INSIDE ECONOMICS

Mark Zandi:                      Welcome to Inside Economics. I'm Mark Zandi, the Chief Economist at Moody's Analytics. And this is a special bonus Inside Economics Podcast. We're going to be focused on climate, climate change, climate risk, and with a particular focus on, let's call it climate change adaptation. And we'll come back to that in a minute to find that what it means and have a discussion around that. And we have a wonderful guest to help us understand that a bit better. I understand he's a bit of an iconoclast in the world of environmental economics, so perfect for Inside Economics. Glad he decided to come and join us. But to participate in the conversation I have two of my colleagues, of course, Cris deRitis. Cris, welcome.

Cris deRitis:                       Thanks, Mark. Happy to be here.

Mark Zandi:                      Yeah. It's good to have you. And of course, Gaurav Ganguly. Gaurav, good to see you.

Gaurav Ganguly:             Hi, Mark. Hi, Cris. Hi, Matthew. Good to see you all.

Mark Zandi:                      And Gaurav, he plays lots of roles. As you may know him, listener, as the leader of our team in Europe, in the Middle East. But he's also in his own right, and I think we've talked about this in the past, but I'd like to just explore it for another minute or two. He's a climate expert. He's, I'd say an expert in climate risk, climate change, and trying to understand what that means for broader economic conditions. And he leads our climate risk team. Gaurav, do you want to just give us a sense of your climate change bonafide? Because you do a lot of things that I can't keep track of, but it'll be good for the listener to hear that.

Gaurav Ganguly:             Yeah. I can't keep track of them either, Mark. But I'm not sure I'd call myself an expert, I dabble most of the time. So I spent several years before I came to Moody's, which was over a year ago by the way.

Mark Zandi:                      It goes fast, doesn't it, Gaurav?

Gaurav Ganguly:             It goes so fast. Time flies.

Mark Zandi:                      By the way, it's the Hotel California Moody's. You know what I mean by that.

Gaurav Ganguly:             Yeah, I know what you mean. I know what you mean.

Mark Zandi:                      You can check in, but you can't check out.

Gaurav Ganguly:             Exactly. Exactly. So I did a fair bit of work at my previous employer, which was HSBC, on looking at financial risk from climate change. And that's how I got started on this journey. And then I got dragged into doing some research at Imperial College in the Grantham Institute for Climate Change and looking at how climate risk should be measured and mapped for different financial risk types. And from then on I then went on to teach at a degree program at Imperial. And then I came here of course, and I had the scenarios team, which does, as I was explaining to Matthew earlier, all our regulatory scenarios for climate. So very much in that space of looking at regulatory scenarios for climate risk, transition risk, physical risk, all that kind of stuff. And once in a while, going off and teaching.

Mark Zandi:                      Well, you, you've teased our guest a couple of times already. Matthew, Matthew. Matthew, Matthew Kahn. Welcome, glad you're here on Inside Economics. It's good to have you on.

Matthew Kahn:               It's great to join you guys. I'm here to learn and to be a little bit provocative.

Mark Zandi:                      Well, provocative is good and we want to pull that out of you Maybe though, Matthew, you're obviously a well-known professor at University of Southern California, USC, and do a lot of work in environmental economics. Maybe you can give us a sense of your background. And the one thing I'm just to lay it out on the table, I'd really love to know how you can write as many books as you do as fast as you do. I find it incredible. Tell me if I'm wrong, but you published two books in 2020, two books in 2021. I'm not sure what happened in 2022, you probably needed a long vacation. I think you have eight books I counted altogether. I think I got that right. So in your bio, I love to hear how you got to where you are, but I'd really like to know your secret sauce for writing books.

Matthew Kahn:               Well, Mark, I think there's quantity and quality. So some of my critics would say, "Matt, stop with the conjectures and let's see you clean up some stuff." And I hope we come back to that. But Mark, I'm full of ideas.

Mark Zandi:                      Interesting.

Matthew Kahn:               I want to tell one story from my youth. And I'm 56 years old and I'm feeling it. 30 years ago when I was at the University of Chicago, I was a student of the Nobel Laureate Gary Becker, and he was the student of Milton Friedman. I met Milton Friedman once and I cracked a joke and he didn't think it was funny and so I learned the importance of being serious. And I'll be serious in this podcast. At that time in 1992, Newt Gingrich, the speaker of the house, was talking about shutting down the EPA, kept talking about the costs of environmental regulation. And I turned to Gary Becker. I said, "But there must be benefits of environmental regulation." And we agreed that that would be a good topic. And Mark, that was the start of my working on environmental topics. And as an Chicago economist, always thinking about the intended and unintended consequences of regulations.

Mark Zandi:                      So is Milton Friedman, you took courses from him, Milton Freeman, did you not?

Matthew Kahn:               Milton Friedman retired from Chicago in 1977, but his students were very active at Chicago and were tough guys yelling at the new generation of students. And I've tried to be a nicer professor, not as smart as those guys, but I think I'm nicer than them.

Mark Zandi:                      Can I ask you, do you remember the joke you told him that he didn't think was funny?

Matthew Kahn:               It was a joke about Chicago winter and when he goes to Hawaii to visit the University of Hawaii.

Mark Zandi:                      Oh, I see. Yeah, interesting. It didn't work. I hear you.

Matthew Kahn:               Not funny.

Mark Zandi:                      Yeah. So you kind of avoided the question around your prolific book writing. Can you just give us a sense of that? What's behind how are you able to do that?

Matthew Kahn:               So Mark, to be serious for a moment, I both write academic stuff for peer review. But when you write a book, it kind of subverts the referee process. I'm looking at Cris as a PhD economist and Gaurav. There's very tough people out there. And when you write a book, you can bundle in more conjectures and more things that may be true. And so Mark, I want to be careful because we may have book editors watching this podcast, but the burden of proof is not as strong. And so when I know that my conjectures can reach people like my mother, that creates incentive for me to work extra hard to get all my ideas out.

Mark Zandi:                      Of course.

Matthew Kahn:               I love economics. My wife is an economist, my son is an economist. It's in the air. But when you write books, you are sort of free to just let it rip and that's sort of dangerous for me.

Mark Zandi:                      Oh, that's interesting. So you feel liberated intellectually, so you can just write and you don't have to worry about citations and causality.

Matthew Kahn:               Mark, to be serious there, I have many conjectures that will only be proven over the next 15 to 20 years. So I don't want to say I'm Einstein with his comments, but I make conjectures that we'll only know if they're right 10 to 15 years from now. And referees say, "Khan, you can't get away with this. We are a science and if we can't reject your hypothesis now, then you're bordering on science fiction."

Mark Zandi:                      Well, I think we're intellectual brothers, Matt, because we're conjecturing all the time. And the best conjectures are ones that are in fact way out into the future, so you're not too worried about whether you're right or wrong. But I think it's a very intellectually important thing to do, right? Because the metaphor I have in my mind is there's this, the Amazon intellectual Amazon forest out there, and you got to sort of cut Greenfield to kind of get out there. And yeah, maybe leave a few branches along the way and it's a little bit of a mess and it's not a straight line. But without cutting that intellectual pathway forward, people don't move as fast. That's kind of how I think about it.

Gaurav Ganguly:             Mark, this doesn't work.

Cris deRitis:                       You know this is a climate risk.

Gaurav Ganguly:             We can't talk about cutting down the Amazon.

Mark Zandi:                      Oh, yeah, yeah, that's right. That's really bad. That is really bad. That's so funny. Not really funny, but you get my drift.

Matthew Kahn:               So Mark, can I give one example of my conjectures? There's a fight in climate change economics of, for those purchasing million-dollar homes in Phoenix, Arizona. Are these guys nuts? So the New York Times keeps writing papers that there's no water, it's going to be 140 degrees. How in the heck can people be purchasing multimillion dollar properties at Scottsdale? Behavioral economists say that these folks are nuts, that they're backwards looking, not forwards looking. And so Mark, in a case like that, and this gets into Moody's and credit rating, I jump in and say, if we see someone with skin in the game buying an expensive condo in Scottsdale, are they technological optimists that will figure out how to use water desalinization to increase the water supply?

                                             Will these guys only be in Phoenix eight months a year and not be there during the summer in a work from home economy? So Mark my mind is always moving perhaps too fast, thinking through how rational self-interested agents when they make a costly choice, could they really be behavioral fools? And so a large chunk of my work is set in the future, trying to battle some of the behavioral economists in a respectful way as I continue to take the efficient markets hypothesis seriously.

Mark Zandi:                      Well, that's a great example about Phoenix, but let's take just a step backwards to frame it. And first I think everyone out there should know, and maybe you'd like to say, you're not a climate change denier. You're not denying that climate change is happening. That's happening.

Matthew Kahn:               The exact opposite. Because climate change scares the hell out of me, both what we're currently seeing, the unknown unknowns are becoming known unknowns. The New York Times is doing a terrific job reporting on the climate challenge. And Mark, because I'm so worried about climate challenges for all over the world, especially for poor people, capitalism is going to begin to kick in. So Adam Smith's invisible hand, the potential to innovate cause of this anticipated threat. So I'm the opposite of a climate denier.

Mark Zandi:                      Yeah. So climate change is happening, there's going to be repercussions. We're going to have all kinds of physical risks, acute physical risks, storms and floods and fires and chronic physical risks, heat stress, sea level rise, all these things are in train, they're happening. But what you're saying, the 35,000 foot level is, hey look, we're going to have to adjust to this. Businesses, governments, people are going to have to make changes to adapt to these risks that events that are going to occur. But this may not be as painful or as unreachable as it feels at the moment. Because if you let markets work, if you let pricing work, if you let insurance markets work, financial markets work, real estate markets work-

Matthew Kahn:               Credit rating.

Mark Zandi:                      Credit ratings work, you'll get to a place that it's going to be cost, but it's not going to be as significant cost as some people seem to think. Is that a fair characterization?

Matthew Kahn:               That is correct. Mark, you can't see the back of my head, but I'm bald. If I were the world's only bald man, no Rogen, no cures for baldness. If enough people have a problem, a medical problem, the pharmaceutical companies step up. Economists are very used to this idea of induced innovation, that aggregate demand induces supply. Mark, that same logic underlies a chunk of my optimism of how capitalism helps us to adapt. Air conditioners becoming more efficient, air filtration suits to protect us from the smoke in the West, a whole variety of strategies that I'm not a good enough engineer to anticipate. But this idea that aggregate demand for solutions, the expectation of misery actually creates incentives for innovation. Mark, a point. There is such optimism in the Biden administration about green energy and innovation for mitigated climate change. There's an asymmetry that there isn't an equal optimism about our ability to adapt to these threats. And so that's been a fight among the nerds.

Mark Zandi:                      Right. You use a term called, which I find a great term, you called it endogenous innovation. So the way I would frame it is innovation that's incented and caused by things that are happening around us, and we are going to adapt and change to those things and innovate to be able to adjust to those things that are going on around us. So it's within the system. It's not something that comes from outside the system, it's already in the system. Just as long as we allow it to work, this will happen, this innovation will happen.

Matthew Kahn:               Mark, I agree. The Nobel Laureate Michael Kramer has done very important work on the opposite. He's argued that in Africa there's poor people who have medical conditions, and because these folks are not rich, drug companies are not innovating to provide these vaccines. And he's talked about incentives for how the rich world, the Gates Foundation can incentivize drug companies to come up with cures for diseases that millions of poor people have. So Mark, I'm not such a magical thinker to believe that capitalism works to innovate for challenges that poor people face. Capitalism often works and chases the dollars of where there is a demand. If real estate owners face flood risk, face fire risk, face particulate exposure risk, capitalism steps up. So a fascinating issue is how we configure free markets to improve the poorest quality of life, because I'm very confident that Elon Musk and Jeff Bezos will be able to adapt to these challenges. The question is for middle class people, will the products that we need be cheap enough and affordable, similar to the air conditioner during the 20th century?

Mark Zandi:                      So I'm just trying to frame your thoughts a little bit so that folks have a really good grip on that. Then I'm going to ask my two colleagues to start pushing you on different aspects of this. But one other thing I want to get clear and on the table is what you're saying, you're not saying anything about climate risk mitigation or the need to provide, like in the Inflation Reduction Act, the incentives, the tax incentives and other incentives in that legislation to help with the move from fossil fuel over to green energy. You're not arguing against any of that. That's not what you're talking about?

Matthew Kahn:               That's correct. So Mark, in my 2010 Climatopolis book, in the first chapter, I come out in favor of a carbon tax. But even 13 years later, no country has a carbon tax, that we continue to see middle class people rejecting, the State of Washington rejected a carbon tax. The fear that rising fossil fuel prices lowers the incomes and employment possibilities of less educated people stalls introducing a carbon tax. So Mark, what I would say is that I'm a realist. Because greenhouse gas emissions are going to continue to rise, and I'd love to see green tech bend the curve, I agree with Greta Thornberg, we need to reduce our greenhouse gas emissions. But because I believe greenhouse gas emissions will continue to rise as the developing world gets richer and consumes more fossil fuels, adaptation takes center stage. I don't view this as surrender.

Mark Zandi:                      Well, actually, I was going to like Gaurav push first, but I'd like to push back first, just based on what you just said. Because the one reason why I've been reasonably optimistic about climate and the threat posed by climate, and fundamentally it goes to what you're saying is that it's about price. If you price something, good things happen. If you price it high, people don't do it. So letting markets work at prices work makes sense. And the carbon tax seems to be the most obvious, straightforward, that's a slam dunk, that's going to work. And there are problems with a straight up carbon tax, meaning taxing CO2 emission.

                                             One is what you mentioned is lower income households, they'll get creamed, right? Because they spend a large share of their budget on fossil fuel and energy and they're just not going to be able to afford it. You could mitigate that risk by just taking the revenue, the tax revenue you generate from the carbon tax and just dividending it back to people. Give everyone a $1,000 check, whether you make $50,000 a year or you make 5 million, you get a $1,000 check. Very kind of progressive policy and you address that issue.

Matthew Kahn:               But Mark, I agree, but we've seen Jim Salee released a recent paper. So I agree with what you said. Jim Salee released a recent paper that that's easier said than done, but we continue to have the paradox. I agree with you and with public finance economists who talk about tax and dividend, but still we see no nation implementing this. Joe Biden, whose fancy himself is the new FDR, has been afraid to propose that. So Mark, if I can get in your face. If it's so easy and if we can write it on a envelope like Arthur Laffer, why hasn't FDR Biden introduced this?

Mark Zandi:                      Oh, the politics of this are bad. All I'm saying though is, and I've observed lots of issues that look like they were off the table and then they were on the table, because something happened. And you can imagine in a world of rising CO2 emissions and increasing risks, physical risks, things will happen to a place where people say, "Oh my gosh, we got to do something." And the most obvious thing to do is the carbon tax. The whole dialogue shifts with regard to-

Matthew Kahn:               I actually disagree again. Even if China introduced the carbon tax, China is just like 15% of the world's population. So the fundamental free rider issue here is in a world where we don't have global governance, any one country, even India, if it unilaterally took this action, is on some level being foolish. The free rider hypothesis lurks here, that everyone's waiting for everyone else to be the first mover here. And so that's the reason I pivoted the adaptation that I don't believe the free rider issue is going away, unless green energy becomes the free lunch that the boosters claim and we can come back to why I don't believe that.

Mark Zandi:                      Well, believe me, Matthew, I'm not arguing these things are mutually exclusive, not at all. I think they should be moving along together. But on the point about the free rider, if the US imposed a border adjustment tax and said, "Hey, if I'm bringing anything from China, I'm going to take account of their carbon footprint and they're going to pay a tax, a tariff to pay for that carbon." So effectively you're putting a carbon tax on the products that they're producing. And we, the United States of America, are the number one economy on the planet, 20% of GDP and we count for a lot of the trade, second most in the world after China, that's going to make a difference.

Matthew Kahn:               Not for long. So I agree, the Nobel Laureate William Nordhaus has endorsed these carbon clubs.

Mark Zandi:                      Yeah.

Matthew Kahn:               I'm starting to write a paper of whether if we unilaterally did that, would that fracture the World Trade Organization? Would China form regional trade blocks with other countries? So there's very interesting game theoretical issues of if we unilaterally tried your idea, and I'd actually want us to try. I agree with the importance of experimenting. But I worry that an unintended consequence would be to create regional traded blocks. So there's a question of if one nation righteously tries to launch this, is this a stumbling block or a building block to a global green trade? And I think that there's points that can be debated there, but I hope that you're right.

Mark Zandi:                      Well, Fair enough.

Cris deRitis:                       Just to clarify, I thought the road you were going down was if there was some type of cataclysmic event.

Mark Zandi:                      Yeah.

Cris deRitis:                       Right. We have this massive heat wave in the U.S, it kills a hundred thousand people.

Mark Zandi:                      Yeah. Right. Exactly.

Cris deRitis:                       That might be a tipping point for some action.

Mark Zandi:                      It changes the dialogue completely.

Matthew Kahn:               I wish that that's true, but I think that that would increase private demand for adaptation products. I don't see a setting, I like Cris' claim, but we've had horrible events. The New York Times has tried to use Hurricane Ian. We've had all sorts of events that have not catalyzed public goods. And so I like that hypothesis, but I think it actually increases the demand for adaptation products. Who are these marginal swing voters who have opposed carbon taxes up till now, who would be scared straight by these shocks? You'd have to trust government with the money. You'd have to believe that we can overcome the free rider issue. There's very interesting questions of who's at the margin here, if I could use some economic jargon, to swing their vote. The people of Berkeley are already with Cris, of who are these swing voters in Dallas who would swing because of the heat wave? And I'd ask you guys as a micro-economist, these are the types of things I think about. The people of Berkeley are fully in with Greta. Who is the swing voters who would now join the coalition?

Cris deRitis:                       Well, if the heat wave hit Dallas, right?

Mark Zandi:                      Well, I was going to say if the heat wave hit Washington, then it changed pretty fast. But anyway, go ahead Gaurav.

Gaurav Ganguly:             So I was going to say, in some sense I agree with Matthew. So Matthew, you started out by talking about science fiction.

Mark Zandi:                      By the way, Matthew, that's high praise. He doesn't agree with anyone ever. Go ahead, Gaurav.

Gaurav Ganguly:             He just says that. Mark just keeps saying that about me.

Cris deRitis:                       I should say, that's just the old gambit.

Gaurav Ganguly:             So you started out by saying that, I can't remember exactly what you said, but something about not wanting to be compared with science fiction or your conjectures to be compared with science fiction, but science fiction can sometimes be really powerful. So I grew up in the North Indian State of Pradesh. And I recently read a book by Kim Stanley Robinson, well-known sci-fi author, called Ministry for the Future. And Ministry for the Future starts with a really, really excellent chapter centered around a heat wave in the North Indian State of Pradesh. Millions die. That is the cataclysmic event that sparks the global rethink around climate change. But what happens as a result of that is not a carbon tax, because a carbon tax by that point is simply too late.

                                             Given the lags in the climate system, it'll take 40 to 50 years for a carbon tax to actually work its way through and reduce emissions enough to cause temperatures to start to go down. So in fact, what happens is that India does a bunch of solar radiation management, it pumps aerosols into the upper atmosphere to bring the temperature down in this book. And I think that speaks to Matthew's point, that if you wait for that cataclysmic events to happen, it's simply going to be too late. You can do your carbon tax stuff, but there'll be so much demand for adaptation, there'll be so much demand for solar radiation management, geoengineering, all sorts of things that fit into that adaptation category, because that's what we'll have to do at that point.

Mark Zandi:                      Wouldn't we do both at that point?

Gaurav Ganguly:             We would do both. We would do both. But that's why I was saying, I was partly in Matthews camp in that I think that there would be just a massive, massive rise in demand for adaptation, because that's the short term. That's all you can do in the short term. Carbon tax, yes, that's good. We'll have to do that. We'll have to plant forests, actually. Probably have to find plants that can withstand high temperatures and all sorts of things, but we'll have to do a huge amount of adaptation.

Matthew Kahn:               So I want to pick up on Gaurav's point and crack a half joke. When I speak to my undergraduates, I talk about the Titanic and everyone thinks about Leo DiCaprio and that love story. There was hubris on the Titanic. It never occurred to them that those icebergs could sink the ship. They didn't even bother to have lifeboats and didn't see the iceberg till the last minute. I asked my students and I ask our listeners, in the case of climate change with the New York Times writing about it daily, do we really not see it? Are we able to imagine?

                                             John Lennon and Yoko Ono had that song, Imagine. If we have more imagination of a horrible future, if we don't adapt, we begin to take baby steps in that direction. And so Gaurav told a painful story about this abrupt turn in direction of the ship. And I'll stop with my bad analogy. But Mark, if we anticipate coming days of pain, self-interested individuals begin to take proactive steps. And so this is my fight with some behavioral economists, my old colleague at UCLA, Jared Diamond, of do we see the iceberg up ahead and do we begin to turn or do we just go right into it?

Mark Zandi:                      Yeah, no, that's a good point. So I think we've got up to the point where we're focused on the adaptation and how viable or not that is. And maybe Gaurav, I'll turn to you. Where do you want to push back on this? What are the difficulties involved in this actually happening the way Matthew's articulating, that self-interested parties are going to because of shifts in insurance rates and the cost of water and whatever it is that people are going to adjust, and the cost here to the economy are going to be, they're not going to be zero, but they're going to be manageable?

Gaurav Ganguly:             Well, first of all, okay, so let me start by saying that I think that adaptation is in the climate science, my reading of the climate science literature, really understudied in terms of looking at it globally and thinking about how much adaptation is actually needed for different emissions pathways. So I think it's really important that we start to really rapidly study adaptation and measure the cost of adaptation and figure out what kind of adaptation we need under different climate pathways. It's really not integrated into the scenario analysis world. So that's first and foremost, really important. Because it's really clear to me that given where we are going, we are not bending the curve. Well, we are going to bend the curve hopefully, but not going to bend the curve sufficiently to bring temperatures below two degrees or even 1.5, and definitely not 1.5 without a whole lot of effort. So adaptation's really important.

Mark Zandi:                      And just put a finer point on that, you're saying given reasonable assumptions about policy and everything else, the temperature global temperatures are going to rise over 2%, two degrees Celsius over the rest of the century, probably even higher than that, probably two and a half to three degrees. And with that kind of temperature rise, you got a boatload of stuff that's going to happen here, bad stuff that's going to happen.

Gaurav Ganguly:             That's right. So there's just this real need for adaptation and I don't think we are as a planet taking it seriously enough. So that's one thing. But then I'd sort of question what you're saying here, Matthew, because again, I'll go back to my home state of Pradesh. I'll compare it to my home country of the UK and to my wife's home country of Germany and say, fine, in some places I can see the self-interest really works and people come along, there's innovation and we'll find solutions. In other places it seems to work less well.

                                             So if I look at the city of Mumbai and the amount of particulate emission in Mumbai, well it's been going on for ages. Or the city of New Delhi, or let's take the city of Jakarta and Indonesia, which is sinking. And it's sinking because at excess groundwater loss. And all sorts of plans have come up over a period of 10 years to try and stop that from happening, but the city remains in trouble and it continues to sink. So it feels to me like, yeah, sure, maybe it's a matter of timing before these innovative solutions are implemented around the world. But in that time a lot of really bad things could happen and a lot of people's lives and livelihoods could be seriously at risk. Would you agree with that?

Matthew Kahn:               I agree. But again, let's do Jakarta. I think Indonesia's getting ready to build a new capital city. And so a point that I make in my Climatopolis book. So guys, a story from Wall Street. I received a call from the Economist Magazine a decade ago. And Gaurav, this joke, this story is directly tied to what you were saying. And the reporter said to me, "Matthew, three questions. Do you agree Wall Street is a productive part of America's economy?" I said, "Yes.' They said, "Do you agree that Wall Street faces sea level rise and could be greatly damaged?" I said, "Yes." They said, "If you combine those two statements, won't sea level rise destroy Wall Street?" And I said, "Guys, Wall Street is a coordination point. Skilled financiers meet there to trade. The place called Wall Street does not have a monopoly on American economic activity. Economic activity can always move to higher ground to Greenwich, Connecticut."

                                             And thus, the key in an economy is where to have productive glomeration? Where do skilled people choose to co-locate? And if places like Southern Manhattan fail to adapt, fail to adapt these seawalls and these Dutch solutions that Eric Adams and the Governor of New York are considering, then new Southern Manhattan will lose, but those areas on higher ground will gain. And so a point in my work is this, with the language from economics is the cross elasticity. If Southern Manhattan fails to adapt, the landowners in Greenwich, Connecticut will gain and the population. There's always a new generation of young people, they will move to higher ground. And so Gaurav is correct, that if there are people who are stuck, who have social networks, they will suffer if they remain in place. But there's always a new generation, we're always rebuilding our capital stock. Cities can always form.

                                             Las Vegas was not a great city 80 years ago. We're always rebuilding. And so this competition between places actually creates safe assets. And Moody's in the future will give these assets higher ratings and they'll be able to borrow it lower interest rates because they moved to higher ground. And so our capital stock is not permanent, we're always rebuilding. And my critics kind of miss that. Those who can't move do suffer. And Gaurav is absolutely right there. But prices will fall for real estate and they'll be compensated with cheaper rents for remaining at a risky place.

Gaurav Ganguly:             So two points to that, because I think I'm talking about two additional things here. One is that it's also about distributional equity, so the poor will suffer. And the poor not just because of your network effects and that sort of thing, not be able to move, but also that a lot of them will be located around in a world with 10 billion people will be located in countries that have poor institutional quality, poor governance, et cetera, will not be able to in a timely manner implement the systems of regulation, the systems of governance, direct the capital needed to enable this kind of shift. And if this happens, then there will be a very, very horrible transition period during which time a lot of the poor will suffer. And you spoke about protecting the poor. So do you agree with that?

Matthew Kahn:               I do.

Gaurav Ganguly:             Then how do you see us overcoming this challenge?

Matthew Kahn:               Gaurav just raised a very, very important point. At USC, there's a young assistant professor named Afshin Igsaad, and I met with him last week to discuss Gaurav's Point. He works with the Nobel Laureate Al Roth. And with Al Roth, they have worked on kidney exchange. How do you set up rules of the game to have larger kidney chains? In proper English, if you have enough people working in a kidney chain, you transfer kidneys from donor to recipient with no exchange of money. Gaurav, what I was meeting with Afshin about, was how do we use the Nobel Laureate Al Roth's tools to resettle climate refugees from the developing world to the developed world, where there's individuals who want to leave places that are being shocked.

                                             There are areas in the U.S like Detroit and Baltimore, that are being depopulated. I believe that there's gains to trade between these areas. So my optimism about adaptation comes from how do we use markets? Mark mentioned water scarcity. How do we use price signals? But also how do we use the field of mechanism design to help climate refugees to be welcomed where they go and to avoid immigrant backlash. And so I'm with Gaurav, that this is a crucial point.

Gaurav Ganguly:             But you're also raising the political dimension here. For all of us as free market capitalists, liberal economists, all of this makes sense, but that's not the way the world works. We might easily get into a protectionist scenario in which countries raise borders.

Mark Zandi:                      In fact, that's true. That's the reality, right? I don't know this well, but my understanding is one of the causes for the mass migration of people from central and Latin America to the U.S is climate related. Their livelihoods are being wiped out by heat and drought, and they can't make a living so they're moving north.

Matthew Kahn:               But Mark, I agree. But this creates an opportunity. Mark, I don't do charity. I'm going to give you a bill for this podcast, that was a joke.

Mark Zandi:                      Well, I'll give you a cowbell, I'll give you a cowbell. How about that? Bottle of wine.

Matthew Kahn:               But to be serious, the New York Times writes long pieces about how immigrants have rehabilitated shrinking towns like Utica, New York and upstate New York. Imagine a situation where immigrants to the U.S have a residency requirement in cities that are looking for young people with certain personality skills.

Mark Zandi:                      No, wait, wait. Matthew though, Matthew, just to stop for a second. We're not arguing the benefits of immigration. We're on board. But to Gaurav's point, if you look at the world, the world is not on board with immigration. Brexit is a lot about immigration.

Gaurav Ganguly:             To make another point around immigration. And that's only because you brought up Jared Diamond earlier, so I feel I have to say something about Jared Diamond in all of this. And that's not to either praise him or criticize him, it's just that he puts out this really clear picture of migration through human history. And if I think of migration through human history and combine that with the formation of the nation state and then think about climate change, and then think about protectionism and stopping migration, I feel that we could be at a point where some nation states, and I'm not talking about the United States or even nations in Europe, but some nation states could start to fail.

Matthew Kahn:               But that's actually fine with me. I'm a fan of competition. We need companies that don't have a good product to fail. So Gaurav, this actually raises a key point. The prospect of failing actually leads to reform. In Phoenix they'll raise water prices and allocate it more efficiently if there's such an imbalance between supply and demand. And so maybe you're going to say this is a bit of a razor's edge argument, but let there be a country that's xenophobic and the natives don't have children. The populations can get older and older, and the demographics of this economy is that they will collapse. And I claim at that point they will reform their politics to welcome immigrants.

                                             And so I'm actually a believer that as the dead weight loss of stupid xenophobic policies rises, we get reform. And so I actually think this is a very useful discussion, that the frontier of climate change adaptation economics is the political economy of... We currently have some bad policies. We have borders, we have misallocation of water, we have large insurance subsidies. I claim that these policies will not persist as the inefficiencies caused by them rise. I sense that you guys have a little bit of a counter narrative of just falling off a cliff, and that's a point of contention.

Cris deRitis:                       First of all, I have no doubt that humans will adapt, we always do. We'll make a way through it.

Gaurav Ganguly:             By definition. Yeah.

Cris deRitis:                       By definition. So that that's taken as a given. It sounds though, as many of your arguments do rest on this notion of the free market. And we know that markets are neither perfect nor complete, so it sounds like you're putting a lot of weight on the ability to address all these market failures. And once we address the market failures, then of course we will adapt and we'll come to the right solutions. But there's no guarantee we'll get there in time.

Matthew Kahn:               Cris, lets jump into that.

Gaurav Ganguly:             That's pretty much my point. I don't think we fall off a cliff. It's more that like everyone says, I think human's ability to adapt is enormous. We've been through so many challenges in our history.

Matthew Kahn:               So guys, let me agree with you and say something provocative. There's a firm called Moody's, and as I understand it, what Moody's does is it provides credit ratings. Suppose that you guys are incentivized to have experts on staff to review for places and firms what physical risks do these face.

Mark Zandi:                      We do.

Matthew Kahn:               And I'm kidding you.

Mark Zandi:                      Oh, you're kidding. Oh, okay. Oh, okay, great. Yeah.

Matthew Kahn:               So if Tesla opens a factory in a place that's going to be 180 degrees in 20 years, I would hope that your nerds downgrade these guys saying that this factory will be obsolete. And then bond buyers would say, "We don't want Tesla bonds." And Tesla would be punished but by you guys for not thinking through the consequences of where it's opened its headquarters and factories. This is free market environmentalism and the central role you guys play as Paul Revere. So part of my optimism of how we keep our productivity going forward is you're the adults in the room, the insurers, the credit rating agencies, the capital markets.

                                             I'm not crediting Elon Musk with being a genius. He's a strange tweeter. But if he has to borrow money, if he has to get properties insured, you're the adults in the room. And so for our more subtle listeners, I don't believe at omissions, I believe in competition. And if you guys are giving the wrong ratings to firms, then a day of reckoning will occur, but there's a competition in your industry to get things right. And so it's through competition, getting closer to perfect competition, that we get to my fantasy of how we get the right price signals to help capitalists to adapt.

Mark Zandi:                      It's interesting. I agree with what you're saying. I don't disagree. I guess the debate centers around the ease of adapting versus the ease of mitigating. And again, they're not mutually exclusive. We've got to do both, there's no doubt about it. But if we're focused and you, we've focused a little bit about how the political economy of getting a carbon tax through and how difficult that will be. No argument there obviously. But around climate adaptation, the complications there are also very difficult.

                                             I'll give you one example, kind of a micro example. Talking about it came to my mind adults in the room. Fannie Mae and Freddie Mac, these are the two largest financial institutions on the planet. They buy mortgages, single family residential mortgages from banks and independent mortgage banks and others. They account for 50, 60% of all the single family residential mortgage loans made in the country. They do not price for climate risk. And the reason they can't or they feel like they can't, this is a political economy issue. And first of all, I should say this is a problem. There's actually academic research, you may know better than I.

Matthew Kahn:               I wrote it.

Mark Zandi:                      Getting adversely selected, right?

Matthew Kahn:               So I wrote that paper.

Mark Zandi:                      Oh, you wrote that? You wrote the paper?

Matthew Kahn:               Yes.

Mark Zandi:                      Oh, I thought it was some fellow from Montreal who wrote.

Matthew Kahn:               So Cris, could you Google Amine Ouazad and me? So I'm the second author of that.

Mark Zandi:                      Oh, okay. Sorry about that. Oh my gosh.

Matthew Kahn:               No, no, you read it, I wrote it.

Mark Zandi:                      You wrote it. Oh, fantastic. That was a great paper. That was a great paper.

Matthew Kahn:               No, it's my friend Amine who's listening, or he will be listening at 6:00. So yes.

Mark Zandi:                      Oh, cool. Okay, very good. Okay, so that's my point. But Fannie and Freddy have a political economy problem. And that is if they price for the risk, meaning they charge a higher insurance rate for credit risk on loans that are on properties where there's more climate issues, sea level rise or whatever it is, they're also raising the mortgage rate for generally lower income households. Because you can see geographically, and again you know this better than I, but that where climate risk is more of an issue is where lower income people are living. They live in areas where there's more climate risk. So by doing so, you're going against exactly what Fannie Mae and Freddie Mac are hoping to do, and that's making mortgages cheaper for lower income households. So this is a political economy problem that they can't address or solve.

Matthew Kahn:               So Mark, I agree. In my book from Yale Press last year, Adapting to Climate Change-

Mark Zandi:                      And by the way, Matthew, I should apologize. I should have known that, that was your work. I apologize for that. But that was very good work.

Matthew Kahn:               Mark, you read it, I wrote it. That's the way it works.

Mark Zandi:                      Okay, there you go.

Matthew Kahn:               So in my book, Adapting to Climate Change, because I've read my paper with Amin, I come out that I want more Americans to be renters, to adapt to climate change. Why is home ownership part of the American dream? Why do we derive status from that? And are sharing economy, I could actually live in Airbnb housing every day. So Cris, I come out in adapting to climate change saying if we were renters, we'd face lower migration costs. We'd hold a more diversified portfolio. Climate change is all about place-based risk, a shock to Miami. But if you hold the world's portfolio, a small share of the world's portfolio, you're diversified. There's no shock. Even Covid didn't move the stock market. There's basically no shock that if you aggregate it across has a macro effect. And so in a renter economy, we avoid all these issues.

                                             And so Mark, I actually think we want to adapt to climate change, we want more of us to be renters and to rent housing from professional management companies who have the capital, the expertise to pay the lumpy fixed cost to retrofit properties and to use big data to monitor the challenges we have. Why are amateurs, why do we have our money in a place-based shock economy? Why do we have all our money in one asset at risk, when we're amateurs in running it? And that was ne of the themes of my book from last year.

Mark Zandi:                      Yeah, you're swinging at a lot of entrenched views. Like home ownership is the pathway to wealth building. You're taking a swing at that.

Matthew Kahn:               But that's false. So Mark, did you see my paper last year?

Mark Zandi:                      That's a whole nother podcast. So I hear you, but to my point about political economy and the ease at which it's going to be, we can make changes in policy to adapt to climate change. Now you're saying we should not incent into home ownership, but rent. Now that may be a good thing or a bad thing, but the political economy of that is really difficult or vexed. No?

Matthew Kahn:               Agreed. And so in my paper from a year ago, I document that African Americans are more likely to own in cities like Baltimore and Detroit and Cleveland, than in tech cities like Portland, Seattle, San Francisco, Boston. And so missed out on the tech boom of the last 20 years. Because when you own a home, you're making a bet on a place. And Mark in a world facing climate change, that's an increasingly risky bet if we're aware of this diversify rather than owning. And so Mark, you're right. You asked me at the start, why do I write so many books? It's because I have so many ideas that run counter to how others think, but I can see the future. And this is the world we're going to live in because this is what we need to do to adapt to climate change. And so I read the New York Times with its doom and gloom, and I slightly chuckle said, "Yes, this is our current world, but this won't be our world in 20 years."

Mark Zandi:                      Boy, the New York Times, you're really picking on those poor guys. Let me do this. I want to explore what kinds of things can policy changes or changes that can be done to help facilitate adaptation. One thing that we're involved with at Moody's, in Gaurav and Cris very intimately so, is around climate risk scenarios that are now being used in the global financial system, more so overseas than in the U.S, although it seems to be headed here. The Federal Reserve is going down this direction where banks, regulated financial institutions are required to simulate different climate risk worlds and see what impact that has on their balance sheet and income statement.

                                             And so far it's more about just gathering information, data, doing the modeling, getting all the infrastructure in place to do the analysis. But ultimately one could imagine that a regulator might say, "Oh, you have to hold more capital. Your cost of lending is going to be higher if you're lending to a business that is more at risk because of climate risk or to a place like a Miami for example because the sea level rise that's more at risk because of climate risk." Is that something you would embrace or that's what you're talking about, that's the adaptation that you're talking about.

Matthew Kahn:               I support this and this is actually controversial among Libertarians. I've read some writing by John Cochran, where he has said, why is the Fed entering the climate space? Why isn't it focusing on the Phillips curve? And I support what Cris and Gaurav are doing for the following. And respectfully disagree with my old teacher, John Cochran. He's not old. I took his class a long time ago. David Wallace-Wells of the New York Times keeps writing about imagination. If banks don't have sufficient imagination for risks they face, then a regulatory audit can be a prompt. This is almost like Richard Thaler, the Nobel Laureate's work on nudge.

                                             A nudge can change your behavior if you're blissfully unaware of a path you're on. And so I do support strongly nudging these banks to take a look at the hidden risks in their books, both on carbon exposure, if there is a future carbon tax and on physical risks. Yes, these banks will incur some costs complying with these rules, but it could play a very helpful role in self-diagnosing challenges. Remember before, I was blissfully cracking jokes about the Titanic, seeing the iceberg. I believe what Gaurav and Cris are doing helps banks to not be the Titanic, if I could speak in eighth grade cliches.

Mark Zandi:                      Got it. So if you're king for a day, you need a week, I'm going to give you a week. You're a king for the week, what one, two, three things do you think policymakers should be doing now to help facilitate climate adaptation?

Matthew Kahn:               So I have sent a piece to the Los Angeles Times that they're clearly going to reject. So when you send a piece to the OpEd, they don't get back to you for a week, it means it was rejected. And here's what I said.

Mark Zandi:                      I've been there. Yeah, I've been there.

Matthew Kahn:               I said, "Guys, we've got drought in the American West. The water utilities have big data on every consumer's bills. Run a randomized field experiment where you invite customers to participate in facing higher prices." So Mark alluded before that we need to risk price, we need to engage in scarcity pricing. Rather than forcing all people onto higher prices, I wanted to offer people an upfront incentive to sign up for dynamic pricing and let them self-select in. And those with the greatest ability to substitute away from water and electricity would voluntarily opt in and reveal themselves. And this is a way to reduce aggregate demand for electricity and water, such that we don't have drought crises and blackouts in Texas. So Mark, to answer your question, we're not running enough experiments.

                                             There's been more agreement during this hour. We recognize that bad politics can sometimes block beneficial changes. One way, we need Guinea pigs here to experiment a little bit. And so if I were king for a day, it would be this small ball of more experimentation with pilot ideas through an opt-in design, where we reward Guinea pigs for participating so that we can learn about our ability for some of us to cope with higher prices. Because we need to use more market signals going forward. Think of traffic congestion in New York City. Manhattan's been so slow to adopt road pricing, it's difficult to pilot such a study. Where would you do it? But you can do that with water pricing and electricity pricing. And so that's sort of my minor league king for a day.

Mark Zandi:                      Well, I hope the LA Times publishes it. I don't think you should send it to the New York Times. That obviously is not going to happen. But maybe the LA Times.

Cris deRitis:                       Not after this podcast.

Mark Zandi:                      Not after this podcast, yeah.

Matthew Kahn:               So guys, if I can ask you a question before I lose you?

Mark Zandi:                      Yeah, sure. Fire away.

Matthew Kahn:               Has Moody's made a decision on how much effort to put in credit rating, how much attention to decarbonization versus physical risk exposure? Are there more and more auditors on your team and are there any trade-offs? Are you boosting your squad on judging different for entities you are grading of their performance on two dimensions, reducing their carbon footprint and reducing their climate physical risks?

Mark Zandi:                      Well, I should say Moody's has the rating agency and that's kind of where you're focused in terms of the ratings on bonds. And you're saying those ratings should also take account of both the climate exposure, both in terms of the physical risk and kind of the transition risk. And Moody's Analytics and that's where we reside. And the entire organization and Moody's Corp is all in on all aspects of this. So we've acquired a number of different firms that collect information and data. We just recently purchased R M S, which is a large insurance risk analytics firm you may know very well.

Matthew Kahn:               I had a very good talk with Robert Woods and we had a very good, that was a good acquisition.

Mark Zandi:                      And they're a great company. And 427 you may recall, they're a Berkeley based firm that does physical risk scores by on a property level and a number of other acquisitions. And we're of course doing, as I mentioned in our world in economics, a lot of work around climate risk scenarios. So yeah, we're all in on this. And a lot of it right now is just collecting the data, making sure we understand the data, trying to figure out where the gaps are, trying to fill those gaps, doing some of the modeling, doing this globally. We are now incorporating explicit climate physical risk assumptions and transition risk assumptions in our forecasts, because we're doing forecasts now out to the end of 2100 for lots of different reasons. And so we are in fact doing that at this point. In fact, Gaurav has kind of led the charge on all that work.

                                             I will say, going back to the carbon tax, in our forecasting, we now explicitly assume a carbon tax will be implemented some 10, 15 years from now, something like that, phased in over time, similar to the CLC proposal with a dividend to pay out to in a border adjustment tax like we were talking about earlier. So yeah, we're all in on this. And investors are coming around. I will say, Matthew, here's one other thing I wanted to mention. Climate is a big problem and we need to address it, but we got a lot of problems that require a lot of attention. The other one that's kind of has probably even more important because it's here and now is cyber risk. That's the other big thing and that's very costly. So that goes to the ability to adjust to climate, because we're adjusting to lots of stuff, lots of different stuff and all of it very complicated and very, very costly. So hopefully that's helpful. Gaurav, Cris, did I miss anything in terms of what we're doing?

Gaurav Ganguly:             No, that's actually just picking up on your last point. That was going to be one of my questions to Matthew. We've got lots of problems. The world faces lots of problems, right? You mentioned cyber, there's climate, there's AI, there's 10 billion people on the planet by 2050, geopolitics. And we're talking about something really important with this climate adaptation. But thinking of all these problems, how successful do you think we will be in adapting?

Matthew Kahn:               So I'm not brave enough to tackle that. I'm going to give a non-sequitur. Silver lining of the Covid crisis was our experimentation with work from home. Work from home helps us to adapt to climate change of all the different permutations. If Matthew's very risk averse, I can work for a Miami firm but not live in the Miami area, live far away if I only have to commute in two days a week. And so Gaurav, I'm always an optimist. My mother warns me against magical thinking. We talk about this, she's my favorite Bobby. But our adaptation to Covid only increases my confidence in my past claims about climate change adaptation, of course, it was great suffering. Close friends of my father's died in New York City and of course I understand this, but the economy as a whole showed an amazing pivot.

                                             And those economists who used very tight mathematical models like the Nobel Laureate William Nordhaus, these models can't incorporate these. And so I support the formalism of modern economics, but we slightly have straight jacketed models that don't appreciate the Austrian ability of our economy to pivot when very ambitious people. A benefit of these 8 billion people, coming back to Julian Simon, are all these potential innovators thinking through new paths for us. And so Mark, if I had to wrap up, Julian Simon had such a great fight with Paul Erlick on whether we were going to run out of natural resources. On some level I'm trying to set myself up as the new Julian Simon of a benefit of having all these people is all the experiments we're running and ideas are public goods. As we learn a path forward, the best ideas will be discovered and don't need to be reinvented. And so this old Jillian Simon, Paul Erlick debate is back and how we use markets and human capital to fuel our acceleration against the very real issues that you guys are working on. I think that's fantastic.

Mark Zandi:                      I agree with you. I want to end on an optimistic note. We can't underestimate the creativity of people, particularly if they're given the right incentives. If you can make money doing something, good things happen. And let prices work, good things happen. I very much agree with you and I think you're right. It's one of those things, and I think for Americans that's more likely than in most other places, right? Because our thinking is along the lines that you're expressing. We want to let markets work. So I think for us, that's going to work. I guess the one concern would be what happens in the rest of the world.

Matthew Kahn:               A note there. In returning to the University of Southern California from Cris' Johns Hopkins, I am now only working with PhD students working on adaptation in the developing world. And Gaurav would be much happier with me. I'm learning from my students from Bangladesh, from India. These guys patiently look me in the eye and say, "Professor, you're wrong." And so while this hour I've come across a little bit as a zealot, in my day-to-day interactions in my office, my young PhD students are debating me point by point as we discuss about frictions, issues in capital markets, issues in insurance markets, and challenges for poor people in the developing world to adapt. Mark, if we have time, can I give one example?

Mark Zandi:                      Yeah, sure. Fire away.

Matthew Kahn:               So in Islam Ul Haq's work on farmers in Bangladesh. These guys have been growing rice and soil salinity from sea level rise is raising the soil solidity where they had been growing rice. If they could pivot to shrimping, they could earn a living. But there's a question of you need extra land to shrimp and you need to get the shrimp to the rich guys of DACA for them to eat it. And they don't have cold storage to get the shrimp there. I'm looking at Mark and he's giving this a B plus. But these are sort of the nitty gritty issues of how thinking through, without engaging in wishful thinking, for those who have to change their game and pivot away from rice to something like shrimping, is it as easy as a Chicago columnist would write on a blackboard?

                                             And of course it isn't. Of what are the transition steps and how are we going to get from here to there? And my students are doing new empirical work, not just chanting at me that the market works. And this is where I learn and this is my agenda over the last 10 years of my career, of the real nitty gritty of connecting the dots. And I think we all agree that that's where we have to go.

Mark Zandi:                      Fantastic. I feel a lot better after this conversation. I really do. Because I think you laid out a really strong case with regard to, and I love this term, endogenous innovation. It feels right to me, particularly in this context. So I want to thank you for taking the time and letting us push a little bit on your thinking, because I think we learned a lot from that. And hope to have you back. And ho hopefully you're right. Very important that you're right, because if not, we got a lot of challenges dead ahead. But thank you.

Matthew Kahn:               Mark, thank you. This was a lot of fun and informative for me.

Mark Zandi:                      Well, with that, listener, this is the podcast and we'll catch you next week. Take care now.