# Global warming is a largescale problem

Global warming is a difficult problem to cope with politically because its footprint is so large. It is a global problem, subject to an effect known as the Tragedy of the Commons. An example of this effect is of a field for grazing sheep used in common by all residents of a village. Let's say that each new sheep added to the flock decreases the harvestable weight of each of the other cute little sheep by 10% (Fig. 13.1). A farmer with one sheep can add a second, doubling his number of sheep. But the result is that all sheep, including the farmer's, lose 10% of their harvestable weight (denoted as "lambchops" in Fig. 13.1). Each will provide 0.9 times as many lambchops as the original sheep did, so the farmer will now own the equivalent of 1.8 of the original sized sheep. Our farmer is better off than when he had only one sheep, while all the rest of the farmers lose 10% of their prior sheep stock.

Total lambchops

Fig. 13.1 The tragedy of the commons demonstrated in a totally made-up story about sheep.

Total lambchops

Fig. 13.1 The tragedy of the commons demonstrated in a totally made-up story about sheep.

In this particular example, there is an overall optimum number of sheep to graze on the common, that will result in the greatest overall number of lambchops. That optimum number of sheep turns out to be about six. If we compute the self-interest of our individual farmer now, let's assume he has one of the six already. The farmer's sheep is worth 0.5 lambchops at this sheep density. Our farmer buys one more, and in the end has two sheep that will each produce 0.4 lambchops, for a total of 0.8 lambchops. It turns out to be in the farmer's self-interest to add sheep, up until there are nine sheep on the yard.

The point is that each farmer's personal best interest is served by grazing as many sheep as he can afford, in spite of the damage to the field. This results in a tendency to overgraze the field. From each farmer's point of view, the other villagers are all also overgrazing the common yard, so his own personal sacrifice, to preserve the common, would be in vain anyhow, and would put his family at a disadvantage. The end result is far more sheep than can be most efficiently supported on the common, decreasing the net yield of sheep in total. Everyone might be better off if they backed off a little bit and cooperated.

There are two potential approaches to preserving the common space. One is to divide it up and assign property rights to individuals. In this case, each individual would have the incentive to preserve the field by not overgrazing because that individual would directly benefit from careful stewardship.

However, for our example of land stewardship, private ownership is not a universal environmental panacea because some element of commonality remains. The aquifer holding water underneath the ground may be overtapped, or soils may be depleted throughout the lifetime of the individual (a sort of commons over time). For fisheries, the ownership society system has holes in it because fish swim around. For the case of global warming, dividing the atmosphere up into parcels is impossible by the nature of the problem. The other potential solution is for some form of collective self-regulation (see Negotiations section).

The decisions made by a single individual are often irrational, and therefore not really well described by economic theory. The collective decisions made by whole societies of individuals, in contrast, often exhibit great sagacity. Economics aficionados speak with reverence of the market, economist Adam Smith's "invisible hand." The market with its law of supply and demand is a negative feedback system, just like the many natural examples in Chapter 7.

However, the market has its blind spots, leading to effects like the tragedy of the commons. In economics, a cost that is not paid by the decision maker is called an external cost. An example of an external cost associated with driving to work is the traffic. One more car will tend to slow down all the other cars on the road, costing other drivers their time. The cost of climate change is not only paid by people who are responsible, but by everybody, soon and far into the future. Our sheep farmer made the other farmers pay part of the cost of his new sheep. If true costs are left external, then the economic balancing act of the market does not take them into account, and tragedies of the commons are the result. An external cost can be internalized by means of taxes or regulations. The idea is to make the market aware of the true cost of a decision to take this path versus that path.

One way to harness the balancing abilities of the market for preventing global warming is a scheme called cap and trade. A regulatory agency allocates permits for emission of climate forcing agents such as CO2, with the total number of permits they issue totaling some lower overall rate of emission than BAU (climate geek speak for business-as-usual). If a company or a country is able to cut its emissions to even lower than its allocation, it has the right to sell its permit to another company or country. The price of the permits is set by supply and demand, same as any other commodity. Presumably the industry for which it is most expensive to reduce emissions would be willing to pay the most for the emission permits. It will induce other industries to reduce their emissions because they can make money doing it, selling their permits to the highest bidder.

In this way, the market finds the most efficient, that is to say the cheapest, means of limiting global CO2 emissions to the cap value. A cap-and-trade scheme in the US for sulfur emissions (generating acid rain) from power plants has apparently worked well. The difficulty with cap and trade for a regional problem like acid rain is that it may allow all the pollution to concentrate in one region, which may be too much for that region. CO2 is a truly global problem, in contrast, and it makes no difference where the CO2 is released, so CO2 emissions would be an ideal problem for limitation by cap and trade.

The market may influence the global warming debate through the insurance industry. We saw in Chapter 12 the huge increase in insurance payout to cover atmospheric-related natural disasters. It is not at all clear to what extent this trend is due to climate or to social factors, but the insurance industry is certainly concerned about the possibility of climate change affecting their bottom line. Insurance companies have been responsible for other preventative measures such as requirements for hard hats on construction sites.

Pollution problems get more difficult to solve, politically, as their footprints expand from regional to global, because of the commons effect. Local issues like contaminated drinking water or urban smog are clearly in the interests of local individuals to solve. You fix it same as you would fix the roof over your head. A clear link exists between the costs of cleaning up and the benefits. Larger-scale, regional problems tend to run into us-versus-them issues. Why should the state of Ohio sacrifice its right to burn high-sulfur coal when the costs of that consumption are paid by the folks in New York? Why should power plants in Chicago pay to clean up their mercury emissions when most of the mercury emission to the atmosphere comes from China? At the most difficult, worst end of this problem, global warming is the most global of issues, the most complicated type to solve.

Global warming is also a difficult issue to address because it is long term. Values need to be related not only from one place to another, but also across time. The way that economists deal with values across time is via a construct known as a discount rate. The idea is based on a question: which would an individual prefer, a cost today or a cost in the future? A cost in the future, certainly, would be the natural response. A rational reason to justify that choice is that one could invest money today and use the interest to help pay the costs in the future. If we were to assume an interest rate of say 3% per year, we could pay a cost of \$100 in 100 years by investing \$5 today (Fig. 13.2). It would be worth paying \$4 today to avoid a \$100 cost in 100 years, but it would not be worth paying \$6 today. The bottom line of this idea is that costs tend to shrink with time.

Of course, the idea of anybody actually going out and opening a bank account with \$5 in it, to save for that cost in 100 years, seems rather quaint. However, economic theory is more than just a prescription for how one could rationally make the most of one's assets; it is also a description of how money tends to flow in our society. The discount rate theory illustrates why financial decisions made by the market tend to be somewhat short-sighted. It's a description of the way money flows. Water flows downhill. Money flows short term.

Years in the future

Fig. 13.2 The discount rate and future costs. How much would it be worth, today, to avoid a cost of \$100 at some point in the future, assuming a 3% discount rate?

### Years in the future

Fig. 13.2 The discount rate and future costs. How much would it be worth, today, to avoid a cost of \$100 at some point in the future, assuming a 3% discount rate?