Sunday, November 28, 2010

SuperFreakonomics: Chapter 5

Many of our decisions, both inside and outside the investment world, are often based on anecdotal information, anomalies, emotions, or existing opinions. SuperFreakonomics illustrates how applying an economic approach can help us change this. Investors can use the tools described in this book, including better and more prevalent use of data, along with an an understanding of the power of incentives to make better decisions.

This final chapter focuses on the issue of global warming, but draws on many of the other concepts discussed in the book. First, the book debunks many of the misleading and exaggerated facts disseminated by the media. There appears to be scientific consensus that the earth is warming, and that humans are contributing to this. But how humans are contributing appears to be wildly misunderstood. For example, ruminants contribute 50% more greenhouse gases than the entire transportation sector! If humans changed their diets from say beef to kangaroo, it would do far more to help the environment than if they all drove hybrids.

The authors stress that negative environmental effects are due to externalities. In theory, we could determine the negative environmental externalities associated with a particular activity, tax it, and use that money to pay the costs that others experience as a result of the activity. Unfortunately, the world's climate operates under such a complex system that the authors argue this is virtually impossible.

Others believe the problem of global warming can be solved by encouraging (or perhaps forcing) people to make sacrifices. But people are not philanthropic enough to make this happen (this topic was more fully discussed in a previous chapter) and therefore this is unlikely to work on a grand scale.

Instead, they believe the challenges of global warming can be met by the same force that has solved environmental issues of the past: technological innovation. The authors describe various attempts at solving the problem of global warming. Many of them are quite simple, yet still sound effective. For more on some of these solutions and the ensuing controversies that followed, see here.

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