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Why “extremely unlikely” climate events matter

January 5th, 2018

I’ve just been advised that my latest article “The importance of ‘extremely unlikely’ events: Tail risk and the costs of climate change” has come out online in The Australian Journal of Agricultural and Resource Economics. For those who can use it, the DOI is 10.1111/1467-8489.12238. For everyone else, here’s a link to a pre-publication version. The main points are

* The IPCC convention is to use the phrase “extremely unlikely” to refer to outcomes (in particular, values of climate sensitivity) in the range of 0–5 per cent.
* Most of the risks against which we act to protect and insure ourselves (for example, car crashes, premature death in any given year) are “extremely unlikely” by this definition
* Around half, or even more, of the expected welfare loss from climate change arises from the worst-case 5 per cent of high values for climate sensitivity.

Nothing really startling here, but it’s the other side of the coin to the contrarian suggestion that since there’s a 5 per cent probability that global warming will turn out not to be a problem, we should do nothing.

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  1. January 5th, 2018 at 19:14 | #1

    Unsurprisingly, the big reinsurance companies were early converts to climate realism.

    Slightly OT, a piece at Climate Home pointing out th une startling indifference of academic finance researchers to climate change: ****climatechangenews.com/2018/01/04/finance-researchers-failing-engage-climate-change/
    Real heads-in-the-sand stuff. Haven’t they heard of Adani, Kemper and Mark Carney?

    There is a faint possibility that the picture might be better if you used “energy transition” as the search keyphrase instead of “climate change”.

  2. John Quiggin
    January 5th, 2018 at 20:50 | #2

    That’s striking. If you look at the reference list for my paper, you’ll see plenty of citations to leading econ journals (general and environmental).

    Closely related, I’d have thought the legal risks being run by companies and individual directors, particularly in the finance sector, who are putting money into fossil fuels must be pretty severe by now.

  3. January 5th, 2018 at 23:08 | #3

    @John Quiggin
    Yes indeed. The CFOs of big companies and managers of investment funds must be losing sleep over climate and transition risks if they are halfway competent – even the central trend estimates and mainstream policy targets like Paris are bad enough, the bad case for many is wipeout. (The really worst case is the end of civilisation and/or capitalism, which in a sense they don’t have to worry about: there are no spreadsheets in a Mad Max world.) But it’s clear that they aren’t getting much help from their floor of the ivory tower.

  4. January 6th, 2018 at 09:03 | #4

    A nice and timely paper. It is odd, but credible, that leaving out the extreme scenarios of the end of civilisation and possibly human life makes the issues more tractable technically, and convincing politically.

    I wonder how the analysis can be combined with that of air pollution, an evil of similar magnitude economically for standard scenarios if not for worst cases. To a first approximation, health damage can be considered as a linear function of local pollution from coal, oil, and wood burning (but not of gas). It is also near-certain in a broad view. Apart from gas, the same policies that mitigate global warming also cut local air pollution. Conversely, policies that cut air pollution will almost always cut CO2 emissions. (The alleged exception, that electric vehicles in cities merely shift CO2 emissions to large fossil power stations, is unsound because even coal power stations are much more efficient (40%) than ICE vehicles (say 15%). Gas power stations are up to 60% efficient, and renewables have negligible emissions.)

    The health and climate benefits of the energy transition are therefore strongly complementary goods. This makes the net cost of aggressive mitigation strongly negative: a free lunch. (Advert for old blog post: *****www.samefacts.com/2015/10/international-affairs/the-25-trillion-free-lunch-of-the-dwarfs/). The high certainty of the health benefits reduces the overall uncertainty of the mitigation policy.

    This ends in a net zero world (ca. 2050), when the new emissions are negligible. The air pollution issue has disappeared. But the technical and financial problem of massive net carbon sequestration is still intact.

  5. Ikonoclast
    January 6th, 2018 at 09:50 | #5


    I agree with James Wimberley that “The health and climate benefits of the energy transition are therefore strongly complementary goods. This makes the net cost of aggressive mitigation strongly negative: a free lunch.”

    I won’t get excited or hopeful until I see a mass mobilisation of resources and people to undertake aggressive mitigation of GHGs and all forms of pollution and environmental damage. This mobilisation must be of the scale of major war effort, though I hesitate to employ the much abused “war against” meme. I predict this mobilisation can only occur after, or during, a full transition to democratic socialism in the general form “cooperative market socialism”. That last phrase needs a post of its own for explanation.

  6. Bernard J.
    January 6th, 2018 at 14:04 | #6

    Closely related, I’d have thought the legal risks being run by companies and individual directors, particularly in the finance sector, who are putting money into fossil fuels must be pretty severe by now.

    It’s a shame that there is apparently no risk for obviously corrupt presidents (and Republican party representatives) who sell the environment of the whole planet for the profit of a very few:

    Donald Trump gives two fingers to planet Earth with massive oil drilling plan

    It’s long past time that the world’s best scientists, economists, and lawyers unite in a cohesive single force to vociferously and conspicuously put companies and governments on notice that they have been long and effiectively warned of the dangers of fossil fuel-caused planetary climate change, and that they hold responsibility for the decades of delay and deliberate stymying of moves to mitigate. These civilisational vandals are not phased by the prospect of dstroying the only habitable planet that we’ll ever have, but they may just listen to the prosepct of financial ruin and imprisonment.

    Nothing else has worked to date, and if these decision makers are permitted to continue for just a few more years as they have for the last four decades, there’s little hope for even a hard-but-survivable-in-some-form landing. In 2018 the world should not be sitting by, looking bemused at Trump’s insanity, but effecting nothing beyond spluttering outrage. Really, what will it take for humans to draw a line in the sand and stop the current trajectory? If we can’t say “enough is enough” to Trump’s latest we’ll simply never be able to do so, and any limping transition away from fossil fuels in the future, after the environment’s been wrecked in the rush to squeeze out a quick profit, will be futile with respect to the well-being of most of humanity and the rest of current biodiversity.

  7. Jim Rose
    January 6th, 2018 at 14:20 | #7

    Thanks for this. Extremely helpful with something I am working on at the moment.

    David Friedman also talks about the importance of taking into account tail events in assessing the threat from global warming and its social costs.

  8. Cameron Pidgeon
    January 6th, 2018 at 16:42 | #8

    @Bernard J.

    “If we can’t say “enough is enough” to Trump’s latest we’ll simply never be able to do so…”

    It depends who you mean by “we” Bernard. Are “we” a collection of armchair commenters, putting in more effort into our observations and ruminations than any substantial real world action? Are we increasingly disillusioned, disenfranchised voters from the slowly subsiding middle classes of the world’s liberal democracies? Or are we members of small cadres of activist groups, the kind who spring to mind when you hear the quote:

    “Never doubt that a small group of thoughtful, committed citizens can change the world; indeed, it’s the only thing that ever has.”
    (Margaret Mead)Read more at: https://www.brainyquote.com/quotes/margaret_mead_100502

    Don’t give up hope Bernard, those small groups are out there, working like buggery. Maybe you should join one. Maybe you are already in one. Maybe I should join one…..

    Happy New year.

  9. hc
    January 6th, 2018 at 17:52 | #9

    My own view is that assigning probabilities here to extreme events based on simulation models is unhelpful. Provided the possible damages are large relative to the costs of addressing them and provided that the event is not utterly far-fetched (so you only select states of the world that plausibly may be of interest) then action to address climate change is reasonable to minimize the regret that you might otherwise experience. I think it is, more-or-less, the IPCC rationale for action.

  10. rog
    January 6th, 2018 at 18:41 | #10

    @James Wimberley I don’t think it is the risk of climate change events that drives them, more that they might lose customers over their stance on climate change.

  11. rog
    January 6th, 2018 at 18:56 | #11

    Joanne McCarthy recently wrote a piece on climate change where homeowners sued a council for loss of property thru storms and subsequently lost the case as the event was not “reasonably foreseeable”.

    There was another situation where Lake Macquarie Council invoked ratepayer fury by reclassifying waterfront property as being at risk to sea level rise. The heat generated was enough to propel well known developer and climate change sceptic Jeff McCloy into the position of mayor of Newcastle, a position that he was later found to be most unsuited to.

    It will take another event to change their minds.


  12. January 6th, 2018 at 22:01 | #12

    The mixture of risks must depend on the case. If your rivals are going in for free-lunch greenwashing (“we buy 100% renewable electricity”), you are under pressure to follow for reputational reasons. If you build flats on the coast, the objective risks from sea-level rise and storms no doubt dominate. What is unprofessional is to ignore both types of risk. Especially if you are a finance academic.

  13. January 6th, 2018 at 22:14 | #13

    The free lunch argument does not unfortunately extend to “all forms of pollution”. It does not include the wave of plastic packaging, noise, ugliness, intrusive advertising, and nuclear waste, for instance. The link here is mainly emotional and political. However, these are mostly more manageable and not life-threatening problems. And there are some free snacks, such as noise reduction from electric vehicles.

  14. rog
    January 7th, 2018 at 04:12 | #14

    On climate change and company policy; it seems that Australian businesses are maintaining their ignorance.


  15. rog
    January 7th, 2018 at 04:26 | #15

    Insurers appear to be aware of risk but not able to evaluate risk until closer to the event – “risk reduction” ie denying reinsurance to high risk properties is seen as one way to limit costs. Climate change is one of many risks.


  16. Ikonoclast
    January 7th, 2018 at 08:19 | #16

    “Really, what will it take for humans to draw a line in the sand and stop the current trajectory?” – Bernard J.

    Unfortunately, it will take a very large and salutary natural disaster affecting rich white people. Since Hurricane Sandy, the Fort McMurray fire and the California fires (to take three examples) were not big enough, one can guess that it will take an event one or two orders of magnitude larger to get their attention.

    Either that or so many of the lower classes will have to become so impoverished as to start starving. Then they will revolt. On the current trajectory, sooner or later one or both will happen.

  17. Anthony Morton
    January 8th, 2018 at 08:40 | #17

    “the contrarian suggestion that since there’s a 5 per cent probability that global warming will turn out not to be a problem, we should do nothing”

    As I understand it, the effect of CO2 and other greenhouse gases has been known since about the 1860s and was well documented by Arrhenius in the 1890s. It is a very complex system with many interactions resulting in emergent behaviour. Is not the statistical analysis of the outcomes of complex systems dependent often on power laws not conventional Gaussian methods? Maybe the 5% is derived correctly, it would be good to know, but when so-called “one in 100 years” events like severe fires and storms sometimes occur close together, one wonders. Also, as I understand it, the nature of future emergent behaviour is unknown. What causes the current unusual cold in the far north of the continent? Does the melting of Arctic and Greenland ice diluting salty ocean currents have a role? While the future may be unknown, the present is not unknown and the existing occurrence of climate change is now clearly unsustainable. Also, I am no economist but it seems that, if externalities like environmental damage and damage to health were to be paid for by us rather than being left for our grandchildren, energy production without fossil fuel would today be much cheaper than fossil-fuel generated energy. Certainly we need to understand energy storage better and to make it cheaper, but more work in this area would almost certainly cost much less than repairing the damage of the status quo.

  18. Newtownian
    January 9th, 2018 at 11:02 | #18

    My thanks for this paper John as it gives me another take on how economists view theproblems posed by very rare but catastrophic events and how to determine/set policy and resource allocation in response to the perceived problems arising.

    This is close to a current interest – catastrophic events as they pertain to the water industry. I’ve ended up focusing on the model problem of solar storm (better described perhaps as Solar Tempests) as such an event is certain and so less coloured by institutional biases etc. The basic science is developing well but the wider policy response is still at the ‘Aspirational’ stage including what is a ‘tolerable risk’ level. A quick explanation of the story can be found in these NASA stories from a few years ago:

    Also of possible interest is a technical economic analysis can be found here though as the authors acknowledge its only a start OUGHTON, E. J., SKELTON, A., HORNE, R. B., THOMSON, A. W. & GAUNT, C. T. 2017. Quantifying the daily economic impact of extreme space weather due to failure in electricity transmission infrastructure. Space Weather, 15, 65-83.

    Why I bring this up is that the impact potential is of the same scale as climate change depending on storm size. Specifically the likelihood of a’big one’ is of the order of 100+ years ARI (Average recurrence interval). And as with climate change impact could be much bigger.

    With this in mind I found your paper interesting in many respects and have the final parting comments:
    – its clear the issue of extreme ‘risk’ management is rising in many different fields and similar conundra are being encountered.
    – the radically different language used by yourself and presumably other economists to understand risks here and formulate responses is interesting. Its strikingly different from the science/engineering approaches I am familiar with.
    – you might want to look at the story a bit further as one of the key vulnerable areas is your old favorite – energy supply and distribution.
    – in case you are interested in the broader science/social side of catastrophic risks and you want to look further this may be of interest BOSTROM, N. & CIRKOVIC, M. M. 2011. Global catastrophic risks, Oxford University Press. (an intriguing absence seems to be an economic take on the diverse issues identifiable).

  19. January 10th, 2018 at 10:16 | #19

    Bostrum is fun. He came up, as an example of a completely unquantifiable risk, with that of an alien civilisation conducting unwise experiments in high-energy physics and inadvertently causing a phase change in the fabric of space-time. This may be sweeping towards us at the speed of light as we speak and will reduce us and the solar system to quark soup when it arrives. Sleep well, all.

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