Case study 1.1: Global Warming

Part I: What to do about global warming

A UN treaty now under discussion looks promising -

as long as it remains flexible

How should reasonable people react to the hype and

controversy over global warming? Judging by recent

headlines, you might think we are already doomed.

Newspapers have been quick to link extreme

weather events, ranging from floods in Britain and

Mozambique to hurricanes in Central America,

directly to global warming. Greens say that worse will

ensue if governments do not act. Many politicians

have duly jumped on the bandwagon, citing recent

disasters as a reason for speeding up action on the

Kyoto treaty on climate change that commits rich

countries to cut emissions of greenhouse gases. This

week saw the start of a summit in The Hague to

discuss all this.

Yet hot-headed attempts to link specific weather

disasters to the greenhouse effect are scientific bunk.

The correct approach is coolly to assess the science of

climate change before taking action. Unfortunately,

climate modelling is still in its infancy, and for most of

the past decade it has raised as many questions as it

has answered. Now, however, the picture is getting

clearer. There will never be consensus, but the

balance of the evidence suggests that global warming

is indeed happening; that much of it has recently

been man-made; and that there is a risk of potentially

disastrous consequences. Even the normally stolid

insurance industry is getting excited. Insurers reckon

that weather disasters have cost roughly $400 billion

over the past decade and that the damage is likely

only to increase. The time has come to accept that

global warming is a credible enough threat to require

a public-policy response.

But what, exactly? At first blush, the Kyoto treaty

seems to offer a good way forward. It is a global

treaty: it would be foolish to deal with this most

global of problems in any other way. It sets a longterm

framework that requires frequent updating and

revision, rather like the post-war process of trade

liberalisation. That is sensible because climate

change will be at least a 100-year problem, and so

will require a treaty with institutions and mechanisms

that endure. The big question over Kyoto remains its

cost. How much insurance is worth buying now

against an uncertain, but possibly devastating, future

threat? And the answer lies in a clear-headed

assessment of benefits and costs. The case for doing

something has increased during the three years since

Kyoto was signed. Yet it also remains true that all

answers will be easier if economic growth is

meanwhile sustained: stopping the world while the

problem is dealt with is not a sensible option, given

that resources to deal with it would then become

steadily scarcer.

That points to two general conclusions about how

to implement Kyoto. The simplest is that countries

should search out ''no regrets'' measures that are

beneficial in their own right as well as reducing

emissions - such as scrapping coal subsidies,

liberalising energy markets and cutting farm support.

The second is that implementation should use

market-friendly measures that minimise the costs

and risks of slowing economic growth.

Part II: Hot potato revisited

A lack-of-progress report on the Intergovernmental

Panel on Climate Change

You might think that a policy issue which puts at stake

hundreds of billions of dollars' worth of global output

would arouse at least the casual interest of the

world's economics and finance ministries. You would

be wrong. Global warming and the actions

contemplated to mitigate it could well involve costs

of that order. Assessing the possible scale of future

greenhouse-gas emissions, and hence of man-made

global warming, involves economic forecasts and

economic calculations. Those forecasts and

calculations will in turn provide the basis for policy on

the issue. Yet governments have been content to

leave these questions to a body - the

Intergovernmental Panel on Climate Change

(IPCC) - which appears to lack the necessary

expertise. The result is all too likely to be bad policy, at

potentially heavy cost to the world economy.

In our Economics focus of February 15th this year,

we drew attention to (and posted on our website)

telling criticisms of the IPCC's work made by two

independent commentators, Ian Castles, a former

head of Australia's Bureau of Statistics, and David

Henderson, formerly the chief economist of the

Organisation for Economic Co-operation and

Development (OECD) and now visiting professor at

Westminster Business School. Their criticisms of the

IPCC were wide-ranging, but focused on the panel's

forecasts of greenhouse-gas emissions. The method

employed, the critics argued, had given an upward

bias to the projections.

The IPCC's procedure relied, first, on measuring

gaps between incomes in poor countries and

incomes in rich countries, and, second, on supposing

that those gaps would be substantially narrowed, or

entirely closed, by the end of this century. Contrary to

standard practice, the IPCC measured the initial gaps

using market-based exchange rates rather than rates

adjusted for differences in purchasing power. This

error makes the initial income gaps seem far larger

than they really are, so the subsequent catching-up is

correspondingly faster. The developing-country

growth rates yielded by this method are historically

implausible, to put it mildly. The emissions forecasts

based on those implausibly high growth rates are

accordingly unsound.

The Castles-Henderson critique was subsequently

published in the journal Energy and Environment

(volume 14, number 2-3). A response by 15 authors

associated with the IPCC purporting to defend the

panel's projections was published in the same issue.

It accused the two critics of bias, bad faith, peddling

''deplorable misinformation'' and neglecting what the

15 regard as proper procedure. Alas, it fails to answer

the case Mr Castles and Mr Henderson had laid out -

namely, that the IPCC's low-case scenarios are

patently not low-case scenarios, and that the panel

has therefore failed to give a true account of the range

of possibilities. If anything, as the two critics argue in

an article in the subsequent issue of Energy and

Environment, the reply of the 15 authors gives new

grounds for concern. This week the IPCC is preparing

to embark on its next global-warming ''assessment

review'' - and if the tone of its reply to the critics is any

guide, it is intent on business as usual.

Nature, scope and methods 5

This case study illustrates the variety of issues with which managerial

economics is concerned. The following questions arise:

1. Is there a problem to be addressed?

2. Is there a solution or solutions to the problem, in terms of strategies or

courses of action that can be taken?

3. What objective or objectives can be defined for these strategies?

4. What constraints exist in terms of operating any strategies?

5. How can we identify strategies as solutions to the problem?

6. How can we evaluate these strategies in terms of costs and benefits, particularly

when these involve life and health?

7. What is the best way of measuring the relevant variables?

8. What assumptions should be made in our analysis?

9. How do we deal with the problem of risk and uncertainty regarding the

future and the effects of strategies in the future?

10. How can we approach the problems of conflicts of interest between different

countries and between different consumers and producers?

It is true, as the IPCC says in its defence, that the

panel presents a range of scenarios. But, as we

pointed out before, even the scenarios that give the

lowest cumulative emissions assume that incomes in

the developing countries will increase at a much

faster rate over the course of the century than they

have ever done before. Disaggregated projections

published by the IPCC say that - even in the lowestemission

scenarios - growth in poor countries will be

so fast that by the end of the century Americans will

be poorer on average than South Africans, Algerians,

Argentines, Libyans, Turks and North Koreans. Mr

Castles and Mr Henderson can hardly be alone in

finding that odd.

TUNNEL VISION

The fact that the IPCC mobilised as many as 15

authors to supply its response is interesting. The

panel's watchword is strength in numbers (lacking

though it may be in strength at numbers). The

exercise criticised by Mr Castles and Mr Henderson

involved 53 authors, plus 89 expert reviewers and

many others besides. Can so many experts get it

wrong? The experts themselves may doubt it, but the

answer is yes. The problem is that this horde of

authorities is drawn from a narrow professional

milieu. Economic and statistical expertise is not

among their strengths. Making matters worse, the

panel's approach lays great emphasis on peer review

of submissions. When the peers in question are

drawn from a restricted professional domain -

whereas the issues under consideration make

demands upon a wide range of professional skills -

peer review is not a way to assure the highest

standards of work by exposing research to scepticism.

It is just the opposite: a kind of intellectual restrictive

practice, which allows flawed or downright shoddy

work to acquire a standing it does not deserve.

Part of the remedy proposed by Mr Castles and Mr

Henderson in their new article is to get officials from

finance and economics ministries into the long-range

emissions-forecasting business. The Australian

Treasury is now starting to take an active interest in

IPCC-related issues, and a letter to the British

Treasury drawing attention to Castles-Henderson

(evidently it failed to notice unassisted) has just

received a positive, if long delayed, response. More

must be done, and soon. Work on a question of this

sort would sit well with Mr Henderson's former

employer, the OECD. The organisation's economic

policy committee - a panel of top economic officials

from national ministries - will next week install

Gregory Mankiw, head of America's Council of

Economic Advisers, as its new chairman. If Mr

Mankiw is asking himself what new work that body

ought to take on under his leadership, he need look

no further than the dangerous economic

incompetence of the IPCC.

6 INTRODUCTION

11 What criteria can we use for selecting strategies from among different

possible courses of action?

12 How do political biases and agendas affect decision-making processes in

practice?

The above questions represent steps in the decision-making process involved

not just in the global warming situation, but also in any situation involving

decision-making. However, many people are unaware of the breadth of issue

that is amenable to the analysis of managerial economics. In particular, they

sometimes regard managerial economists as being apologists for greedy capitalists,

who do not take quality of life into consideration, or the long-term interests

of the public. They may view markets with suspicion and doubt their ability to

allocate resources efficiently, for example the creation of trading rights in pollution.

They may fear deregulation, seeing it as leading to the exploitation of

consumers by monopolists. They may believe that it is impossible in principle

to put a money value on human life or health. Theymay believe that governments

should not be swayed by narroweconomic interests and analysis, and have a duty

to exercise ethical principles which otherwise would not be considered. Such

antagonistic feelings towards global capitalism have been expressed at various

meetings of international politicians to discuss world trade. On amore academic

level, there has for some years been huge controversy surrounding the publication

of a book by Lomborg3 taking an economist's approach to these issues.

Much of the sentiment expressed is based on an ignorance of the issues

involved, a misuse of statistical information and a lack of understanding of

economic analysis, its relevance and application. One major objective of this

book is to explain not just the methodology of managerial economics but also

the breadth of its application, and to illustrate that it can have a lot to say about

the types of issue raised in the above case study. All the case studies in the text

have been selected with this objective in mind; for example the following

situations and issues are discussed: prize money in sport, the law of diminishing

returns applied to computer software, Internet banking and competition,

price discrimination in the pharmaceutical industry, issues in the National

Health Service, deregulation of electrical utilities, the level of fuel taxes and

subsidized car manufacturing.

This is the case, please help me