The “dismal theorem”

by | 29 Oct 2020 | Economy – Social - Tech

Yesterday, I had the chance to do a last face-to-face course at Dauphine, one day before the new confinement.

It focused on the economic analysis of climate change, and concluded with the analyzes of Martin L. Weitzman and his “dismal theorem”.

Professor Weitzman was for half a century one of the most brilliant environmental economists. A professor of economics at Harvard, he and Robert N. Stavins led a famous seminar there on this subject.

In various papers published around 2007, in the wake of the Stern Review, he highlighted the possibility that climate change could induce disasters that are poorly taken into account in the cost-benefit analyzes that are usually applied in terms of climate policy assessment.

In short, future events of extreme severity should be taken into account even if their probability of occurrence is very low and their theoretical discounting makes them insignificant in a cost-benefit analysis.

This is the “dismal theorem”, which in scholarly terms tells us that in a stochastic universe where the probability that the destruction of capital increases by an order faster than the net value produced, the social discount rate tends towardsa  negative one so that the discount factor tends to infinity.

Come on, let’s say it more simply with an example that everyone will easily understand!

Imagine a health economist carrying out a cost-benefit analysis about the implementation in his country of a pandemic prevention policy a few years ago. It is quite likely that he would have attributed a fairly low probability to the risk that an alive pangolin sold in the Wuhan market would cause a global pandemic, with huge human and economic consequences ….

If he had been particularly wise, our economist would however have taken this risk into consideration (i) assigning it an enormous monetary value, (ii) weighting it with a very low probability, and finally (iii) reducing it by discounting to very few things, considering that it was not for now.

On the basis of this analysis, the politics would obviously have given up incurring the costs of preparing his health system. At best, “in a precautionary approach “, he would have assigned a small budget line dedicated to this preparation.

What Weitzman is telling us is that such an approach in the climate field does not make any sense: we have to think quite differently and focus future work on better accounting for disaster risk.

A dig at Willam D. Nordhaus, but also at Lord Nicholas Stern, even if Weitzman recognizes in the latter the immense merit of awakening conscience.

And a theoretical validation of the “moral” principle of precaution.

It is claimed that Martin Weitzman once said to a colleague “If we don’t think an idea deserves the Nobel Prize, we shouldn’t be working on it” …

Come on, let’s tell each other everything: in his 1895 will, Alfred Nobel did not retain economics as a category eligible for his prize. It was only since 1968 that the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel” was awarded.

It was William Nordhaus and his non-disruptive vision of climate change that got the precious sesame in 2018.

Evil tongues will say that bankers don’t like to be disturbed in their view of the world. But it is in reality the Royal Swedish Academy of Sciences which, like other Nobels, awards the prize.

And that day, she chose the man whose the politically correct speech was the least difficult to hear!

Professor Weitzman disappeared under very sad circumstances at the end of August 2019. He was 77 years old and is said to be very worried about losing his lucidity.

And what a lucidity!

Iconography : after the labor day fires, San Francisco, September 2020 © Patrick Perkins