Below the fold, I sketch the rational expectations view of how climate change adaptation unfolds in an economy populated with self interested, forward looking decision makers. Â If government invests in local public goods such as Sea Walls then firms and households will re-optimize accordingly. Â If you are interested in the “multiple equilibria” Â introduced by government choosing whether to build Sea Walls (and it is more likely to if it believes that more people will live in the at risk area) as a function of how many people live in the affected area (and more will if they expect that Sea Walls will be built) then read this paper.
Self interested people have an incentive to form their best guesses about the probabilities and impacts of different future scenarios.  Climate change poses some trouble here because it creates a “non-stationarity” in the sense that the random variables (the impacts of climate change) have means and standard deviations that change over time.   Intuitively, how do you plan to hit a moving target?   If the bullseye target never moves, where your darts land is still a random variable but you know how to practice.  How do we adapt as the target moves?   Professor Rumsfeld has taught us that when you “know that you don’t know” what to expect, the prudent person builds some slack into their decision so that they don’t regret their choice some time in the future.
With this background, let’s consider two pieces in today’s NY Times. Â First, we hear from the President of Tulane University. Â Universities are place based and his University is in New Orleans. He has strong incentives to argue that his University (which was horribly injured by Katrina) is back and is robust in the face of the next storm.
To the Editor:
Orrin H. Pilkey (“We Need to Retreat From the Beach,†Op-Ed, Nov. 15) makes what appears to be a reasonable argument against rebuilding shorelines or homes near the beach destroyed by Hurricane Sandy. Unfortunately, this is reminiscent of what New Orleanians heard after Hurricane Katrina: Why rebuild New Orleans, because it will always be prone to flooding?
Since when did our country develop a standard that we abandon places prone to repeat disasters? People live in danger zones knowing that danger may strike again: San Francisco sits on a fault line, much of New Orleans is built below sea level, and the Eastern seaboard is a flood zone.
In every case, community feeling and the attachment to home has trumped scientific facts and urban planning.
The “resilient development†Mr. Pilkey refers to as a less good alternative to “retreat†can work. New Orleans and neighborhoods like the Lower Ninth Ward exist today because of significant improvements in their flood protection system, proving that the art of the possible can work.
SCOTT COWEN
President, Tulane University
New Orleans, Nov. 19, 2012
In my Climatopolis, I argue that it is fine for New Orleans to rebuild if the investors there use their own $.  President Cowen forgets that billions of federal tax payer dollars were used to rebuild his University’s city.  That’s bad incentives.
Note that at the end of his letter he engages in some public relations to signal to outsiders that New Orleans is now safe. I hope he is right.
A more salient and optimistic example of rational expectations is provided in this piece .  The boss of this firm was prudent enough to build his key floors 4 feet higher to reduce flood risk.  Here is a quote that highlights how we will adapt to climate change:
“But the real storm preparations had been accomplished six years earlier, when Sims Metal Management approved a design for a state-of-the-art city recycling plant that is rising at the South Brooklyn Marine Terminal.
Reviewing projections for local sea-level rise, the company and its architects decided to elevate portions of the site to heights exceeding city requirements by four feet. Using recycled glass and crushed rock discarded from projects like the Second Avenue subway line, they raised the foundation for the plant’s four buildings and a dock.
The fill added $550,000 to the plant’s costs of around $100 million, said Thomas Outerbridge, Sims Metal’s general manager.
But it proved more than worth it. When a 12-foot storm surge swept through nearby streets and parking lots on Oct. 29, the plant’s dock and partly completed buildings did not flood.
“It paid for itself long before we expected it,†Mr. Outerbridge said. “It was built with the idea that, over the next 40 years, this would prove a prudent thing — and the proof came during construction.â€
This case study highlights the key adaptation recipe. Â Note that if we are “behavioral agents” who do not engage in forward planning then we have a problem. Â Such individuals will not have taken the precautions that Sims Metal Management took. Â This point has not been discussed by academic economists but in my Climatopolis I argued that climate change planning poses the ultimate test for distinguishing whether neo-classical economists or behavioral economists have the right model of predicting human behavior. Â The “doom and gloomers” embrace both a behavioral economics view of individual rationality and a benevolent paternalistic view of government. Â That’s quite a statement.
How do the neoclassical decision-makers decide rationally whether the governments of the world will finally act to reduce the risk by aggressive mitigation?
For an example of a non-mythical paternalist government doing so, see here. Not enough perhaps; but if there´s one thing that central planners get wrong, it´s the impact of (policy-driven) scale on prices and the resulting market-driven tipping-points. Renewable energy in China is outracing these ambitious targets. Aussie expert Ross Garnaut says pungently that ¨in China thermal coal is in deep s**t¨.
If Sandy had come in with a bigger surge, the recycling plant would have flooded anyway and Matthew could be pointing to its management as an example of bad decision-making.
Here´s the six-year rolling list for North Atlantic tropical storms, to 2017, when it will start again, minus the monsters whose names are retired. Which one will be much bigger than Sandy?
The more I read the work of cognitive psychologists and others who study the human brain and resultant behavior, the less compelling I find phrases such as ‘rational decision-making’.
I´m puzzled by Matthew´s assertion that ¨if we are “behavioral agents†who do not engage in forward planning then we have a problem.¨ Since when does behavioural economics as practiced by say Akerlof and Kahneman treat humans as dumb Pavlovian stimulus-response machines? I thought their idea was to take our solidly established cognitive biases, and/or our necessarily limited (and unequal) information, seriously, and build forward-looking models closer to reality than ratex. The Cassandra problem is that these theories predict the massive market failures we observe.
I mostly was thinking of Kahneman when I wrote that first comment, as the last book I read on the subject was his Thinking, Fast and Slow. I’m not sure he explicitly advocates for forward-thinking models in the book, but rather explains the brain’s thinking constructs and how we need to understand its limitations. It argues somewhat differently than Eli’s comment below but comes to some of the same conclusions - making Matt’s old-school models problematic.
In my Climatopolis, I argue that it is fine for New Orleans to rebuild if the investors there use their own $. President Cowen forgets that billions of federal tax payer dollars were used to rebuild his University’s city. That’s bad incentives.
There’s plenty of blame to go around in the Katrina disaster, but a big chunk certainly goes to the Army Corps of Engineers.
And for the umpteenth time, I will point out that to the extent storm damage is due to climate change, it’s reasonable to make those who contribute to climate change help pay the costs. Saying the costs have to borne solely by the victims sets up some pretty bad incentives also.
Does that make sense?
Who is the rational decisionmaker in the Sims case? The climatologists who gave predictions covering a range of possibilities? The engineers who beleived them? The finance people who approved the extra $650k? The insurnace people who might lower the premiums after the event showed the plant was les liable to flooding? What happens if the various players who supply roads, rail, shipping, power and labour to the Sims plant do not reach similar conclusions, or are unable to implement different arrangements due to different institutional circumstances, are affected, and the plant sits high, dry and unusable? To whom should we attribute that outcome? Rationality is these circumstances is problematic; individual decision-making even more so.
“Professor Rumsfeld has taught us that when you “know that you don’t know†what to expect, the prudent person builds some slack into their decision so that they don’t regret their choice some time in the future.”
Um, just to help you out on that whole reality-based thing, Rumsfeld did not do that; he proceeded blithely to f*ck things up.
Humans are incredibly irrational decision makers. Assuming they are not underlies our greatest tendencies to apologize for inequality and injustice. We tell ourselves, “It is their own fault. They could have done differently. They made a rational choice.” Yet again and again, we see that people do not. Any businessman who has ever depended on advertising knows this well. Any politician who has calculated his message knows this. Any one who has struggled with diet, a budget, or quitting smoking knows this.
The problem is that it is near impossible to understand the irrational drivers of our own behavior. With great work, we can find ways to counteract this irrationality, but it is largely in the darkness that we work. God knows what it is that is driving you to take that bite of the fattening donut. Your bad childhood? The time you spent reading Zorba the Greek? An impulsive temperament? All the brain research and psychology that exists can only give us the faintest hints. The fact is that the causal mechanisms at work in any given second, when each of our billions of neurons involved in the choice is firing off with its 7000 connections, making up the entirety of consciousness and unconsciousness, is unfathomable.
We learn to counteract the irrationality, in order to supposedly act more rationally. Yet are we really acting more rationally, or have we simply been able to design habits for ourselves that have out-maneuvered the negative impulses? “Rationality” is merely shorthand for *choosing the correct option*.
In a fundamental way, society can be thought of as a vast, evolving system of habit formation. At the individual level, we feel very rational and “in control”. But at the macro level, patterns emerge that tell a very different story. Instead of individual, rational actors we see the products of systems such as family, peer relations, education, government, and social norms that conspire to design not only an individual’s ability to make correct choices, but - more foundational still - an individual’s ability to design for himself the ability to make correct choices. Thus, the choice as whether to eat the donut or not is dependent not only on an individual’s choice, but the individual’s prior ability to have designed for himself the ability to make that choice. For instance, after week three of having successfully fought the 8am donut cravings, the choice to not eat the donut will be far easier than it was on day one. (I’m not actually hip to diet design, but you get my point: successful routines for habit formation are successful because they are routines, not individual, isolated choices).
So, does this mean that no one ever ought be held accountable? Should we all get to make base, easy, immediately gratifying decisions with no concern for external effects, with the excuse that we had no control? This is generally the first response many have to the argument I have presented. Yet this is a case in which patient, nuanced thinking is called for! If you will recall, I spoke of the element of social design in individual decision-making. Just as we would set for ourselves a course of habit formation that we hope will bring about correct decisions, so too we set for society a course of policy that we hope will bring about correct social behavior. So too we design our formal and informal social institutions. The idea is to look ahead and put in place systems that we hope will flourish. This utilitarianism makes the question of blame somewhat irrelevant. Policies ought be designed that foster, through the mechanics of incentives, social good.
If the question was mere utility, it could be answered by either side of the aisle. It could mean lowering taxes on the “job-creators”, harsh sentencing for criminals, or letting residents in low-lying areas suffer rising tides without assistance - the right-wing model. Or it could mean a more left wing emphasis on the benefits of redistribution, leniency, or shared burdens. To the extent that these are subjective, evidence based controversies, the chips will fall where they will.
But what is removed from the equation is the moral posturing that has traditionally been wrapped up in left vs. right politics: no one is to blame. So, even if we will all benefit from “job-creators” getting tax breaks, they are not inherently morally superior by their good works. They have merely been the recipients of social circumstance that have allowed them - being in the right place at the right time - to do good things. We can argue until the cows come home about the extent to which their work is actually good, and how much money is the right incentive for them to continue whatever it is they are doing. But in the end, they are products of *us*, as the saying might go, “we built them”.
And so too did we build those who, at the other end of the spectrum, we now see are playing out what society has designed for them in the form of irrational, self-indulgent or poorly-planned behavior. We can also argue about the extent to which these people’s behavior is all that bad, or whether by circumstance it appears so (the “negligent mother” may indeed be working two jobs and thus have no ability to look after her delinquent son). But regardless, again, “we built them”. So when designing policies that, in the interest of deterrence, or disincentivization, will create hardship (or refrain from lessening it) on individuals caught in such a tangled web of causality, we must admit that, as they are not the originators of their actions, rather society is to blame, their hardship is a form of Earthly purgatory.
It may allow us to sleep easier at night believing that the many who suffer do so at their own choice. But it is a convenient fiction.
I confess much of this argument is aimed squarely at the right, who though at times concede some degree of social determinism, generally downplay it, if not deny it completely. After all, who then, if not government is going to help enfranchise those whom society has failed to give an equal design? The utilitarian case for less government action is rather weak. And, more noticeably, a great portion of right-wing framing is not utilitarian at all, but rather a direct appeal to an assumed agency (“I built it”), or merely a sense of unfairness at the notion of social design - redistribution is unfair because well, “I built it”. The truth is that, were government indeed pared down to only its most basic elements, poverty and class-mobility would not suddenly cease, or even diminish. The supposed moral hazard in provision of social services, or even such things as student loan forgiveness - as former candidate Romney complained about - is a convenient excuse for a callousness that comes from not seeing individuals as determined by social design, whose ability to make rational choices is constrained by a prior ability to develop in themselves this ability, and so on, outwards into the fabric of socialization.
So I’m all for utilitarian incentives. But when their effect is serious hardship in the lives of real people, we must ask ourselves if there was not another, better way to have both incentivized good choices, without having allowed such trauma to have occurred.