Keynes, Hayek and Global Warming

Jo Nova points to the excellent Keynes versus Hayek rap videos and compares with global warming views. My own observations are more to do with the nature of theory.

To compare Keynes & Hayek, I believe that we need to separate Keynes from the mainstream Keynesians. Keynes saw theory as a means to get the policy he wanted. It was the Keynesians (starting with John Hicks’ IS-LM analysis) that started the modelling approach. Both Keynes and Hayek eschewed the mathematical modelling of modern economics. In this Keynes would be closer to the perspective of GLS Shackle than Keynesians

  1. Keynes saw the economic system as being essentially unstable. There was no tendency for the economic system to tend towards an optimal equilibrium. Rather it could get stuck for long periods with high unemployment. This seems to parallel to the notion of tipping points. The Keynesian multiplier The parallel in CAGW theory can be seen in the positive feedbacks and tipping points. When Bob Carter says that climate is homeostatic (or Warren Meyer at climate-skeptic uses his ball in a bowl illustration), they criticize the climate models for being Keynesian. I would think that the Carter/Meyer view of climate is similar to that of Hayek on economic phenomena. Climate is essentially chaotic, having only general empirical regularities. However, it has tendencies towards equilibrium. Please note that Hayek occupies a position close to Keynes this issue. Walrasian General Equilibrium with perfect knowledge and instantaneous leaps from one equilibrium to another is an extreme caricature of more mainstream economics. Here Keynes v. Hayek is more apt for the views on climate.
  2. Keynesians view all the essential features of the economic system as being essentially knowable, capable of being reasonably represented in mathematical models. Hayek calls this a “pretence of knowledge” (the title of his Nobel Prize lecture), as although we may know essential features of the system, the relationships are highly complex and changing. The problem is not just lack of measurement, it is having data that is capable of being modelled in order make manipulation of these variables possible. In economics, the manipulation is control of macro economy. In climate, it is to control the global average temperature.
  3. Keynesians believe that a few major measures are sufficient to describe an economy. CAGW theorists believe that the global surface temperature and atmospheric CO2 are key measures. Hayek questioned whether such variables were meaningful. CAGW theorists are on much shakier ground than the Keynesians here. Bob Carter points out in his book that the stored heat in the atmosphere is a tiny fraction of that stored in the oceans. When it comes to stored CO2 the problems are even greater.

But when it comes to the rhetoric of global warming, the analogy should not be with Keynes, but with Karl Marx. Climate models give true scientists perfect insight into the real nature of climate. Those who are on the outside are delusional and/or are either knowingly, or subconsciously, acting as lackeys of the oppressive class. In Marx the oppressive class are the bourgeois, in climate alarmism they are Big Oil.

Limits of an Economists Policy Tool Kit

Tim Worstall on the ASI Blog looks at the robust economic tools that are available to control externalities. Here I enlarge on a blog comment looking the limits of these tools in combating climate change.

Although economic solutions may be “hugely cheaper than the sort of command and control systems”, that does not mean they are a solution in every circumstance. In the area of climate change mitigation there are four practical areas where such solutions may have higher costs than the original problem.

  1. The economic policy is applied too far. The benefit to cost ratios will fall the greater the desired change. A 1% reduction in CO2 can be achieved, ceteris paribus, by economic solutions at a benefit to cost ratio of much greater than 1. The costs will rise exponentially after that, so for a given state of technology, the ratio will quickly reduce to less than one. This is the implication of Richard Tol’s 2010 paper “An Analysis of Mitigation as a Response to Climate Change” (2.5MB pdf). Looking at various scenarios, reducing the total amount spent on climate change mitigation from $2.5 trillion to a twentieth of the size increases the benefit to cost ratio from 1/100 to 3/2. I try to graph this here.
  2. Any Cap and trade or Carbon taxes will not be implemented in their purest form. Public Choice theory (or practical examples) will predict that special interest groups will seek to maximize their returns. Those businesses that will be harmed will seek to reduce the effectiveness. Those who can make easy gains (and thus have permits to sell) along with any potential administrators of the scheme will be keen to promote it. There is a long policy chain linking the pure theory and the final outcomes. These various levels of policy formulation and implementation diminish the benefit / cost ratio as I attempt to outline here.
  3. Scheme avoidance. For either a carbon tax or a carbon trading scheme, if there is competition from those outside the area of the scheme that is not proportionately shared by all emitters, then those facing the competition will have the gravest effect on their business. For instance both the steel industry and fossil-fuel power stations are huge CO2 emitters. The European steel firm cannot pass on the cost of the permits to its customers, as it is competing with firms in emerging economies with little or no carbon-trading. A British coal or oil power station does not have this competition, and its main competition comes from the more expensive nuclear power stations, the less reliable wind and the finite hydro-power stations. In the short-term it can pass on the costs. Protectionism is not a solution as it imposes extra costs.
  4. The more encompassing a cap and trade scheme, the greater the number of participants and the complexity. The greater of severity of the scheme, the greater the potential economic gains and losses. Combine these two areas and you create large potential gains from out-right corruption, or engineering biases through the political system, or having unidentified inefficiencies.


    The economic tools might be quite powerful and robust, but put into the hands of inexpert users can create a lot of harm. A bit like a hot-hatch in the hands of 17-year-old trying to impress his mates on a night out.

NICE Supports Big Business Profits at Expense of Consumers

The impact health watchdog NICE, consisting of non-economists, should be aware of a couple of points of economics when they propose a minimum price for alcohol. (Times and BBC)

First, alcohol is inelastic with respect to price. This is why, like tobacco and petrol, there can be such huge taxes with very little impact on consumption. In particular, those dependent on alcohol, like those dependent on class A drugs will absorb the price hike by reducing expenditure on other things (food and clothes for the children), rather than reduce consumption.

Second, the minimum price would raise the price of all alcohol, with the impact of squeezing shifting demand away from the cheapest varieties. Those who buy premium beers and £5 a bottle wine will see the price of their tipple rise, though maybe not quite as much a the white cider and the cheapest plonk. It is only the drinkers of 25 year old malt, first estate Chateaux Laffite and the older vintages of champagne and port who may not notice the difference.

Third, is to combine these two factors and see who gains. Consumption overall will drop very slightly, but the profit margins on 95% of the market will increase substantially, with the worst of the cut-throat competition eliminated. Add to that proposed restrictions of advertising, that will eliminate potential competition and the biggest gainers will be the retailers and the drinks companies. The losers will be the 99% of consumers who do not reduce total spend on alcohol.

Excessive alcohol consumption is a cultural, not an economic problem. From 1900 to 1930 consumption fell by 70% due to two factors – the temperance movement and the elimination of young men, the heaviest drinkers, in the Great War. It is only by a cultural change that consumption will fall. See my earlier posting here. A small change in price will not save thousands of lives per year. Any economic model that predicts this is flawed.

Inflation – How NOT to eradicate the deficit.

Nobel Laureate Paul Krugman makes a sensible comparison of the debt crisis in Britain with Greece in the New York Times.

His major error to say that an advantage for Britain of retaining its own currency is in possessing the ability to reduce its real debt levels through inflation. However, to do so could be quite dangerous for the economic health of Britain for two reasons linked to a simple fact. Nominal interest rates tend to follow inflation so real interest rates tend not to be negative for long.

1. Borrowing for house purchase tends to be on variable interest mortgages. Fix rate mortgages are uncommon. Assume inflation rose to 10% (halving the real value of debt every 7 years). People would, in the short-term see monthly repayments more than double. My own monthly repayment mortgage (lower than average) would go up from 20% of income to 50%. The impact would cause house prices to fall again and consumer spending to plummet. So far the UK has avoided the house price crash of the 1990 to 1992, when tens of thousands of homes were repossessed. Mortgage debt is relatively higher now than then.

2. If inflation took off before the deficit was much reduced, the average rate of interest on the national debt would increase rapidly. This could mean in the short term the real cost of interest payments could increase, increasing the primary surplus. Further, the experience in Britain both in the late 1980s and mid 1990s is that after inflation, real interest rates remain high for a long period.

Possessing a constraint is a positive advantage of the euro. However it is only feasible if member nations had stuck to the original rule of maintaining the government deficit to less than 3% of GDP. However, it did not work without an additional rule – to keep the budget in a small surplus when the economy was at, or above, the long-term growth rate of the economy – the project was bound to fail in a deep recession.

Hopi Sen is aggrieved, with a slight justification, that Paul Krugman makes similar points to his post of a day before.