Making Decisions in the Face of Uncertainty

 

Washington, D.C., June 10, 2014 – How can governments and businesses make investment and policy decisions in the face of enormous uncertainties? That’s a question facing many in the world today as scientists assert that global warming could be an existential crisis, but with great uncertainties attached.

The World Bank’s economics team offers some perspectives on this difficult topic (and a tip-of-the-hat to Georgia Tech’s Judith Curry for pointing me to this paper). The World Bank paper suggests that the conventional approach to the metrics of evaluating policy options – such as net present value – may not be the best approach. Instead, says the World Bank, “alternative methodologies can improve decision processes, especially those that lead with analysis and end in agreement of decisions.”

The key to this approach – which the paper cryptically calls “agree-on-decision” methodology – starts with “stress-testing options under a wide range of plausible conditions, without requiring us to agree ex ante on which conditions are more or less likely, and against a set of objectives or success metrics, without requiring us to agree ex ante on how to aggregate or weight them.”

In the case of global warming, this approach offers some advantages, since the uncertainties of the predictions of impacts – despite the uncritical media coverage of the “sky-is-falling” scenarios – are profound. On top of that, the preferred policy options of those who buy the apocalyptic vision of the future are often extremely costly, which suggests an approach that can ascertain the least-cost approaches.

The World Bank report says, “Continued efforts by climate scientists and others to increase knowledge about the climate and future climate scenarios are valuable. However, uncertainties about climate change and its impacts may increase as scientific inquiry diversifies and deepens. Therefore, decision makers should accept the irreducible uncertainty about the future climate and formulate adaptation and mitigation policies to manage it.”

That strikes me as a well-founded conclusion.

The World Bank report suggests four features that can make decisions robust in the face of uncertainty:

* No and low-regret decisions. These decisions, says the report, “have high utility no matter what the future brings. Thus, they can be robust even to deep uncertainties.”

* Flexible and reversible decisions. These decisions, says the World Bank, “are typically more robust than irreversible ones because they enable us to adjust our decisions as new information becomes available.”

* Safety-margin decisions, which the bank argues “can reduce the risk of bad options at negative, zero, or negligible cost.” The report adds, “Cheap safety margins are especially important for adaptation measures that are not reversible of flexible.”

* Decisions with reduced time horizons. “Reducing the lifetime of investments is one way of reducing uncertainty around a decision,” says the World Bank.

These all strike me as wise policy measures, and appear to follow the general economic and policy principle of not making the ideal the enemy of the good. Small, reversible, marginal, and short-term policies all make sense given the lack of full understanding of the global warming problem and its implications.

So what flows from this? I agree with Judy Curry’s assessment:

“The [World Bank] acknowledges deep uncertainty in our understanding of climate change. But this uncertainty is not a reason for inaction. Until U.S. and UN policy makers (and other national governments) begin to understand this, we will continue to have gridlock on climate policy, scientists will feel the need to be advocates, climate science will be politicized, and climate scientists will play the manufactured consensus game.”