Friday, November 28, 2008

Summer grabs me by the throat once again

Last year I deviated from my standard summer routine by holidaying in Sydney rather than in Ulladulla NSW where I have enjoyed my holidays for most of the past 20 years. But I am reverting to form and heading off to Ulladulla tomorrow for a minimalist summer vac – two weeks. I stay in a house about 200 metres from Narrawallee Beach. I like it more than a little.

Up the coast a bit is Jervis Bay where I have spent the last 6 years trying to track down Eastern Bristlebird. I have often seen it at Barren Grounds but never at Jervis Bay – until 2 years ago when, with son William, I saw it clearly in heath near the old lighthouse along with Brown quail. The definition of success depends on one’s horizons.

Apart from such highlights my life is measured out in coffee-spoons of surf-beer-KFC then test cricket followed by a late afternoon surf repeat then vino. Sometimes, if I am energetic, I drive down to Mollymook and watch the dolphins from the Mollymook Golf Club and follow this with some flabby seafood. This is paradise.

I am not sure how much I will post over the coming weeks so this is an open thread. Comments are welcome particularly on my valuable contributions to improving the lot of suffering humanity. Leave Kevin Rudd out of all discussions – I’ll think of him every time I wax my surfboard anyway.

Refusing to consult foxes on welfare of chickens

160 countries have refused to admit cancer producers into discussions on limiting the global spread of cigarettes.  The countries argued there is a fundamental conflict between the interests of public health and those of cigarette producers.  That is obviously true.

Meanwhile, the Lancet reports that, at current smoking rates, 100 million Chinese men will die as a consequence of smoking between 2000-2050.  Many will destroy family finances vainly seeking a cure for their ailments.

Cigarette producers generate far more human misery than international terrorism.

Thursday, November 27, 2008

Violent, racist Islamists kill innocents in Mumbai

The reports of the overnight killings in Mumbai are horrifying. The image of religiously-motivated young men searching for totally innocent civilians with American or British passports and then killing them because they originate from these particular countries makes all civilised humanity recoil.  Pure evil.

Sympathies for the 100+ dead innocents and for the 280+ injured and something approximating a prayer for those held hostage by these evil men.

Update 1: In Cairo 20,000 holy Muslims have surrounded 1,000 holy Christians in a Church chanting Jihad verses  and claiming "We sacrifice our blood and souls, we sacrifice ourselves for you, Islam" while the entrapped Christians chanted "Lord have mercy". The Muslim mob included young children and women.

Update 2: The attack in India may have been planned with a view to eliciting tit-for-tat responses.  This would create a dangerous new front-line in the war against terrorism. India has 150 million Muslims but far more 'safe' non-Muslim targets.

Resurrecting the mammoth & science fiction

$10 million to resurrect the mammoth? It is better to concentrate conservation resources in attempting to limit current species extinctions than to engage in resurrectionist science that has almost no chance of success.  There will not be a mammoth coming to a zoo near you soon. 

Tuesday, November 25, 2008

BHP-Billiton - Rio Tinto deal is off

On July 14 2007 I tipped a possible takeover bid for Rio by BHP-Billiton. On November 8 that year it happened. I got it wrong however in suggesting it likely that eventually some sort of deal would be done. In dramatic news yesterday the 3.4 BHP-Billiton shares for 1 Rio Tinto shares bid was abandoned. As it turns out too my conditional argument that Rio Tinto was a cheap way of getting into BHP-Billiton provided the takeover goes through, although correct, is now irrelevant since the deal is not going through. In fact, those who punted on the takeover going through are taking a caning - Rio were off 36% in London when I looked at 12-46pm (London Time) - the biggest drop in 20 years. There will be fallout from this alone. I'll watch Rio with interest on the ASX tomorrow.

Currently Rio is trading at 1.4 times the value of a BHP-Billiton share - the terms of the merger implied a valuation of 3.4 times. Apart from having the bid abandoned Rio is stuck with the $35 billion dollar debt resulting from the top-of-the-market takeover of Alcan last year. BHP-Billiton has only $6 billion in debt and is a much bigger company.

This outcome suggests to me that the takeover was possibly not a good deal at all for BHP-Billiton and that Rio Tinto by playing hardball in negotiations with BHP-Billiton severely disadvantaged their own shareholders. I cannot believe that the possible monopoly and synergy benefits were worth 36% of Rio's capitalisation.

The Chinese who bought a massive slab of Rio script to help thwart the takeover paid over-the-top prices and are caught with their pants down. Their 7 billion pound stake is now worth about one quarter of that. The steel makers however can rejoice a little since the possibility of a world's resources monolith is no more. Fascinating stuff and congratulations to BHP-Billiton directors and management for not being wedded to a dubious deal.

A few insiders seemed to have got a sniff of what was happening - BHP-Billiton shares surged strongly in the days prior to the announcement.

Monday, November 24, 2008

Climate change - Obama's problems and the Garnaut prescription

Over at the East Asia Forum blog two useful articles on climate change:

Frank Jotzo looks at Barack Obama's climate change problems.  He argues that the double bottom line argument for US pursuing an active mitigation stance (improving global climate, reducing US dependence on imported oil) has become a triple bottom line case given the current financial crisis because the investments required can held driver a revival of the US (and world) economies.  He argues that a model for encouraging co-operation between the super emitters (US, China, India) might lie in the prescriptions of the Garnaut Review with its advocated equal per capita emissions targets by 2050.  Broadly I agree. Increased taxes on US imported oil use could be motivated by the vast costs of stabilising the Middle East to ensure supply.  Moreover, the weak case for emphasising capital intensive expansion strategies in the face of a likely long world recession - the move won't directly target employment - is bolstered by the by the double bottom line arguments cited.

Shiro Armstrong writes a piece defending the Garnaut conditional targets that despite some earlier reservations I support.  I agree with Armstrong that Garnaut has received an unfair press - including initially from me - Garnaut is focusing on what is realistically achievable. Tightened targets - which many in the Green movement support - can be negotiated once weaker targets (that will, in themselves, be difficult to negotiate) are agreed to.  The Garnaut Review has provided a useful input into the UN discussions of a post-Kyoto treaty in Copenhagen in 2009.

The East Asia Forum is a blog well worth bookmarking.

Sunday, November 23, 2008

Indonesia & climate change

Indonesia is the third-largest greenhouse gas emitter on the planet - after China and the United States. The vast bulk of its emissions are caused by deforestation of its tropical rainforests - particularly in central Samatra.  Deforestation emissions in Indonesia are about half the total emissions of China.

 Australia has an interest in reducing these emissions if only because this might help forestall the arrival on our doorstep of millions of impoversished environmental refugees generated by climate change.   In addition, Indonesia has 120 million hectares of rainforest and 10% of the world's biodiversity that people around the world value as public goods. 

Australia does have an aid scheme to help Indonesia limit deforestation but the amounts involved are of the order of tens of millions of dollars when billions are required.

There are huge potential climate change mitigation as well as biodiversity conservation benefits from limiting this deforestation.   Integrating forestry into Clean Development Mechanism arrangements would be a low cost way of reducing global emissions.

Saturday, November 22, 2008

Car industry woes

Chapter 11 is the best outcome for GM since it will permit the types of restructurings that are currently impossible given union demands for taxpayers to pay their member’s salaries and state resistance to plant closures. The US autoworkers were big financial supporters of Obama’s election campaign and for good reason. An aid package from the US Government won’t fix things. Wage costs at US auto-makers are a mile higher than comparable costs for Japanese producers, like Toyota, based in the US. The three US auto-makers (Ford, GM and Chrysler) are asking for a loan of $25 billion to prevent what they claim will be 3 million in job losses within a year and $156 billion in tax losses over 3 years. In other words they are suggesting a bailout is a bargain. This view is predicated on the assumption that Chapter 11 would involve an evaporation of the three firm’s assets and a total loss of all jobs which is false.

Henry Paulson has refused to allow his $700 billion piggybank to be used as a general source of bailouts in the economy and, in particular, to the auto industry.

Australia can scarcely point with high-minded free market zeal to the disgrace of a possible $25 billion US auto bailout by the US Government. Such a bailout will seek to preserve inflated wages and conditions for US workers but Australian workers in Geelong and Adelaide won’t benefit. The Rudd Government has already committed its own $6.2 billion handout to foreign multinationals based in Australia – proportionately higher in given Australia’s diminutive industry size than the US bailout. And news to hand – Ford will stay in Geelong and not cut 600 jobs as announced last year. Ford will invest $21 million upgrading its environment-friendly car production facility of which $13 million will be funded by Kim Carr, err no, by the Australian public.

The Productivity Commission have clamoured to favour lump-sum handouts of the ACIS type to the Australian car industry over tariff protection because such measures do not alter relative prices.  It would be better however to forego both lump-sum handouts that have very limited incentive effects and tariffs.

Friday, November 21, 2008

George Soros: The crisis & what to do about it.

Always of interest to read Soros' views - here.  Can also look at him at MIT discussing his new paradigm for financial markets - here.

Thursday, November 20, 2008

Viral fads

On the real estate crash.

Which is a pale imitation of a memorable previous post here on slow rates of acceptance for a sixtieth birthday party.

In fact, the same clip has been exploited many times. It has become a viral internet fad!

Now for the really bad news

The Dow Jones last night fell another 5% to end up below 8,000 - its lowest level for 5 years.  Banking stocks were again savaged as were auto producers - a large slab of the US auto industry faces the prospects of collapse. In addition the US is experiencing deflation - the US CPI dropped 1% in October. The December Share Price Index Futures was down 4.6% in Australia so a future dramatic rout on Australian equity markets will occur today driven in part by an overnight commodity price retreat.   The All Ordinaries is at half its peak level of about one year ago.  Indeed the betting agency Intrade are selling bets on the possibility of the US going into Depression in 2009 with GNP falling by 10% or more (HT Gregory Mankiw) . The current implied depression probability is around 0.15.  It is not a negligible disaster probability.

The problem for Australian and the world is that people all want to save more because they see their residential and share market wealth decreasing.  This has created a 'paradox of thrift' - in seeking improvement in individual financial positions by saving more they bring about a sharp contraction in demand and therefore economic activity that makes society as a whole worse-off. Indeed they end up saving less. The RBA is not convinced that lower interest rates will succeed in expanding the economy - the real need is for a traditional Keynesian fiscal expansion.

The share market collapse is a leading indicator that Australia is in for very tough economic times ahead.  That is for sure.


Thanks Sir Henry

Wednesday, November 19, 2008

Sense & stupidity in America

Most academics believe that US universities are among the best in the world - of the top 20 fully 17 are supposed to be in the US. Yet in many respects American society is ignorant. It is a paradox that presumably reflects a divide.

In late 2006 fully 55% of Americans believed in Creationism. Of the remainder 27% believed in God-driven evolution while only 13% believed in Darwin's Theory of Natural Selection. Low income people and Republicans dominate in the stupidity stakes.

Moreover, America seems to have a monopoly on Creationist stupidity. A British Survey of 103 Christian religious ministers showed that 97% did not believe the world was created in 6 days and 80% did not believe in the existence of Adam and Eve.

If Americans hold foolish religious beliefs I guess it doesn't matter much. But on climate change issues only 18% of people believe that climate change is real, human-caused and with serious consequences. Troubling since, at least until recently, the US was the world's largest Greenhouse gas emitters.

I was puzzled at the AEA meetings in Chicago in 2007 that so many participants disbelieved the anthropogenic climate change hypothesis. Maybe these same people believe that we are all around because of a sinful fornication between Adam and Eve.

Tuesday, November 18, 2008

Barack Obama the great black hope

I said that Barack Obama would be the US President when it was unpopular to say so.  This video interview with CBS confirms my belief that Obama may well be a great US President. Apart from letting his necktie dangle a bit this interview suggests that real inspiration lies in this man.  It is a big ask to get the US out of its current hole but Obama seems to be a top person with intellectual agility/ability and personal charm.

Case for a migration policy discriminating against entrants with above-average health costs

The recent case where parents with a child having Down's Syndrome were excluded from migrating permanently to Australia has aroused much emotion.  It is widely seen as discrimination against disabled people. It is nothing of the sort. It is discrimination against immigration applicants who may not provide net economic benefits to Australia if they are awarded migrant status.

The lifetime cost of supporting a Down's Syndrome child at a discount rate of 5% was  estimated 10 years ago at $235,000. With a public health system most of this cost will fall on the taxpayer.

Having new migrants usually increases the value of assets and non-wage incomes received by Australians so we derive economic gains from immigration. But Australia provides many public goods - social security benefits and health benefits are prominent examples.  There are incentive reasons to suppose that those with above-average health costs and poor employment prospects have incentives to migrate to Australia.  The restrictions placed on the immigration intake are those designed to screen against such 'adverse selection'.

I know that when I post these remarks that commentators will describe me as heartless in rejecting these children. But  I am not.  About 1 in 600 live births is a Down's Syndrome child so there are around 250,000 such children born per year around the world.  Any interest in improving the welfare of these children would be best addressed by intensifying pre-screening and treatment options rather than admitting a handful under our very limited migration quota.

Families who wish to bring Down's Syndrome children (or family with any preexisting health condition) to Australia should find it possible to guarantee private provision of all extra health costs.  But this is not feasible in Australia because 'Bleeding Heart' do-gooders will never allow enforcement of such a contract.  This lack of resolve means that people with pre-existing medical conditions will continue to be unfairly excluded from immigrant entry.  Being tough here - the alternative suggest - implies being reasonable and kind.

Using sensible heuristics in adapting to climate change.

My paper Classical Decision Rules and Adaptation to Climate Change suggests ways of thinking about adaptation decisions in practical climate change settings where probability information is poor.

The idea is to identify the net benefits from climate change when policies are applied and they work in averting catastrophic outcomes,  when climate change does not produce catastrophic outcomes even without policy and when policies fail to be effective even though adaptation policies are applied. Then one can implement a version of the Precautionary Principle and try to avert the maximum possible damage - this is a minimax rule or, alternatively,  try to minimise the regret one experiences in the future - the minimax regret rule.  The minimax rule suggests adapting only if one can be sure policies will work. The minimax regret rule always provides a case for enacting policy if losses consequent to climate change greatly exceed the costs.  This rationale justifies 'all weather' policies but can justify trying a mix of policies only if employing the mix eliminates the prospect of policy failure. The analysis is applied to a two period model of the Murray-Darling River system.

Monday, November 17, 2008

Clearing the fog

This is a guest post by Rabee Tourky, Professor of Economics at the University of Queensland

In a previous post on this blog I began describing how to my mind the market failure associated with the financial crisis has to do with market incompleteness. That is, we found ourselves in a situation in which one could not use the available securities to diversify away from certain risk.

I'll take the opportunity to refine, in a loose way, my market incompleteness argument.

First, I'll specifically address the apparent failure of the efficient markets hypothesis with regard to the securitization of default instruments; basically these were not markets in the sense understood by economists. Second, I'll conjecture a transmission mechanism in which market incompleteness, associated with a sudden collapse of the span of existing assets, affects non-financial firms; basically the mechanism is driven by a failure of the Modigliani-Miller theorem.

It is now becoming apparent that the markets for securities associated with credit default instruments was not a market in the usual sense, and not a market in which one expects prices to convey meaningful information. These assets were priced to models (inspired by relatively recent works of Darrel Duffie, I guess) and not to market. Further, these securities were essentially not traded. In the words of Susan Wachter of Wharton:
What's new this time is that unlike the securitization of the past, the securitization is tranching of risk in very complicated CDO's, CLO's, SIV's instruments which do not trade. So we do not have market discipline. Although the price of the loan may be varied by risk, the price of the mortgage instrument and the securitization of the mortgage instrument, these securities did not trade. Therefore, there wasn't a market discipline to price the risk and give the signal that these were extraordinarily risky instruments. They were marked to model, not to market. There were lots of fees up front across the board. But the ultimate risk was unknown, because in fact they weren't priced to the risk.
Let me now turn to the second point.

Imagine a sudden collapse in the span of available financial assets. How does this affect the real economy?

To understand this let's recall the Modigliani-Miller theorem, which in a very general setting tells us that the debt-equity ratios of firms do not affect their values. Of course, we know the Modigliani-Miller theorem could fail when there are possibilities of bankruptcy and under certain tax regimes. However, it is likely that what we are seeing now is the failure of the Modigliani-Miller theorem because of a sudden collapse in the span of available financial securities.

The idea, as far as I know formalized by Piero Gottardi in a 1995 article in Economic Theory, is that when there are any type of derivative securities over the shares of a firm, a change in the capital structure of a firm will modify both the real equilibrium allocation and the value of the firm. This is because "payoff of the derivative securities is affected in a non-linear way by changes in the firm's financial policy; thus the set of the agents' insurance opportunities is also modified".

In summary, there was an ineffective market for default securities that collapsed because these securities were not priced in a market setting. This sudden change in the span of financial securities meant that there was an abrupt change in the relationship between firm capital structure and value. Many firms were faced with an unforeseen need to change their capital structure and much of what we see now is a result of this shift of firm capital structures.

Much of the turbulence in relative assets prices will subside when this shift in firm capital structures is completed. We will also know when the financial crisis has resolved itself when this process is complete and when it becomes apparent that firm capital structure has become as irrelevant to firm value as it was prior to the crisis.

In this regard, at this stage government policy should be two pronged. First, helping establishing appropriate clearing mechanisms for default securities so that they are priced by markets; this involves standardization and a measure of regulation. Second, trying to facilitate the capital structure transitions that most firms are currently engaged in. One idea is to guarantee matching government-debt based funding for new equity based funding.

Addendum (inserted by Harry Clarke)

These two papers by Frank Milne, Bank of Montreal Professor of Economics and Finance at Queen’s University, make points similar to those made by Professor Tourky.

The first is a policy oriented piece:

The second is a more technical paper that sets out the failure of liquidity modelling in the Arrow-Debreu model that underlies derivative and risk management models:

Sunday, November 16, 2008

Rudd the grub

It is obvious that our grubby little ear-wax-munching Prime Minister Rudd has damaged Australia by betraying the embellished form of a conversation he had with President George Bush. The story was embellished in an attempt to make the US President appear stupid (What is the G20?) and our own PM appear smart. The effect of Rudd's loquaciousness in repeating to reporters a personal conversation with Bush was to damage Australia and to destroy the trust that any foreign leader would ever place in our grubby little PM. And Rudd looks like a pretentious, myopic smart-arse rather than anything approximating an intelligent PM. Even Melbourne's Pravda recognises the damage.

BBC News describes the gaffe by Rudd as an attempt to make Bush look like a fool. It is a great way of treating our most important ally! Imagine how the Chinese and other nations see the stupidity and immaturity of the Rudd blunder. No one would trust him again.

Malcolm Turnbull is quite correct in remarking that:

"Mr Rudd's desperate desire to big-note himself has done real harm to our relations with the US.

It is clear enough that the US President has been deeply offended. President Obama and other American leaders in the future will be very wary about saying anything to Mr Rudd and other Prime Ministers, in case what they say winds up on the front page of a newspaper.

"Mr Rudd has sacrificed our nation's reputation for trustworthiness and discretion on the altar of his own vanity.'' (my bold)
Kevin Rudd's glib meaningless 'I will do whatever it takes' assurances, his declarations of war everywhere on every issue and his thin skin when the opposition takes him to task on any of his stupid policy measures - the unlimited deposit guarantee to the banks and the decision to encourage 450,000 Australians to abandon private health insurance - mark him as the worst PM Australia has had since Paul Keating. No qualifications - Rudd is a disaster.

Rudd is unreliable in a crisis and pretentious to the point where he believes the meaningless pollie drivel he offers the media as opinion. Rudd has seriously damaged Australia and I am confident will do more damage.

Update: Catallaxy has a discussion K Dudd a national embarrassment. The Age discusses the meeting between Rudd and Bush - "Rudd looks sheepish. Bush looks prickly".  Scraping the bottom of the barrell of Labor's cheersquad we have Mark Banish from Larvatus who doesn't deny Rudd gossipped about Bush's stupidity to the media - he just argues Rudd has done us all a favour in pointing out Bush's ignorance!

Saturday, November 15, 2008

Lunch at Chateau Harry

1 dozen fresh oysters with lemon and a side salad of tomato, lettuce, sliced kiwi fruit and orange.
2 dozen lightly-grilled, skewered prawns spiced sparingly with mixed herbs.
More than 1 glass of Yalumba Viognier 2007.

The sun outside, beating down, defeats any vague thoughts of mowing the unkempt lawn.  Golf if it cools a bit.

The upside to the downside of being back in Oz.

Thursday, November 13, 2008

Foolish views on climate change being promoted at Quadrant

Recent issues of Quadrant contain a number of ‘denialist’ views on climate change issues that will leave those concerned with the implications of climate change troubled. Quadrant could analogously act as an outlet for the flat earth society and the outcome of supporting such a similar sustained attack on scientific logic would make no more sense than supporting climate change denialists without offering anything in the way of the majority accepted-science contrary view.

The most recent article by Bob Carter follows efforts by Ray Evans (here and here) and papers by Ian McFadyen (here) and William Kininmonth (here). All are attempts to debunk the global warming hypothesis as phoney science. None of the Quadrant contributions provide a mainstream contribution to recent climate change debates and indeed the minority views of these denialists are not set in the context of the broader debate.

The denialist studies are surprisingly weak in terms of their force of argument. The authors apparently reject numerical model building of the type carried out by the Intergovernmental Panel on Climate Change on the grounds that the IPCC relies on a scientific consensus (not in itself something reprehensible), that some parameters used in the modelling are not known with certainty (true of most modelling!) and that the models used contain biases consistent with the anthropogenic warming hypothesis (somewhat unfair since they do account for natural radiative forcings).  The authors implicitly question the incentives and integrity of researchers carrying out these mainstream studies while complaining at the same time they they themselves arec under the same sort of credibility attack from mainstream scientists. Moreover, it is true that prominent members of the climate denialist camp, such as Fred Singer, have also in the past denied connections between passive smoking and lung cancer. Singer has also denied that the ozone layer is being depleted and denied that there is a connection between this depletion and the incidence of cancer.  All of these claims have been refuted by mainstream science.

It is difficult to make much sense of the denialist claims with respect to climate given that there is an abundance of different types of evidence supporting the claim of substantial anthropogenic induced rises in temperature over the past 100 years. For clarity I summarise this below.

The denialists represented in Quadrant however largely ignore this mainstream literature or treat it dismissively and cite only evidence and counter-claims that they see as supporting their position. However many of the views they exposit are rejected by mainstream scientists and have been repeatedly refuted as they are endlessly recycled. For example, their claims that warming has not occurred since 1998 and that the Hockey-stick graph is a fiction have themselves been refuuted using careful statistical study. The claim that temperatures have not increased since 1998 were rejected in the Garnaut Review - Garnaut commissioned two respected econometricians to test the claim - and in a suibsequent careful study by meteorologists Robert Fawcett and David Jones. While denialists might not agree with these counterarguments they cannot simply ignore their existence and declare as an uncontested and obvious fact that temperatures have not increased since 1998.

The claim that the 'hockey stick' wrongly suggests a recent, distinctive sustained rise in temperatures is not something that supporters of the anthropogenic climate change hypothesis necessarily rely on to support their position – as the Stern Review points out there is much additional evidence - but the specific objections raised by denialists have been broadly rejected - with some qualifications - by groups such as the National Academy of Sciences. Why has this counter-evidence and the counter-views not been cited in the Quadrant articles? It is not self-evident truth that current global mean temperatures are simply a repeat of past recent experience in terms of peaks.

The denialists present themselves as a persecuted minority whose views are being marginalised by groups such as the IPCC and by most of the 2,500 climate scientists who contribute to the IPCC work. This is an unfair characterisation and a slur on the integrity of these workers. Most scientists do accept that climate change is anthropogenic though it is recognised that a small minority group dispute this consensus conclusion. But practical climate change policy calls for decisions and, utilising a 'balance of probabilities' argument, the consensus view is being relied on for public policy purposes not the view of a tiny group of scientists who reject the mainstream science. Indeed, it is difficult to see what other approach might conceivably be adopted from the perspective of policy. The insights of science are never final and it is almost certain that current climate science views will be refined and perhaps even revised dramatically. But that there is not scientific certainty on climate change does not mean that action to deal with climate change should be stalled. Indeed, if the principle that no action in this world could be taken without definitive absolute certainty, not much would ever happen.

For non-scientists such as myself who are forced to make judgements on climate change in order, for example, to make informed electoral choices the responsibility is to be as informed as possible and then to respect the consensus views of mainstream science. This is not to say that these views may not be one day overthrown by new scientific findings – it is the duty of scientists to probe and attack each other’s work – but this does not mean that citizens should endorse the views of a minority of scientists who hold what seem to be implausible views at odds with standard science.

Indeed it seems that the denialists are behaving in a strident and seemingly irresponsible way in rejecting the consensus science on climate change without at least assembling and taking seriously the alternative consensus evidence and presenting the debate in a balanced way. Why do they not consider the possibility that they may hold erroneous views that, if they were accepted, would impose huge damages on our children and on future generations? Is it only that their views have finally not been accepted in public debates that makes these minority-view scientists strike out with their strong claims?

The upshot of the denialist position is that attempts to prevent ‘human-caused global warming’ will be a ‘costly, ineffectual and hence futile exercise’ (Carter). Therefore climate change, if it does occur, should be addressed solely by adaptation policies so that society learns to live with heating effects. These claims about the primary role of adaptation and of the infeasibility, expensive climate change policies will be discussed below.

First let me cite from a standard text, Gordon Brown’s Ecological Climatology, what are the conventionally understood facts on climate change science. These views cannot be accepted by denialist scientists since they imply that their core beliefs are false.

1. The earth’s mean surface temperature has increased by 0.74oC between 1906-2005.
2. The rate of warming over the last 50 years is almost double the rate over the whole 100 years. The latter half of the twentieth century was probably the warmest in 1300 years.
3. 11 of the 12 years from 1995-2006 are among the 12 warmest since 1850.
4. Not only air temperature but oceans and ground temperatures have increased.
5. Spring snow cover in the northern hemisphere has decreased with lakes and rivers freezing later in autumn and thawing earlier in spring.
6. Glaciers and permafrost are melting and Artic sea ice is shrinking.
7. Increases in concentrations of greenhouse gases are a positive radiative forcing that has warmed climate.
8. It is extremely likely that humans have exerted a substantial warming influence on climate. It is extremely unlikely that natural radiative forcing (solar irradiance plus volcanic aerosol) have had a warming influence comparable to that of anthropogenic radiative forcing.
9. Climate change models that include only natural forcings do not explain the late twentieth century warming while models that include anthropogenic forcings such as greenhouse gases and aerosols do simulate the warming.
10. The balance of evidence suggests that annual global mean surface temperatures will warm by from 1-6oC by 2100 in response to increased concentrations of greenhouse gases.

These widely accepted views contradict denialist claims. Denialists who wish to have their views taken seriously should at least admit that these are consensus views and consider them seriously because wrongly rejecting these views can have serious implications in terms of social costs.
The claims by the denialists that climate change can be dealt with entirely by adaptation rather than mitigation and that climate change measures will be prohibitively expensive and infeasible can be decisively rejected.

There is nothing a priori wrong with the claim that adaptation policies alone can deal with climate change.  But the empirical evidence on costs suggests that this approach is not viable. Adaptation policies alone will be insufficient to address the impacts of climate change partly because of impacts of change on the natural world. For example, there are extreme problems of facilitating biodiversity adaptations to climate change given rapid projected rates of temperature increase and the fragmentation of natural landscapes that inhibit natural 'migratory' adaptation responses. In addition, adaptation responses that would be called for to adapt to such things as sea level changes, changes in the agricultural sector and 'heat island' effects in cities are often concentrated in developing country megacities with low ability to invest in adaptation. Even in wealthy countries such as Australia it would be prohibitively expensive to protect the whole coastline from sea level change changes contingent on climate change.

That mitigation efforts to thwart drastic climate change will be prohibitively expensive is rejected by major recent reports. Unmitigated climate change of 6oC would involve catastrophically large costs as suggested in the Garnaut Review -  respected organisations such as the International Energy Agency in its recent World Energy Outlook 2008 forecast temperature rises of up to 6oC. Every aspect of modern life would be destabilised by such temperature changes and global as well as national welfare would be lower in 100 years than now. This is a catastrophic outcome that is worth focusing on even it it is a relatively low probability event because of the extraordinary costs associated with it.  Rates of mean warming of more than 3oC would be very likely (Stern estimates the probability as 0.69) with the 550 ppm emmission targets that are endorsed in reports such as the Stern and Garnaut Reviews.  The best science that we have suggests that this degree of warming would be associated with the destruction in Australia of the Great Barrier Reef, the Victorian Alpine biodiversity habitats, Kakadu National Park and irrigated agriculture in the Murray-Darling Basin.  If the minority view of the denialists were accepted as the basis for public policy and it were wrong the costs would be extraordinarily high.

At a discount rate of 2.7% the Garnaut Review estimate that discounted costs of targeting 550 ppm emission targets by 2050 are 3.3% of discounted GNP while the costs of aiming for 450 ppm targets are 4.2% of GNP. These are significant costs but not prohibitively so. The Stern Review reaches much the same conclusions - the costs of not acting strongly enough to deal with climate change greatly exceed the costs of taking decisive action to address it.  Accounting for risks of catastrophic change Stern computes the cost of not addressing climate change as a permanent loss in consumption per head of 5-20% whereas the permanent cost of stabilising emissions at between 500-550 ppm would be around only 1% of GNP.

The question whether climate change mitigation is feasible or not turns on the question of community and political will and whether or not an agreement can be forged at the United Nations climate change conference in Copenhagen next year to significantly cut developed country emissions and to reduce the growth rate of global emissions. Garnaut’s assessment is that a 550 ppm target is more feasible than a 450 ppm target because of high offsetting growth in developing countries that will tend to swamp reductions in developed countries. With the policy framework he suggests an equal per capita emissions target across all countries can be achieved although the scale of reductions becomes harder with a long-term 550 ppm target. The argument for the desired global level of emissions cutbacks is can 'optimal insurance' argument - how much are society's prepared to pay to help prevent the possibility of a severe long-tailed catastrophic climate future.

Efforts to forge an international agreement to cut emissions are not helped by claims that anthropogenic climate change is 'phony science' so that efforts to control emissions should not be made. The views of the denialists need to be exposed for the delusions they involve and for the narrow perspectives they represent in the area of climate science. These minority views offer the potential for substantial risks to society if they were adopted and proved to be wrong.

One can ask why are these conservative denialists so strident and seemingly irresponsible in rejecting the consensus science on climate change without at least assembling the alternative consensus evidence? Why do they not consider the possibility that they may hold erroneous views that, if they were accepted, would impose huge damages on our children and on future generations? One can conjecture that it is only that their views have finally not been accepted in public debates that makes these minority-view scientists strike out in the way they have.

Barack Obama is Irish

This entertained me.
Thanks Bernd

Tuesday, November 11, 2008

China impressions

I have had a fascinating and enjoyable visit to China. I spent a month here in 1988 but, Beijing at least, is an entirely new city now. I am sometimes not a great supporter of Chinese policies but, to their credit, the achievement of the Chinese authorities in constructing the new Beijing is in many respects remarkable. Beijing is modern, swanky and would be even an attractive place to visit as a tourist. Moreover, it is not just entrepreneurial spirit that is doing this - the ordered attractivess of Beijing contrasts starkly with unplanned city growth in the sub-continent and in cities such as Bangkok. Things work in Beijing and the city is highly liveable!

I have been am particularly fascinated by the beautiful Peking University Campus and by the happy youth here. Many foreign students are also here studying happily. The Chinese hospitality to visitors is superb. The Chinese postgraduate students are intelligent and have strong academic motivation. Their questions on my climate change policy were rewarding to me and valuable as a way of improving the paper. One perceptive student criticised global trading arrangements to implement low cost global carbon controls from the perspective of Coasian transactions costs! These students know a lot of economics. The students even have an 'on campus' group which studies climate change.

To be frank I can think of no comparable group in Australia. I wonder why not. Why the difference?

I also wonder why it is that Australia sees Chinese students as a source of university funding rather than a chance to interact with a great civilisation. Foreign students in China have a Chinese buddy who helps them with such things as language difficulties. Why doesn't Australia do the same thing?

I think Australia has things to learn and mimic from the new China.

My provisional overall impressions about China? Too many to blog about and far too contradictory at this stage - yes it was only a short visit. Nearly forty years ago I heard the Zen philosopher Alan Watts say that the two things that would most drive the world's future were LSD and China. I think he got the first one wrong but on the second point I feel he is right. China will be both the world power and the key global economic force - that is something I have long believed. But China will also be a world cultural and academic centre. The signs are all there. The Chinese place a high priority on education, on learning from the rest of the world and have a candidness about current Chinese problems.

The fact of Chinese wealth and power is vaguely known to many. The Chinese themselves see it more clearly and are already preparing for hickups in terms of perceived 'threats from China' as the world comes to see it more starkly as a reality. The world's economic institutions were designed without China's blessing - I am sure they will insist on more regulated structures. Many other things will change as the dominant role of the US and Europe fade.

I'll try to sort out my ideas on these issues at a future date. At present I am typing these notes on the free internet service at Hong Kong airport. I like the fact that luggage trolleys within this airport (and Beijing) are also free - a courtesy appreciated by tired out travellers without local currency. A thought that occurs to me is the efficiency and courtesy in this airport compared to the disgracefully degraded facilities at airports such as Los Angeles with their incredibly rude and inefficient customs agents.

The US is squandering its wealth by dissaving and standing by as its infrastructure degrades. China has one of the highest savings rates in the world and is building a new society with high educational and cultural values. I am over-generalising but there seems to be some sort of lesson and sign for the future here.

Sunday, November 09, 2008

Obama supports conscription

Gregory Mankiw points out that Barack Obama supports the conscription of youth into community service. I wonder how many aged lefties will now dump on Obama on the basis of past Vietnam Moratorium ideals. Well of course its not this aged lot who now face the prospect of being conscripted so that a certain amount of soundly-justified hypocrisy is plausible.

Maybe spending the last week in China has dented my democratic ideals but I think the Obama suggestion makes a lot of sense.

Tuesday, November 04, 2008

Beijing Forum & climate change

I am spending the next week in Beijing attending the Beijing Forum while staying at one of the oldest - and best - academic institutions in China, Peking University. On Sunday I am presenting a paper ‘Strategic Issues in Global Climate Change Policy: an Economic Perspective’. This paper uses game theory to analyse the strategic interactions between the greenhouse gas emission (GGE) policies of large countries such as the US and China accounting both for policy spill-overs and carbon leakages (gains and losses that result when some countries control GGEs and others do not).

I argue that incentive issues associated with gaining international cooperation are intensified by the existence of carbon leakages but that side-policies (such as border taxes) in conjunction with adopting the correct consumption-based accounting framework can offset the effects of leakages. Unfortunately there are a host of practical and GATT-illegality obstacles to implementing border taxes. The types of incentive problems that do arise can sometimes be resolved by rich countries compensating poor countries and then mitigating by transferring resources from points where mitigation is highly valued to points where mitigation is cheapest. This accords with ‘public goods’ principles. ‘Embarrassment effects’ – experienced if isolated countries who do not mitigate suffer psychic costs – also convert intractable Prisoner Dilemma games into more tractable Assurance games that can be resolved by simple commitments. Penalties imposed on non-mitigators can be direct, when they are relatively ineffectual, or indirect and more effectual. I discuss the approach by Gersbach (2008) for the establishment of a Global Refunding System into which the carbon taxes of the world are paid. Countries get rebates depending on the effectiveness of their policies and are effectively penalised if they do not mitigate enough. This is an option worth exploring.

In a multi (more than 2) country setting, having an extra country mitigate has the ‘moral suasion’ effect of reducing potential carbon leakage losses faced by current non-mitigators if they should choose to mitigate. But offsetting this, the countries which hold out and are the last to mitigate get carbon leakage gains from those who do. Overall the case for progressive moral suasion is unpersuasive.

Intermediate or ‘no regrets’ policies – such as those offered by China – do provide ‘moral suasion’ arguments for cooperation simply by reducing to some extent possible carbon leakages. Again they only diminish to a small degree the benefits expected if a country holds out as a non-mitigator.

Dynamising these policy tasks faces issues of modelling arbitrariness. It is easy to come up with a number of dynamic and repeated game models which capture various features of the issues but certainly not the whole story. I keep falling back on the simple idea that (with numerous qualifications) the US has a good deal of strategic power in the present situation because it is better equipped to adapt to climate change and facers lower adjustment costs anyway than does a country like China. I am working on these issues further with colleagues in Melbourne particularly with respect to using behavioural economics insights.

Generally I am very interested in China and its climate change policies which have attained a high priority in Chinese policy thinking. I am interested in learning what I can during my brief Chinese visit. There are a large number of policies – oriented toward adaptation and ‘no regrets’ options such as energy conservation which address climate change issues with serious intent.

RBA backflip

In hindsight the RBA overreacted to inflation in making interest rate hikes up to March 5 this year when rates peaked at 7.25%. After being cut by 100 basis points last month they were cut by another 75 points today to be 5.25%. Global deflationary forces have removed the risk of inflation and the clear, substantial risk is a severe recession in Australia accompanied by our own mini debt crisis if house prices really crash.  Official interest rates are at their lowest level since December 2003 but still remain high relative to those abroad.

Can we save the world economy?

This panel discussion (George Soros, Nouriel Roubini, Jeffrey Sachs) moderated by CNN's John Roberts on saving the global economy. You need to reserve some time - its about 90 minutes - but worthwhile.

Not being on your own

Robert Solow is one of the most entertaining - and perceptive - economics writers I know. He also has a zany sense of humour but that is another story. This book review by Solow of Peter Gosselin, High Wire: The Precarious Financial Lives of American Families, provides an excellent critique of the perils of privatising social security. The general message - pay a little tax to protect the sick, the old, the unemployed, and the victims of natural disaster. This is a good social deal and typically best organised by the public sector.

Monday, November 03, 2008

Algal biomass as alternative energy source

This is a guest post by modest, Sydney-based journalist Sir Henry Casingbroke. Sir Henry previously contributed this related post.

I am surprised how little discussion there has been about one of the most obvious and painless ways of doing something practical about emissions of CO2 into atmosphere.

The main problem lies with electricity generated by burning coal followed by internal combustion engines using petroleum products.

Three vague “solutions” have been offered, none of which is likely to eventuate in Australia: (1) electricity generation from nuclear energy (2) carbon sequestration by piping carbon dioxide underground (3) “clean-coal” technology.

First, nuclear energy has the twin political problems of siting the disposal of spent fuel. As a uranium producer we wouldn’t be in a position to export the spent fuel overseas for storage, both morally and practically – we’d have to store here. It can safely be buried deep underground but it is at a huge cost and complexity as is currently done in Sweden. Then there is siting the facility itself - because nuclear power stations use water for cooling, in Australia they would have to be located on the coast to utilise seawater. But that’s where the vast bulk of our population is. The attendant complication is that electricity generation needs to be closeish to where it is needed because of the substantial energy losses in the high-power transmission lines – thus creating an impasse – nuclear generation needs to be on the coast and near people, but people don’t want nuclear power stations anywhere near them. This is obviously in a too-hard basket politically and so we can assume that nuclear power stations aren’t going to be built here any time soon. And even if one or two were to be built, that wouldn’t make much difference to our base-load needs, coal would still have to used for the bulk of our electricity so the problem would remain.

We do have an abundance of good quality coal and it is sited just where we need it – close to industry and major population centres, and furthermore, we have developed our industry and infrastructure around it. Abandoning coal as an energy source is just not going to happen, no matter what politicians and do-gooders say.

One of the “solutions” flogged around last year was carbon sequestration, which involves rerouting the CO2 that would go out the chimney by piping it underground instead. But geology would have to play an important part in this – carbon dioxide could leak to the surface through fissures somewhere else unless there is a uniform and solid rock formation enclosing the gas securely. The consequences of such leakage would be dire as CO2 in high concentrations and under pressure it would be lethal to people and animals. The problem here is that even if this technology was to work (doubtful), the geology under the land on which the coal stations are currently situated is not congruent with that type of solid, non-porous rock that is required to seal in the pressurized gas. That is because our power stations are embedded in a geology that contains coal and shale, both notoriously porous. The best thing that can be done is reduction in soot and particles in the air through mechanical and chemical scrubbing but CO2 will keep building up in the atmosphere in an increasing rate as the economy and the population grows.

Back to first principles. The holy grail in energy is to more efficiently and cleanly transform solar energy into power. Coal is a solar battery, i.e. solar energy stored in carbon (and which returns to the atmosphere as CO2).

While you can’t eliminate the carbon dioxide as you extract energy from coal, it is possible to recycle the CO2 in a useful way to produce more energy so that you minimise the amount of CO2 emitted per kilowatt of power.

The solution in the quickest timeframe is to grow algae biomass in ponds in proximity to power stations. Fast growing algae require lots of CO2. Some species of algae produce easily harvested oil that can be turned into diesel.

It was suggested as early as the 1950s that large-scale ponds growing algae could be used to transform solar energy into usable energy.

Coal power stations near population centres are ideal places to site such ponds because they emit plenty of CO2. Algal ponds can use wastewater and wastewater nutrients plus all that CO2 to grow the algal biomass. The CO2 and solar energy combine in photosynthesis. Photosynthetic organisms such as algae and photosynthetic bacteria in waste combine to make solar energy available in useable forms such as methanol from its algal biomass and diesel fuel from its oil for internal combustion engines.

(To make biodiesel you need methanol as a reagent because the oil straight from the plant is far too viscous to be used in an internal combustion chamber. Algal bloom biomass can provide both the methanol and the oil, although methanol can be also sourced from coal and natural gas.)

By siting auxillary diesel powered power generators alongside the coal steam turbine power generators it would be possible to thus use the algal biomass fuel in situ without having to truck it anywhere else. You would also have a source of methanol from either coal or the biomass. Again, the carbon dioxide emitted by the diesel power generator plants could again be recycled.

This system can be put into effect with current technology and without having to scrap our existing power generation infrastructure.

It has the added benefit of being comparatively simple way of reducing our reliance on non-renewable petroleum based fuels, it is intelligent and practical use of solar energy, and it uses wastewater around cities that otherwise pollutes the environment. Excess biofuel diesel generated at the ponds can of course be onsold for use in transport to power trucks, buses, trains and cars.

Finally, an article by Michael Briggs of the University of New Hampshire, physics department does some maths on how much land would be needed to produce algal diesel for all US transportation needs: the figure is 39,000 sq km.

By way of comparison, land made useless by dryland salinity in Australia is currently around 54,000 sq km and growing. (Algae would grow very well in salinity affected land.)

Of course, Australia’s annual diesel fuel usage is a lot less than that of the USA – our 8 billion litres vs 530 billion litres or 1.5%. Extrapolating this means we would consequently use a lot less land for all our transport diesel needs.

Currently, algal diesel would cost about twice that of petroleum based diesel. But factor in its CO2 ameliorating factors. Remove the removal of the fuel excise on biofuels, and we have a goer here. I imagine the cost would come down in time.

Speculators & politicians

This Commentary article by John Gordon puts the current financial crisis in historical perspective - specifically relates it to the US banking crisis of 1836 - and identifies the main regulatory/political  failures.  A quality 'conservative' assessment.

Sunday, November 02, 2008

Robert Shiller on bubbles

Robert Shiller - the 'rational exhuberance' man - sees speculative bubbles as an instance of 'group-think' (yes, that is well-known) where, among experts, few will stick their neck out to present a divergent view.  It seems that taxi drivers with basic powers of observation (their eyes open?) can outperform MIT-trained PhDs in economics.  Might I suggest:

Meta-Theorem 1: When situations seem ridiculous they probably are. 

Last year I asked:
'Despite the attempts of my macroeconomic colleagues to convince me all is fine I still find it hard to understand how Australians can be in a sound credit position when 16 years into an economic expansion our credit aggregates are growing at 15.9% annually and our money stocks are growing at 15.4%. This is during a phase where inflation looks like peaking at around 3%'.
I have still not heard anything like a sensible answer to this question but I will 'stick my neck out' and make the bold prediction that the answer to this question will, in the medium-term, determine Australia's fate in the current financial crisis.  Who needs economists and finance experts? Give me astute taxi drivers anyday. The RBA told us that our low savings rates were an illusion because our investments in the stock market and the capital gains were were earning on our debt-financed love-affair with housing made us, in fact, one of the highest savings countries in the developed world - only the US beat us!

It is not only private sector heads who should roll in the current crisis.  The comforting noises made by the RBA were misleading.

Update: To be fair there were many misleading voices. James Galbraith estimates only 2 or 3 out of 15,000 economists in the US foresaw the mortgage crisis. Gregory Mankiw estimates about 10 or 12.  we all need to eat a bit of humble pie over this one but macroeconomists should be assigned large slices.

Saturday, November 01, 2008

Obama to be president

I forecast that Barack Obama would be the next US President when it was unpopular to do so.  Of course given the polls I am happy to retain this forecast as evidence of my luck or prowess now. I think Obama is something of a populist visionary/demagogue, has loose ideas on tax and tariffs and defeatist attitudes on Iraq. If introduced I think the illiberal economic policies Obama apparently endorses will harm America and the world - particularly in the face of an imminent severe recession and given two intractable wars.

But as it stands there are only two choices here and I think John McCain has left his running far too late.  He is too old. His selection of Sarah Palin seems to have unnerved America and cast doubts on his judgement. McCain sounds wooden and old. It is interesting that even the conservative Economist endorses Obama.

The positive aspect that Obama does bring is his ability to talk to Americans in an intelligent way.  Whatever you think of the man I cannot recall George Bush doing this.  Bush often read pollie talk from a script.

I believe that race and religion should not be factors that bear on election outcomes but if a black man is elected to be a US President it would say something very positive about America. That also says something about me - I had only just entered university when Martin Luther King Jr. was murdered.  That was less than 40 years ago but then the current situation was unthinkable.

What is clear is that if Obama is elected his visions/demagogary and populism will count for little in providing practical ways of addressing the immense problems that the US faces.  Most immediately a likely severe recession but, down the line, the long-term problem of addressing excessive US debt levels.  One can foresee the likely disappointment that many overly optimistic Americans will experience when it becomes clear that in many respects he must fail. But his intelligence and fair mindedness will help.

Update: Tim Blair comments on moves to deflate unrealistic expectations if Obama wins.