Reactions on the ECF Annual Conference 2010
The Volterra Approach
This is the theme of the conference of the European Climate Forum www.european-climate-forum.net this year. Listening to the speeches I am struck by the parallels in analysis between thinking about the impact of climate change and that of infrastructure.
First, we have the scientists. Climate modellers talked about the difficulty of building models that properly incorporated short term natural cycles in order to identify the longer term effects as well as the challenge of separating out local climate effects which are also distinct from large scale impacts. This debate is entirely similar to that about the effectiveness of models of the economy. Most macroeconomic models are concentrated on identifying the prospects for the next five years, and are based on data only since the Second World War. Yet at the same time they are based on equilibrium behaviour which is highly unlikely to be observed in the short term (possibly also the long term but that is the next paragraph). Like climate models, they are imperfect, and like climate models, the pressure to provide the policy outputs militates against model development and strongly against admitting imperfection, data problems or errors.
Second, we have the impact analysts. Many speakers focussed on the distinction between mitigation and adaptation. This raises a debate about economic dynamics which is pretty much absent from the models. A reliance on equilibrium focussed models lies behind the kind of analysis provided by Stern, which shows a long term steady state growth of the world economy which happens anyway and thus gives a small cost to investment in climate change mitigation. In other words, the economy grows and investment happens regardless. The same approach lies behind the difficulty in showing that infrastructure projects generate real additional growth – since the models also show that growth happens anyway. In both infrastructure and climate change models there are too few linkages between investment choices, technologies and growth rates. Thus the baselines have too many assumptions built into them which mean that the real impacts of either cannot be properly evaluated.
Third, this leads to the question of project and investment finance. Finance is the elephant in the room in both topics. In climate change, investments either to mitigate or adapt are seen as a cost. Yet analysis of, for example, the coastal cities, shows that creating flood defences has a significant payback in protecting growth prospects, when the dynamics are separately considered. A dynamic analysis of renewable power projects in Germany shows that it creates added value and added jobs – and thus an ability to raise the funds to create the investment. Finance for investment has to be raised from somewhere. It can come from the taxpayer, whose ability to insist on a payback is rather limited, but whose ability to pay is also in the end limited. Or it can come from savers through the investment funds and pension funds where this money is put. Savers need to get something back for what they put in and they need to be sure that the money will be there. In large regulated investments, which is what infrastructure and climate change projects generally are, this means that government must allocate the returns from these investments to the projects, rather than seeing the returns as coming from the general activity of the economy.
In the UK, it is government practice to ask whether an activity creates additionality or not. The stronger the belief in the underlying equilibrium growth or the economy, the harder it is to show that anything will be additional. This applies both to an infrastructure project and to climate change mitigation projects. Both require spending – transport systems, power systems for example – and both have payback in fares, fees and economic growth. That economic growth needs to be better recognised if we are to raise the funds to make these investments.
Large projects have implications which change the terms on which the economy operates. Such projects are those which drive economic growth and those which are largely exogenous to models – even those which purport to make technical change endogenous. They change the structure of relative prices, and work through the networks of connections by which innovation can occur. Understanding this is key to deciding on investments and needs to be better appreciated by those who are still captured by a now out of date of economic model.
Read more: http://www.volterraapproach.blogspot.com/