Misplaced Trust: Inconvenient truths about the UN’s global warming panel

The following is the text of an op-ed article, written by David Henderson which appeared in the Wall Street Journal Europe on 11 October 2007. I think it is sufficiently interesting and worrying in its implications for it to be reproduced here.

Governments across the world are mishandling climate-change issues. Policies to curb ‘greenhouse-gas’ emissions too often take the form of costly specific regulations, rather than a general price-based incentive such as a carbon tax. More fundamentally, there is good reason to question the advice on which governments are basing their policies.

This advice is brought together through an elaborate process which governments have themselves created. The process is managed by the U.N. Intergovernmental Panel on Climate Change (IPCC), established in 1988. This panel is made up of government officials, not all of whom are scientists.

The IPCC process has since produced four massive Assessment Reports, designed to provide the basis for climate-change policy. These cover the whole range of issues, including economic, scientific and technical aspects. The latest in the series, AR4, will be completed next month. It will run to more than 3,000 pages, and its preparation has involved a network of some 2,500 experts.

Because of this extensive and structured expert participation, the IPCC process and its findings are widely taken to be professionally above reproach. Yet the expert network is only one of three main groups of participants in the process. The Panel itself, at the center of the process, is a separate body from the network. Third are the national-level agencies—the policy makers—that it reports to.

Governments have formally laid down, in the “principles governing IPCC work,” that Panel reports “should be neutral with respect to policy.” But this instruction can apply only to the expert reporting process. As officials, the Panel members and those who appoint them are of course identified with the policies of their governments. And virtually all governments are formally committed, within the 1992 UN Framework Convention on Climate Change, to the “stabilization of greenhouse gases in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system.” Since 1992, the risks arising from human-induced global warming have been officially taken as proven. Policies have been framed accordingly.

These committed Panel members, and their equally committed parent departments, provide the lists of persons from which the expert network is largely chosen. They also review, amend and approve the draft Assessment Reports. Hence departments and agencies which are not—and cannot be—neutral in relation to climate-change issues are deeply involved, from start to finish, in the reporting process.

Policy commitment often shades into bias. From the outset, leading figures within the IPCC process have shared the conviction that anthropogenic global warming presents a threat which demands prompt and far-reaching action. Indeed, had they not held this belief, they would not have been appointed to their positions of influence. Both they and their ministers are apt to make confident, alarmist statements which go well beyond the more guarded language of the Assessment Reports. A notable instance was the October 2006 joint statement by two European prime ministers that “We have a window of only 10-15 years to take the steps we need to avoid a catastrophic tipping point.”

The expert reporting process itself is flawed, in ways that reflect this built-in high-level official bias. Despite the numbers of persons involved, and the lengthy formal review procedures, the preparation of the IPCC Assessment Reports is far from being a model of rigor, inclusiveness and impartiality.

A specific weakness in some IPCC documents is the treatment of economic issues, which is not professionally up to the mark. One aspect of this has been the use of invalid cross-country comparisons of real GDP, based on exchange rates rather than purchasing power parity estimates.

A basic general weakness is the uncritical reliance on peer review as a qualifying criterion for published work to be taken into account in the assessments. Peer review is no safeguard against dubious assumptions, arguments and conclusions if the peers are largely drawn from the same restricted professional milieu. What is more, the peer-review process as such is insufficiently rigorous, since it does not guarantee due disclosure of sources, methods and procedures.

Failures of disclosure, such as many journals would not tolerate, have characterized published work that the IPCC has drawn on. The Panel has failed to acknowledge this problem and take appropriate action to deal with it. The issue is simply evaded in the relevant sections of AR4.

So far, despite the prospective high costs of what could be mistaken policies, governments have paid little attention to telling outside criticisms of the IPCC process. As a former Treasury official, with later close dealings with economics and finance ministries in OECD member countries, I have been surprised by the way in which these ministries have accepted uncritically the results of a process of inquiry which is so obviously biased and flawed.

Even if the IPCC process were beyond challenge, it is imprudent for governments to place such heavy reliance, in matters of extraordinary complexity where huge uncertainties remain, on this particular source of information, analysis and advice. In fact, the process is flawed, and this puts in doubt the accepted basis of official climate policies.

In relation to climate change, there is a clear present need to build up a sounder basis for reviewing and assessing the issues. Governments should ensure that they and their citizens are more fully and more objectively informed and advised.

Two broad lines of action could be taken to this end. One is to improve the IPCC process, by making it more professionally representative and watertight. The other is to go beyond the process, by providing for alternative sources of information and advice. An independent expert review of AR4 would be a good place to start.

Mr. Henderson, a former chief economist of the OECD, is a visiting professor at the Westminster Business School in London.

Carbon Offsets: Open House for Waste, Fraud and Corruption

The UK House of Commons Environmental Audit Committee wants to compel airlines and other “carbon-intensive” businesses to offer customers the means to offset their environmental impact.

Presumably they would do this by forcing these businesses to buy more offsets in the carbon offsetting market, which is predicted to be worth at least £4 bn a year by 2010.

Like politicians everywhere, the Environmental Audit Committee, when diagnosing the presence of a problem, look for a solution that will involve preferably no visible price tag at all, and in any case no price tag that can be traced to them.

If excessive CO2E (carbon dioxide equivalent greenhouse gas emissions) are a problem, there are but two solutions. The first is command-and-control methods: limit the scale of the activities creating excessive CO2E emissions by administrative or regulatory fiat. In the limit, ban them. This was done with chlorofluorocarbons (contributors to the ozone hole over the Antarctic) which were phased out by 1996. It can be effective if something is to be banned completely. That is not possible with CO2E emissions. Any conceivable future will have continued emissions of CO2E. Bureaucrats are not very good at deciding who can produce how much CO2E in hundreds of thousands of activities and firms. Last time something like that was tried we called it Central Planning.

The second way to reduce CO2E emissions is to make it more expensive at the margin to engage in the activities/processes that produce CO2E. By increasing their marginal cost to the producer using the CO2E-intensive process and to the consumer engaged in CO2E-intensive activities, an incentive to economise is created. This can either be done through, you guessed it, taxes on production processes and consumption activities that produce CO2E or through 'cap and trade'.

With explicit taxation, the authorities set the tax rate per quantum of CO2E emitted at the level expected to achieve the desired level of (and reduction in) CO2E emissions. With cap and trade, the authorities determine the upper limit or quota on the amount of C02E emissions that will be allowed in a given period. They create permits to issue that amount of CO2E and either give them away or auction them off. If they are given away, there has to be an efficient secondary market in CO2E emission permits for the scheme to have any effect.

In a world without uncertainty, the competitive price of a permit for a given quantity of CO2E emissions under cap and trade would be the same as the tax paid on that quantity of CO2E emissions under explicit taxation. In a world with uncertainty, they are similar but not equivalent; neither one obviously dominates the other under all circumstances. Politicians, including Gordon Brown, prefer cap and trade, because it hides/obscures the fact that for it to work, it must be equivalent to a tax; however, it does not look like a tax and will not show up in conventional tax burden calculations. Also, you can hand out the credits free of charge to your friends (including the heavy historical polluters).

A first-round give-away does not necessarily reduce their effectiveness of cap and trade in reducing CO2E emissions, as long as the permits can be resold on an efficient secondary market. With such a market, a heavy polluter (who will have to retain most or all of its free allocation rather than selling them at a profit to other polluters) remains confronted with a higher opportunity cost of CO2E emissions at the margin. However, compared to the government auctioning the permits off to the highest bidder, giving them away is a lovely device for making lump-sum wealth transfers to the government’s friends.

Command-and-control methods, taxation and cap and trade all have the same informational requirements: the authorities must be able to monitor the quantity of CO2E actually emitted. That is no small task in many instances, which is why taxes and cap and trade tend to focus on the biggest emitters only. Sometimes it’s easy. A CO2 tax can be added onto the regular fuel tax to encourage lower CO2E emissions in transportation using petrol or diesel fuel.

Offsets, the creation of credits that can be added to the (national, regional or global) CO2E quota under cap and trade schemes, require not only the (difficult) verification of how much CO2E is actually emitted in the real world, but also the impossible verification of how much CO2E would have been emitted in some counterfactual alternative universe. The quantity of offset credits earned by some activity is the net quantity of CO2E that has been saved as a result of this activity.

Just stating it makes one shout out: impossible! Fraud! Bribery! Corruption! Wasteful diversion of resources into pointless attempts at verification! And indeed this is what is happening before our eyes. Enterprises get paid for not cutting down trees and for installing filters and scrubbers they would have installed in any case. The new Verification of the Carbon Counterfactual industry is growing in leaps and bounds. The amounts of money involved are vast and the opportunities for graft, bribery and corruption limitless. The offset proposal has birthed a monster.

Who came up with this demented offset concept? It’s an attempt to placate the developing world for not having enough CO2E emitting activities historically to benefit from a significant free initial allocation of credits in proportion to a country’s historical track record of CO2E emissions. If we had a common worldwide tax (say a constant real amount per unit of CO2E emissions), nobody would have thought of offsets. If the UN were the only source of carbon credits, and if it were to auction the entire quota each period in a single, transparent global auction, no-one would have come up with this ludicrous offsets concept. It is because countries were awarded free CO2E quotas under the Kyoto Protocol and under subsequent EU schemes in proportion to their past CO2E emissions, that we found former heavy polluters like Russia with permits that were surplus to requirements, but poor newly industrialising countries like Vietnam with very little by way of free initial allocations. So we had to do something for the historically CO2E emissions-innocent developing world. What was chosen was the most real resource-wasting and corruption- and rent-seeking inducing scheme anyone could think of. Masses of jobs for engineering consultants, environmental auditors, lawyers etc. All verifying the unverifiable and getting paid handsomely for it.

If we want to help the developing world to install CO2E efficient technology and to discourage CO2E-inefficient production, transportation and consumption, we hould encourage these poor countries to tax these CO2E-intensive activities; we should then send them unconditional cash to take care of the distributional and poverty consequences of the higher CO2E taxes. That, however, would mean higher taxes in the rich countries, or lower public spending in rich countries. And God forbid that reducing CO2E emissions would have a visible price tag. Truth, courage and politics: three concepts almost never encountered in the same place.

The browning of 'Chindia' (This post appeared first in Mint, daily business newspaper published by India's HT Media Ltd in association with The Wall Street Journal,in New Delhi and Mumbai, Views, Thursday April 12, 2007.)

In the first part of this post, I considered two risks to the continuation of the spectacular growth of China and India: The risk of a cyclical downturn and the risk of serious social and political instability. I now turn to the third risk: The risk of domestic environmental supply-side constraints on economic growth becoming binding.

I want to focus here on the local (national) natural resources of clean, fresh water and fertile land. (Some would add clean air as well.) These are not only important domestic ‘consumer durables’ but also key inputs into the production of the goods and services that are captured by conventionally measured GDP indices. Although both fresh water and fertile land are in principle renewable or restorable given enough time, energy and other resources, they are in practice being depleted, polluted and poisoned at a spectacular, increasing and unsustainable rate.

These resources are either under-priced or not priced at all. In India, for instance, water is supplied to the agricultural sector virtually free of charge. ‘Flat rate pricing’ for agricultural power means that the private marginal cost of electricity use in agriculture is zero. The environmental externalities of land use (erosion, deforestation, desertification) also are not priced properly or internalized in other ways. The environmental consequences are disastrous. The resulting depletion and destruction of water and land resources is a form of environmental capital depreciation, which should be deducted from the net real output or real national income measures used in the growth accounting exercise. Instead, it is ignored. Output is, therefore, overstated. The water constraint is likely to be the first one to become binding in both China and India, certainly within 10 years. It will impair even the production of those goods and services included in conventional GDP measures. By 2020, OWEC (the Organization of Water Exporting Countries that will no doubt be created soon) may well be more influential than OPEC. It may seem strange that with 71% of the earth’s surface covered by water, this would become the binding constraint on growth. Unfortunately, only 3% of this surface water is fresh water.

Well-informed observers of Chindia, such as Martin Wolf of the Financial Times, argue that Chindia will avoid these disasters by learning to price these scarce resources (especially water) appropriately. After all, the advanced industrial countries, including the UK, the US, Germany and Japan, have made considerable strides in that direction.

There are two problems with this optimistic perspective: Scale and speed. When the UK was 50 years into its industrial revolution (around 1820), it had 21 million inhabitants. Today, it has 60 million. The US in 1850 had 24 million people; it had 76 million in 1900 and today has 300 million. Today, a couple of decades into their industrial revolutions, China has 1.3 billion people and India 1.1 billion. Over the 80-year period between 1820 and 1900, UK real GDP grew at an average annual rate of 2.06%. Over the 50-year period between 1850 and 2000, US real GDP grew at an average annual rate of 4.07%.

China proposes to have an annual growth rate of real GDP of not much less than 10%. India shoots for 8% or 9% real GDP growth. What these two countries jointly propose is growth on a cale that is more than 200 times larger than what the UK and the US managed during their industrial revolutions. The national, regional and global environmental impacts will be cataclysmic. Chindia will not have a century or more to figure out how to make growth environmentally sustainable—a process still far from complete in the UK and the US. They have less than a decade. Unless China and India reorient their growth policies towards environmental sustainability, the 21st century may well become the century of Chindia—but for a very different reason from the one prophesied by the current cheerleaders.

I am not arguing that things are bound to go disastrously wrong. It is possible that all water and energy use (including agricultural) in India will soon be priced at something close to long-run marginal social cost. It is, however, more likely that neither long-run marginal social cost pricing of water and power, nor some other effective non-price rationing mechanism for scarce water and power, will be put in place in the foreseeable future. It follows that there is a significant risk that things will go disastrously wrong.

Just how likely are the prompt and massive reorientations of economic and social priorities in both India and China that are necessary to avoid disaster? History offers little guidance, as problems on this scale and of this scope have not occurred before. Because India’s 60-year experience with an open, pluralistic and democratic system of government gives it an edge over China with its 60 years of totalitarian communist party rule, I am more optimistic about India than about China.

But I have serious concerns even for India.

Too many cheers for 'Chindia' (This post first appeared in Mint, daily business newspaper published by India's HT Media Ltd in association with The Wall Street Journal,in New Delhi and Mumbai, Views, Wednesday April 11, 2007.) There has been a world-wide bout of ‘Chindiaphoria’—the widespread conviction that China and India can continue with their current growth rates for a long time, possibly decades. While everything is possible, I believe the risks to economic growth in these two countries are much more serious than markets and pundits recognize. I shall focus on three risks: The risk of a sharp credit contraction and cyclical downturn, domestic and political risk, and environmental risk. The second is obviously not independent of the third.

First, the cyclical risk. Both India and China are in the terminal stages of a credit boom. So there will be a cyclical slowdown in both. If the monetary and fiscal authorities act in time (they seem well behind the curve in both countries), and if they have the right instruments and the political will and freedom, the credit boom can end with a whimper.

A hard landing seems more likely, since the politically feasible tools for restraining credit growth are only partly effective. China’s authorities rule out the most effective and least distortionary policy response: Raising interest rates and allowing the yuan to appreciate more rapidly. Instead they rely on ineffective increases in reserve requirements and distortionary command-and-control techniques—basically selective credit controls from the central planning days. In India, the belated increases in the Reserve Bank of India’s (RBI) key policy rate to 7.75, and the accompanying increase in reserve requirements by 50 basis points, is rather late and still too little. The effectiveness of these and earlier RBI restrictive measures last year has also been undermined by the extraordinary spectacle of the finance minister, P. Chidambaram, cajoling public-sector banks not to pass on interest-rate increases to borrowers. Other populist, distortionary and, in all but the short run, ineffective anti-inflation measures of the Union government have included a ban on wheat exports.

Second, domestic political risk to growth is seriously under-priced by domestic and global investors. In China, economic liberalization is proceeding side by side with continued political repression. Growing wealth and rising average prosperity levels are accompanied by equally spectacular increases in inequality and, more recently, by growing numbers of people who are worse off and often reduced to living in absolute poverty. The sustainability of such a social-political-economic configuration has never been tested. India has had a representative form of government for 60 years. I believe this is an important socio-political safety valve.

Unfortunately, India needs such a safety valve. It is hamstrung by the widening gap between the urban and rural communities, by the continuing debilitating effects of its caste system, and by serious religious tensions, especially between fundamentalists in the Hindu and Muslim communities. India also has an atrocious record for educating its underprivileged in general, and its women in particular. The Maoist Naxalite terrorist movement is a serious internal threat to security and stability. There is a clear risk of greater religiously motivated extremism and terrorism, and of unholy alliances between home-grown and domestically oriented terrorism and international terrorist movements, especially the fundamentalist Islamist terrorist networks. There is no evidence that the political establishment is about to come up with a policy that is tough on domestic terrorism and tough on the causes of domestic terrorism. Blaming Pakistan for every bomb that explodes is not a policy.

Third, and probably most importantly, the environmental risk. Environmental constraints on growth in Chindia rarely figure prominently in discussions. The same omission invalidates the recent growth accounting exercise for India and China by Barry Bosworth and Susan M. Collins of the Brookings Institution. In this approach, the growth of output is the sum of the contributions of physical capital accumulation, agricultural land area growth, labour input growth and total factor productivity growth. Output is seriously mismeasured and a key input—the services yielded by the stock of environmental capital—is ignored completely. For Chindia, this omission matters even in the medium run.

The environmental constraints I want to focus on are not India’s and China’s contribution to global climate change and to other global environmental externalities, although these are of growing significance. Global warming may bring some benefits to parts of the globe (especially the current cooler and colder regions of the northern hemisphere). It will be an unmitigated negative for the Indian subcontinent and for China.

In my next post, I will focus on how the local or national natural resources of clean, fresh water and fertile land may in no more than a decade become binding constraints on economic growth in Chindia.

China's Environmental Worm is Turning Sooner Than Expected Today's Financial Times (Tuesday July 10 2007) reports that "Campaign to clean the Yangtze under way", "Official willing to sacrifice growth" and "Factories must improve or close". It even looks as though the State Environmental Protection Agency (SEPA) may be developing into something more than a hopelessly understaffed paper tiger . Mr Li Yuanchao, Communist party secretary of Jiangsu province, is quoted as saying that "The measures [to protect the environment] must be strictly implemented even if they cause a 15 percent downturn in the province's gross domestic product'. Probably nowhere in the world is measured GDP a worse proxy for the value of currently produced goods and services than in China, where in the heavily industrialised regions the air is unbreathable, the water undrinkable and much of the soil unfit for cultivation or residential use. The environmental and ecological externalities of the Chinese miracle are of such a staggering magnitude that they will soon begin to impinge even on the production of those things captured in conventional GDP measures. They have long since driven a growing wedge between measured GDP and any measure of economic welfare (MEW). The external effects are partly global in their impact (through global climate change driven by greenhouse gas emissions) but many are national, regional and local in nature. I would add the food safety problems that are now affecting Chinese exports but have been a well-established public health problem inside China to the list of urgent Chinese environmental and ecological challenges. Unless they are addressed promptly, the Chinese miracle could become a nightmare.