Best Idea of the Day: Climate Change Futures Markets

George Mason University economist Robin Hanson makes two interesting points in response to the controversy over the hacked e-mails at the University of East Anglia's Climate Research Unit, which triggered a self-congratulatory reaction among global warming skeptics.

Robin's first point is that the apparent bad behavior among the academic scientists is really nothing more and nothing less than you might expect if you'd unearthed ten years' worth of e-mails from virtually any academic department at virtually any academic institution in the world. I'm not an academic myself, but I work with them, socialize with them, interview them -- and I grew up as a university brat. The notion that academics are immune from institutional or external political considerations, that they're devoid of their own viewpoints and biases, or that they are otherwise some Platonic manifestation of the ideals of the scientific method is hopelessly naive. But that's an indictment of the scientists and not of the science -- and I'd virtually guarantee that if you'd hacked into the inbox of a global warming skeptic, or a Republican member of Congress, or the Exxon Corporation, you'd find them saying things that were equally uncouth.

But Dr. Hanson's more important argument is this one:

It is a shame that academia works this way, and an academia where this stuff didn’t happen would probably be more accurate. But even our flawed academic consensus is usually more accurate than its contrarians, and it is hard to find reliable cheap indicators saying when contrarians are more likely to be right.

If you don’t like this state of affairs join me in trying to develop a more reliable consensus mechanism on such topics: prediction markets. It just takes time or money. Prefer instead to act shocked, just shocked, when the other side is shown to do this stuff, while reserving your side’s ability to do the same? Then I have little respect for you.

Emphasis in original. I had the chance to meet Dr. Hanson for lunch last month, when I interviewed him for my book project. Now, Robin is certainly a bit more gung-ho about predictions markets than I am -- but he is also aware of their limitations. His perspective is that whatever their flaws, predictions markets are liable to be better than the alternatives, because they incentivize accuracy -- as opposed to some of the more perverse incentives that often prevail in debates about complex issues, and which were certainly manifest both at East Anglia, and among the skeptics who wrote about the "scandal".

Climate change predictions markets, indeed, could be a particularly fruitful application of the concept for a number of reasons:

1) The markets would help to clarify exactly the extent to which there is in fact a consensus about climate change. There is, I believe, an abnormally high degree of disingenuousness within the global warming debate, most of it coming from one side. We would very quickly find out if the skeptics -- and for that matter the believers -- were willing to put their money where there mouths were.

2) The market would help businesses and governments to hedge against both the dangers of climate change, and against potentially somewhat costly efforts to mitigate it.

3) The market would encourage climate change believers to add some specificity to their forecasts. Scientists have been somewhat loathe to make specific, near-to-medium term predictions about climate change (e.g. "there's going to be heat wave in Europe in 3 of the next 5 year"), out of what is probably a reasonable fear that they'll get more blame for an incorrect forecast than credit for a successful one. Markets would force people to think more strenuously about how to make reasonably specific predictions in an environment of great uncertainty.

4) The markets would encourage people from outside the academic sphere to develop their own models of climate change, thereby reducing the risk of groupthink.

5) The markets would encourage the development of new modelling techniques, and would encourage an allocation of greater computing resources toward the climate change problem -- existing CPU resources are generally inadequate as compared to the potential scope of the crisis.

6) The markets, if well designed, could help to provide an assessment of the tangible impact upon climate change of various policies under consideration by governmental and international bodies.

7) The markets, if well designed, could potentially help to establish a price for carbon, providing an alternative to the very useful pricing function of emissions trading markets if it is determined that such approaches are suboptimal or politically untenable.

8) The markets could help to price in new information more quickly -- something which is a bit of a problem since most of the work on climate change is being done in academic, governmental, or international institutions, which tend to slow-moving as compared with the private sector.

I'm sure that I could come up with a few more benefits -- as well as a few potential pitfalls. And certainly, the design of the markets is not trivial. But get Dr. Hanson and Justin Wolfers and Richard Thaler a few other smart people in a room and I'm sure they could come up with something reasonable. Personally, I'd envision a robust series of contracts on temperature, CO2 emissions, precipitation, and perhaps tropical storms that expired at various intervals along the lines of those used for US Treasury bonds -- say at 3, 5, 7, 10, 20, and 30 years. I'd encourage the use of options and perhaps derivatives, which can be helpful in pricing not just the mean estimates of temperature or precipitation but also the uncertainty surrounding these estimates. I'd run the markets through a major, cross-national platform such as the United Nations, IMF or World Bank, so as to encourage participation and create liquidity. And I'd make them open to as many people as possible with few legal restrictions or transaction costs. It wouldn't be perfect. But it would be a hell of a lot better than something like this or this pass for expert opinion on climate change.