Economics and Reason

I get emails every day from Tyler Cowen and I enjoy them. This one, How economists use GDP to think,  is useful for a couple of reasons.

It exposes a reason to study proportionality

We don’t understand large numbers. The U.S. GDP at $23 trillion is just a number. By itself, completely meaningless. Even 1% of GDP is vast number, $230 billion. That is about the value of all economic activity for a year in Greece. A big amount. One percent of the US economy is about the sales for for Amazon during 2020. You need to be big to capture 1% of U.S. GDP.

When we study growth in the economy. 2% in a year, a not so special rate, is huge in absolute form. Growth of two Amazons in a year. Not child’s play.

Sometimes thinking in percentage change has value. We have a sense of that.

It allows us to estimate long time spans and their effects

The article points out a familiar fact. The estimate for climate change effects is that if we do little or nothing, by 2100, (the article uses 2200, but I think that is a misprint) there will be 10% of GDP missing. We know $2.3 trillion today would be a serious setback and it is unlikely to be meaningless in 2100.

The author points to the expectation that spending in the present is likely to generate a “profit” in terms of GDP. I didn’t see the reasoning so I built a model.

The question is how much spending each year would cost the same loss of GDP and get an environmental benefit.

How the future will look.

If we look at the American economy at $23 trillion and estimate growth to be 2% annually, we can guess 2100 will be about $110 trillion. If we are going to be missing $11 trillion, it would make sense to address it.

How much should we spend?

Critical thinking says we must spend less than $11 trillion to avoid loss. But that doesn’t deal with the long time sequence. A good question, I think, is how much each year should we spend so the spending that reduces the climate change affect costs no more than $11 trillion over 79 years.

If we assume we could get 2% GDP growth then if we spend some money each year and end up at $110 trillion less 10%, $99 trillion, then we are no worse off and have helped the environment. That means we grow at just 1.864% instead of 2%.

So  spending 0.136% of GDP will result in a financial loss of the same amount we would lose if we did nothing. We help the environment though at that should be worth something. So a profit. Any amount bigger means the loss to spend as we go exceeds the economic value. That does not necessarily imply we should not spend more, it just means we need to assess the future cost more completely. Given how hard it is to do, and how hard it would be to estimate the effect of new technology over eight decades, it seems unlikely there will be anything other than rhetoric.

We should think it through critically nonetheless.

The annual expenditure

If 0.136% of GDP is the breakeven financial number, how much should the United States spend next year? Well, 0.136% of $23,000,000,000 would be right. That is $31,280,000,000.

The current thought on this subject is spending should be higher than $31 billion next year. Maybe we are over-solving the problem. Not uncommon. The federal budget proposal in the U.S. is $36 billion. In the range of reasonable, Given we know next to nothing of how technology will evolve and we are relying on the current science being settled. “Settled science” is an oxymoron. It has never happened in history. Some of the money should be going to clarifying the problem and the possible solutions.

Worst of all, states spend money too. I didn’t add that up, but it’s safe to say the current response is far more than the breakeven suggests.

Maybe we are not doomed. Of course, it depends on how good the 2100, 10% estimate is, how many other effects there could be, and how effectively the money is spent. We can’t know that yet. A reasonable guess.

In Canada the federal spending alone is forecast at $15 billion. Based on a GDP of $2 Trillion the spending should be about $2.5 billion. The budget is 6 times more than reasonable. Plus the provincial spending on top of that. Are they serious? More likely virtue signalling worth $12 billion.

Canada isn’t going to change anything by much, but spending money always looks good to some. Wasteful.

An alternate scenario

If we believe the solve it in 10 years or less rhetoric, 2022 spending must be $251 billion.  Before doing that, there are a few other things we might want to know.

  1. What can you give up to divert the cash? I doubt shaking the couch in the oval office will discharge $215 Billion.
  2. Is the 10-year number a political number or  science number? I am going with political, so meaningless outside politics.
  3. If it is a science number, how good is the science? Pretty poor if you apply normal science standards. Correlation and causation problems and confirmatory bias use of statistics.
  4. Does the number include the technology changes likely to happen beyond 2031? No, and we don’t know what those are.
  5. Is the allocation of the spending plan the best one possible or is it a guess? Electric cars are not an answer. You could work the economics out with little effort.
  6. What are other countries doing? Maybe the worst offenders are curing their problems faster.

Based on reasonable answers to the six questions, much more than the current spending request would be irresponsible. As we learn more we may be able to spend even less, or maybe we must spend more. Patience is a seldom-seen virtue in politics.

The takeaway

  1. If climate change can be proven to be a potential catastrophe, economic thinking is not the only way we should think about it. Likely not even a good way.
  2. Absent catastrophe, climate change spending might not be the problem the hysterical folks, like in Canada, are making it out to be.
  3. Objective science and research in better technology will add to our understanding and our economically justified spending.
  4. Subscribe to Tyler Cowen’s email feed.
  5. Think at least one step past the rhetoric.

I help people have more retirement income and larger, more liquid estates.

Call in Canada 705-927-4770, or email don@moneyfyi.com 

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