Month: December 2006

Sensitivity analysis

John Quiggin88 Comments

One of the points on which economists generally agree on is that sensitivity analysis is a good thing. Broadly speaking, this means varying the (putatively) crucial parameters of a model and seeing what happens. If the results change a lot, the parameter justifies a closer look.

In the case of the Stern Review of the economics of global warming, sensitivity analysis quickly revelas that the crucial parameter is the pure rate of time preference. This is the extent to which we choose to discount future costs and benefits simply because they are in the future and (if they are far enough in the future) happening to different people and not ourselves. If like Stern, you choose a value near zero (just enough to account for the possibility that there will be no one around in the future, or at least no one in a position to care about our current choices on global warming), you reach the conclusion that immediate action to fix global warming is justified. If, like most of Stern’s critics you choose a rate of pure time preference like 3 per cent, implying that the welfare of people 90 years (roughly three generations) in the future counts for about one-sixteenth as much as the welfare of people alive today, you conclude that we should leave the problem to future generations.

So, responses to a Stern Review provide another kind of sensitivity analysis. If you don’t care (much) about future generations, you shouldn’t do anything (much) about global warming.

The empirical basis of the Green Lantern theory

John Quiggin26 Comments

The idea that winning wars is a matter of willpower (what Matt Yglesias calls the Green Lantern theory of geopolitics) has been getting more and more attention as the situation in Iraq deteriorates.

At one level, the triumph of will theory is immune to meaningful empirical refutation. Whenever a nation loses a war, it can be argued that, with more willpower it would have prevailed. The one exception is where the nation is utterly destroyed, in which case, there will be no one interested in observing the failure of will.

There is, however, a specifically American version, which can be given some kind of empirical support. Until Vietnam, the United States had, at least according to the official accounts, never lost a war. The willpower theory holds that this loss was due to domestic weakness rather than defeat on the battlefield, and that subsequent failures of US forces in Lebanon, Somalia and elsewhere represent “Vietnam syndrome”.
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Bananas

John Quiggin33 Comments

I just ate my first banana since cyclone Larry. My intertemporal elasticity of substitution for bananas is too high (at least for time periods of a year) to justify buying them at $12/kg, but the sight of some lovely bananas at $8/kg was too much temptation for me.

This reminds of the story about Evelyn Waugh told (IIRC) by his son Auberon. Bananas had been unobtainable in England during the War, and Auberon and his two siblings had grown up hearing about this marvellous fruit. The first shipment after the War arrived and the government of the day (the only seriously socialist government in British history) decreed that every child in the country should have one. Waugh senior claimed his family’s allocation of three, cashed in the family ration of sugar and cream and ate the lot in front of his children.

Reviewing the Stern Review, again

John Quiggin28 Comments

Following the publication of this piece in the NY Times, I’ve had a string of email exchanges with Hal Varian, cc:ing Brad DeLong in the role of interested onlooker. I was surprised by the NY Times article since it included both a correct statement of the way in which Stern treats discounting and income redistribution (roughly speaking a 1 per cent change in income has the same value whenever it is incurred and whoever receives it) with a lot of statements that were either misleading or downright wrong, implying that the near-zero rate of pure time preference in the Stern Review implied a near-zero discount rate for cash flows.

Since Varian is one of the brightest and most technically careful people in the economics profession, I was unsurprised by the correct statement, but very surprised to see errors I’d already refuted when put forward by Arnold Kling, Bjorn Lomborg, Megan McArdle and others. Email revealed that the main problems arose from editorial attempts to ‘simplify’ things for readers, but we still have a lot of disagreements about the justifiability or otherwise of inherent discounting.

In any case, all this has spurred me on to produce my long-promised review of Stern on discounting, at least in draft form. Read, enjoy and criticise.