Green ideologists don’t apply economic theory to their arguments. Why? If they did, most of the time their current demands on the taxpayer wouldn’t (allow a bit of a pun here) hold water.
The bits of theory and public policy analysis they don’t, won’t or are afraid to use properly include present value calculations combined with positive and negative public goods theory. They pay too little attention to national differences in current and future economic/social/political culture and power, and finally they ignore the common sense of key historical data.
The errors made by policymakers who are under pressure from green activists, East and West, sometimes “help” and sometimes don’t help current taxpayers on the opposing sides of the Pacific.
The formula for the current or present value (PV) of a sum of money (C) in some number of future years (n) “discounted” (meaning the relevant interest rate over the period, including factors for risk, uncertainty and the time value of money) at a specific interest rate (i) expressed as a number, so a rate of 6% becomes 0.06 in the following equation: PV = C divided by (one plus i) that sum raised to the nth power: in symbols: PV = C/(1+i)n.
This simple formula “shrinks” to a current or present value of distant future “damages” done by global warming. The degree of shrinkage in the value of future money caused by the interest rate can be very large.
We are using interest rates in the reverse way we usually do. For example, with a 50% interest rate, one dollar or one yuan becomes one and a half dollars or one and a half yuan going forward to next year. But going “backward” from next year to this year, 1.5 dollars or yuan “shrinks” to just one dollar or yuan.
The present value of $10,000 received 100 years from now discounted at 6% per year is $25.16. In the political context of green demands on today’s taxpayers, it means that a claim that some global-warming problem that appears 100 years from now but caused by current activity should be “fixed” today only if today’s cost for the fix is less than the said $25.16.
Now that final number of $25.16 is quite sensitive to the interest rate. The present value of $10,000 received 100 years from now discounted at 3% is $499.74. If the greens discount at all, they assume low interest rates. But I challenge greens to find me a lender who will “sell” me money, not to be paid off until year 2122, at 3%.
Let’s use a more realistic interest rate. The present value of $10,000 received 100 years from now discounted at 10% is only 47 cents! To drive the point home, a 10,000-dollar future problem is not worth fixing today if the cost of doing so is less the one-half dollar in today’s money.
Remember, whatever violent things happen to future values (maybe because of inflation between now and then), all these calculations are done in today’s dollars (or yuan/renminbi).
Costs to Chinese people
As soon as we start calculating things in renminbi, we must say something about today’s value placed on money in the pockets of today’s Chinese people, who are poor relative to their descendants, versus the psychic value placed on tomorrow’s money by tomorrow’s very rich Chinese grandchildren.
Although China has experienced a phenomenal improvement in the economic, social and political well-being of its citizens over the past 30 years, there remain places and persons in China who are in great need of today’s money now. They should not morally, and they better not politically, be taxed heavily today in order to “fix” problems that are 100 years off.
This is especially true when rational policymakers know that if the rate of improvement for China’s people experienced these past 30 years continues to be vigorous for the next hundred years, then distant problems will be easy to fix because everyone is so rich.
In other words, tomorrow’s green Chinese problems are not worth fixing now because the Chinese citizens who are now asked to pay for tomorrow’s problems are now poor, at least in comparison with their very rich grandchildren, who can easily afford to fix the problems as they pop up in those “years to come.”
The average annual income earned by today’s Chinese household is about 72,000 yuan, or around US$10,600. The present-value formula works in both directions.
Using the 6% growth factor from the calculations above, we see that the average Chinese grandchild’s household will earn 10,000 divided by 25.16 or 397.5 times more than today’s taxpayer household, or 72,000 x 397.5 = 28,620,000 yuan. Yes, that is 28 million yuan.
A Chinese person living 100 years hence can well afford to fix almost any problem his grandparents left undone.
Costs to American people
Remember, all these figures are in current dollars. In contrast, the average American household’s income today is $68,703, compared with the dollar value of Chinese household income of $10,600. Americans will also get much richer in times to come, but income growth in the US will not be as rapid as it will be in China.
Again, using the numbers above, the income growth factor to be expected in a USA that grows at 3% over the next hundred years is equal to 10,000 divided by 499 = 20. That means that Americans living one hundred years from now can be expected to have incomes 20 times greater than their grandparents. So US household income in 2122 is predicted to be, in today’s dollars, $68,703 x 20 = 1,374,060, or $1.37 million.
Note that if the exchange rate between the yuan and the dollar remains at about 6.71, the average Chinese annual income will be, in yuan terms, greater than American annual household income: $1,374,060 x 6.71 = 9,219,942.60 yuan. Chinese householders’ annual income one hundred years from now will be 3.1 times greater than their American counterparts’.
That will mean great changes in all the world’s culture, economy, military balance and politics at the United Nations. It seems to make sense that if anyone should pay today for green dreams, it should be the Americans, and the deal should be that China can afford to pay their share later.
Oddly enough, paying today will be cheap compared with what rich Chinese folks will pay later. Of course, getting such a promise is politically unlikely and realistically to be quite risky. One result of green ideological and political pressure to “get climate fixed now now now” is cross-Pacific political tensions of high order.
Cost-benefit analysis
Public goods (and bads) are goods and services whose consumption, production or continued existence impact more persons and economic players than those who are deemed to be the immediate, private/public consumers, producers or owners of such goods and services.
Examples of public bads range from a neighbor who plays super-noisy-loudspeaker online games in the middle of the night to the owner of a slaughterhouse/stockyard/abattoir whose operations make his entire neighborhood smell bad.
Greens claim that goods they don’t like, such as big super-powerful V-8 gasoline-powered cars or coal-fired electricity-producing plants, should be eliminated because they create waste products that heat the general environment, making economic and social conditions worse for everyone, even those persons without cars or those who use only a little electricity.
But if we broaden our definition of public goods and bads to include the general unhappiness that follows from green “solutions” like high gasoline prices, high taxes, burdensome regulations, resentments among citizens of nations like China who feel they should be allowed to wait until they can afford to pay for “cleanup,” then a case can be made that the public impact that comes from immediate, immoderate, international “cleanup” must be seen to be a big part of the problem, and painful “solutions” should either be replaced or we might better wait and let our grandchildren take on the issues themselves.
Cost-benefit analysis is fundamentally simple. It says no nation should spend more (cost) on green projects than the project is worth (benefit). Complications arise (as above) when costs are immediate, and benefits appear in the distant future.
Also, if costs are exacted from nations that cannot easily pay them, especially when paying the cost now may delay the time when such nations may expect to be much richer (China) and the nation that is demanding such “equal burden sharing” might expect to be, when benefits come flowing in, relatively less able to handle the problems once they finally appear (Americans and the West in general).
It looks like a case of “we will be much poorer than you when the time comes that these issues must be fixed. While we still have the riches and the leverage that comes with it, we want you to pay now on the same basis as we do for future benefits that we all will share.”
Let us apply common sense to these numbers and return to the interest rate. As we have seen, high interest rates are able to shrink future problems almost to invisibility. In July 1981 the US federal funds rate (or bank rate) rate hit 19.54% (FRED data at St Louis Federal Reserve Bank).
The PV of one million dollars 100 years hence at 19.54% is four cents. In my recent junk mail, I received a credit-card offer. Checking the fine print, I saw that the eventual interest charged, after initial “come-on” pricing was over, was 21%. Such sky-high rates are not reserved for moments of runaway inflation, as was the 1981 case.
Real people, not just mafia persons, pay double-digit rates all the time. So let us take a mid-point.
The PV of one million dollars in green costs, experienced 100 years from now, discounted at 20.54 is one cent. The last calculation means that today’s taxpayers should not be asked to pay, in today’s money, in order to fix a million-dollar year-2122 problem, any more than one US cent, or, when in China, no more than 0.06719 yuan to fix things now.
Fixing a thousand-million problem (that is, a billion) should not be fixed if present-tax collections (from the entire nation) add up to more than a thousand cents, or ten dollars. A thousand future billion-dollar green fix-it problems (that is to say a trillion-dollar problem) should not be allowed to raise the all-over national current tax burden by more than 10,000 dollars. The idea that today’s taxpayers should be charged billions or trillions today to fix problems that are a century away is ludicrous.
Here we see why green advocates have a narrative featuring permanently flooded coastal plains, croplands turned into deserts and massive die-offs of temperate-climate-adapted plants and animals. The conjured-up threat to our very existence the green enthusiasts typically predicts allows them implicitly to assume a potential future cost from “failure to act” that is unimaginably high.
What history teaches
But that narrative is far too bleak. It does not stand up to the facts of history. Recent studies of tree rings and other temperature-sensitive artifacts, dating from the time when Rome occupied Britain, quite clearly show that the parts of the Western world that were under cultivation were 2 degrees Celsius warmer than today.
The reality of the Roman warm period is not in doubt. The Romans grew grapes and made potable wine on their Roman estates. The Mediterranean, the Roman lake, was also 2 degrees warmer than now.
I take note that civilization did not suffer from heat collapse then. Instead, quite possibly because the heat helped agricultural foundation of the glory that was Rome, the civil parts of the world (as Edward Gibbon called them) were more welcoming to the plow, the earth was more fertile, the livestock more fecund than is the case today.
When the environment cooled off, the Dark Ages followed. Roman times were in some respects the best years that mankind heretofore experienced until the coming of the Industrial Revolution.
It is not quite a case where one is asked to ignore one’s lying eyes and instead listen to Jeremiah, the weeping prophet, and his dire predictions, but it does strain common historical sense to think global warming, should it return the world to Rome’s climate, poses an existential threat to civilized life.
To sum up, the green enthusiasts not only fail their economics exam, but they add to the tensions between East and West. It is more than a schoolhouse problem.
Tom Velk is a libertarian-leaning American economist who writes and lives in Montreal, Canada. He has served as visiting professor at the Board of Governors of the US Federal Reserve system, at the US Congress and as the chairman of the North American Studies program at McGill University and a professor in that university’s Economics Department.