Yearly Archives: 2007

109 – Long jump world champion 2007

In all athletics events except one, the world record from 39 years ago is well below the general standard of current leading competition, but in long jump, the opposite is true.

Long-time readers of Pannell Discussions know of my fascination with the long jump world record, particularly in the wake of Bob Beamon’s superhuman jump at the 1968 Mexico Olympics. See the incredible story here.

Last week at the World Athletics Championships in Osaka, there was a terrific long jump competition. Irving Saladino from Panama grabbed first place on the very last jump of the competition (which takes hours, not just the 5-10 minutes worth we see on television). I would have felt sorry for second placed Andrew Howe from Italy if he (and his mother in the stands) hadn’t gone so totally off the scale with celebrations when he snuck ahead of Saladino by one cm just before that. Howe looked much more sober after Saladino’s last jump.

For me, one of the key points of interest in watching big athletics events is to see how the world’s best long jumpers compare to the mark that Bob Beamon set in 1968. Last week, as usual, they didn’t get anywhere near it. It has been beaten once, by Mike Powell in 1991, but for the past decade or so, nobody has come close to it. In a sport where a few centimetres usually makes the difference between first and second place, Beamon’s monster leap of 8.90 metres would have won the world championship last week by 33 cm – more than a foot! In old measures, Saladino jumped less than 28 feet, but Beamon jumped more than 29 feet.

In 1968, Beamon broke the then world record by almost two feet – surely the biggest percentage improvement in an athletics record since the very early days of record keeping, and making this jump one of the greatest physical feats in human history. In Osaka last week, only two of the competitors actually exceeded the record that had stood prior to the Mexico Olympics. The rest of the competitors didn’t get within 2 feet of Beamon.

It may be some consolation to modern long jumpers to know that Beamon himself never got within two feet of the record again. It was a freakish one-off.

This story is fascinating because it is so starkly different to all the other athletics events. In other events, the world record from 1968 is far below the general standard of current leading competition, but in long jump it is exactly the opposite.

David Pannell, The University of Western Australia

108 – Setting policy targets

Targets to be achieved from public investments often seem to be determined by judgment and a fair bit of guesswork. Is there a better way?

Targets for policy investments are often set in a wishy washy way. Here is an example. Under the regionalised natural resource management (NRM) programs in Australia, the regional bodies that are responsible for planning and prioritising investments were required by the government to establish “aspirational” targets for NRM outcomes. This process injected a huge dose of unreality into the planning process – the aspirations expressed are vastly different from feasible realities in most cases.

There was also a requirement to set “Resource Condition Targets” (RCT), which were meant to be more realistic and achievable. However there was no requirement that these RCTs be determined rigorously. With few exceptions, they were not backed up by good analysis, and in truth, most of the RCTs in “accredited” regional strategies are not achievable.

The setting of targets based on wishful thinking does have its defenders. I’ve heard people argue that it will stretch people, and give them something to aspire to. However I think it is more likely to make people disheartened and cynical, and it makes realistic monitoring and evaluation impossible. The process seems to have encouraged monitoring and evaluation of activities, rather than outcomes. Given the current mindset around targets, it is not surprising that the regional NRM bodies and governments alike have struggled to get a good monitoring and evaluation process happening.

I think a better approach is to choose targets as the last stage of the planning process. I’d proceed as follows:

  • For a range of possible NRM investments, estimate their costs and identify their likely NRM outcomes.
  • Select those investments that give the best aggregate NRM outcomes for the available budget.
  • Set the targets to equal the most likely NRM outcomes that were identified in the first step for those investments that have been selected for funding.

(The approach assumes that the best available investments are actually worth funding. This may not always be true.)

Note that targets do not drive the process in any way. They are an output of the process.

This approach to planning and target setting flows directly into a good monitoring and evaluation process. The targets are realistic, and failure to meet them can be understood in the context of the analysis that was done to select the targets. Monitoring and evaluation would include updating the analysis and the targets over time as new information emerges. In other words, monitoring and evaluation looks a lot like the original planning process, but adapted to account for new information.

David Pannell, The University of Western Australia

107 – Why don’t farmers use futures markets more?

Most of us prefer to avoid risk if we can. Some farmers reduce their risk by “hedging” – that is by locking in the sale price of their production in advance using futures contracts or fixed-price contracts. However, only a minority of farmers do so. Why is that?

The simplest economic models of price hedging indicate that producers should always hedge all of their production. This will eliminate their risk of the sale price falling by the time they have produce ready to sell. Of course it will also eliminate the chance of the price rising, but for most people, falls matter more than rises (i.e. most people are “risk averse”).

From that description, hedging seems like a great opportunity to reduce one of farmers’ main risks. Why then, is hedging not a dominant practice in agriculture. There are several reasons.

One is that the simplest models are too simple. They neglect several factors that tend to reduce the attractiveness of futures contracts.

  • Transaction costs. Participating in the futures markets takes time and costs money. For example, in futures markets, producers have to meet margin calls, which require them to pay money in advance for a proportion of the value of the contract. This is inconvenient, and it has interest costs. It has been estimated that the transaction costs amount to about 2% of the value of futures contracts in Australia.
  • Basis risk. When a farmer signs up for a futures contract, it is usually not for exactly the same product as the farmer is producing. The future market price of the product specified in the futures contract will probably vary in a (hopefully slightly) different way to the product the farmer is producing, so the contract doesn’t exactly cancel out the price risk that the farmer faces.
  • Production risks. If you allow for the fact that the amount of product that will be available for sale at the end of the growing season is not known with certainty, it can be preferable to hedge only a portion of the expected production (depending on other circumstances).

Another reason is that hedging does not only affect the riskiness of the farmer’s outcome – it also affects the expected level of payoff (“expected” in the statistical sense of a weighted average). Most economic research publications on hedging make the assumption that the farmer’s expectations about price match the market’s; their expected price is the same as the futures price. In reality, a population of apparently similar farmers has a wide variety of price expectations. For those who are relatively optimistic about prices, there is a disadvantage in locking in at what they perceive to be a low price. Doing so would reduce their expected income, so they choose not to hedge.

Then there is the question of how much a farmer has to gain from hedging. If the farmer is among the majority of farmers who are not very risk averse, there may be little benefit in hedging. Figure 1 shows one example. The horizontal axis shows the proportion of expected wool production that the farmer might hedge, and the vertical axis shows the payoff from doing so. The payoff is called the certainty equivalent, which consists of the expected profit minus a risk premium. For a wool farmer with low risk aversion, and with price expectations that match the futures market, the potential gain in certainty equivalent by moving from zero hedging (the left edge of the top curve) to the optimal level (56%) is tiny. In other words, the payoff function is very flat (another example to add to those discussed by Pannell (2006)).

Figure 1.

There is a more substantial gain from hedging possible for highly risk-averse farmers (the dashed curve), but we know from empirical studies that they are a minority. Given this result alone, it is not surprising that the majority of farmers have a limited interest in futures markets.

David Pannell, The University of Western Australia

Further Reading

Pannell, D.J., Hailu, G. Weersink, A., and Burt, A. (2007). More reasons why farmers have so little interest in futures markets, submitted to Agricultural Economics, pre-publication version available here (132K pdf file).

Pannell, D.J. (2006). Flat-earth economics: The far-reaching consequences of flat payoff functions in economic decision making, Review of Agricultural Economics 28(4): 553-566. Prepublication version here (44K).

106 – The Great Global Warming Swindle

On July 12 ABC TV in Australia aired “The Great Global Warming Swindle”. This followed saturation promotion in days leading up to the broadcast, including items in various current affairs and news programs. They followed the broadcast with an interview with the film maker, and then a panel discussion of “experts”. It was one of their highest-rating programs for the year, but altogether it was an uninspiring two hours of television.

The main messages of the film were (a) that the key driver of climate change is not carbon dioxide, but is variations in solar radiation, and (b) that there is a climate change science industry that has a vested interest in creating alarm in order to generate an ongoing flow of research funds.

The film itself looked slick, and content-wise it had its moments, but overall there were too many flaws. In relation to the first message, I felt that the position put was far too black and white, with no ifs or buts. This made the film an easy target, because there are always ifs and buts. The ABC journalist Tony Jones showed that the key graph illustrating a tight correlation between solar radiation and global average temperature had been truncated in the 1980s, and that since this time the relationship has apparently broken down. There were various other points of criticism made, but this was the most telling. The response to this by film maker Martin Durkin was very unconvincing.

Solar radiation surely is one important driver of climate, but there are strong theoretical reasons to expect elevated CO2 to have some influence too. Predicting how much influence is extremely difficult, and as a modeler I don’t think the long-term predictions from climate models are at all reliable, but that’s not the same as saying that elevated CO2 levels will have no impact at all.

In relation to the second message, the film maker overplayed his hand badly by making the bald and untargeted statement that “we are being told lies”. In my view, the judgments of many climate scientists have been influenced by non-scientific factors, there are problems with the politicisation of climate science, and there is great overconfidence about predictions from complex computer models.

But I don’t think there are many scientists who knowingly and strategically tell lies. (A few appear to, but even they probably don’t think they are doing so.) The accusation of lies is easy to counter by wheeling out some passionate and well-informed climate scientists who clearly are not lying.

The real story about climate change is not as black and white as claimed by this film, nor by its opposition. As in most big environmental issues, the decision problem is complex, murky, and fraught with uncertainties and imponderables. And even if one takes the IPCC’s predictions at face value, one can still reasonably not support taking dramatic immediate action. That actually seems to be the position taken by most economists working in the area (notwithstanding the Stern report).

In the interview with the film maker, he came across (to me at least) as nervous and rather slippery.

The panel discussion was just awful.

The protagonists were again too certain of their positions. It is all black and white, apparently (or white and black if you’re on the other side).

The ABC had asked only two scientists (Bob Carter and David Karoly, from opposing camps) onto a panel of eight for a discussion about the science! These two got into an argument over the trend of global temperatures since 1998 which was just ridiculous. You can’t tell anything about climate on such a short time scale. They both should have known better. Apart from that, Karoly was a better performer in the debate, but it wasn’t much of a debate.

Two of the panelists emphasized that some big businesses are taking action, but this was completely irrelevant. As Michael Duffy (a journalist on the panel) pointed out, there are good business reasons for them to do that irrespective of whether they believe the science. In any case, why would we believe the opinions of business leaders (or, for that matter, of journalists – there were two on the panel) on questions of science?

The other journalist, Robyn Williams, contributed two of the lowest points of the discussion: appearing to cast aspersions on the credibility of Richard Lindzen (a well respected climate researcher who is a prominent critic of climate change orthodoxy) because he is a smoker; and claiming that the National Academy of Science review vindicated the Mann “Hockey Stick” graph of past temperatures, which is complete nonsense, but went uncorrected. In fact the Hockey Stick would have been an easy target, having been completely demolished by competent statisticians, but the program didn’t mention it.

Audience question time was even worse, and further highlighted the degree of polarisation that exists on the issue. Some audience members seemed rather unhinged and a number of the comments were completely incomprehensible. Where did they find these people?

There is a serious debate to be had, but this clearly wasn’t it!

David Pannell, The University of Western Australia

105 – A carbon tax?

Most of the attention in discussion of climate change policies has been on a carbon market. But what about a carbon tax? Some well-qualified economists have expressed a preference for it.

In PD#104 I talked about a market for carbon emissions, which is the approach taken in the Kyoto Protocol. Kees van Kooten (from the University of Victoria in Canada) emailed to ask, what about a carbon tax?

In a sense the two options are mirror images:

(a) A market for carbon emissions is based on direct restrictions on the quantity of emissions. The price of emissions adjusts according the supply of emission permits – more restrictive supply, higher price.

(b) A carbon tax is based on setting the price of emissions, and allowing the quantity of emissions to adjust – higher tax, fewer emissions.

William Nordhaus is probably the leading economic researcher working on climate change. He has a new paper out that argues the case for a carbon tax, instead of a carbon market. Advantages of a tax approach (mostly taken from the Nordhaus paper) include the following:

  • One of the difficult issues in negotiating the Kyoto protocol was reaching agreement about the target emission levels for each country. In a carbon tax system, there would be no need to haggle about the targets of individual countries. Emitters in each country would face the same tax. “Countries would not be advantaged or disadvantaged by their past policies or the choice of arbitrary dates” (Nordhaus, 2007, p. 36).
  • We would like to strike the “right” balance between economic activity and emissions abatement, but because of the great uncertainty about almost everything in the climate change problem, we don’t know which quantity of permits or which tax level would strike that balance. Given that we are likely to get the permit level or the tax level wrong, which mistake is likely to be worse? This is a question first posed by Martin Weitzman in a famous paper back in 1974. Nordhaus argues that, in the case of climate change, the scope for costly mistakes is greater for a market system. For example, Pizer (1997) estimated that, for this reason, the expected net benefits of a carbon tax would be five times greater than for a market system.
  • In a carbon market in the short term, the supply of permits is fairly fixed, while the demand for them is not very responsive to price. This means that prices can be very volatile, as they have been in the European CO2 market. Such volatility can be very costly as people constantly attempt to adjust. The price of a carbon tax is set administratively, and so is not volatile at all.
  • The receipts from a carbon tax can be used to reduce taxes on income or other goods or services.
  • Quantity-based systems probably have a greater potential to generate corruption. In a market system, emission permits have a value, and so who gets them at what price can be manipulated by corrupt regimes and officials.
  • The administrative apparatus already exists for a tax system

On the other hand, there are some disadvantages of a tax approach, including the following.

  • Even once the tax was in place, it would be difficult to tell what effect it was having on emissions.
  • There would still be a need for haggling on a country-by-country basis, although on different issues. For example, some countries already have higher taxes on transport fuels. How should these be considered when setting a new carbon tax?
  • People just don’t like taxes. Their unpopularity may affect the acceptability of the policy in some countries.
  • When the market approach is introduced, the permits can be given to current emitters, increasing the political acceptability of the system.
  • There may be equity concerns about applying the same tax rate in developing and developed countries.

Overall, Nordhaus concludes that a carbon tax would probably be better than a carbon market. Given the above disadvantages, it’s possibly not a clear-cut thing, but he may be right on balance. It’s at least worth considering in the debate.

An interesting side issue in Nordhaus’s paper was that he put the carbon price in the context of current fuel prices. According to Nordhaus, a CO2 price of $30 per tonne (which sometimes is discussed as the sort of thing we should expect) would result in a rise in petrol price of 6 cents per litre (22 cents per gallon). I was really surprised at how low that was. It’s roughly the magnitude of weekly fluctuations in retail petrol price where I live, and less than the range among petrol stations at any point in time. It seems to me that this would have a tiny impact on carbon emissions, at least from transport fuels, and probably from other sources as well. Given the very large emission reductions that scientists claim are necessary, it suggests to me that the carbon price required to achieve the desired emission reductions will be much higher than the prices we’ve heard about so far. (Either that, or we’ll be needing some radical new technologies, and hence a strong focus on technology development.)

David Pannell, The University of Western Australia

Further Reading

Nordhaus, W.D. (2007). To tax or not to tax: Alternative approaches to slowing global warming, Review of Environmental Economics and Policy 1: 26-44. http://reep.oxfordjournals.org/content/1/1/26.full.pdf

Pizer, W.A. (1997). Prices vs. quantities revisited: The case of climate change, Discussion Paper 98-02, Resources For the Future, Washington D.C. http://www.rff.org/documents/RFF-DP-98-02.pdf

Weitzman, M. (1974). Prices vs. quantities, Review of Economic Studies 41: 477-491.