Gernot Wagner | Writing

Smart tariffs can help towards goal of lower emissions

noreply@blogger.com (Gernot Wagner) — Mon, 07 Jan 2008 11:00:00 +0000

Letter to the Editor, Financial Times, January 7, 2008.

Sir,

You argue against imposing any form of carbon border tariffs by invoking "slippery slope" reasoning ("The greening of globalisation", editorial, January 4): such tariffs, you say, could result in tit-for-tat restrictions. Possible, but most reactionary tariffs would and probably should be struck down by the World Trade Organisation. Yet the WTO would likely allow carbon tariffs combined with domestic caps or taxes, for good reasons. They provide a unilateral solution to an inherently global and complex problem without violating trade rules.

The system would enable globalisation to work for the environment - not, as you fear, prevent it from doing so. Current information deficits encourage consumer backlash against flowers grown in east Africa and flown to London, despite them being more carbon-efficient than those grown in energy-intensive greenhouses in Europe. A smart tariff system would be far preferable to consumers shifting en masse to products labelled "locally grown" - from both an environmental and a free trade perspective.

The economically ideal solution is a global cap or tax scheme, but smart tariffs come in as a close second. In addition, they would ease the transition by inducing poor exporting nations to move towards a path of lower emissions sooner.

Andreas Vogel,
Vice President, SAP Research

Gernot Wagner,
Consultant, Boston Consulting Group

The worth of nations

noreply@blogger.com (Gernot Wagner) — Sat, 01 Dec 2007 23:43:00 +0000

Worth Magazine, December 2007.

Imagine a business with an annual report containing nothing but revenue figures—and for only some of its operations. That is what happens when we focus on GDP as an indicator of how national economies are doing.

Revenues matter, but costs are equally important in figuring the true health of a business or a country. In a company, materials must be bought, machines lose their usefulness over time, and buildings require repair. Similarly, the economy of a country includes depreciation and the costs of doing business. National accountants adjust GDP to arrive at a net figure that accounts for worn-down roads and bridges, but there is more to a country than its physical infrastructure.

We are aware that trees are important to the environment, for example, but a tree doesn’t factor into GDP unless it is part of a commercial transaction. The sale of a Christmas tree appears in the GDP. An identical tree in the forest does not—at least not until it becomes plywood—and its contribution to a healthy environment does not appear on the country’s balance sheet.

If these factors were included, the adjustments to nearly every country’s GDP could be enormous. The cost of environmental degradation and pollution in China is equal to about 8 to 12 percent of the country’s GDP per year. That wipes out most of China’s impressive annual GDP growth, lately in excess of 10 percent.

China announced earlier this decade that it would start to calculate its green GDP, only to backtrack once the first numbers revealed some bad news. That turn of events is not new. The United States followed a similar path in the 1990s. It first started to measure subsoil assets, such as coal still in the ground. The coal industry did not like the results, and Congress soon bowed to lobbyists and included a line in the appropriations bill barring any such future activity. That ban has since disappeared, but national income accountants are still wary of doing anything too public.

Simon Kuznets—the father of U.S. income accounting who won the 1971 Nobel Prize in economics for his work—was the first to point to the limitations of calculating GDP without factoring in costs. On one hand, it is innocuous if the GDP feeds on a deteriorating environment: Companies produce, which adds to the gross domestic product, and other companies clean up their pollution, which again increases the GDP.

A large problem arises, however, with the way that GDP figures are used. The press, the public and even some economists equate them with statements about a nation’s overall well-being. And, up to a point, material wealth does mean better living conditions. China in the last two decades pulled more people out of poverty faster than any other country in history. Yet the enormous deterioration of its environment is equally unprecedented.

The United States provides another case in which GDP growth and overall welfare might no longer go hand in hand. Recent studies on childhood obesity conclude that children today might not live as long as their parents.

Ideally, we would develop an entire dashboard of indicators—economy, health, environment—and accord them all equal or similar weight in policy decisions. In practice, however, economic decisions often dominate. That is why it is essential to create monetary measurements of the environment or health and education, and integrate them with existing GDP measures.

When it comes to balancing 50 jobs against 50,000 trees, logging companies are able to point to hard economic data while environmental activists must plead for the sympathy vote with pictures of virgin forests and perhaps a fuzzy baby animal. But it is indeed possible to calculate the economic worth of trees left standing. They are natural water and air filters. Providing clean drinking water and removing carbon dioxide from the atmosphere add real value to society. Another sizeable part of the equation is the recreational value of forests and their contribution to the tourism industry.

Green GDP is not the result of green accounting; it is simply good accounting. The more data that the policymakers have to steer a country’s economy, the better. It is technically feasible to create such monetary measurements of our environment. What remains to be done now is the actual counting.

Gernot Wagner, a consultant in New York, served as the 2007 Peter Martin Fellow on the editorial board of the Financial Times.

Response to "Is Energy Independence the Answer?"

noreply@blogger.com (Gernot Wagner) — Sun, 30 Sep 2007 15:10:00 +0000

This week's NPR show Living on Earth aired some listener responses to the commentary, "Is Energy Independence the Answer?":

GELLERMAN: We got an earful about our recent commentary from Gernot Wagner who made the case that energy independence for the United States is not only unachievable, but undesirable.

Wes Tator, who listens to LOE on New Hampshire Public Radio, emailed to say, 'I thought your speaker was right on.'

But Cat Givens from Portage Lakes, Ohio sent us 'a resounding yes' to energy independence. She tunes in to WKSU and writes: 'The war on terror would be a thing of the past if we close down our dependence on oil and use the energy resources already available to us—like...ethanol, solar, wind, and battery-powered cars. There are green alternatives we can utilize right now.'

For the record, I agree with Wes Taylor, and with Cat Givens. The war on terror could well be a thing of the past if we became independent from oil. But there is an important difference between independence from all oil and independence from imported oil or energy in general.

Total oil independence might well be desirable. Becoming independent from imported energy alone, though, is not. None of this, of course says much about whether either would be achievable.

Is Energy Independence the Answer?

noreply@blogger.com (Gernot Wagner) — Sat, 15 Sep 2007 15:41:00 +0000

Living on Earth, National Public Radio's environmental news show, Week of September 14, 2007. (Radio-version of Chicago Tribune op-ed: "Energy goal should be to diversify," June 24, 2007.)

[CURWOOD:] Rudy Guiliani is not the only one talking about energy independence. It seems to be the mantra of just about all the presidential candidates, not to mention other politicians in Washington. For some, the goal is lower gas prices. For others, it's concern that oil-rich regimes hold sway over foreign policy. But commentator Gernot Wagner argues either way, energy independence gets us nowhere.

[WAGNER:] Talk of energy independence misses the point. The goal must be energy security. This is most often achieved by diversifying dependence, not by calling for independence.

President Richard Nixon started the craze with Project Independence in 1973. It has been a losing battle from the start. At the launch of the project, the U.S. imported a third of its oil. Now it imports over 60 percent.

Without draconian measures, energy independence is unachievable. The cheapest available oil, at the moment, is from the Arabian Peninsula. Meeting all need for oil domestically would come with a hefty price tag.

And those willing to pay a higher price in order to extricate foreign policy from perceived oil grip would do well to remember that the regimes they seek distance from will be enriched by that higher price. The market for oil is global. That makes it pointless to try to wean ourselves off particular suppliers.

The U.S. can declare today that it will not import any oil from Saudi Arabia. There is enough oil on the market to avoid shipping directly from Saudi to American ports. Someone else will gladly take the shipments from Saudi Arabia. But as long as there is no universal boycott of Saudi oil, we will be dependent on it – and we will still have U.S. tanks in the Middle East, if not U.S. tankers.

It is even more dangerous to link energy independence with environmental goals. We need to get away from oil and promote alternatives, but decreasing pollution is not the same as decreasing energy imports. Ethanol, for example, can deal with pollution but, for the most part, should not be used to address independence.

At the moment, the best source for ethanol is sugar cane. On environmental grounds, cane beats corn by a long shot. The most sensible environmental policy would be to drop all ethanol tariffs.

But slashing tariffs on ethanol increases our reliance on foreign fuels. Ethanol production shifts to Brazil, which could, at some point, replace Saudi Arabia as the lowest cost producer of the world's fuel of choice. Energy independence would decline. At the same time, energy security would go up. A democratic Brazil is clearly a better energy supplier than an autocratic Middle East. Even so, relying too heavily on Brazil could undermine supply security just as well. The goal should be to diversify.

Calls for energy independence undermine what really matters. The distinction with energy security is subtle, but important. Not only is energy independence unachievable, it is not even desirable.

Financial Times editorials

noreply@blogger.com (Gernot Wagner) — Fri, 17 Aug 2007 15:26:00 +0000

For the past four months, I have served as Peter Martin Fellow on the editorial board of the Financial Times in London. There I wrote about economics, energy and the environment.

I cannot post any editorials here, but I will gladly confirm having written well-received ones and will disavow any knowledge of the occasional dud.

Energy goal should be to diversify

noreply@blogger.com (Gernot Wagner) — Sun, 24 Jun 2007 18:30:00 +0000

Chicago Tribune, June 24, 2007.

While the U.S. Congress debates the latest energy bill, the eventual outcome amid intense lobbying by all sides is anybody's guess. One part, however, is certain: Calls for energy independence will be aplenty. These pleas will be as passionate as they are misguided. The goal must be energy security. This is most often achieved by diversifying dependence, not by calling for independence.

President Richard Nixon started the craze with Project Independence in 1973. It has been a losing battle from the onset. At the launch of the project, the U.S. imported a third of its oil. Now it imports more than 60 percent. That has not prevented George W. Bush and most major candidates vying to succeed him from pursuing the issue. But regardless of who takes it on, it will be a lost cause.

Energy independence is unachievable -- barring Draconian measures. Economic forces are aligned to exploit the cheapest available energy source, which is not located in the U.S. or in any other major energy-consuming nation. Oil from the Arabian Peninsula comes in second to none.

Moreover, the global nature of oil markets makes weaning ourselves off particular suppliers pointless. If the U.S. uses some oil -- any oil -- produced anywhere in the world, the price it pays will be determined, in part, by potentially hostile regimes. Moreover, U.S. demand for oil will increase that price and -- at least indirectly -- hand money to these regimes.

It would be desirable to shift from oil to alternative sources of energy, but here again, talk of energy independence muddles the issue. Some environmentalists like to link energy independence with the fight to combat climate change. We do indeed need an appropriate, predictable and consistent price on emissions of greenhouse gases, which would tip the balance away from oil and other carbon-intensive energy sources toward cleaner fuels. But decreasing pollution is not the same as decreasing energy imports. Ethanol can deal with the former, but, for the most part, should not be used to address the latter.

Currently the best source for ethanol is sugar cane. Neither the U.S., with its emphasis on corn-based fuel, nor the European Union, with rapeseed and sugar beet as its homegrown sources, can compete with Brazil and some Central American countries, where sugar cane thrives naturally. Cane beats corn, beet and rapeseed by a long shot on environmental grounds. The most sensible environmental policy would be to drop all ethanol tariffs. Given the powerful corn lobby in the U.S. and increasingly strong domestic ethanol lobbies in the EU, this is unlikely to happen. Talk of energy independence only exacerbates this boondoggle. Farm lobbies can now cloak their arguments for maintaining subsidies and import tariffs in the language of environmental concerns and of national security.

Yet slashing tariffs on ethanol would increase U.S. reliance on foreign fuels. Ethanol production shifts to Brazil, which could replace Saudi Arabia as the lowest cost producer of the world's fuel of choice. Energy independence would decline. At the same time, energy security would go up. A democratic Brazil is clearly a better energy supplier than an autocratic Middle East. Nevertheless, relying exclusively on Brazil could undermine supply security just as well. The goal should be to diversify.

Most countries already diversify to some extent in another dimension. The U.S. imports around 10 million barrels of oil directly per day. In addition, the U.S. imports about 1 million barrels a day indirectly, embedded in manufactured goods. China imports oil, burns it to fuel its plants, and the U.S. and others import the final products. If China and other poor manufacturing countries did not produce these goods for export, the U.S. and fellow rich consuming nations would have to import most of the oil or other forms of energy directly to produce the same goods.

Calls for energy independence undermine what really matters. Those arguing for it risk making the nation less secure. Sadly, energy independence is a powerful rallying cry for campaigns. It polls well and motivates people to put energy on top of their political priorities. That agenda-setting factor should not be underplayed. Yet the ends do not always justify the means. Here, the end would be unachievable and, more important, undesirable.

Dissertation

noreply@blogger.com (Gernot Wagner) — Wed, 09 May 2007 13:33:00 +0000

Essays on Environmental and Natural Resource Economics: Introductory Chapter

Informed policy circles no longer question whether to use economic instruments to solve environmental problems. Domestic European debates on global climate change focus on whether to use carbon markets or taxes. Even calls for banning incandescent light bulbs are wrapped in arguments of induced technological change and similar economic language. That is part of the problem. Economics is used to justify virtually everything, making it an extremely powerful tool – and increasing the stakes for economists producing environment-related research.

The United States imports around 10 million barrels of oil per day. That number is known and of much concern in the energy and national security communities. It also forms the basis of many studies concerned with macroeconomic effects of foreign energy dependency. Other important research areas in economics are the “pollution haven hypothesis,” based on the fear that dirty industries may migrate to poorer countries in search of lax environmental standards, and the “environmental Kuznets curve,” the conjecture that pollution follows an inverse-U-shaped pattern in relation to income. Demonstrated anecdotally, large-scale studies generally find no support for the pollution haven hypothesis and empirical results for the environmental Kuznets curve are by and large fickle. Research leading to my first paper shows that all three areas may have overlooked an important aspect of the data.

In addition to direct oil imports, the United States imports 0.8 million barrels embedded in manufacturing goods. That number has important national security implications. It also enables a direct way of studying both the pollution haven hypothesis and the environmental Kuznets curve. Relatively richer countries consume more energy-intensive products than they produce. Trade accounts for the difference. Future research needs to show whether that translates into a large-scale pollution haven effect. But at the very least, it shows the importance of choosing the correct model and data, especially since the data are not complicated. Careful accounting can produce the necessary figures and highlight important yet previously overlooked details.

Conventional wisdom says that negative environmental externalities dampen growth. Sick workers are less productive. That is certainly true and an important problem to study. Numerous economic papers have made seminal contributions in this area. The general conclusion seems clear: pollution hampers growth. The second chapter of my dissertation indicates that the opposite could be the case as well. Measured output might grow because of environmental externalities: pollution decreases the availability of previously free environmental services such as clean air. Households satisfy their demand by purchasing air purifiers. This transaction increases economic activity: GDP goes up. But households need to work more to pay for previously free environmental services: welfare goes down. In many ways, this is a problem of mismeasured welfare. A proper welfare indicator, such as comprehensive or “green” Net National Income (NNI) would decrease in this economy, but I do not argue for scrapping GDP altogether. Economic activity goes up, as it should. Welfare in this model does not keep pace with output because people value the environment and their leisure. Green NNI would go down.

One hopes that this issue has not been studied before because broad empirical investigations deemed the effect negligible, but I am afraid one reason is mathematical tractability. The model is extremely complicated, even by growth theory standards, and leaves much room for future theoretical work. But that is not the highest research priority. Instead, further work ought to investigate this phenomenon empirically. An important approach might be to look at natural experiments or case studies where pollution has sparked the adoption of new products or services to defend against negative environmental impacts. While important as a first pass, it will always be possible to find particular cases where consumer products replaced free environmental services. It would be particularly valuable to demonstrate the relative importance of negative externalities in economic growth by using cross-country or cross-regional growth regression, the tools of empirical growth economists, or engage in a large-scale accounting exercise in an attempt to account for defensive expenditures in national income accounts.

My third paper, joint work with C.-Y. Cynthia Lin, underscores some of the same points of theoretical modeling and empirical investigation. In many ways, this paper has the typical format of an economic paper. (It is also the only one of the three papers that has already been accepted for publication in the Journal of Environmental Economics and Management, the top field journal.) The paper revisits the basic Hotelling model of natural resource extraction, which uses the arbitrage condition to show that the value of natural resources in the ground rises at the rate of interest. The basic model assumes no technological progress, no stock effects, no new discoveries, no demand changes, and no market imperfections. None of these assumptions is realistic. We relax the first two and calibrate the model to fit data from 1970 through 2004. I feel fortunate to have co-authored this paper but am fearful that it taps into the same potential fallacies I highlight in my first two chapters.

The modeling choice was largely driven by mathematical feasibility. The choice of time periods was entirely driven by data availability. Our model – like most others looking at the same phenomenon – is silent as to whether the two theoretical extensions are indeed the most important ones in the list. Putting full faith in the model, one can conclude that technological progress had been a powerful force, keeping resource prices constant over long periods of time. Another equally potent force might have been new discoveries. We acknowledge as much throughout the paper, but by virtue of our model’s focus on technological progress are not able to say much more. The same goes for the empirical analysis. Since 2004, prices for most minerals have increased dramatically, defying our observation that prices have remained constant over long periods of time. Is it because technological progress has suddenly stopped? That is what our model seems to suggest. Or does it relate to a host of other factors including rapid demand increases in China and India, which lay outside of our model?

Economic work on the environment wields enormous influence. My brief experience writing for the editorial board of the Financial Times has shown me how decisions with significant public policy consequences are often based on a single economic study. Striving to have one’s work be as inclusive as possible is not merely an academic exercise. Being able to draw conclusions unbound by data availability and modeling choices should be the starting point, not the end result of good economic research in general. It is all the more important in an area where economists answer questions linked to a system much larger than the one we are used to studying. After all, in the words of Senator Tim Wirth, “the economy is a wholly-owned subsidiary of our environment.”

Full dissertation.

Energy Content of World Trade

noreply@blogger.com (Gernot Wagner) — Wed, 09 May 2007 13:28:00 +0000

Abstract: I construct a comprehensive dataset of oil and total energy embedded in world trade of manufacturing goods for 73 countries from 1978 to 2000. Applying this dataset to debates on the dependency on foreign energy sources makes clear that achieving complete energy independence in the foreseeable future is unlikely to be feasible and may not be desirable. Applying it to the discussion of environmental Kuznets curves (EKCs) highlights an important distinction between production and consumption of energy. Richer countries use relatively less energy in their industrial production yet still consume relatively large amounts of energy indirectly. A further investigation largely excludes structural shifts of production in and out of the manufacturing sector as an explanation for the downward-sloping portion of the EKC. Country-level analyses add caveats but show tentative support for the cross-country conclusions.

Paper, data, and program files.

Green Accounting in a Ramsey Model: Undesirable Growth Fueled by Environmental Degradation

noreply@blogger.com (Gernot Wagner) — Fri, 13 Apr 2007 14:10:00 +0000

Abstract: Green accounting can take on various forms of adjustments to standard output measures. In a Ramsey model it highlights the importance of defensive expenditures and their role in output and welfare calculations. If both labor and environmental quality are included in a standard Ramsey growth model with two kinds of consumption goods, negative externalities increase the steady-state path of per capita output. At the same time, per capita utility – as well as societal welfare – decline. Economy-wide technological progress and population growth further widen this discrepancy between per capita output and utility. Accounting for defensive expenditures in this context enables an accurate description of welfare in that economy.

Full paper

Economics Focus: Bayesian Asset Pricing

noreply@blogger.com (Gernot Wagner) — Wed, 21 Feb 2007 16:24:00 +0000

The less we assume we know, the smaller the asset pricing puzzles

When physicists test their theories against the real world, they are frequently correct to five decimal places after the comma. Economists tend not to be as lucky. Approximating within an order of magnitude is often all they can hope for when applying their theories to the data. However, even that has proven to be elusive in a quest to explain asset pricing phenomena with economic theory.

This inability to match theory with data has given rise to three related failures of neoclassical economics applied to financial markets: the equity premium, the risk-free rate, and the variability mismatch puzzles. Given historic trends, neoclassical theory for plausible risk parameters predicts that stocks ought to pay less than 0.1% more annual return than the safest assets. In reality, equities pay a premium over 6% above short-maturity U.S. treasury bonds – a discrepancy by a factor of more than 60 – much more than an order of magnitude. Reversing the logic, the risk-free rate for bonds is much too low compared to theoretical predictions. Lastly, the observed variability in the stock market is much higher than reasonable expectations about the economy itself. Yet theory says the two should be the same. Worse still is that attempts to solve one puzzle frequently exacerbate at least one of the others.

A defining characteristic of neoclassical economics is its adherence to the frequentist school of statistics. Frequentists believe that there is an underlying, true structure of asset prices. Their distribution is known; only the correct parameters are uncertain. With enough observations, we can approximate the correct mean and variance around it and act as though the parameters are known.

Bayesian statistics provides an alternative school of thought. Bayesians are not only uncertain about the correct parameters; they also do not know the true structure of the problem. Instead of setting out to accumulate massive amounts of data to approximate an unbiased sample, Bayesians rely on appropriate “priors,” pre-existing assumptions. Reverend Thomas Bayes first presented these ideas in eighteenth century England. Frequentists have managed to sideline them for most of their existence, but Bayesian statistics has experienced a renaissance of late, particularly in areas where data are sparse. Bayesians can draw inferences with as little as one data point.

Asset pricing is not an area that comes to mind in the context of paltry data. Hardly any field in economics can rely on as many observations. With decades of publicly available minute-by-minute pricing information from various stock markets around the world, equities are a fertile ground for frequentist statistical study. This abundance of data seems to have been the demise of theoretical economists trying to explain the asset pricing puzzles in the past. Many economists have suspected that Bayesian structural uncertainty may play a role in explaining these puzzles. Now Martin Weitzman, an economist at Harvard, has carried this idea much further. His paper* shows that all three asset pricing puzzles may be reversed when relying solely on Bayesian statistics. Some added mathematical wizardry brings us to a happy middle ground, where the puzzles disappear into the realm of statistical curiosities rather than massive failures of the theory.

Uncertainty is worse than risk

Mr Weitzman’s argument relies on the fundamental difference between risk and uncertainty. Risk refers to the frequentist worldview of unknown outcomes given known distributions. Uncertainty is linked to the Bayesian idea of unknown outcomes and unknown underlying structures. Poker players face risk. The distribution of a deck of cards is known. The risk of the game comes with not knowing the exact outcome of the next draw. Investors, according to Mr Weitzman, face risk and uncertainty. They do not know the exact outcome. More importantly, though, the underlying structure of the distribution is likewise unknown to some degree.

This distinction is not new to economics. It traces back to Frank Knight’s Ph.D. dissertation**. Mr Knight was a towering figure in early twentieth century economic thought. He went on to lead the Economics Department at the University of Chicago for two decades beginning in the 1920s. Most economists would recognize his distinction between risk and uncertainty. Few have known what to do with it.

Compared to the standard normal distribution often assumed by frequentists, a pure Bayesian analysis results in a “Student-t” distribution with significantly thicker tails. Cataclysmic crashes and miraculous price rallies now have a much larger chance of occurring than neoclassical theory allows. By putting a slightly higher probability on these extreme events, the asset pricing puzzles are even reversed. Pure Bayesian theory would predict a larger equity premium than is seen in reality. At the very least, it is no longer clear what puzzle needs to be explained: excessive equity premiums claimed by frequentists or overly modest premiums observed by Bayesians.

[Insert graph here: Student-t, “Bayesian-t learning”, and standard normal distributions shown in one graph, with decreasing thickness of tails.]

Mr Weitzman creates a hybrid dubbed “Bayesian-t learning” distribution with characteristics of both the frequentist and Bayesian approach. In fact, both are special cases of this more general theory. That is always a good way to find acceptance for one’s research. Instead of declaring past approaches wrong, simply sell your own idea as a generalization subsuming previous work. Most importantly, the task for economists now becomes a matter of model calibration to fit the data, rather than searching for the correct model in the first place.

As with every path-breaking piece of research, the question of why nobody has considered this previously remains. In this case, that question is the real puzzle. Economists needed only to take the ubiquitous warning for stock investments seriously: past performance does not guarantee future results. It appears that investors have stuck to that mantra all along.

* “Prior-Sensitive Expectations and Asset-Return Puzzles”. January 2007.

** “Risk, Uncertainty, and Profit”. 1921. Boston, MA: Houghton Mifflin.

Steady-State Growth in a Hotelling Model of Resource Extraction

noreply@blogger.com (Gernot Wagner) — Mon, 11 Dec 2006 22:38:00 +0000

Abstract: This paper re-examines the Hotelling model of optimal depletable resource extraction in light of stock effects and technological progress. We assume functional forms for cost and demand so that the solution to the Hotelling problem is a steady-state consistent with the empirical observation that the growth rates of market prices have remained zero over a long period of time. We use data on 14 minerals from 1970 to 2004 to estimate the supply and demand functions using SUR and 3SLS and to test the model. We validate the model for 8 of 14 minerals.

Paper, data, and program files.

Green accounting instead of Green GDP

noreply@blogger.com (Gernot Wagner) — Sun, 14 May 2006 21:36:00 +0000

Letter to the Editor of the Financial Times

Sir,

Patrick Hubert interprets your article on China scrapping its "green GDP index plan" (May 10) as a potential case of "breaking the thermometer in order to deny the evidence of rising fever" (May 12). I interpret it as a potentially misleading headline.

After quoting a Chinese government official as saying that green GDP is "virtually impossible to calculate", your article goes on to say that China will still pursue green accounting. In other words, China will create a second thermometer measuring the state of its environment -- a set of "environmental satellite accounts" in the green accounting lingo. That should have been done all along. It will provide much more information than one single index number.

Gernot Wagner

Repsol YPF-Kennedy School of Government Fellow in Energy Policy,
Harvard University,
Cambridge, MA 02138, US

'Energy tax' is a non-starter – rebrand it 'price stabilisation'

noreply@blogger.com (Gernot Wagner) — Mon, 06 Feb 2006 13:52:00 +0000

Letter to the Editor, Financial Times, US Edition, p. 14, February 6, 2006.

Sir,

A high oil price is good for the environment, but it does not have to be good "for the totalitarians in Saudi Arabia," as Jacob Weisberg argues ("A Union address that ran on empty", February 2). The solution is simply a variable tax on all crude oil imports aimed to stabilise the final price. Oil price volatility creates a heavy cost for American industry and consumers.

Under the name of an "energy tax", this proposal has been a political non-starter for decades. Re-branding it as a "price stabilisation" measure aimed at lessening our addiction to oil should have something for everybody.

Gernot Wagner

Repsol YPF-Kennedy School of Government Fellow in Energy Policy,
Harvard University,
Cambridge, MA 02138, US

World's Toughest Briefs: Hybrid Cars

noreply@blogger.com (Gernot Wagner) — Sun, 15 Jan 2006 14:44:00 +0000

The Financial Times challenged all creative minds to design an ad campaign to broaden the appeal of hybrid cars. I teamed up with Michael Saji. Here is a sample of our entry.

Hybrids mean freedom from pollution, from high gas bills, from foreign oil. That is common knowledge. Our campaign associates hybrid technology with a new kind of freedom. The freedom associated with SUVs and race cars. "Free to Roam" and "Free to Accelerate" emphasize these aspects. "Free to breathe" shows that the campaign is flexible enough to tie these new-found freedoms back to commonly held believes about hybrid technology. The campaign can be adapted to fit any car company that is currently working on hybrid SUVs, Toyota being only one of many.

Free to Roam

"Next gas, 500 miles." Not a problem if you get 50 miles to the gallon. Even if it is an SUV. Now that I have a hybrid, I'm free to go wherever I please, as far as whim or fancy takes me. And I can take comfort in traffic knowing that.

Free to Accelerate

As I zoom down the tunnel, I enjoy the power of a hybrid V6 engine. People don't realize that with a hybrid, you just get more—more acceleration, more torque, more power, without the poor mileage of a turbocharger. No wonder they're developing hybrid engines for F1 racers.

Free to Breathe

Imagine a world with pollution cut in half. Suddenly your breaths are cleaner, crisper. Freer. Now imagine your cost of gas cut in half. Take a deep breath and enjoy. Hybrid technology gives you both, and much more.

Website launched

noreply@blogger.com (Gernot Wagner) — Mon, 17 Oct 2005 14:06:00 +0000

This website was launched on October 17, 2005. Any weblog entries prior to this day were, in fact, not posted on the date indicated in the time stamp, but sometime over the past three months.

Even now, though, this page is not a typical weblog, with daily musings on the latest chatter in cyberspace. It is rather a place for my writing, which is mostly intended for other media. The weblog format makes it very easy to publish all my pieces in one place and solicit reader comments.

For another experiment to turn the idea of weblogs upside-down, please see my green accounting bibliography, also published in form of a blog.

The Case against Happiness

noreply@blogger.com (Gernot Wagner) — Sat, 13 Aug 2005 02:57:00 +0000

Opinion piece written with fellow Ph.D. student Joe Mazor.

Ask yourself a question: On a scale of one to five, how happy are you?

What did you consider when you assigned yourself a number? According to the latest studies, the average person thinks about family relationships, their financial situation, work, community and friends, and health, in that order - with some thoughts about personal freedom and personal values mixed in. What do we leave out? A comfy bed, three meals a day, central heating, all the creature comforts our mothers kept telling us to be grateful for because somebody somewhere does not have them. We simply take them for granted as the status quo.

Our personal well-being depends on two factors. The first is the daily pleasures that we come to take for granted. This includes not only our creature comforts, but other pleasures - social and mental - which are part of our status quo. Psychologists call this our "adaptation level."

The second is the emotions resulting from the relative comparisons we constantly make to this status quo: what we have relative to what we used to have, what our neighbours have, what we believe we ought to have. When prompted to state their happiness, people focus on the second factor. They do not report the part of well-being that they take for granted.

Confusion around these two factors and how we should measure well-being has sparked a fundamental debate within economics. On one side are traditional economists who focus on consumption as a proxy for well-being. Our spending affords us a certain level of daily pleasures that we quickly get used to. Thus, consumption as measured by gross domestic product (GDP) is an important component of the first factor, the pleasures of the status quo that we take for granted.

On the other side of the debate is a new breed of "happiness economists" who want to wean the economics profession away from an admittedly unhealthy obsession with GDP. They advocate using stated happiness instead as the measure for well-being. Lord Richard Layard's book Happiness: Lessons from a new Science (2005) is only the latest example in this literature. By focusing exclusively on stated happiness, however, they only capture the second component of well-being, emotions associated with comparisons to the status quo.

To understand the distinction between the two components of well-being, think of Lord Layard's central heating, an example he uses in his book. A higher income allowed him to install central heating to keep his house warm. Initially, his well-being increased for two reasons: First, he was happy because this new situation was an improvement over the status quo. Second, he experienced the comfort of his pleasantly warm house.

After many years, Lord Layard has come to take the pleasures of the warmth for granted. Central heating has become part of his status quo, and so no longer makes him happy. Lord Layard clearly recognizes that if we take the heating away, he would be unhappy. What he fails to recognize is that even though his central heating no longer makes him happy, his pleasantly warm house still contributes to his well-being on a daily basis.

A groundbreaking book on well-being edited by psychologist and economics Nobel Laureate Daniel Kahneman formalizes this argument. Even these experiences we are used to contribute to our well-being without adding to our happiness.

It is worth mentioning that not all pleasures are equally easy to adapt to as a warm house. In particular, as Lord Layard recognizes, the pleasures we get from our relationship with family, friends, and God are more complex. Their complexity makes them harder to take for granted. Thus, factors like a good family life can be a continual source of both pleasure and happiness.

If well-being is a combination of our status quo pleasures and our happiness, focusing on either one alone will result in misguided policy. Should we have a higher income tax? If we overlook happiness, as many traditional economists do, we would answer with a resounding no. Higher income taxes create distortions, which lower our GDP. If we overlook the pleasures that we take for granted, as Lord Layard does, the answer is yes. Discouraging work would mean more free time to pursue what truly makes us happy, like a good family life. Since higher income would not make us happier in the long run, nothing is lost.

The truth lies somewhere in the middle. Both the pleasures we take for granted as well as happiness are important to our well-being, and there is often a trade-off between the two. In order to make informed policy such as setting the proper income tax, we need to create a more comprehensive welfare figure than GDP; one that includes both our central heating systems and the quality of our family lives. But we certainly should not abandon GDP altogether and rely on happiness surveys alone.

From The Answer Desk: Green GDP

noreply@blogger.com (Gernot Wagner) — Sat, 30 Jul 2005 17:10:00 +0000

The Gross Domestic Product has its share of problems as a welfare indicator. This post to the Environmental Economics blog describes some alternative measures:

Tim Haab asked me to respond to a question by Jonathan Pfeiffer from The Answer Desk:

I'd like to see an overview of ways of measuring economic progress that don't ignore ecological concerns. For example, what alternatives are there to indicators such as gross domestic product? (Alternatives should include indicators that somehow factor environmental data into the equations.)

Jonathan, you are right to point out that the Gross Domestic Product (GDP) almost completely ignores our environment. Even worse, actually, GDP often includes the environment on the wrong side of the balance sheet. If we first pollute and then pay to clean up the mess, both activities add to GDP. Environmental degradation frequently looks good for the economy. In that regard, GDP is a poor welfare measure.

But first, a quick defense of GDP: It does a pretty good job of measuring the size of our economy. Most importantly, it was never intended as a welfare measure. GDP measures market transactions. It does not include the value of your leisure time, the value of taking care of your kids at home, or the value of the oxygen produced by the tree outside your window. In the end, environmental degradation frequently looks good for the economy because it often is good for the economy. It is bad for overall well-being, but it increases GDP.

That said, we — and this includes economists — frequently fall into the trap of using GDP as a measure of how well we are doing as a society. This is often done out of necessity, since we do not have a consistent, alternative measure of true well-being. Up to a point, it is also a pretty good approximation. There is most certainly a correlation between material wealth and well-being. Not eating at all would put a damper on our welfare. Eating too much, however, could actually make us feel worse again. The question is where is the point of inflection. Starting when does one more dollar of GDP decrease well-being? This is where the alternative measures of well-being come in.

Among the first to ask this question were two Yale economists, Bill Nordhaus and the late James Tobin, in a paper titled "Is growth obsolete?" in 1973. They developed the Measure of Economic Welfare, which used GDP (or more accurately NNP, net national product) as the starting point and made some imputations for the value of leisure and the depreciation of natural capital, among others. It turned out that GDP tracked the MEW pretty closely. Their conclusion: "Is growth obsolete? We think not."

Next came Daly, Cobb and Cobb in 1989 with the Index of Sustainable Economic Welfare. They made some further adjustments and concluded that "empirical evidence that GDP growth has increased welfare is very weak."

In the 1990s, Redefining Progress entered the picture. They developed the Genuine Progress Indicator, which makes the most far-reaching adjustments to GDP. They conclude that the growth of well-being has not kept pace with that of economic output. "GPI started declining around 1975, while GDP keeps increasing."

Besides these three alternative measures of well-being, there are efforts underway to amend official GDP statistics. Several countries, including the United States, have attempted to make such calculations at various points in time. The United Nations Statistical Office, which publishes guidelines on how to calculate GDP, also produces a set of rules for environmental or green accounting.

In the end, though, it’s politics, stupid. For all its inglorious number crunching, green accounting tends to be politically loaded. In the United States, it was Congress that stopped any official efforts through one line in an amendment to several appropriations bills. For more on this sorry tale, listen to an NPR story by yours truly.

For an overview of green accounting in general, you may be interested in this green accounting bibliography.

Re: Open Letter to President Summers

noreply@blogger.com (Gernot Wagner) — Tue, 06 Jul 2004 23:54:00 +0000

To: Richard Melvoin (Harvard Board of Overseers)
Cc: Lawrence Summers, William Fitzsimmons (Dean of Admissions)
Subject: Re: Open Letter to President Summers

Dear Dr. Melvoin:

Thank you for thoughtful response to our open letter to President Summers about Harvard's admissions policy of giving applications from children of alumni an "additional look."

I fully agree that Harvard should maintain its differentiated admissions policy, bringing in people "with a range of backgrounds and experiences." "Meritocracy," as stated in the open letter, is by no means focused solely on academics. I applaud the admissions committee for striking a delicate balance in determining the composition of every entering class.

No matter how differentiated the admissions process, however, it has a binary outcome. One either will attend or will not. For some students, therefore, having parents who attended Harvard may, in fact, be a decisive criteria in being admitted to Harvard College.

Virtually all achievements or characteristics presented in the application package are particular to the student. Some, of course, are inextricably linked to his or her upbringing. Children of alumni will most certainly be strong candidates for admission, and their rate of acceptance will understandably be higher than the overall rate. Why ask for an applicant's parents' college affiliation, if the characteristics that make them a strong candidate for admissions are already reflected in other parts of the application?

The answer President Summers and others have used is that it is instrumental to the kind of "community" Harvard is. This poses the question of which kind of community we would like Harvard to be. I agree that Harvard is Harvard -- and Cambridge, Cambridge -- in part because of some of the aura created by families with impressive genealogies and longstanding ties to Harvard. This, however, is a reflection of a bygone era.

As far as I understand it, the community Harvard tries to create now is indeed one of meritocracy -- whether it is excellence in academics, public service, the arts, or in a number of other areas. It is this commitment to excellence that has propelled Harvard to be one of the premier institutions of higher learning in this country and in the world. Such a position brings with it an enormous amount of power as well as responsibility. President Summers talked at length about how this power can and should be used to combat inequality in the United States. He ended his Commencement Address by calling upon all of us "to ensure that our University affirms its promise to advance the vital quest for equal opportunity in America." Removing the "ever so slight tip" for children of alumni, would further both goals -- creating a community based on merit and excellence, and reaffirming our commitment to equal opportunity.

As you allude to in your letter, the other reason why Harvard should maintain its policy of giving children of alumni an "additional look" is money. (This, of course, again poses the question of which kind of community Harvard would like to be. Would we like to suggest that the "ever so slight tip" in the admissions process might be "bought" in any way?) Harvard does indeed have a remarkable financial aid program. My wife and I will be the first ones to admit this. Without Harvard's generous support, my wife would not have been able to attend. Without its need blind admissions system for international students (to my knowledge, unparalleled in the United States, at the time of my college application), I would not have been able to go to college in this country. We are forever thankful for this.

Removing the "slight tip" for children of alumni may indeed decrease the amount of money available in Harvard's financial aid funds. So does the policy of no longer requiring families with incomes of less than $40,000 to contribute to the cost of attending Harvard for their children. Both are initiatives aimed at addressing inequality in the United States, and they (may) come at a price. Both initiatives, however, may also encourage some alumni to donate to Harvard: for example, the signatories of this open letter.

Sincerely,
Gernot Wagner

Cc: President Summers, Dean Fitzsimmons

End Legacy Admissions at Harvard

noreply@blogger.com (Gernot Wagner) — Sat, 03 Jul 2004 21:59:00 +0000

Dear President Summers:

At this year's Commencement exercises, you talked at length about the widening inequality gap in the United States and mentioned a number of initiatives Harvard is taking to address the problem. You also said that the college admissions process is trying to put each student's achievements in the context of his or her "background and the circumstances under which credentials have been achieved," adding that private SAT prep courses are among "the least economically diverse in America." Despite these pronouncements, Harvard College continues to defend its admissions policy of giving applications from children of alumni an "additional look."

Immediately before your speech, Robert G. Stone Jr., chair of the Committee on University Resources, read off the impressive fundraising achievements of Harvard reunion classes. He drew attention to the fact that two college class reunion chairs had the same last name and said that this was the kind of tradition we would like to maintain at Harvard. His proclamation was met with applause from some members of the audience, including briefly from you.

It is wonderful to have successive generations of the same family attend Harvard and then commit considerable time and effort to the university. Their contributions, though, would be even more impressive without the fact that children of alumni get "an ever so slight tip." This "tradition" stands in striking contrast to the university's commitment to educational equality. In the words of The Economist magazine, it is a "helping hand for those who least need it."

With your admirable effort to address the problem of educational inequality, you are sending a strong message that "Harvard is - really and truly - an option for exceptionally talented students whatever their financial means." It is, however, diluted by the conflicting message that children of alumni receive that additional look.

Coming from well-educated and relatively wealthy parents, our (future) children will already have an enormous advantage in the college admissions process. Should they ever decide to apply to and be accepted at Harvard, we would not want them to have any doubt in their minds that it is because of their abilities and future potential - not because their parents are Harvard alumni.

We urge Harvard to end its policy of favoring children of alumni in the college admissions process.

Sincerely,

Gernot Wagner '02
Siripanth Nippita '00

Avik Chatterjee '02
Kimberly L. Collins '02
Rohit Goel '02
Daniel B. Giffin '99
James Grimmelmann '99
Rita Hamad '03
Michael D. Hartl '96
Myung H. Joh '02
Jonathan G. Koomey '84
John L. Larew '91
Darryl Li '01
Tse Wei Lim '02
Erika Lundquist '99
Adam Marlowe '02
Chris Meserole '02
Nicholas Murphy '02
Zuzanna Olszewska '01
Marisa Perez '99
Michael Prokosch '70
Brian Questad '00/'01
Sanjay Reddy '91, A.M. '95, Ph.D. '00
Dianne Reis '93
Lori Rifkin '00
Travis Schedler '02
Dale Shuger '00
Caroline Stanculescu '00
Mary Ann Walter '00
Calvin C. Wei '00

Add your name to this list!

Further readings:

"A Hereditary Perk the Founding Fathers Failed to Anticipate" by Adam Liptak, New York Times, January 15, 2008.

"The New College Try" by Jerome Karabel, Op-ed, New York Times, September 24, 2007.

"The Old College Try - Why do alumni give to universities? To get their kids in, of course," Slate (July 6, 2007).

"Poison Ivy: Not so much palaces of learning as bastions of privilege and hypocrisy," The Economist (September 21, 2006).

The Price of Admission: How America's Ruling Class Buys Its Way into Elite Colleges -- and Who Gets Left Outside the Gates by Daniel Golden, Crown (September 5, 2006).

"Inequality and the American Dream," The Economist (June 15, 2006).

The Chosen: The Hidden History of Admission and Exclusion at Harvard, Yale, and Princeton by Jerome Karabel, Houghton Mifflin (October 25, 2005). Reviews of The Chosen: "Ivory Tower Intrigues: The pseudo-meritocracy of the Ivy League" by James Traub, Slate (October 24, 2005); "Merit in Motion," The Economist (Novemer 26, 2005).

"Getting In: The social logic of Ivy League admissions" by Malcom Gladwell, The New Yorker (October 10, 2005).

Equity And Excellence In American Higher Education by by William G. Bowen, Martin A. Kurzweil, and Eugene M. Tobin, University of Virginia Press (April 15, 2005); "A Thumb on the Scale: The case for socioeconomic affirmative action," Harvard Magazine (May-June 2005), excerpts of chapter seven of the book.

"Ever higher society, ever harder to ascend," The Economist (January 1, 2005); Letter to the editor by William Fitzsimmons, Harvard College Dean of Admissions, in response to the article (January 20, 2005).

"The Legacy of Legacies" by Jerome Karabel, Op-Ed, The New York Times (September 13, 2004).

"Bush, a Yale Legacy, Says Colleges Should Not Give Preference to Children of Alumni," The New York Times (August 7, 2004).

"Herkunft bestimmt Karrierechancen [German: Birth determines career prospects]," Die Presse (August 4, 2004).

"College Admissions and Legacies," Talk of the Nation, National Public Radio (January 15, 2004).

"The curse of nepotism," The Economist (January 8, 2004).

"The Senate and Alumni Admissions" by Josh Gerstein, Op-Ed, New York Sun (November 6, 2003).

"How Affirmative Action Helped George W." by Michael Kinsley, Time (January 21, 2003).

"Family Ties: Preference for Alumni Children In College Admission Draws Fire" by Daniel Golden, The Wall Street Journal (January 15, 2003).

"Legacies in Black and White: The Racial Composition of the Legacy Pool" by Cameron Howell and Sarah E. Turner, NBER Working Paper No. w9448 (January 2003).

"A Second Look: Attacking Legacy Preference" by Jesse Shapiro, Perspective (November 1997).

"Why Are Droves of Unqualified, Unprepared Kids Getting into Our Top Colleges? Because Their Dads Are Alumni" by John Larew, Washington Monthly (June 1991): p. 10-14.

Fixing GDP: Green Accounting in the United States

noreply@blogger.com (Gernot Wagner) — Sat, 10 Apr 2004 03:17:00 +0000

Living on Earth, April 9, 2004, National Public Radio's Environmental News Show. I wrote and produced the story, Steve Curwood edited and voiced it.

Listen to the story in mp3 format (7:45min, 3.8MB).

[background: Wall Street opening bell]

When it comes to counting all the beans on Wall Street and in Washington, D.C., the only cookbook that matters is the Gross Domestic Product, or GDP. If the Gross Domestic Product is going up, people say the economy is growing. If the GDP is falling, they say we're in a recession. Whichever way it goes, investors, business folks, voters and presidential candidates use the GDP as an indicator of how well the nation is doing.

[Wall Street opening bell fades out]

The GDP is supposed to measure the total production and consumption of goods and services in the United States. But the numbers that make up the Gross Domestic Product by and large only capture the monetary transactions we can put a dollar value on. Almost everything else is left out. And that's why some economists have a problem with this influential accounting system.

[background: Cambridge playground]

At a playground in Cambridge, Massachusetts a child is being attended by a daycare center employee. Her wages add to the GDP. Nearby another child is being watched over by his grandmother. But, under GDP accounting rules, granny's contribution has no economic value.

[Cambridge playground fades out]

The concept of the GDP was developed to help steer the US economy out of the Great Depression, and through World War Two.

[Davis:] It was developed as a means of measuring economic output, and in fact for planning purposes during the war period.

Professor Graham Davis is an economist at the Colorado School of Mines.

[Davis:] But the public and the press, and probably some economists, have fallen into the trap of using GDP and, more specifically, growth in GDP as an indication of economic progress.

Prof. Davis cites coal mining as an example of how the Gross Domestic Product number can be a misleading growth indicator.

[Davis:] Every time we mine a ton of coal, GDP goes up by $17 a ton, but that doesn't take into account the fact that we've harvested one ton of coal from the Earth and that ton of coal is no longer there.

So-called green accountants would add in depletion, says Professor Davis. And when you do that, the numbers start to change.

[Davis:] The value to society of that ton of coal in GDP terms would be about $17 for West Virginia coal. In green income terms, it would be about 5 Dollars and 50 cents.

And this adjustment only accounts for the decrease of coal in the ground and the depreciation of the equipment used to mine it. It does not consider a potentially larger, human cost.

[Scarbro:] I contracted black lung, and also bad hearing. I can't hear anything.

James Scarbro is a retired West Virginia coal miner. He spent almost 32 years working in the mines.

[Scarbro:] How does it affect me now? Well I can't do much work. I mean, I can get out here, and I can work a little bit, but I gotta gauge myself as I go about it. I've been into the hospital in and out, for I bet you, in the emergency room 10-15 times, and it was with the symptoms of a heart attack.

But Mr. Scarbo's medical bills aren't subtracted from the economic value of coal. Indeed, under the accounting system used by the Gross Domestic Product, his illness actually adds to the GDP. That's because medical costs to treat black lung disease add to the economy. So does the cost of cleaning up abandoned mines. If a coal slurry impoundment escapes and ruins miles of rivers, cleaning up the mess adds dollars to the GDP, too. So, in this case, environmental degradation looks good for the economy.

[Daly:] We add together benefits and costs, and changes in inventory – everything goes in. We don't subtract anything.

That's Prof. Herman Daly. He's an economist at the University of Maryland School of Public Affairs. He says a key flaw of the GDP is that it ignores core accounting principles of business.

[Daly:] A firm always has two accounts: they have a benefit account and a cost account. They have a revenue account and their expenditure account. They never add the two together. That would be the height of silliness. But that's exactly what we do with GDP.

So some economists would argue that these are examples of some fundamental problems with the Gross Domestic Product: we don't measure unpaid work or services that may benefit society, we treat expenses as income, and we often fail to value natural resources. Back in 1993 the Bureau of Economic Analysis, the official bookkeeper of the U.S. economy, began responding to concerns that the GDP needed retooling.

Director Steve Landefeld says the agency began working on a green accounting system called Integrated Environmental and Economic Accounts.

[Landefeld:] We went forward trying to do in a best-practice kind of way a set of basic accounts where we began with the frankly more easily measurable commodities, such as petroleum and other mineral resources. In 1994, what we did was we tried to put together what we called a prototype set of accounts. The estimates were fairly significant.

[background: Capitol Hill hallway]

These initial results released in 1994 showed that GDP numbers were overstating the impact of mining companies to our nation's economic wealth. Mining companies didn't like those results, and it didn't take long for Capitol Hill to react.

Alan B. Mollohan, a Democratic House Representative from West Virginia's coal country, sponsored an amendment to the 1995 Appropriations Bill that stopped the Bureau of Economic Analysis from working on revising the GDP and that's where things stand today. The Bureau of Economic Analysis is still not doing any work on revising the GDP in a way that considers such things as environmental impact accounting.

[Capitol Hill hallway fades out]

By the way, if the Bureau had focused its first work exclusively on forests instead of looking at coal and oil, the numbers might have been more appealing to present critics. Natural re-growth of trees has increased the economic value of our nation's forests by approximately 2 to 3.5 percent annually over the last half century. So, in some instances, accounting for the environment might actually boost economic indicators.

[Background: Cambridge playground]

Meanwhile, back at the playground in Cambridge, we are reminded of the work of sociologist Juliet Schor. She has been counting up the unpaid service part of our economy, from meals cooked at home to volunteers at local hospitals.

[Cambridge playground fades out]

[Schor:] It turns out that the stuff we do that we don't get paid for is almost as big, not quite anymore, because the market sector has been increasing the fraction of human labor that it covers. Now people are spending more and more time in the market. But it's a very, very large economy that's not included, almost as large as the one we measure.

If the meal cooked at home is worth as much - or more - as the one served by a single mother employed at the local fast food joint, it changes the calculus of such programs as workfare. And if a tree that is growing is worth as much or even more than one that is cut, that changes the calculus of forestry.

Rethinking of how we measure our economy raises broad questions. But Juliet Schor cautions that new statistics alone are not the answer.

[Schor:] We need new statistics, without question, but if we got the new statistics tomorrow, it wouldn't have solved the problem. We need a lot more than that. We also need a new set of incentives, we need new awareness, we need new kinds of human behavior, we need new power relationships. Those other things are really fundamental to making new statistics effective.

Still, professor Herman Daly says one needs to start somewhere with correcting these statistics.

[Daly:] This really has nothing to do with green or brown or anything, it is just good economics.

Download transcript as a PDF.

The Economics of Tree Hugging

noreply@blogger.com (Gernot Wagner) — Mon, 02 Feb 2004 04:09:00 +0000

Interview printed in GSAS Bulletin 33 (6), February 2004, Graduate School of Arts and Sciences, Harvard University.

How did you develop your environmental awareness?

Like for most people, it started quite early, with recycling in kindergarten and so on. But the first time I became aware of the interplay of the environment and the economy was in tenth grade in Austria when my English teacher handed me a copy of Al Gore's Earth in the Balance. Basically, it's a manifesto on what we ought to do to save the planet. There was this one paragraph in which he talked about how the most fundamental economic measurement is GDP, and that how we deal with GDP right now is completely at odds with the goal of the environmental community.

In what way?

There's nothing wrong with GDP as a proxy for economic power or economic output. But in many ways, the focus on boosting GDP is contrary to what is important to overall well-being. For example, environmental degradation adds to GDP. If Brazil cuts down its entire rainforest and sells off its trees this year, GDP would jump by an enormous amount because the market value of all those trees gets added to GDP. But nobody subtracts the fact that... those trees are no longer there.

Is green accounting an alternative to GDP?

No, ideally it would supplement our current economic accounts. Again, there's nothing wrong with GDP as a measure for economic output. But in many cases that's not what it is being used for. We use GDP figures as a proxy for how well we are doing as a nation, [as if it is] a proxy for overall well-being or even happiness.

GDP doesn't measure non-market goods and services. That's where the "green accounting" work comes in. I believe most economists would say that [green accounting] doesn't have anything to do with being green or being environmental, or being anti- or pro-industry. It's simply good economics: accounting for all inputs, including our environment. You account for how much labor is out there in the economy. You account for machines and other capital. But one big item missing [from our accounts] is natural capital. Green accountants would argue that, in addition to having capital and labor accounts, there should be accounts for natural capital: timber, subsoil assets, water resources, and clean air.

Where is green accounting being done?

Sadly, it often depends on the initiative of private groups or foundations. There are a few official case studies and some governments, such as the Netherlands or the Philippines, are producing semi-official numbers. But basically no country does it seriously, as in publishing quarterly figures, [and saying] here's our GDP and here's our GDP adjusted for environmental measures.

Why not?

Because of a lack of will and lack of knowledge. Traditional economic accounts haven't been around for that long either. It was actually a Harvard professor, Simon Kuznets, who came up with the theory of how we should measure economic output. That effort in a sense helped pull the US out of the Great Depression. Before that, we didn't know how well we were doing in [terms of] economic output. Kuznets came up with the first accounts, and [output] has been measured ever since.

Unfortunately, governments don't see a similar urgency for greening GDP. Even though in the '50s or '60s Kuznets was one of the first and most vocal advocates in saying, "GDP is good, but use it for measuring economic output and economic output only. Don't use it as a proxy for societal well-being because that's not what it's intended to do."

On a technical level, it's immensely difficult to agree on appropriate measures. Should we just stick to things that you can touch, like forests, coal, oil, natural gas? Or should we also measure open space or clean air? The question is: What do we care about? It gets complicated pretty quickly.

What do you think should be included in the measures?

That's a tough one. Most importantly, we should make sure to create a separate account for [each resource]. If you don't believe in the clean air account, then add up everything else and use that as your measure.

In terms of what should actually be reported, ideally it would be some sort of multidimensional measure. Say, GDP went up by 7.2 percent last quarter. But people are working more and [taking] less vacation; the timber stock is going down; and [the environment is becoming] more polluted. Then you might say [that] economically we are doing better, but everything else is worse, so maybe we should try to scale down our economic activity for a while and try to focus on other factors.

Do you approach your scholarship from an activist's viewpoint?

I wear Birkenstocks, if that counts for anything. But seriously, the question is always: Where can you have the most impact? No matter which topic it is in the environmental movement, your influence stops as soon as economics starts. You can argue for preserving trees [until] it goes against, say, employment and you have real, hard economic data that 100,000 people are going to be out of work because you are trying to save trees. If you're an environmentalist, you have to [ask yourself] am I an environmentalist because I care about trees or because I care about people? I would say I'm an environmentalist because I care about people.

It's tough then to make choices. You can really only make [them] as soon as you actually compare apples to apples. As in, you have hard economic data supporting the fact that you lost 100,000 jobs, so you need hard economic data saying that these trees are actually worth something in real dollar figures. With green accounting, you could determine the economic value of these trees [because] they purify water, provide watershed protection, and produce oxygen. They also have timber value and provide recreational benefits, which you can put a dollar value on.

Some people would say there's a lot of carbon monoxide in the air but it hasn't killed me yet, or we took out ten acres to build a WalMart but I can buy a DVD player for only $29. How do you combat that kind of disdain for environmental and ecological factors?

In the end, it comes down to valuing human life. Economists usually have a tough time selling this, but what they talk about is a statistical life. We would never say one person is worth a million bucks, another is worth two million, and a young and healthy person is worth eight million bucks. You would never say that individually, but statistically we do put a dollar value on human life.

Say one human life in the US, statistically speaking, is worth $3.8 million. How many lives do you save by decreasing carbon monoxide emissions per pound, and how many trees do you need to plant to do that? If you plant a thousand trees to save one life, then every tree's air purification services are worth $3,800.

Do you have a mentor?

I have been fortunate to have Professor Dale Jorgenson as my advisor. He was the first person to introduce me to the academic side of green accounting.

Other professors at Harvard are also working on this issue: Robert Stavins, Bill Clark, David Cutler, and Martin Weitzman, who pretty much started the entire field. He showed that it makes theoretical sense to use comprehensive, annual income figures as a proxy for overall well-being. I'm still trying to understand his latest book on the subject, but once that happens, I'll be knocking on his door again.

Download February 2004 GSAS Bulletin as a PDF.

How Well Are We Doing?

noreply@blogger.com (Gernot Wagner) — Fri, 05 Dec 2003 03:57:00 +0000

New York Times, 4 December 2003, Letter to the Editor, p. A-38.

To the Editor:

I would like to add one more statistic to your "Index of Missing Economic Indicators" (Op-Ed, Nov. 30 ["The Productivity Paradox" and "The Unemployment Myth"]): a true welfare measure. Gross domestic product and its cousin gross national product have long been used as proxies for how well we are doing as a nation, even though they had never been intended for this purpose.

Gross domestic product per capita is a good proxy for economic prowess, but as long as environmental degradation, increased military budgets and other "defensive expenditures" add dollars to the gross domestic product, equating it with societal well-being is woefully misleading.

Gernot Wagner
Cambridge, Mass., Nov. 30, 2003

Der Rest der Welt [German: The Rest of the World]

noreply@blogger.com (Gernot Wagner) — Tue, 01 Apr 2003 13:18:00 +0000

Mein erstes Buch ist im Ueberreuter Verlag erschienen. Wie der Titel vermuten lässt, ist das Ganze leider nicht allzu ernst zu nehmen: Der Rest der Welt: Ein Reiseführer für überzeugte Daheimbleiber. Mehr dazu auf der Seite zum Buch.

Waaaahhhh? Inglés anybody? Since you asked for it: I wrote a book. It's in German, but it got its own English web page.

Interpreting Sustainability in Economic Terms: Dynamic Efficiency Plus Intergenerational Equity

noreply@blogger.com (Gernot Wagner) — Fri, 28 Mar 2003 06:08:00 +0000

Economics Letters 79 (2003): 339-343. With Robert N. Stavins and Alexander F. Wagner.

This paper tries to lay out the possible contributions of economics to the interdisciplinary debate on sustainability. Economists have long confined the concept of sustainability to allocation decisions across generations. Instead, we argue that any reasonable definition of sustainability should also include the idea of optimality. We cannot use sustainability as the sole policy criterion, if it does not also imply efficiency.

This definition has another advantage. It would enable economists to be humble and play to their main strength. Economics is much better equipped for dealing with efficiency than equity. This, of course, is not a value judgement about the importance of efficiency versus equity. Equity is at least as important as efficiency, but it is best left to the political process.

Abstract: Economists have confined the concept of "sustainability" to intertemporal distributional equity. We propose a broader definition, combining dynamic efficiency and intergenerational equity, and relate it to two concepts from neoclassical economics: potential Pareto-improvements and inter-personal compensation.

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Global Goals: NPR Commentary on the Parallels between the Kyoto Protocol and Soccer

noreply@blogger.com (Gernot Wagner) — Sat, 08 Jun 2002 02:47:00 +0000

[Curwood:] Most of the world's nations are enthusiast about it, except the United States. Europeans support it, despite exorbitant costs to their economies. Some governments use it for political gain. And Japan seems to be signing on only for the prestige. We're not talking about the Kyoto Protocol on global warming. No, it's World Cup Soccer, underway in Japan and South Korea this month. As commentator Gernot Wagner explains, there are a few parallels between the world's favorite environmental issue and its favorite pastime.

[Wagner:] After last July's decisive global warming summit in Bonn, the New York Times ran the following headline: "178 nations reach a climate accord; U.S. only looks on." And so goes it for soccer. Billions of people around the planet will tune in the World Cup on TV this month. Only a fraction of them will be in the U.S. Even though at the grassroots level, soccer is a popular sport here. More than seven million youngsters in the U.S. play on soccer teams. Only five million kids play organized baseball.

When you poll most Americans, they'll tell you that climate change is a real and serious problem. But don't mention giving up SUVs or paying higher gas prices. Sacrificing is out of the picture.

It's okay to have kids play the game at the park down the street. But ask TV executives to do without the ads that constantly interrupt U.S. sporting events, and you might be asking too much. Soccer has only one break during its 90-minute run.

On the other hand, consider this parallel between soccer and Kyoto. The U.S. has a knack for developing niche markets that often make sense, but go largely ignored by the rest of the world. For example, the U.S. has long insisted on using market-based mechanisms like emissions trading to cut greenhouse gases. Despite problems with global equity considerations, these trading schemes are a powerful tool in the fight against climate change. In soccer, the U.S. niche is the women's game. As reigning world champions, women's soccer is extremely popular in the States, but is often ignored -- even laughed at -- overseas.

Meanwhile, Japan plays a role on the stage of apparent contradictions. Its upper house of parliament unanimously ratified the Kyoto Protocol a few days ago. But overall, the nation's support for the treaty has been less than enthusiastic. You might say the same about soccer in Japan where baseball players and sumo wrestlers, rather than goalies and strikers, are the heroes. Still, Japan is pouring tons of money into the World Cup, nearly $5 billion alone on new stadiums, which will likely go belly-up when the game is over.

And finally, there are the Europeans. Many EU nations are blindly supporting the Kyoto Protocol, despite predictions of exorbitant costs to their economies. And today, they are paying for the World Cup, too. In Europe, the games air live in the morning through early afternoon. Not surprisingly, when labor statistics are tallied for June, sick days will be up and worker productivity down.

But for those seeking convergence of the parallel worlds of soccer and climate politics, there was encouraging news this week. First, the world was stunned when the White House admitted that global warming was real and humans were the cause of it. A few days later, the world was shocked again when the underdog U.S. soccer team beat fifth-ranked Portugal, sparking a wave of soccer fever here. So perhaps, in soccer and climate politics, parallel lines can one day meet.

[Curwood:] Commentator Gernot Wagner is Living on Earth's occasional webmaster, a recent Harvard grad, and he's pulling for Brazil to take the Cup.

Living on Earth, 7 June 2002, National Public Radio's Environmental News Show, hosted by Steve Curwood.

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