate 1/3 greater than 20 years ago.

The IPCC's predictions of significant warming in northern latitudes should give urgency to assessing potential methane releases from Siberia and the Arctic. But, these fears were not in the IPCC report.

Any committee requiring politicians to agree is going to take time arriving at a consensus. The IPCC’s climate scientists had to run the gauntlet of government delegations, who had to approve every word of the summary prior to publication. By and large, the IPCC scientists insist they ‘faced down political interference’. The prize of having governments formally sign off on the report will, they hope, make any compromises worthwhile.

Future IPCC work on climatic risk and uncertainty should address the prospect of extreme catastrophic climatic events. Such events lower the discount rate one should apply in climate change policy modelling. Also, as I pointed out in an earlier post, such events need to be analysed from the perspective of the ability of policies to offset them. Extremely disadvantageous events that cannot be offset suggest lower incentives to embark on policy and a case for delaying action. Extreme events that can be offset enhance arguments for intense and prompt policy activism. I set out the analytics of such arguments here.

A US attack on Iran?

I’ve speculated over the past year about the prospects of the US going to war with Iran. The Economist this week thinks there are good reasons for supposing it might happen despite the US defence secretary’s claim February 2 that ‘We are not planning for a war with Iran’. They advance four reasons.

• Iran's apparent determination to build nuclear weapons, and a fear that it is nearing the point where its nuclear programme will be impossible to stop (see here).
• The advent of Mahmoud Ahmadinejad, a populist president who denies the Holocaust and calls openly for Israel's destruction: his apocalyptic speeches have convinced many people in Israel and America that the world is facing a new Hitler with genocidal intent.
• A recent tendency inside the Bush administration to blame Iran for many of America's troubles not just in Iraq (see here) but throughout the Middle East.
• The predicament of George Bush. ‘A president who is now detached from electoral considerations knows that his place in history is going to be defined by the tests he himself chose to put at the centre of his foreign policy: bringing democracy to the Middle East and preventing rogue regimes from acquiring weapons of mass destruction. Given his excessive willingness to blame Iran for blocking America's noble aims in the Middle East, he may come to see a pre-emptive strike on its nuclear programme as a fitting way to redeem his presidency’.

The Economist regards a US strike on Iranian nuclear facilities as a reckless gamble that would at best delay not end Iranian nuclear ambitions:

‘It might very well rally support behind a regime that is at present not conspicuously popular at home, emboldening it to retaliate inside Iraq, against Israel and perhaps against the US itself. Besides, it is far from clear exactly how dangerous a nuclear-armed Iran would be. Unlike Iraq under Saddam, Iran has a complex power structure with elements of pluralism and many checks and balances. For all its proclaimed religiosity, it has behaved since the revolution like a rational actor. To be sure, some of its regional aims are mischievous, and in pursuing them it has adopted foul means, including terrorism. But the ayatollahs have so far been shrewd calculators of consequences. There are already small signs of a backlash against the attention-seeking Mr Ahmadinejad. Like the Soviet Union, a nuclear Iran could probably be deterred’.

This is not to say a nuclear Iran isn’t dangerous – it is. Iran's nuclear efforts might, for example, provoke a pre-emptive strike by Israel, which is already a nuclear power.

‘For Israelis, whose country Mr Ahmadinejad says he wants to wipe off the map, it is not all that reassuring to hear that Iran can “probably” be deterred. Even if Israel were to decide against such a strike, Iran's going nuclear could destroy what is left of the international non-proliferation regime. It has proved hard enough for Arab states such as Egypt and Saudi Arabia to live with Israel's undeclared bomb; if their Iranian rival got one too, the race to copy might soon be on. On top of this is the danger that a nuclear Iran would feel safe to ramp up attempts to spread its revolution violently beyond its own borders’.

Every effort should be made to stop an Iranian bomb. But a better way than an armed strike is to encourage the talks between Britain, France and Germany and Iran rather than to bludgeon Iran into nuclear compliance. Iran claims its nuclear programme is for civil purposes only so last year, the Europeans called its bluff by offering trade, civil-nuclear assistance and a promise of talks with America if it stopped enriching the uranium that could produce the fuel for a bomb. When Iran refused, diplomacy led in December to economic sanctions by the Security Council.

This is a promising approach. The diplomacy at the UN proceeds at a glacial pace. But Iran is thought to be several years from a bomb. And meanwhile the Americans, Europeans, Russians and Chinese have at last all lined up on the same side of the argument. What is required now is a further tightening of the economic squeeze coupled with some sort of an incentive—most usefully an unambiguous promise from Mr Bush that if Iran returns to compliance with the nuclear rules it will face no attempt by America to overthrow the regime. Even then, America and Iran may be fated to lock horns in the Middle East. But the region, and the world, will be a good deal safer without the shadow of an Iranian bomb’.

Meanwhile Paul Krugman also agrees that what would be a disastrous attack on Iran is increasingly likely – he describes this as the Scary Movie 2 possibility.

Anna Nicole Smith RIP

They don't waste time do they?

The culture vultures are picking at her bones already. Over at Deltoid the newspaper space given to this 'minor American celebrity' is being compared to the lack of space given to reports of 'excess deaths' of 650,000 Iraqis. Clever point Tim! I thought her life and death were very sad. The following image of her proposed casket was circulating on the web today. I guess it should be amusing.

But the more I looked at it the less amusing it became. Again, I just felt sad for her. She was 'fabulously gorgeous' and deserved a much happier life.

Dealing with climate change at low cost

One way of thinking about the economic policy problem associated with climate change policy is to think of trying to move economies toward more sustainable levels of carbon emission at low cost. Despite some alarmism about the costs of dealing with climate change the consensus is that the costs should, in fact, be quite low. John Quiggin has suggested that dealing with climate change satisfactorily will cost 1-3% of GDP.

Without endorsing this specific figure I agree with the general notion that dealing with climate change can probably be accommodated at low cost. Moreover, the economic task is to make this cost as low as possible and, I would argue, market processes can help achieve this objective. As I suggested, in a recent post, capital markets are already oriented to assessing the costs and benefits for individual firms of climate change – markets are supporting those that are well prepared for dealing with hefty carbon regulations and penalizing those firms that are not. The implied resource reallocations from this reorientation of sentiment - this favours firms which are well-prepared - will smoothe the impact of climate change on the economy by producing lower adjustment costs.

The Weekend AFR 10-11/2/07 (19-21, 42, 62 subscription required) takes this analysis further. It argues that a technological revolution akin to the internet revolution will help to ‘cool the planet’. This revolution will reflect both the threats and promises of climate change and should dominate world capital markets for the next 25 years. The task is to accommodate a 50% growth in global energy demands while reducing dependence on fossil fuels by drawing on new technologies, nuclear power, geothermal power and other renewables. This is complicated by the fact that there are pent up demands for energy as companies have delayed new projects partly because of policy uncertainty and, partly, I suspect, because of fossil fuel price uncertainty.

Just as with the internet boom a lot of money will be out there chasing winners. A lot of this will be ‘old energy’ money seeking to adapt to a new world but some will be the hard-earned savings of John Doe's, like your scribe, trying to make a buck. Motivating this greed is an important development that can help resolve the climate change problem.

Among the equity-market bets you can place in Australia that might do well out of climate change problems are:

• Babcock & Brown Wind – wind generation.
• Energy Developments – gas, coal, methane, landfill power.
• Ceramic Fuel Cells – ceramic fuel cells.
• Transpacific Industries – waste management.
• Viridis Energy Capital – gas from landfill.
• B&B Environmental – green power, biodiesel, recycling.
• Dolomatrix – liquid waste technologies.
• Quantum Energy – energy efficient hot water systems.
• Geodynamics – geothermal energy from hot rocks. (Tim Flannery has a small investment!)
• Envirozel – water storage and treatment.
• CO2 – malle carbon sequestration.
• Agri-Energy – ethanol production in the US and Australia.
• Phoslock Water – water treatment.
• BlueScope – plans cogeneration & (regrettably) seeking protection from government.
• OneSteel – seeking to reduce emissions. Increasing use of recyclables.
• AGL – about 41% generating capacity is emissions free.
• Origin Energy – focus on renewables. Has 15% of Geodynamics.
  

The prospects for these alternatives improve dramatically if a carbon trading scheme or carbon tax is set in place. Their prospects will not be improved by a nonsensical ‘free market’ approach to dealing with global warming discussed at Catallaxy on the basis of enforcing property rights on local pollution problems. Markets work only when externalities have been internalised and global warming is the 'mother of all' externalities.

The best policy approach is make the greed instinct work is to embed in the entrepreneurial consciousness the notion that using carbon-based fuels with current technologies will shortly involve greatly increased future costs. This needs to be done clearly now. Waiting for others to act is a foolish 'defect' strategy in a global Prisoners' Dilemma where a possible outcome is that future life on earth might be very difficult. Current actions to implement a carbon trading scheme are a useful start. Such moves, if they enforce a high enough price on carbon emissions, provide the right price signals for:

• Evaluating and investing in nuclear, geothermal and other alternative energy technologies as well as waste disposal technologies.
• Developing cleaner coal and fossil fuel burning technologies in power generation.
• Encouraging firms to invest in energy conservation in cars and other energy-using consumer durables.
• Encouraging consumers to exercise appropriate conservationist constraint in using energy.
• Conducting energy technology and economic research.

All these things interact to drive the greed instinct in the direction of dealing effectively with climate change. Of course one must deal with idiot politicians who value a position of power at low pay rather than dealing effectively with an urgent issue. The Labor Party should throw into the basket of foolish ideas its policy that allows others to use nuclear power based on our uranium resources but not us. Furthermore, State governments which respond to pressures from energy providers to give them exemptions from carbon controls as a precondition for carrying out new investment (as NSW as done for BlueScope) should be exposed for their shameless lack of principle and not re-elected.

Cricket tragedies

Last Wednesday Monash University’s Centre for Policy Studies (COPS) defeated LaTrobe University’s Department of Economics and Finance in our annual cricket match. Conditioned as we are to defeats it still hurts - particularly when Monash bats poorly and scores a total of only 126 – not even batting out all of its 30 overs - and when LTU responds by 'snatching defeat from the jaws of victory' by posting a total of only 115. LTU's run chase was too slow - too many missed opportunities.

Monash’s amiable boss Professor Peter Dixon looked ruffled as LTU’s score approached that of his team but smiled broadly as, yet again, the almost inevitable happened. A review of last year’s defeat was posted on this blog. I didn’t play myself this year but, after learning from Peter that my bowling had terrorized him in the past, I might get back into training for 2008.

Yesterday I went to the First Final in the One Day Commonwealth Bank Series between Australia and England. The outcome was disappointing for Australia since it lost. But England celebrated its third consecutive victory and deserved congratulations – despite the close apparent margin with England winning with only 3 balls to spare – it was by far the better team.

Australia started brilliantly being 1-170 at one stage with superb batting performances by Ponting and Hayden. But they were all out in the 48th over for 252 which did not look enough on a very even pitch. England started disastrously and were 3 for 125 at one stage and then responded as the Aussies usually do. They fought back brilliantly. Paul Collingwood’s 120 was a solid innings that won the game for England. Apart from Brett Lee‘s 3 for 41 the Australian bowling didn’t look good. McGrath looked old and out of it.

The Mexican Wave survived despite warnings that were regularly screened stating that it was banned. There is a loutish stupid adolescent element who damage the game – I thought those who booed Collingwood on getting his century (pictured) need to be sent to re-education camps in a Gulag - but I agree with Yobbo that banning the wave is not the way to go. The wave is a bit of fun.

The crowd was small for the MCG at under 40,000. The banning of the Mexican wave may have played a minor role as may the expectation (proved false) that England would not be competitive. But I also think the facilities at the MCG are appalling – at least for the average mug like me who is not an MCG member. The seating is uncomfortable, the electronic reporting systems are 60% advertising and the food and beverage services are beyond belief. The food is expensive and genuinely disgusting. Not a great deal for the $60 I paid for my ticket.

I enjoyed the cricket but the drones who banned the Mexican wave seem to also lack much business sense.