Select Committee on Economic Affairs Written Evidence

Memorandum by Sir Ian Byatt


The Context

  I am a Senior Associate with Frontier Economics and an Honorary Professor at Birmingham University. I was previously Director General of Water Services (Ofwat) and, before that, Deputy Chief Economic Adviser to the Treasury, where I was responsible for leading micro-economic/supply side analysis within the Government Economic Service. I had worked in the Department of the Environment in the early 1970s on the Club of Rome predictions. I welcome the opportunity to briefly elaborate the views set out in the letter published in the Times on 24 October 2004.

  That letter argues that, in this area, government and opposition are now of one mind. Both hold an alarmist view of the world, and call for a radical—and costly—programme of action. Both seem to believe that prospective climate change, arising from human activity, poses a grave and imminent threat to the world. Such statements go well beyond what can be taken as established facts.

  My own reading of the evidence is that many of the scientific issues surrounding climate change remains unsettled. More importantly, in my view, there are a number of economic issues that have not been adequately addressed. It is premature to conclude that any human-induced global warming would necessarily occur rapidly and further, that any such warming would be catastrophic. I do not, therefore, agree that drastic and far reaching action is justified, especially without more careful consideration of the type of action appropriate, and of the costs associated with it.

  The actions favoured by ministers appear chiefly to take the form of a range of higher targeted subsidies, and of stricter controls and regulations to limit CO2 and other greenhouse gas emissions. All of these measures would raise costs, for enterprises, for households, for taxpayers. They would make many people, including some of the poorest, significantly and increasingly worse off.

  These actions should be challenged on four grounds:

    —  The underlying analysis begins with projections of emissions that are subject to much greater challenge than is generally recognised;

    —  They neglect the power of market mechanisms;

    —  They involve a flawed approach to decision taking; and

    —  They underestimate the costs of the policies suggested.

  I turn briefly to each of these points and conclude by arguing, based on my own experience, of the importance of ensuring proper use of economists in the Government Economic Service in these matters.

The Future and the IPCC Process

  Temperatures have risen in recent years. There is insufficient evidence, however, that this represents a lasting change in long-term trends, or that human activities are solely or primarily responsible for these changes, or that single remedies, such as radical cutting of carbon emissions, will reverse them.

  The history of our climate shows significant, yet imperfectly understood, changes in the past. The treatment of economic growth in the IPCC scenarios is flawed. Changes will take place in basic parameters. For example, the energy intensity of economic growth has changed significantly as energy prices have changed. (In his evidence to your lordships, Professor McKitrick has pointed out that global emissions per capita have levelled off since around 1975.)

  Other market responses will influence outcomes. There are offsetting effects. For example, discharge of CO2 increases biomass as well as carbon in the atmosphere. The trade-offs involved in these issues should be more closely studied.

  Modelling has its uses in trying to understand the future. But it also has its dangers and its track record in making predictions, even within a range, is poor. The data used in models is subject to error, complex models are difficult to disentangle and different techniques of modelling produce different answers. There is often some particular parameter in a complex situation that dominates the answer. My own experience of understanding the Club of Rome projections in the 1970s and of forecasting the price of oil in the 1980s convinced me of the dangers of relying too heavily on quantitative modelling in policy formulation. In his evidence to your lordships, Professor McKitrick has argued that the modelling procedures are flawed because of mistakes in the underlying factor analysis.

  Scenario planning can be valuable as a way of linking uncertainty with analysis of possible actions. But to be helpful, the scenarios must cover a wide range of possibilities and, furthermore, some analysis of probabilities is essential. The IPCC scenarios suffer from a limited range as well as from limited analysis of the underlying economics.

  More broadly, the handling of economic issues within the IPCC process is open to question, and cannot be viewed as professionally representative. I believe that Treasuries and Ministries of Finance should pay more attention to this aspect of the process, both nationally and internationally.

  I conclude that there is neither sufficient evidence to forecast the "hockey stick" changes emerging from the IPCC work now set out in the Government's Paper on Energy (DTI Our energy future: creating a low carbon economy. Cm 5761. 2003), nor to justify the drastic action thought necessary.

The Role of the Market Economy

  Where there is diversity in perceptions, preferences and situations a market approach has major advantages over the command and control approach of setting "scientifically determined safe targets". This is particularly important where the implementation of policies to meet such targets would involve drastic action with limited chances of success and the potential for massive waste of resources.

  As Sir Alan Peacock has shown (The Political Economy of Sustainable Development Presidential Address to the David Hume Institute, 2 October 2003) markets take account equally of human altruism and human selfishness. They provide highly sophisticated ways of doing this. In contrast, command and control policies typically fail to achieve their objectives in a cost-effective way. They cannot take proper account of the mass of relevant information. Their use risks making mistakes, often on a massive scale. Notable examples are government support for aviation and nuclear power. A more recent example is provided by the government's response to foot and mouth disease, where large numbers of farm animals were slaughtered with little consideration of alternatives.

  It does not follow, of course, that market mechanisms are always sufficient fully to meet social or collective objectives. Some governmental intervention may be needed fully to secure collective objectives. But rather than adopting policies that impose their view of collective objectives, governments can help markets to work better by creating incentives to more socially acceptable/less environmentally damaging behaviour. This use of incentives is particularly effective when there are differences in situations, endowments and preferences. They are also much more transparent.

  Market mechanisms can be particularly effective in an uncertain world. Government planning is inevitably based on imperfect knowledge. As new facts emerge and perceptions change, governmental planning easily becomes stranded in wrong solutions. In contrast economic agents have demonstrated a remarkable ability to adapt to change and to respond to market signals. As Professor Anderson has argued in his evidence, there is a wide range of ways of reducing CO2 and other greenhouse gas emissions. The use of market signals would help to explore which are the more acceptable and cost effective ways of doing this.

  The use of market mechanisms also provides a running check on the costs of policies. Initial estimates of costs can be built into a policy instrument, such as a carbon or greenhouse gas tax. Should that instrument prove to be less effective than had been originally estimated, i.e. more costly,—because, for example, costs of compliance have been underestimated—further consideration of the costs and benefits of the policy are prompted. By contrast slow progress or apparent failure of command and control policies tends to prompt intensification of the policy simply because the immediate objective is not being achieved sufficiently rapidly.

Decision Rules

  Human beings—in diverse positions with differing objectives—respond to circumstances in different ways. Situations where there are multiple actors and multiple objectives are not best characterised as situations where there are specific problems to be solved. It is not helpful to approach them as one where "we", the human race, led by a benevolent leader, or advised by a Platonic guardian, must rely collective action to secure a single objective. Rather than targeting "safe scientific" standards, whatever the costs of doing so or the benefits of achieving them, it is more useful to ask how economic agents with different capabilities can be expected—or encouraged—to adjust their behaviour.

  The use of the precautionary principle is frequently used to justify action where severe damage is in prospect, albeit with a low probability. This can involve a flawed approach to decision taking. To be prudent may be wise, but the rule must be applied systematically. There may be risks that global warming is taking place, but there are also risks that policies designed to counter this will damage the achievement of other objectives. For example, world economic growth is the only sure way sustainably to reduce world poverty. And economic growth leads to reductions in the energy intensity of GDP. The precautionary principle should be applied in a comprehensive way, taking a balanced approach to all the risks, and not simply to some of them.

  Dealing with uncertainty is essential, yet the state of analytic techniques is still limited. To do the job properly must involve a large element of judgement. It is not enough to combine unsatisfactory scenarios with over reliance on one decision rule, especially when it is applied selectively.

The Costs and Benefits of Policy

  In my experience, the costs of government actions are usually underestimated by government ministers—often by a large margin. This was my regular experience both in the Treasury and in the regulation of the water industry. There is already evidence of substantial underestimation of the costs of "green" electricity. (David Simpson Tilting at Windmills: the Economics of Wind Power Hume Occasional Paper No. 65 April 2004)

  In my experience as a government advisor and at Ofwat, the benefits of environmental policies are rarely analysed carefully or systematically. Difficulties in assessing benefits are avoided by simply asserted that they always outweigh the costs—or "that there is no choice". In this case we are told to "save the planet" with little idea what this involves other than a slogan for virtuous action.

  In reading the uncorrected evidence of DEFRA officials, I was struck by the lack of evidence of damage/benefit functions in this area and the lateness of attempts to fill this gap. Despite the difficulties of such work, it cannot be right to base far-reaching policies on this foundation.

  Furthermore, there are always opportunity costs to be considered. Many more policies are said to be essential than there are resources to implement them. It is necessary to consider the alternative use of the resources used as well as the financial costs of proposed actions. This rarely happens in this area.

  Conventional wisdom alleges that the civil service is too concerned with "policy" and too little with "delivery". There may be some truth in this, but the view that civil servants are employed simply to implement strategy and to take no part in its formulation risks creating situations where action, and not always well judged action, is taken without adequate consideration of all the consequences, including the unintended consequences.

  Recent years have seen the growth of powerful single interest pressure groups, the NGOs. They often have charitable status and are well financed and well staffed. They have become political bodies, with considerable lobbying power, although their accountability is to their members, not to a democratic constituency. They are usually interested in furthering specific objectives, not considering the trade-offs involved in policy choices. That role must fall to democratically accountable government, which needs adequate resources to discharge this responsibility. These resources do not all need to be within government, but there must be sufficient internal capability to ensure that proper analysis is carried out and properly presented to ministers. External checks may be necessary to ensure that this is taking place.

The Role of Government Economists

  The presence of professional economists inside the government is a crucial aspect of such a capability. It can help to reduce the risk of hasty and ill-considered action. It can also guide action in ways that will help to ensure that policies have been subject to rigorous economic analysis. The government has recognised the importance of economists by expanding the Government Economic Service (GES), which now comprises some 800 trained economists.

  But are they being well used in this area of policy? There is no evidence that they are having a powerful influence on decision taking in this area. Yet substantial resources, including public money, are at stake. Baroness Farrington told your Lordships on 21 April 2004 that the government was satisfied that the economic and statistical work of the IPCC is the most comprehensive assessment available. If it is the best available, it is only because economic experts have not been properly deployed, either by HMG or other governments. My own perception is that the economic issues are being avoided and that Baroness Farrington's later assertion that "the views expressed by Mr Castles and Mr Henderson were considered extremely carefully by the government" reveals economy in drafting rather than economics in policy.

  I urge your Lordships to examine the role of the GES in consideration of these issues, both in Whitehall and in guiding the work of the IPCC.


  I am concerned that:

    —  The UK Government is pursuing polices to combat climate change that are a less than fully considered response to a situation that is much more uncertain than acknowledged; and

    —  The economic analysis underlying governmental decisions is at best inadequate and in some respects seriously flawed.

29 March 2005

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