KEN HENRY. The political economy of climate change

Myopia, loss aversion and free-rider problems undermine the provision of public goods, including global public goods like climate change mitigation.  It’s easy to understand why climate policy has been a failure in Australia.    But what happens when the central case of long-term projections, something outside of the bounds of what has been considered probable in the near-term, comes crashing into the present?  That’s what our politicians were dealing with through 2006, following several years of drought.  Eventually, entrenched positions were abandoned.  Could we see this happen again?

Just over ten years ago the Australian Parliament rejected for a second time the Rudd Government’s Carbon Pollution Reduction Scheme (CPRS) and the Liberal Party changed leader to Tony Abbott, bringing to an end a 2 ½ year period in which all major Australian political parties supported world’s best climate change mitigation policy.

The Howard Government had been reluctant to embrace emissions trading.  It wasn’t until late in 2006 that Prime Minister Howard accepted that an increasingly complex patch-work of ad hoc interventions would not satisfy public concerns about climate change, eventually commissioning a Task Group report on an emissions trading scheme.  The core recommendations of that report were accepted by the Coalition Government mid-2007, a few months before the election that brought Labor to power.

What lessons does this earlier period have for the present?

Humans have a tendency to overweight the short-term, heavily discounting, even ignoring, longer-term consequences.  This behavioural bias is usually labeled ‘myopia’.  Humans are also prone to over-valuing costs relative to benefits, a behavioural bias labeled ‘loss aversion’.  Because of myopia and loss aversion, human decisions are frequently not rational.

Governments are also prone to short-term decision-making, and overvaluing costs relative to benefits.  But this can be rational for people elected for a parliamentary term of only a few years, directly accountable to myopic voters having to deal with the pressing day-to-day cost of living.  Why would it make sense to expend energy, and political capital, dealing with a problem that is not even on the radar of the electorate, or which is considered unlikely to have a significant impact on the general quality of life for some decades to come?

It is rare for democratically elected governments to identify distant problems for near-term action.  The ‘burning platform’ narrative, constructed on Paul Keating’s 1986 banana republic warning, provides one case study.  The narrative anticipated a substantial deterioration in the quality of life.  Even though that projection might, realistically, have applied to generations beyond those then voting, the narrative was sufficiently powerful to motivate an ambitious program of policy reforms.  The banana republic warning resonates even today, notably in intransigent attitudes to budget deficits.

Another government-initiated warning came at the end of the reform period, with the publication of the first intergenerational report, in 2002.  That report, and its successors published in 2007, 2010 and 2015, was intended to motivate policy effort to lift productivity and workforce participation.  But the narrative constructed on the intergenerational reports has not been successful.  One plausible reason is that it has avoided ‘burning platform’ language, consistently describing challenges emerging over a 40 year time horizon.  The Australian National Outlook report, released earlier this year, has a similar posture, seeking to inform people of long run challenges and opportunities, again over a 40 year projection period, rather than sounding the alarm with the threat of crisis.

Climate change provides another case study.  Last century, policy makers all over the world became aware of projections by climate scientists that suggested that our quality of life could not be sustained without considerable behavioural change, and that a failure to change behaviour dramatically would probably have devastating consequences for the physical environment and for human welfare.  Climate science projections typically involve a time-scale of a century or more.  And while the ‘central case’ is always alarming, most projections provide a wide range of plausible outcomes.

All policy proposals to mitigate climate change involve relatively certain short-term costs in return for considerably less certain, and very distant, future benefits.   Unsurprisingly, people who are highly susceptible to myopia and loss aversion simply don’t ‘get it’.

And there is a further challenge for those who propose measures to mitigate climate change.  This is due to what economists label the ‘free-rider’ problem, a source of market failure that undermines the optimal provision of public goods, national security being the classic example.  Unlike private goods, public goods are both indivisible and non-excludable.  These characteristics mean that everybody has access to the same quantity of the public good regardless of what they pay for it, even if they pay nothing.  (Different people might value the same quantity more or less highly, as they do private goods.)  But if you access the same quantity as everybody else irrespective of what you pay, then why would you pay anything at all?  Surely, it is rational to ‘free ride’ on others.  This is why the provision of public goods is a responsibility of government, with its unique power to raise revenue through taxation.

Of course, even with the provision of public goods being underpinned by taxation, people will still seek to free-ride. This form of behaviour is labeled tax avoidance.  Avoiding contributing to the financing of public goods seems to make sense from the perspective of the individual, since it avoids a personal cost without impacting the benefit received.

Climate change mitigation is a global public good.  Every individual in every nation benefits, irrespective of the cost they bear from the mitigation activity.  So why wouldn’t every nation ‘free-ride’ on others?  Surely, it is rational for every nation to avoid making any contribution to mitigation.

Myopia, loss aversion and free-rider problems encourage political leaders to assume a posture of complacency.  Nothing needs to be done urgently, and doing anything at all might merely be to impose an avoidable short-term cost on the nation, with no impact on global events.  Better to adopt a posture of comfort and relaxation: ‘She’ll be right, mate.’

It is no wonder climate change policy has proved so difficult.  Yet in 2007 every government in Australia – Commonwealth, State and Territory – was united on the desirability of implementing a world’s best emissions trading scheme (ETS) to achieve climate change abatement, with the Howard Government being the last to join the consensus.  How did Australian governments arrive at that position?

Before answering that question, it is worth noting that climate change mitigation is not the only global public good in respect of which our governments have had to consider an appropriate posture.  Most Australians would consider it a defining national characteristic that we have been prepared, on several occasions, to make an out-sized contribution; an effort considerably larger than what might be anticipated by reference to our tiny population and GDP shares.  Think of our human sacrifices in the two world wars of the last century and in our participation in the so-called ‘war on terror’ in the wake of the horrific events of 11 September 2001. These and several other disproportionate efforts have sent a message, both domestically and internationally, that Australia will act decisively, and join any coalition of willing partners motivated to make the world a safer place for this and future generations.  We can always be counted on to make a disproportionate contribution to that goal.

Yet Australia’s posture on action to achieve climate change mitigation is very different.  Australia was a signatory to the December 1997 Kyoto Protocol on climate change.  But nobody involved in the negotiations over national carbon abatement targets for that protocol, least of all the Australians sitting at the table, considered that we were wanting to make an out-sized contribution.  It would be fair to say that the Australian posture on climate change commitments has generally been to negotiate the smallest respectable abatement target.  We have had our reasons, but none of them has a shred of moral decency when stacked up against the sacrifices we have been prepared to make in pursuit of other global public goods.

The thing that produced the extraordinary political alignment in 2007 had nothing to do with Australia’s positioning in international affairs.  It was an overwhelmingly domestic volt face.

Public attitudes to climate change in the early years of this century demonstrated that while Australians might generally be tolerant of complacent leadership, the weight of public opinion, and community expectations of leaders, can swing rapidly.

Short termism appears to satisfy a basic human desire for comfort.  The ostrich syndrome illustrates an extreme case.  It may be false comfort, but it is comfort nevertheless to deal exclusively with those things we consider reasonably certain and manageable.  This is how we perceive the near term; reasonably certain and manageable.  In contrast, the distant future is inherently uncertain and difficult to manage.

But what happens when we get a nasty surprise?  What happens when we discover that what we are experiencing in the present is well beyond the bounds of what we had considered probable in the near term and is something we cannot control?  Well, short termism then provides no comfort at all.  And when what we are experiencing in the present looks very much like the central case of what the experts have been predicting for the long-term, when we find a nightmarish future crashing into the present, we might want to know why our political leaders have not been doing everything humanly possible to make the world a safer place, for this and future generations.

This is the position that confronted the Howard Government in September 2001, following the terrorist atrocities committed on America, and again late in 2006, following several years of devastating drought in Australia.  And today’s catastrophic bushfires, and rapidly vanishing water security, again following years of drought, put the present government in a similar position.  The political economy of late 2019 is looking a lot like late 2006.

Some have a view that when people are running for their lives from bushfires it would be indecent to have a mature conversation about climate change.  I know some of the people who have fled bushfires these past several weeks.  As they have run, they have wondered whether their governments have done enough to make the world a safer place.

Ken Henry was Secretary to the Treasury from 2001 to 2011.                

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Ken Henry was Secretary to the Treasury from 2001 to 2011.

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