A Sane Climate Change Adaptation Article Published in The Guardian
Optimists can learn from reading this recent piece in The Guardian.
It makes the simple point that historical data on weather patterns is less informative about short term and medium term future weather predictions. We know this. When confronted with such uncertainty about uncertainty, what does a prudent decision maker such as a farmer do?
How do decision makers adapt to fundamental uncertainty?
#1 You diversify your bets. The farmer can invest in growing a portfolio of crops or investing in assets whose payoff is negatively correlated with the crops that the farmer is growing. There are many hedging strategies.
#2 The asset owner could sell the asset. Comparative advantage is an old idea. Home owners are amateurs. Small farmers have less access to capital, management skill and diversification strategies than big farms and private equity investors. Asset markets allow buyers and sellers to trade assets. If a farmer cashes out, is his life ruined? No, there are many things one can do in this life and many places where one can move. A fundamental idea from microeconomics is that we have the capacity to substitute. So much of doom and gloom in climate reporting is due to the implicit assumption that nobody is able to substitute. For example if the price of berries increases, what food do you now eat? If you can’t grow as much wheat on your Kansas farm as you used to, what do you do next? In our emerging WFH economy, farmland can be turned into housing. There are always alternative uses of every asset including land.
#3 A decision maker could beg his Political Representative for subsidies. Now, I would call this maladaptation because of the moral hazard effect. If government officials promise “free $” for those who suffer from climate shocks, then this eliminates the incentive to take costly upfront actions to adapt to the expected shock. If government treats people like they are children, then they will act as children! The problem here is that a subsidized economy requires somebody to pay the taxes to cover the expenditure on the subsidies.
My complaint is that shrewd decision makers are using ideas from behavioral economics to claim that they are fools. Let me explain. The expectation that there are subsidies in terms of disaster relief reduces one’s incentive to research emerging climate risks. The irony arises; the more risk an individual faces lowers the ex-post damage that the shock causes because the individual has an incentive to be prepared for the shock. The expectation of Government intervention diminishes the incentive to self protect. Shrewd decision makers have an incentive to pretend that they never thought about the risk. Behavioral economics (the idea that people are fools) gives wise men the incentive to hide out and pretend to be a fool so that they can flip a one sided coin. If no shock occurs, great! If an ugly weather event occurs, then they claim they were fooled and beg for a bailout using Federal Tax dollars.
I prefer to live in a world where Climate Science makes progress identifying the risks different areas face and investors use their own money to decide how they want to invest. Some will choose to rent rather than own. Comparative advantage will emerge. Who has an edge in managing risky properties? This was a theme of my 2021 Adapting to Climate change book.
Of course, wild weather will affect some investors more than others but as individual decision makers make their own decisions; some will make the right decisions and they will gain from their correct bets.
#4 A final idea from economics that is relevant here is “option value”. Given that we know that we do not know what wild weather will be in the medium term, it is wise to pursue a strategy such that one does not lock in. By preserving options, one can optimize later as we learn more about place specific risks and as we enjoy progress in engineering and real estate and infrastructure design. I explore this theme in this 2017 paper.
Optimal real estate capital durability and localized climate change disaster risk☆
https://doi.org/10.1016/j.jhe.2017.01.004Get rights and content
Abstract
The durability of the real estate capital stock could hinder climate change adaptation because past construction anchors the population in beautiful and productive but increasingly-risky coastal areas. However, coastal developers anticipate that their assets face increasing risk and this creates an incentive to seek adaptation strategies. This paper models climate change as a joint process of (1) increasingly destructive storms and (2) a risk of sea-level rise that submerges coastal property. We study how forward-looking developers and real estate investors respond to the new risks along a number of dimensions including their choices of location, capital durability, capital mobility (modular real estate), and maintenance of existing properties. The net effect of such investments is a more resilient urban population.