These Economists Are Making Me Thirsty

Before Kevin Rudd became Prime Minister, he promised a rather interesting thing: "evidence-based policy".

This caused quite a stir within Australia’s public services. After more than 11 years of a Howard government in which critical decisions on the future of the country increasingly seemed to depend on the advice of the Prime Minster’s spouse, here was an incoming government led by a man who had previously sat at the top of the Queensland bureaucracy, apparently committing to make decisions based on fact.

Early actions of the Rudd Government seemed to fuel the fire of hope. The 2020 Summit, on one level clearly a piece of cunning political spin-doctoring, also showed at least a superficial commitment to listening to a range of different opinions on important matters of public policy.

And then there is the Rudd Government’s love of enquiries. There have been literally hundreds announced, some of them even before Labor won government, on issues ranging from the very big (climate change, defence, the nation’s tax system) to the very small (visual arts and music education).

Why is this important? Because it offered a chance to reform the way Australia’s public policy is made. Instead of the 24-hour news cycle driving cravenly political decision making, perhaps we could look forward to a government that would make policy by examining the facts, in consultation with ordinary citizens as well as highly paid lobbyists, and after taking in the best advice.

So far, that hasn’t happened.

To see why, we need look no further than the Garnaut Review on Australian climate change policy. Now we have most of the reports and releases associated with the Garnaut Review, including the all-important Treasury modelling assumptions, we can see how Australia’s policy is really made.

It’s made by faceless men and women in the central departments of government (Treasury, Finance, Prime Minister and Cabinet) who are in the thrall of a particular belief system. Some have called it "economic rationalism", others the "neoclassical synthesis", and still others "neoliberalism". For the sake of brevity, let’s just call it "economics".

"Economics" needs a pair of inverted commas because it’s a particular kind we’re talking about here: the neoclassical model, as propounded by the economics schools of most of our nation’s universities, including the ones that provide many of the recruits to the Treasury, like ANU’s. Its ubiquitous textbook is by Harvard economist N Gregory Mankiw.

We’ve heard all the criticisms of this kind of "economics" before. It assumes that markets are generally competitive, the average person is a rational calculator of costs and benefits, and that nearly everything can be explained by supply and demand. It assumes that problems like climate change or bank failures are really just instances of market failure. Fix the market — by, say, recapitalising banks, or by creating a carbon price — and you fix the problem. Voila.

"Economics" in this broad sense dominates the thinking of policy makers in Canberra, Washington and London. When Kevin Rudd claimed he was a "fiscal conservative", what he was really proclaiming was that he would cleave to the economic orthodoxy as practiced by the Departments of Finance and Treasury.

And "economics", in this sense as a shared belief system or orthodoxy, is the dominant force behind the Government’s emerging climate change policy. You could sum it up by saying "economics is more important than science", or perhaps more bluntly, "money is more important than the planet".

If this sounds harsh, then let us examine the conclusions of Ross Garnaut’s Review. Garnaut accepted the science that tells us the planet is warming rapidly and calamitously. But he argues that the politics and economics of getting the world to agree to limit greenhouse gas emissions makes it unlikely we’ll be able to do anything. So Garnaut suggests Australia shoot for an emissions target that guarantees destructive climate change. As I pointed out at the time, it’s one of the most depressing policy documents ever produced in this country.

Now the assumptions behind the Treasury modelling that will inform the official Government response to climate change have been published. These are detailed in the recently released Treasury Department’s "Climate Change Mitigation Policy Modelling: Assumptions and Data Sources". This is the first tidbit of the long-awaited Treasury modelling that was promised long ago, and as Malcolm Turnbull pointed out, was not previously released.

The assumptions behind the Treasury modelling are even more depressing than Garnaut’s document. Why? Because they subscribe to the very religion of "economics" that is turning out to be so deeply flawed. Worse, it turns out some of the modelling is from agencies intimately linked to the fossil fuel industry.

One of the models is the GTEM model, developed by ABARE, the Australian Bureau of Agriculture and Resource Economics. ABARE is a notoriously backward agency whose stance throughout the Howard government’s reign was openly pro-pollution and climate change denialist.

Under its long-term boss, Dr Brian Fisher, ABARE was responsible for the infamous "MEGABARE" model that made Australia a laughing stock in connection to the Kyoto negotiations, as Clive Hamilton details in his book Scorcher. ABARE is not truly independently funded: it routinely takes money from the corporate sector to fund its activities. Fisher has since left ABARE to head up a fossil fuel lobby group, Concept Economics.

The second model the Treasury is using is by academics Warwrick McKibbon and Peter Wilcoxen. McKibbon and Wilcoxen are world experts in climate change economics, and Garnaut built on many of their ideas in his Review recommendations.

But McKibbon and Wilcoxen are far from disinterested and unbiased. They are, in fact, activist academics who have long been highly sceptical of the scientific facts of climate change and highly critical of the entire UN Framework Convention on Climate Change.

Instead, they are enthusiastically promoting their own solution to this global problem, which they not immodestly call "the McKibbin-Wilcoxen Hybrid, also known as the "McKibbin-Wilcoxen Blueprint".

Will it work? Who knows? What we do know is that they propose the junk the current system and replace it with their own. To put it mildly, that’s not very likely to happen.

The third model that Treasury is using is a highly neoclassical framework developed by Monash’s Centre for Policy Studies. This centre specialises in developing what the economists called "Computable General Equilibirum" or CGE models.

What are CGE models? Well, it’s complex. They can be traced back to the work of mathematical economists like Kenneth Arrow and Leon Walras. CGE models are now the backbone of micro-economic analysis. When Wayne Swan and Malcolm Turnbull talk about "modelling," this is what they are talking about.

But as mentioned above, CGE models are based on some important assumptions: perfect competition, perfect information, complete markets and rational individual consumers. Unfortunately, these assumptions are wrong. As Nobel Prize winner Joseph Stiglitz points out, "these models have serious inadequacies."

In other words: they don’t work.

The reputation of neoclassical economic models in general is currently in tatters. Take risk modelling at major merchant banks. The 1990s and 2000s saw the much-praised development of so-called "Value at Risk" models which were meant to calculate how much money a bank or hedge fund could lose on any one day.

These much-touted models, some of them developed by Nobel Prize winners, didn’t predict the crisis that brought down Long-Term Capital Management in 1998, and they didn’t predict the subprime meltdown either. As risk expert Jon Danielsson writes in a forthcoming paper, blame the models.

But in the halls of power in Canberra, the stubborn hegemony of neoclassical economics means that Australian policy will be based primarily on economic models that don’t work, rather than climate models that actually do.