An amazing thing has happened over the last five years.   Against all expectations, American emissions of carbon dioxide into the atmosphere, since peaking in 2007, have fallen by 12%, back to 1995 levels.  (As of 2012. US Energy Information Agency).   How can this be?   The United States did not ratify the Kyoto Protocol to cut emissions of greenhouse gases below 1997 levels by 2012, as Europe did.  

Was the achievement a side-effect of reduced economic activity?   It is true that the US economy peaked in late 2007, the same time as emissions.   But the US recession ended in June 2009 and GDP growth since then, though inadequate, has been substantially higher than Europe’s.  Yet US emissions continued to fall, while EU emissions began to rise again after 2009 (EU).  Something else is going on. 

The primary explanation, in a word, is “fracking.”   In fourteen words: the use of horizontal drilling and hydraulic fracturing to recover deposits of shale gas.  

One can virtually prove that shale gas is the major factor behind the fall in US emissions.  Natural gas, especially when burnt in combined-cycle gas turbine power plants, emits only half as much greenhouse gas (GHG) as coal.   Ten years ago domestic natural gas production appeared to be reaching its limits; the industry was so sure of this that it made big investments in terminals to import Liquefied Natural Gas (LNG).  Yet the fracking revolution has increased the supply of natural gas so rapidly since then that liquefaction plants are now being built at LNG port sites in preparation for export.   Clean natural gas occupies a rapidly increasing share of the generation of electric power.   It has come largely at the expense of coal’s share.  Within power generation, natural gas is up 37% since 2007, while coal is down 25%.  As a result, natural gas has drawn close to coal as the number one source of US power — unthinkable a short time ago. Renewables have been rising, but still constitute only 5% of power generation in the US.  This is less than hydroelectric and far less than nuclear, let alone coal or gas.

Meanwhile, the role of coal - the dirtiest fuel — has been rising in the energy mix of the rest of the world, not falling (IEA, Dec. 2012).  Coal’s share of power has even risen since 2010 in Europe (EC), where some countries are phasing out emission-free nuclear power and no shale gas boom has appeared.    (The trans-Atlantic comparison does not offer grounds for self-righteousness, however.   GHG emissions remain far higher in the US than in Europe.)     

The advent of shale gas in the United States has had a variety of implications for the economy, national security, and the environment.  The implications are surely more good than bad. 

Short-run economic advantages include job creation.   Medium-run economic advantages include the “re-shoring” of some manufacturing activities.   Long-run advantages include reducing macroeconomic vulnerability to future global oil shocks such as those that led to serious recessions in the 1970s.  (It would be wrong to claim job creation as an advantage in the long-run.  Jobs that are created in the oil and gas sector would otherwise be created somewhere else.  But during the last five years of high unemployment, every new job has helped.) 

Moving beyond economics, the reduction in net energy imports is good for US national security.  What happens in the Middle East will still matter, but as oil imports fall American foreign policy will not be as constrained as in the past. US net oil imports have already fallen by half since 2007 and the downward trend is expected to continue, especially if one leaves aside imports from Canada.   In Europe, the new developments can help break Russia’s troublesome stranglehold on the supply of natural gas.

That leaves the environment.  Here as well the effects on net appear beneficial.   As already noted, the substitution of natural gas in place of coal slows global climate change. Indeed the United States is now on track to meet the Obama administration’s international commitment of emissions 17% below 2005 levels by 2020.  But natural gas is also better for local air quality.  Burning coal puts sulfur dioxide, nitrous oxide, mercury and particulates into the air. 

Yet it is among environmentalists that heartfelt opposition to fracking has arisen.  Why?

Environmentalists seem to have three sets of fears.  First, they worry that shale gas will displace renewable energy sources such as wind and solar power.  But the fact is that GHG emissions can’t be reduced without cutting coal emissions and that shale gas is already displacing coal in the US.  This is not speculation about the future.  It has already been happening.  If renewables or fusion or something else currently unknown can take over after 2050, then great.  But we would still need natural gas as a bridge from here to there. 

Put differently, if the world continues to build coal-fired power plants at the rate it has been, those plants will still be around in 2050 regardless what other technologies have become available in the meantime.  Solar power can’t stop those coal fired plants from being built today.  Natural gas can. 

Cheap natural gas also helps with heating buildings and increasingly with transportation as well - particularly if electric plug-in cars become more widespread.  In overall primary energy production, natural gas at 31% has now surpassed coal, at 26%. The graph below shows the two lines crossing. (Table 1.2,  US EIA).  Solar and wind together account for only 2% of US primary energy production.  

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       Throughout history, big economic and political shocks have often occurred in August, when leaders had gone on vacation in the belief that world affairs were quiet.   Examples of geopolitical jolts that came in August include the outbreak of World War I, the Nazi-Soviet pact of 1939 and the Berlin Wall in 1961.  Subsequent examples of economic and other surprises in August have included the Nixon shock of 1971 (when the American president enacted wage-price controls, took the dollar off gold, and imposed trade controls), 1982 eruption in Mexico of the international debt crisis, Iraq’s invasion of Kuwait in 1990, the 1991 Soviet coup, 1992 crisis in the European Exchange Rate Mechanism, Hurricane Katrina in 2005, and US subprime mortgage crisis of 2007.   Many of these shocks constituted events that had previously not even appeared on most radar screens. They were considered unthinkable. 

The phrase “black swans” has come to be used to mean a very unlikely event of this sort.  Managers of Long Term Capital Management in 1998 or of most major banks in 2008 have suggested that they could not be expected to have allowed for a financial collapse such as the one that followed the default of Russia or the one that followed the bursting of the US housing bubble, because it was a “7-standard deviation event,” that is, an event of inconceivably tiny probability…in the realm of the probability that two major meteors hit the earth at the same time.   This is nonsense.  If the statistical model says the probability of a financial crisis is that low, it is the model that is wrong.  This is like the case when “hundred-year floods” turn up every few years.

A bit more enlightened are people who talk about Knightian uncertainty or “unknown unknowns.” Ignorance with humility is better than ignorance without it.    A still better interpretation is that statistical distributions have “fat tails,” in technical terms.  But it would be nice to get beyond the Jurassic Park lesson (”don’t be surprised if things go wrong”), to be able to say intelligent things about what causes tail events. 

       What does “black swan” really mean?   In my view, it should refer to an event that is considered virtually impossible by those whose frame of reference is limited in time span and geographical area, but that is well within the probability distribution for those whose data set includes other countries besides their own and other decades or centuries. 

      Consider five examples of mistakes made by those whose memory did not extend beyond a few years or decades of personal experience in a small number of countries.

1. “All swans are white.”  The origin of the black swan metaphor was the belief that all swans were white, a conclusion that might have been reached by a 19^th century Englishman based on a lifetime of personal observation and David Hume’s principle of induction.   But ornithologists already knew that there in fact existed black swans in Australia, having discovered them in 1697.  A 19^th-century Englishman encountering a black swan for the first time might have considered it an event of unthinkably low probability, even though the relevant information to the contrary had already been available in ornithology books.  It seems a waste of an excellent metaphor to use the term just to mean a highly unexpected event.  A better use of “black swan” would be to mean an event that would not have been quite so unexpected ex ante if forecasters had cast their data net over a broader set of countries and a longer time perspective.

 2. “Terrorists don’t blow up big office buildings.”   Before September 11, 2001, some terrorist experts warned that foreign terrorists might try to blow up tall American office buildings.   These warnings were not taken seriously by those in power at the time.   Many Americans did not know the history of terrorist events taking place in other countries and in other decades.  

 3. “Housing prices don’t fall.” Many Americans up to 2006 based their behavior on the assumption that nominal housing prices, even if they slowed down, would not fall.   After all, “they never had before,” which meant that they had not fallen in living memory in the United States.   They may not have been aware that housing prices had often fallen in other countries, and in the US before the 1940s.  Needless to say, many a decision would have been made very differently, whether by indebted homeowners or leveraged bank executives, if they had thought there was a non-negligible chance of an outright decline in prices.

 4. “Volatilities are low.”   During the years 2004-06, financial markets perceived market risk as very low.  This was most nakedly visible in the implicit volatilities in options prices such as the VIX.  But it was also manifest in junk bond spreads, sovereign spreads, and many other financial prices.  One of the reasons for this historic mis-pricing of risk is that traders were plugging into their Black-Scholes formulas estimates of variances that went back only a few years, or at most a few decades (the period of the late “Great Moderation”).  They should have gone back much farther - or better yet, formed judgments based on a more comprehensive assessment of what risks might lie in wait for the world economy.

 5. “Big banks don’t fail.”   ”Governments of advanced countries don’t default.”   ”European governments don’t default.”  Enough said.  Greece’s debt troubles, in particular, should not have caught anyone by surprise, least of all northern Europeans.   The perception was that euro countries were fundamentally different from emerging markets, that like Germany they were free of default risk.  Suddenly, in 2010, the Greek sovereign spread shot up, exceeding 800% by June. But even when the Greek crisis erupted, leaders in Brussels and Frankfurt seemed to view it as a black swan, instead of recognizing it as a close cousin of the Argentine crisis of ten years earlier, the Mexican crisis of 1994, and many others in history, including among European countries.

      My next blog post will list some of the shocks that, even though low-probability, have high enough probability that they should be treated as thinkable rather than unthinkable, they would have great consequences, and they therefore warrant some advance preparation.

The parties to the UN Framework Convention on Climate Change are meeting once again in Durban, South Africa, from November 28 to December 9.  The period covered by the Kyoto Protocol ends in 2012 and the clock is running out on negotiations for a successor agreement.  Progress at Copenhagen two years ago and Cancun one year ago was slow.   Negotiations have been blocked by a seemingly insurmountable obstacle. The United States is at loggerheads with the developing world, especially China–now the world’s largest emitter of greenhouse gases (GHG)–and India.  

Fortunately, there might be a way to break through this roadblock.  A formulas-based approach, building on existing commitments, could attain desired mitigation of concentrations of Greenhouse Gases, while yet avoiding the imposition of disproportionate economic costs on any single country or group of countries.  The political feasibility of our proposal has been borne out over the last year, in that the specifics have turned out to be consistent with positions recently taken by the important players.  This despite what appears to be a Gordian knot too big to be untied.

On the one hand, the leaders of India and China are clear: They won’t cut emissions until after the United States and other developed countries have cut theirs first. After all, the industrialized countries created the problem of global climate change, and got rich in the process. Developing countries shouldn’t be denied their turn at economic development, they argue. As the Indians point out, Americans emit more than 10 times as much carbon dioxide per person as they do.

On the other hand, the U.S. Congress is equally clear: It will not impose quantitative limits on U.S. GHG emissions if it fears that emissions from China, India, and other developing countries will continue to grow unabated. Indeed, that is why the Senate was unwilling to ratify the Kyoto Protocol ten years ago. Why should U.S. firms bear the economic cost of cutting emissions if energy-intensive domestic aluminum smelters and steel mills, for example, would just migrate to countries that have no caps and cheaper energy (a problem known as leakage)? Global emissions would simply continue their rapid rise in a different part of the world. Emission cap legislation will not pass the Senate as long as major developing countries haven’t accepted quantitative targets of their own.

Global issues of leakage and competitiveness can only be effectively addressed at the multilateral level. The climate change negotiators need to coalesce on a specific mechanism for setting the actual numbers for future emission targets. The framework must address the three gaping holes in the Kyoto Protocol: the absence of a mechanism for setting targets in the long run, the lack of participation by many major emitting countries, and the lack of faith that signatories will fulfill their commitments.

I see one practical solution to the apparently irreconcilable differences between the United States and the developing countries regarding binding quantitative targets: Washington would agree to join Europe in adopting emission targets that would cut substantially over the next 40 years. Simultaneously, in the same agreement, China, India, and other developing countries would agree to a path that immediately imposes binding emission targets on them. These would be targets that in the first five-year period simply follow the so-called business-as-usual path, defined as the rate of increase in emissions that these countries would experience in the absence of an international agreement, as determined by experts’ projections.

The idea of developing countries committing only to business-as-usual targets will be met with loud objections from both environmentalists and U.S. business interests because it doesn’t obligate China or other developing countries to cut emissions. But this commitment is far more important than it may sound at first. Specifically, it precludes carbon leakage from undermining the environmental goal of the agreement. The developing countries can’t go above their set business-as-usual paths as they would in the absence of this commitment and, therefore, can’t exploit developed states’ emissions reduction efforts by expanding carbon-intensive industries. This step mitigates the competitiveness concerns of carbon-intensive industries in developed countries.

Such an approach recognizes the reality that it would be irrational for China to agree to substantial cuts in the short term. Indeed, the developing countries, for their part, may object when asked to take on any kind of binding targets at all, at this stage.  But they should realize that they would gain in strictly economic terms from such an agreement.  The commitment, in an international system of emission permits trading, would give China the ability to sell permits at the world market price. How do we know Beijing would come out ahead? It is currently building roughly 100 power plants per year to accommodate its rapidly growing energy demand. The cost of shutting down an already-functioning U.S. coal-fired power plant is far higher than the cost of building a new low-carbon plant in China. For this reason, when a U.S. firm pays China to cut its emissions voluntarily, thereby obtaining a permit that the U.S. firm can use to meet its emission obligations, both parties benefit, even in strictly economic terms. The environmental benefit is that China’s aggregate emissions would voluntarily fall below its business-as-usual commitment from the beginning.

Of course, the next step to this solution requires that China and other developing countries make cuts below their business-as-usual path in future years and, eventually, make cuts in absolute terms as states gain confidence in the framework. But the developing countries must agree to the principle of making cuts similar to those made by Europe, the United States, and others who have gone before them, taking due account of differences in income. Emission targets can be determined by formulas that follow from four important guidelines:

(1) They give lower-income countries more time before they start to cut emissions.

(2) They ask richer countries for steeper cuts than poorer countries. This is a principle that turns out to have been embodied in the targets accepted by countries last year at Cancun. (See Figure 1, where the relationship between agreed emission cuts and income per capita is highly significant statistically.)

(3) They lead to a gradual convergence of emissions per capita over the course of the century.

(4) They take care not to reward any country for joining the system late.    

 Figure 1: Estimated progressivity in Cancun emmission targets (including former Soviet countries)

 An application of FEEM’s WITCH model reveals that these formulas produce emission targets that obey common-sense constraints:  no country or group of countries is asked to adopt targets that would cost it more than 1% of GDP over the century as a whole or more than 5% of GDP in any single five-year time period.

Realistically, no country (rich or poor) will abide by targets in any given period that entail extremely large economic sacrifices relative to the alternative of simply not participating in the system. It is time to stop making sweeping proposals that assume otherwise, and to pursue instead the narrow thread of the politically possible.

[The specifics of the formula's proposal are explained in "Sustainable Cooperation in Global Climate Policy: Specific Formulas and Emission Targets to Build on Copenhagen and Cancun," a background paper co-authored with Valentina Bosetti, for the annual Human Development Report just released by the UN Development Programme, Nov. 2011.  All estimates were updated in light of recent developments, relative to our earlier paper, "Politically Feasible Emission Target Formulas to Attain 460 ppm CO2 Concentrations," forthcoming, Review of Environmental Economics and Policy (Oxford University Press) Winter 2012.]

This column appears at Vox.  Comments may be posted there.

Korea may have an opportunity to exercise historic leadership, when it chairs the G-20 meeting in Seoul, November 11-12.    This will be the first time that a non-G-7 country has hosted the G-20 since the larger, more inclusive, group supplanted the smaller rich-country group in April of last year as the premier steering committee for the world economy.  With large emerging market and developing countries playing such expanded economic roles, the G-7 had lost legitimacy.  It was high time to make the membership more representative.    But there is also a danger that the G-20 will now prove too unwieldy, in which case decision-making might then revert to the smaller group.

When countries like China and India used to demand a larger voice in world governance based on their large populations, they did not get very far.   Substantive power in multilateral governance is allocated according to the Golden Rule: “He who has the gold rules.”    But after a few decades of miraculous economic growth rates they now have the economic heft.    China is now larger economically than Japan or Germany.   Brazil is also one of the seven largest economies.

Beyond GDP, we have recently seen a historic role reversal, in which debtor-creditor patterns have changed.    Many developing countries, breaking historic patterns, took advantage of the global boom of 2003-2007 to achieve high national saving rates, particularly in the form of strong government budgets, while the advanced countries did not.   As a result, the debt levels of the top 20 rich countries (debt/GDP ratios around 80%) are now twice those of the top 20 emerging markets.   And it is rising rapidly.   A number of emerging market countries now have higher credit ratings than a number of so-called advanced countries.  A stronger fiscal position is one of the reasons that countries like China could afford to undertake large and sustained fiscal stimulus in response to the 2008-09 global recession.   The United States and United Kingdom, by contrast, had wasted the preceding expansion running budget deficits, and hence by 2010 had come to feel heavily constrained by their debts.

It is understandable if Korea views its hosting of the G-20 as another opportunity for marking its arrival on the world stage (as when it hosted the Olympics) or for consolidating its status as an industrialized economy (as when it joined the OECD).  But it should make more of its opportunity than this.  Korea should seize the chance to exercise substantive leadership.   Otherwise, the risk is that its period in the chair could appear like a replay of the chaotic Czech presidency of the EU in the first half of 2009, which confirmed the feelings of some in the larger European countries that it was a mistake to let smaller countries take their turns behind the wheel.

Korea can serve as a bridge between the G-7 and the developing countries.  But chairing a successful meeting will be a challenge, with respect to both meeting management and substantive issues.

With regard to managing the meeting, the challenge comes from the size of the group.   There is always a tradeoff between legitimacy and workability.   The G-7 was small enough to be workable but too small to claim legitimacy.  The United Nations is big enough to claim legitimacy but too big to be workable.  The latest evidence of this was the Conference of Parties of the UN Framework Convention on Climate Change in Copenhagen last December.  The UNFCCC proved a totally ineffectual vehicle, in part because small countries repeatedly blocked progress.    President Obama was able to make more progress by spending a few minutes in a room with a few big emitting countries than the delegates had achieved in two weeks.

The G-20 has enough legitimacy for its purpose — which is more limited than the purposes of formal institutions such as the UN, IMF, and WTO.  It accounts for 85% of the world’s GDP, for example.    But it is too big to be workable as a steering group.  A principle of multilateral talk-shops is that conversation is not possible with more than 10 in the room.  With 20 delegations, each reads prepared statements;  there is no give and take and the communiqué is a watered down least-common-denominator press release.   Not only does the G-20 have more than 10 delegations; it actually has more than 20.

The G-20 needs a smaller informal steering group within the steering group, a G-6 or G-9 within the G-20.   It could meet in the evening before the main G-20 meeting and discuss how to organize the discussion in the larger group.

Who would be in the G-6 or G-9?   It would be unwise to be too specific at this point.  Nevertheless, the US, Japan, and Europe (represented perhaps by the EU Commission), must be there on the rich-country side; China, India, and Brazil must be there on the developing-country side.   Of course the pressure to expand is always irresistible.  Europe could be represented by both the U.K. and euroland.    In Seoul, Korea has to be there as the host. Who would be the 9^th country in the G-9?   It should be the country of which the person reading this blog post is a citizen.

What about the substance of the meetings?   The group will discuss whatever the bigger countries consider it most useful to discuss at the time.    Five possible topics include:

• At long last, giving more seats on the IMF executive board to big emerging market countries, in proportion to their rising economic clout,offset by consolidation of some of Europe’s seats.
• More financial regulatory reform, such as coordination of any small taxes or penalties that members want to apply to risk-taking banks.
• Global current account imbalances. Perhaps there will be a statement agreeing that large current account deficits or surpluses tend to lead to problem (absent some good economic justification), that exchange rates and budget deficits both bear some responsibility for current large imbalances, and that the burden of adjustment should be born by neither one alone, but rather by both.
• Macroeconomic exit strategies. I personally would favor an articulation of the proposition that concrete steps toward long-term fiscal consolidation in each country need not require premature withdrawal of current fiscal stimulus. An example would be to raise the future retirement age or take other steps today to reform public pensions, even while simultaneously enacting some short-term stimulus in the US and UK.
• Moving toward a new agreement on climate change to take the place of the Kyoto Protocol after 2012. Korea is in a good position to lead, as essentially the first post-Kyoto country to accept emission targets.

Don’t judge the outcome of the meeting by what appears in the media.   Press reviews usually pronounce such summits a let-down.   But occasionally such meetings are important, in ways that are often not clear until later.

Consider the London G-20 meeting of April 2009.    It was not obvious at the time that it had been a success in terms of substantive policies.   Observers even compared it to the infamous failed London Economic Summit of 1933, which was a way of saying that the world had not learned the lessons of the Great Depression.    But the 2009 meeting appears far better in hindsight.  Looking back on 2009, fiscal stimulus turned out to be more widespread in 2009 than one might have guessed.    Similarly, global monetary policy was easy, avoiding another big mistake of the 1930s.  The G-20 unexpectedly agreed to triple IMF resources and bring the SDR back from the dead.  Even in the area of trade policy, despite fears of protectionism, the outcome was not bad at all by the standards of past recessions, let alone in comparison with the Smoot-Hawley tariff of 1930.   Overall, policy-makers’ immediate response to the global recession in 2009 did not repeat the mistakes of the early 1930s.

Currently, however, the advanced countries are in danger of repeating the mistake that President Franklin Roosevelt made in 1937, when he cut spending prematurely and sent the US economy back into recession.  Perhaps the G-20 will be a venue in which the big emerging market countries can remind the U.S. and the U.K. of the lesson they once knew but have now forgotten — what it means to run a countercyclical fiscal policy.

[This column was written for Project Syndicate. Comments can be posted there.]

Most observers judged as a failure the December meeting in Copenhagen of the Conference of Parties of the UN Framework Convention on Climate Change (UNFCCC).    But then the usual way of judging such meetings is to look for a communiqué that voices sweeping aspirations, such as the G-7 “decision” at L’Aquila last summer to limit global warming to 2 degrees centigrade.   In reality, without any evidence of countries agreeing what is each one’s share of the burden, such proclamations are worthless.  Better tiny steps on the ground than giant flights of rhetoric.

Is there any sign of progress, even tiny steps?    (more…)

The international press reports, “At Climate Talks, Danger to Free Trade Mounts.”

The Copenhagen negotiations have essentially failed to include, among the many topics covered, one that will be critical in the coming years:   the question of import tariffs or other trade penalties that individual countries apply against the products of other countries that they deem too carbon-intensive.    Such border measures are already in EU and US legislation (the Waxman-Markey bill, not yet passed by the Senate).    Properly designed, they could turn out to be the missing instrument needed to get each country to cut emissions without fear of others taking unfair advantage, via leakage.   More likely, national politics will turn them into protectionist barriers.

Actions taken multilaterally would probably make the difference as to whether border measures are used for good or ill.  Here is my personal ranking of five possible scenarios.

1. Best choice — a system of multilateral sanctions as part of a new “Copenhagen Protocol” or other treaty, following the precedent of trade sanctions in the Montreal Protocol on Stratospheric Ozone Depletion.

     2.   Next-best choice — national import penalties adopted under multilateral guidelines:

• (i) Measures can only be applied by participants in good standing.
• (ii) Judgments to be made by technical experts, not politicians.
• (iii) Interventions in only a ½ dozen of the most relevant sectors.

   3. Third-best choice — no border measures at all.

   4.  Fourth choice — each country chooses trade barriers as it sees fit.

   5.  Worst choice: national measures are subsidies to adversely affected firms, which may take the form of free emission permits (as is contemplated in EU provisions).    These do nothing to limit carbon leakage.  They function simply as bribes to those industries lucky enough to receive them, in return for political support.

I am writing from Copenhagen, the site of the 15^th Conference of Parties to the UN Framework Convention on Climate Change.     If one were to judge by outward appearances, the prospects look dim for a meaningful global agreement by the end of the week.   

First, most conference participants have been put through an experience that seems designed to convince them that global warming may not be such a bad idea after all:  a registration system that requires waiting in long lines in freezing temperatures.  (Wait times commonly reported this week vary from one hour for China’s negotiator to 8 hours for other participants, such as prominent NGO leaders.  Even 9 or 10 hours.)    
 
Second, there has been little convergence of positions.  The views expressed here cover the same fantastically and unbridgeably wide range as they did at the time of the Kyoto meeting 12 years ago.   At one end of the spectrum, developing countries are still asking for reparations - African delegations boycotted Monday’s meetings;  and demonstrators are still very confused about who they should be trying to persuade and how.   At the other end of the spectrum, the climate change deniers are also represented here.  Recent opinion polls show that the percentage of skeptics among the fickle American public has risen very recently, even though the scientific evidence for anthropogenic warming continues to mount.   (For some reason, many find it easier to deny science than to make any of the less indefensible arguments available to critics: that global warming wouldn’t be all bad, or that cutting emissions enough to prevent it would be too expensive, or that the U.N. is not a competent instrument, or that geo-engineering would be a cheaper approach.)    

Most importantly, the impasse between the rich countries, notably the United States, and the poor countries, notably China, remains.   That, of course, is why world leaders acknowledged some months ago they would not be able to agree in Copenhagen on a successor treaty to the Kyoto Protocol
 
Many here, however, take hope from the idea that President Obama would not have committed to come to Copenhagen at the end of this week if the White House did not have reason to expect to be able to achieve at a higher level an interim understanding that goes beyond the positions that the negotiators until now have been instructed to take.

My own plan for how to break the impasse has been detailed in this blog before. (The paper is now published, in a book co-edited by Joe Aldy and Rob Stavins).   The proposal can be boiled down to a couple of bare essentials:

Stage 1: 

• Annex I countries commit to the post-2012 targets that their leaders have already announced.
• Others commit immediately not to exceed BAU, thus precluding leakage.

Stage 2: 

• When the time comes for developing country cuts, targets are determined by a formula designed so each is asked only to take actions analogous to those already taken by others before them. Developing countries could agree now to the principle, without yet agreeing to specific parameters.

(To post comments, go to the Roubini Global Economics version of this post.)

Alan Krueger, Assistant Secretary of the Treasury for Economic Affairs, suggested in a recent speech a useful metaphor to distinguish different kinds of economic indicators. Some indicators are like the gauges on the dashboard of the car — industrial production, unemployment, inflation and so on.  They give the latest bits of information on the business cycle outlook, for businesspeople, government policy-makers, economic forecasters, and anyone else who wishes to follow such developments at high frequency. Many of these numbers are collected on a monthly basis. Other statistics are like the results of 10,000 mile checkups – the poverty rate, infant mortality, life expectancy, carbon emissions, natural resource depletion, the crime rate, traffic congestion, leisure time, and other measures of inequality, health, the environment and the quality of life.  They supplement market-measured activity and are needed in order to get a comprehensive feel for welfare and the longer term sustainability of the economy. This second category of statistics is more often collected on an annual basis.

GDP is the single indicator that gets the most attention. Lately much of that attention has been very critical. In late September, the most recent in a long line of critics weighed in. This group was weighty indeed: the Commission on the Measurement of Economic Performance and Social Progress was created by French President Nicolas Sarkozy, chaired by Joseph Stiglitz, chair-advised by Amartya Sen, and coordinated by Jean-Paul Fitoussi.  Nobel-Prize winners abound. The Commission believes that we have been focusing too much on market-measured output:   “By their reckoning, much of the contemporary economic disaster owes to the misbegotten assumption that policy makers simply had to focus on nurturing growth, trusting that this would maximize prosperity for all. “What you measure affects what you do,” Mr. Stiglitz said…”If you don’t measure the right thing you don’t do the right thing.” (New York Times, Sept. 23, 2009.)

I certainly agree that the non-market variables are important, both in the sense that they should be measured well and in the sense that policy-makers should put some priority on them as objectives. But I question whether the measurement issue and the objective issue are as closely linked as many would have it. I especially question any claims that the role of GDP should be in practice be replaced with a single concept that factors in these other measures of the health, inequality, the environment, etc.    GDP is a comprehensive measure of market output, is available quarterly, and belongs on the dashboard. The other variables are typically available only annually, and there is no way to know how to aggregate them into a single number, let alone to aggregate them together with the standard economic measures. By all means, take the 10,000 mile checkups seriously. But don’t remove GDP from the dashboard.

I am not sure I see the claim that the measurement problem is the reason for the myriad errors our national policy makers have made in recent years (notwithstanding the Bush Administration’s notorious downgrading of science). We have perfectly good tools for helping to make decisions about environmental regulation, for example, in the form of cost benefit analysis.  GDP measurement issues have nothing to do with that. Perhaps you believe that a Republican Administration may want to pressure the EPA to count some environmental damages at zero or suppress the evidence entirely; perhaps you believe that a Democratic Administration may want to count some economic costs at zero or abandon cost benefit analysis entirely. Yes, that would have a big effect on the policy decision. But what does any of it have to do with GDP?

In the same newspaper reporting Joe’s comments, I read of a development that has received mysteriously little attention: according to numbers from the Energy Information Agency, greenhouse gas emissions fell sharply in 2008 (by more than 2 ½ %), are falling even more in 2009 (about 6%), and in the next few years are almost certain to remain easily below the levels of 2005.   (See the chart below.)  The oil price spike in 2008 deserves some credit. Some might wish to try to give some credit to policy too. But there can be no doubt that the main reason for the sharp fall in emissions is the recession. A simple statistic for the unitiated: although CO2 emissions in an average year rise by 0.8%, they fell that much in both 1991 and 2001, the last two recessions, in addition to the much larger drop in the much larger recent recession. That is not a coincidence.

How should one value a 9 percent fall in emissions against a 3.8% fall in real GDP (from the 2007Q4 peak to the 2009Q2 apparent-trough)? I strongly suspect that a majority of Americans, no matter how well-informed regarding the science, would think that the output loss outweighs the climate benefit by far. A minority, in favor of very drastic action on climate change, might implicitly choose the other way. (I myself am in favor of pretty serious action, but not in favor of policies that impose huge economic costs, either because they are too drastic or are designed in an inefficient way. And of course engineering a recession would be a very inefficient way to do it.) Are Joe Stiglitz and Amartya Sen among those who think we are better off on balance? I have no idea. To ask the question is to help illuminate why attempts to sum everything up into a single number, such as “Green GDP,” fail.

Incidentally, if Joe does think that the estimated 9 percent fall in emissions outweighs the 4% loss in GDP, then he doesn’t think that our current situation constitutes a “contemporary economic disaster,” but, rather, a gain in welfare.  It would then logically follow that any policy decisions that got us into this situation (whether attributable to incomplete information about banking activity or inequality or anything else), were good, not bad!

Source: US Energy Information Agency

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National leaders are meeting at the United Nations in New York today, to discuss the climate change negotiations.    Talks will continue at the G-20 meeting in Pittsburgh later in the week.   But hopes look very bleak for progress sufficient to produce at Copenhagen in December a successor treaty to the Kyoto Protocol.   The biggest roadblock is the familiar game of “After you, Alphonse.”  The United States will not accept quantitative emission targets unless China, India and other developing countries do the same, at the same time.    But the developing countries will not cut their emissions below the Business as Usual path (BAU) unless the rich countries go first. 

My own proposal for how to break the deadlock is a plan that tries in a politically realistic way to assign emission targets, leaving no country feeling it is being asked to incur an economic cost that is unfair or too large.    The targets are derived from a family of formulas   The specific detailed example of the plan that I have given in the past attained an environmental target by the year 2100 of CO2 concentrations equal to 500 ppm.  It did so without violating the political constraints, which included the constraint that no country is asked to accept an ex ante target that costs it more than 1% of income in present value, or more than 5% of income in any single budget period.

The G-7 leaders, meeting in Italy in June 2009, set a more aggressive collective goal, corresponding approximately to concentrations of 380 PPM.   I have recently been trying to hit that goal, working with Valentina Bosetti, within the same political constraints and framework of formulas.    To achieve the more aggressive environmental goal, we advance the dates at which some countries are asked to begin cutting below BAU.  We also tinker with the values for the parameters in the formulas (parameters that govern the extent of progressivity and equity, and the speed with which latecomers must eventually catch up).   The resulting target paths for emissions are run through the WITCH model to find their economic and environmental effects.   We find that it is not possible to attain the 380 ppm goal, subject strictly to our political constraints.  We are, however, able to attain a concentration goal of 460 ppm with somewhat looser political constraints. 

Some may conclude from these results that the more aggressive environmental goals are not attainable in practice, and that our earlier proposal for how to attain 500ppm is the better plan.   We take no position on which environmental goal is best overall.   Rather, we submit that, whatever the goal, our approach will give targets that are more practical economically and politically than approaches that have been proposed by others.

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On her visit to India two days ago, Secretary of State Hillary Clinton was publicly rebuffed when she raised the problem of global climate change.    The Indian environment minister declared “we are simply not in the position to take legally binding emissions targets.”

No single country can address this problem on its own.  Hence the international negotiations that will take place in Copenhagen in December to try to find a successor treaty to the Kyoto Protocol.   But the international effort has run into a seemingly insurmountable roadblock.     On the one hand, the US Congress is clear: it will not impose quantitative limits on US emissions of greenhouse gases if China, India, and other developing countries don’t impose quantitative limits on theirs.   Indeed, that is why the Senate was unwilling to ratify the Kyoto Protocol ten years ago. The logic seems completely reasonable:  why should US firms bear the economic cost of cutting emissions if carbon-intensive activities would just migrate to countries without caps and global emissions continue their rapid rise?   On the other hand, the leaders of India and China are just as clear:   they are unalterably opposed to cutting emissions until after the United States and other rich countries go first.   And why should they?   The industrialized countries created the problem of global warming, in the process of getting rich;  the poor countries should not be denied their turn at economic development.  As the Indians point out, Americans emit more than ten times as much carbon dioxide per person.      

A total impasse.  Or is it?   I see one — and only one – practical solution to this apparent Catch-22:   The United States agrees to binding emission cuts — something like those in the Waxman-Markey bill that passed the House of Representatives on June 26;  and, simultaneously, China, India, and other developing countries agree to a path that immediately imposes on them binding emission targets — but targets that in their early years simply follow the so-called Business-as-Usual (BAU) path.    BAU is defined as the rate of increase in emissions that these countries would have experienced anyway, in the absence of an international agreement, as determined by experts’ projections.

The idea of developing countries committing only to BAU targets would provoke outrage from both environmentalists and US business interests, because it does not obligate these countries to cut emissions.  But both of those groups should realize that this commitment would be far more important than it sounds. It would preclude the carbon leakage which, absent such an agreement, would undermine the environmental goal.  It would mitigate the competitiveness concerns of carbon-intensive industries in the rich countries.  

This approach recognizes the reality that it would be irrational for China and India to agree to substantial cuts in the short term.   Indeed these countries, for their parts, will probably react with outrage at being asked to take on binding targets of any kind at the same time as the United States.   But they should also come to realize that they would actually gain in strictly economic terms from such an agreement, by acquiring the ability to sell emission permits at the world market price.

Of course an environmental solution also requires that China and the others subsequently make cuts below the Business as Usual path in future years, and eventually make cuts in absolute terms.   This can be done in such a way that the developing countries are not asked to make cuts that are different in nature than those made by Europe, the United States, and others who have gone before them, taking due account of differences in income.  But no country – rich or poor – will make sacrifices in any given period that impose huge economic costs on it.   It is time to stop making sweeping proposals that assume otherwise, and to pursue instead the narrow thread of the politically possible.