Tuesday, April 7, 2009

Becker, Murphy and Topel on economics of climate change

Becker, Murphy and Topel have an interesting take on the economics of climate change. They state here that "the expected benefit from climate change policies is actually more sensitive to a very small probability that global warming results in a catastrophe than to a change in the discount rate". They appear to be in favor of limited action through small broad-based carbon tax that could be ramped up over time.

However, if there is a very small probability of a catastrophic event (essentially tail risk) and if global warming has some positive feedback (in the non-judgemental engineering sense of the word), then there is no way to know this probability*the expected loss, and therefore, the expected value calculations could be off significantly. If the recent financial crisis has highlighted one thing, it is that people are terrible at tail risk assessment. Given that people are unable to appropriately assess tail risk, it seems to me that Pascal's wager arguments would suggest that we should be more actively pursuing climate change mitigation. Taleb makes a similar point here.

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