Tuesday, October 18, 2005

Solving the issue of global climate change*

Ok, so the title is fairly inaccurate. This post will not solve much, but it will present a different way of looking at things. So the problem with global warming is that certain people (many of whom are currently running the government) have no incentive to acknowledge that it even exists, let alone that it might be a problem in the not too distant future. Why? Let's take a developing country, China, for example. Pretend that there is a world governing body that can effectively regulate environmental emissions country by country. So this governing body assumes that China is polluting too heavily, and decides they need to cut down on their emissions. What does this do? It encourages foreign investors (in this case, Americans might be foreign investors) to not invest their money in China. This is because the newly imposed environmental regulations make it much more costly to invest in China. This means that the economic development of China is greatly depressed because there isn't much foreign money flowing in, and domestic investors spend more money on meeting those regulations that could otherwise be invested in development.

Let's assume there is no (or little) environmental regulation, and China develops quickly, and once they reach a reasonable level of wealth, they can then focus on cleaning up the environment. That's what the current U.S. administration is banking on. However, that's basically the position the U.S. is in now, and many people would argue that there is far too little being done in terms of environmental regulations here. Why? According to standard economic models, it is always better to invest in the development of a country and push those regulations further and further into the future. If you had a billion dollars to spend and you were promised a 7% return in one year, would you agree to spend only $750 million to invest and spend $250 million on cleaning up your industry? It would make more sense to say let's invest the $1,000,000,000 this year, take that 7% return, then we'll have that much more to work with next year to help clean up the environment. The problem is that there's always a next year.

So that's the problem. Bored yet? Oh wait, there's actually an even bigger problem. Nobody really knows what or when something is going to happen. So potentially, many pundits of global warming could be absolutely correct and maybe nothing bad will happen. Maybe recent warming trends are nothing more than normal fluctuations that play out over billions of years. Or maybe something disastrous is looming right around the corner.

Therein lies the solution. In order to convince certain people that something must be done, the problem has to be framed differently. Let's take a look at terrorism. Before September 11, 2001, I would venture to say that very few investors took it upon themselves to judge the risk of a potential terrorist attack. However, it's probably one of the first considerations now for American investors in foreign countries, especially ones with which we have volatile relationships. There are even insurance policies against terrorist attacks for many industries.

Why, then, can't the possibility of global climate change be viewed as an insurance problem? Investors pay a premium to hedge against risks of fires, floods, and now terrorist attacks. Why not global climate change? I see two main reasons why this hasn't happened yet. First, there are few comprehensive studies that predict the effect of climate change on various industries. There are some that predict effects on GDP, but what we need is something like this: 1 degree Celsius rise, fishing industries may suffer; 2 degree Celsius rise, increase in hurricanes that affect economies of coastal towns; 5 degree Celsius rise, New York, San Francisco, L.A. are swallowed up by the ocean, Missouri is the new east coast, and the American economy collapses. And so on and so forth.

The second reason why I believe not much has been done is that people are in their nature very reactive rather than proactive. But that's just stupid. Let's learn some lessons from history. Do we really need events like Sep. 11 and Hurricane Katrina to drive people to action? Aren't there enough creditable people predicting doom if nothing is done to address the current situation? It's not as though addressing the problem in this way requires too much out of the government. Basically, all that is needed is a centrally sponsored program (somebody's got to pay for it) to do research into the effects that POSSIBLE changes in global climate may have on industries. Then the onus is on the people involved in those industries to decide for themselves and "buy their insurance policies" in the form of polluting less. I have health insurance and car insurance, and I would have them even if it wasn't so cheap through work or required by law. And if I was the CEO of a big company and there was research done that a small change in the global temperature could drastically affect my earnings, I would definitely spend some money to try to prevent that from happening. That's self-enforcing, and that's the beauty of the free market.

Comments? Questions? What am I not thinking about?

*views expressed in this commentary are not necessarily those of Shannon Skerritt's.

how about those white sox?
I like my sox how Eric likes his women-tall and black.
you made my head hurt.... owww....
It seems that in most industries there are many companies, and in a countries economy huge numbers of industries, and of course in the world large numbers of countries, all of which have their economies and industries and companies. Single companies can only do very little to change the problem. So you end up with the free rider problem. Most companies have no incentive to work against the problems because if they do it will make them less competitive in the marketplace. Only companies in industries that are most affected have an incentive to invest in preventing it. Hence one of the reasons that many ski resorts buy wind power. I dont know how you get around the free rider problem in this case. Any ideas?
Yeah, I thought about that as soon as I finished posting this. The old tragedy of the commons. But look at the recent Walmart actions as an example of how companies can make a reduction in pollution while helping their bottom line. That's the idea. Also toll roads/highways are the classic example of how to solve the free-rider problem. Any idea how to adapt this to industries?
Post a Comment

<< Home

This page is powered by Blogger. Isn't yours?