[Update: Part two of the interview is now posted here]
Over the weekend I spoke with Thomas Schelling, who won the 2005 Nobel Prize in Economics for his work on game theory and collective bargaining. Schelling's early work was about war and arms control, but I wanted to speak with him about a different collective bargaining problem that's been in the news: Global climate change.
Climate change presents the world with an incredibly complicated bargaining arrangement. The big costs will be born by future generations, and born more heavily by countries other than the United States. The responsiblity for those costs is also distributed unevenly around the wrold, and there is no enforcement mechanism for a global agreement. And underscoring all of this is a great deal of uncertainty about what will happen 50, 100, or 500 years in the future.
I was hoping Schelling could help me make sense of this. Part one of our conversation is below. We discussed the financial crisis first, then moved on to discuss Waxman-Markey and the upcoming Climate Change Conference in Copenahgen. I will publish part two, in which we discuss international collective bargaining, tomorrow morning. My questions are in bold.
Conor Clarke: I've been trying to call a lot of economists who don't have blogs, to sort of canvass opinions about the state of the field and particular topics within it. There's been a lot of handwringing in the past couple of months about the failure of economics and in the particular the failure of rational expectations model. What do you think about state of the field and where it's going?
Thomas Schelling: The first thing I have to tell you is that I haven't really been a macroeconomist for the last 40 or 50 years. And I never was much attracted to the rational expectations model. I think it imputed too much. Let me put it differently. I think rational expectations can lead to several alternative equilibrium situations, depending on what people choose to expect. If people expect the price of coffee to go up, they will make it go up. And if people expect the price of coffee to go down, it will go down. And the rational expectations model doesn't necessarily tell you what external ingredient beings to sway opinion in one direction or another.
But you have written about some things that seem to me quite relevant to this crisis. In particular I'm thinking of your book MicroMotives and MacroBehavior, which deals with how small changes in perception and preference can lead to relatively large macro events that have some tipping points.
Yeah, and I did think for a long time that dividends from common stocks were low compared with the return on a decent bond holding, and I thought that's because the market prices had been rising so steadily that taking together dividends and appreciation, common stocks were a very good deal.
On the other hand, I thought, if the stock market should ever try to level off, then people would discover that, in the absence of their expected capital gains, they'd be better off in the bond market. And that would mean that it would be every hard for the stock market, after rising as it did for so long, to stop and stay level. It would have to go down, not stop. And once it started to go down it could go down quite substantially. And I think that actually happened.
But the current financial crisis is so much more complicated than the stock market! And I have a hunch that not a great many macroeconomists paid much attention to all the different kind of credit systems we have. And I can't be sure because I don't keep up with everything they write, but I think maybe the financial markets became much more complicated than they used to be. And as a result, maybe the macroeconomists just couldn't keep up with all of that.
Or maybe it's just that the situation became severely unstable. You know, housing and common stocks were beginning to fall at about the same time, and consumer spending declined partly because of the decline in capital gains. And an awful lot of the prosperity was due to the impact of stock market appreciation on people who began to get used to their capital gains as if they were regular income.
[laughs] But that about exhausts my commentary on that subject!
Well then let me ask you about something you have been writing about more recently: Collective bargaining over climate change. And I wanted to ask you first about something you wrote for Foreign Affairs seven years ago, about Kyoto: "Global climate change may become what nuclear arms control was for the past half century." Has that come to pass? Congress is dealing with the legislation now, and we go back to Copenhagen at the end of the year.
Well, I think international climate change is not yet getting serious attention. I don't expect much to come out of Copenhagen at the end of the year. I think there's too much of an expectation that if you hold a great big conference, something can come out of it. I think the president, and maybe the vice president, should get the secretary of state and the secretary of energy and the head of the Environmental Protection Agency to designate very high level people -- from both parties and both houses of Congress -- and put together a team of 12 or 15 people who would work full time on this. They would negotiate with the British, the French, the Germans and if necessary the Russians to begin to talk about what to replace the Kyoto Treaty with. And it would be their full time job for many months, until they have worked out some kind of an understanding of what their next commitments would be.