Abstract
The problem of avoiding dangerous climate change requires analysis from many disciplines. Mainstream economic thinking about the problem has shifted after the Stern Review from a single-discipline focus on cost-benefit analysis to a more inter-disciplinary and multi-disciplinary risk analysis, already evident in the IPCC’s Assessment Reports. This shift is more evidence of the failure of the traditional, equilibrium approach in general to provide an adequate understanding of observed behaviour, either at the micro or macro scale. The economics of the Stern Review has been accepted by governments and the public as mainstream economic thinking on climate change, when in some critical respects it represents a radical departure from the traditional treatment. The conclusions regarding economic policy for climate change have shifted from “do little, later” to “take strong action urgently, before it is too late”. This chapter sets out four issues of critical importance to the new conclusions about avoiding dangerous climate change, each of which have been either ignored by the traditional literature or treated in a misleading way that discounts the insights from other disciplines: the complexity of the global energy-economy system (including the poverty and sustainability aspects of development), the ethics of intergenerational equity, the understanding from engineering and history about path dependence and induced technological change, and finally the politics of climate policy.
This chapter is a revised and updated version of an earlier paper discussing the topic in the context of the Stern Review. See Barker (2008).
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Notes
- 1.
- 2.
- 3.
The carbon price associated with this target is not the topic of this paper, but it is of great interest. With limited literature to assess such a price, AR5 suggests that it is in the range $US50 to $US100/tCO2 by 2030, rising after 2030 and in year 2010 prices. See p. 31 http://report.mitigation2014.org/drafts/final-draft-postplenary/ipcc_wg3_ar5_final-draft_postplenary_technical-summary.pdf
- 4.
Tol and Yohe (2007, p. 233–4) accuse Stern of “substandard analysis” and “dubious economics”; Nordhaus (2007a, p. 5) claims that Stern is “political” and the discount rates used are “extreme” (p. 6); Dasgupta (2007, 2008, p. 7) accuses Stern of choosing parameter values so “that they yield desired answers.” Such charges are perhaps more appropriately made against neoclassical economics as in (Mirowski 1989, 2002; Barker 1996; Nelson 2001; DeCanio 2003; Ackerman and Nadal 2004; Foley 2006; Nelson 2006; Beinhocker 2006; Ackerman and Stanton 2014). The charges also contrast with the praise by leading mainstream economists and Nobel Laureates quoted in the Review, such as Mirrlees, Sen , Stiglitz, and Solow, and support after publication from Arrow, DeLong and Deaton among others. There are far too many references to include here, so I have only included examples of the mainstream literature and the new literature.
- 5.
Other disciplines are just as important, including the humanities, but I am restricting the discussion to a few issues. In particular, I do not consider in any depth the analysis of development, which is crucial for adaptation to climate change
- 6.
Economics is the study of social activity undertaken with its primary purpose the expectation of reward, which usually involves money, the motivations of such activity and its consequences both good and bad, e.g. for equity and the environment. In contrast the neoclassical economist Robbins (1932) defined economics as “the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses” (p. 16), asserting that economics is a value-free science.
- 7.
It has become debatable whether neoclassical equilibrium economics is mainstream anymore (Colander et al. 2004; Dequech 2007). This paper argues that Stern has shifted the mainstream away from the traditional neoclassical approach to climate-change economics. See (Maréchal 2007) for a supporting view. For a more general view see (Hodgson 2007). Prominent economists are acknowledging that for macroeconomic growth “The right way to think about this complex set of issues is not clear, but it is clear that the competitive paradigm cannot be fully appropriate.” (DeLong and Summers 2001). Arrow (2007) accepts the Stern estimates of costs and benefits, quoting the range of GDP mitigation costs (3.4 % to −3.9 %) from the meta-analysis in (Barker et al. 2006a, b). Akerlof (2007), the 2007 President of the American Economic Association, exposes the weaknesses of neoclassical macroeconomics and suggests that early Keynesian macroeconomic theory has more explanatory power. Deaton (2007) supports the Stern treatment of discount rates: “Whatever it is that is generating market behaviour, it is not the outcome of an infinitely lived and infinitely far-sighted representative agent whose market and moral behaviours are perfectly aligned, and who we can use as some sort of infallible guide to our own decisions and policies.” (p. 4)
- 8.
Samuelson and Nordhaus (2001) is the 17th edition of a textbook originally published by Samuelson in 1948. Yohe (1989), another contributor to the traditional literature, has published a study guide to this textbook. Nordhaus is taken as the exemplar in this chapter (rather than a straw neoclassical man) because of his economics, methods and distinction in the field. He provides full details of equations, exposing all his assumptions. His approach is followed by many others and his models are widely used for academic climate policy analyses. It is characteristic of his work, and of his school, that qualifications to the economics or results (e.g. extreme events, recycling of carbon tax revenues or induced technological change) are introduced independently, but subsequently there is usually a reversion to the core model even when the qualifications produce radical effects on the results (Nordhaus 1993, 2007b). Other problematic features one would expect in a CBA, e.g. environmental co-benefits of GHG mitigation, are ignored. Eventually, if the qualification becomes mainstream, it is accommodated in the model or analysis (Mirowski 1989, 2002).
- 9.
To avoid confusion, all estimates have been converted to $/tCO2 in this chapter. The price base is given where known. Despite their apparent precision, Tol’s estimates cover different base years and price bases, because he does not appear to have converted the estimates to a consistent basis. They are all in real terms in his original sources, but typically adopt different base years for the discounting and prices. This lack of comparability in the underlying data renders his averages undetermined, a problem not mentioned by Tol.
- 10.
They are also five times smaller than the carbon prices revealed by the market before the Great Recession starting in 2009 led to over-supply of allowances. Phase 2 of the EU emission trading scheme has a carbon price over $20/tCO2 (March 2008), arguably to achieve a much weaker internal EU target than that implied as optimal by the CBA literature. Weitzman (2009) has shown how a more considered treatment of catastrophe radically changes the traditional conclusion.
- 11.
Dasgupta (2007, p. 5) summarises the traditional view (incorrectly but reflecting academic and political perceptions) as: “Nordhaus…has been studying the economics of climate change for over three decades. The most remarkable conclusion of his studies—conducted on his Dynamic Integrated Model of Climate and the Economy (DICE)—has been that, despite the serious threats to the global economy posed by climate change, little should be done to reduce carbon emissions in the near future; that controls on carbon should be put into effect in an increasing, but gradual manner, starting several decades from now. This conclusion has withstood the many modifications Nordhaus and others have made to the climate science embodied in DICE. Their idea is not that climate change should not be taken seriously, but that it would be more equitable (and efficient) to invest in physical and human capital now, so as to build up the productive base of economies (including, especially, poor countries), and divert funds to meet the problems of climate change at a later date.” Nordhaus (2007b p. 237) in fact has carbon taxes starting in 2005. Later work on the RICE model yields strongly escalating carbon prices, with a median of $14 $/tCO2 in 2015 (2005 prices) and much higher prices if the analysis uses the Stern report discount rates (Nordhaus 2011). Others using DICE (see note 14), but altering the assumptions, come up with Stern-like conclusions (Ackerman et al. 2010).
- 12.
It is significant that his critics have mainly criticized technical assumptions about discounting in a CBA and have asserted that he has based his conclusions on this CBA. In fact the results of the CBA are to be viewed as “indicative only” and to be “interpreted with great caution” (p. 174) and their discussion takes up only 16 out of nearly 700 pages of the Review.
- 13.
“…the optimal climate change policy reduces long-run global warming from 6.6 to 6.2 °C.” (Nordhaus 1997, p. 324). His more recent “optimal” rate is closer to 3 °C, see below.
- 14.
- 15.
UNFCCC, 1992, states as its objective: “to achieve stabilization of greenhouse gas concentrations in the atmosphere at a low enough level to prevent dangerous anthropogenic interference with the climate system.”
- 16.
Dietz, et al. (2007a) show how risk analysis can change the conclusions of the CBA.
- 17.
I exclude from this critique the integrated assessment modelling of Hope (2013), whose PAGE model emphasises uncertainties.
- 18.
Tol ignores the value judgment underlying all cost-benefit analysis, namely that the equilibrium outcome of rational self interest is in some sense optimal for society. He presents his survey of a set of essentially subjective estimates, often done by the same clique of authors, as observations of probability density functions, when they are basically undetermined (see note above), not properly sampled, or even independent.
- 19.
“… the uncertainty is so large that a considerable risk premium is warranted.… More importantly, there is a 1 % probability that the social cost of carbon is greater than $78/tC. This number rapidly increases if we use a lower discount rate – as may well be appropriate for a problem with such a long time horizon – and if we allow for the possibility that there is some truth in the scare-mongering of the gray literature.” Tol 2007 (conclusion). Tol (2005) does not mention a risk premium or that the damages may be unbounded, although the fat tail of damages is emphasized as a feature of the analysis.
- 20.
- 21.
This is not to undermine the usefulness of the static incremental abatement schedule, showing abatement options as a set of non-linear steps rising as the carbon price rises, and usually referred to as the MAC.
- 22.
- 23.
Tol (2007) asserts that high carbon taxes would bankrupt some countries. He seems to be confusing tax revenues with tax payments. The tax revenues accrue to governments and benefit their finances; they benefit the population if used wisely. One such use is to ensure that all home owners adopt low-GHG technologies. The tax payments may not be a problem if safeguards to protect vulnerable social groups predate or accompany the introduction of a carbon tax.
- 24.
See Barker and Crawford-Brown (2013) for a discussion of the use of meta-analysis to suggest that macroeconomic costs should be higher.
- 25.
There is a literature devoted to the issue of whether economics is a science or not. See (Mirowski 1989, 2002; Weintraub 2002; Katzner 2003). It is a science in that theory and observation are considered together when and where possible or in that mathematics is a science (Samuelson’s position). However, neoclassical path-independent economics as a mathematical science is strictly a branch of mathematics rather than economics, since it violates a basic law of physics, the Second Law of Thermodynamics. Nordhaus (2007b) himself is ambiguous about whether economics is a science or not, since he repeatedly distinguishes economics from science.
- 26.
See Quiggin (2008) for an explanation. The use of a zero discount rate specifically for climate damages in a cost-benefit analysis of climate change (Hasselmann et al. 1997) anticipated in some respects Stern’s use of low discount rates and also set off a fierce debate with those supporting an aggregate discount rate for all types of damage (including loss of human life) or sectors, which they justified by the traditional neoclassical treatment (Heal 1997; Nordhaus 1997) relying on the assumption of social groups being identical representative agents having full information and foresight. This traditional approach also denies any significance to the empirical finding of differences between sectors in the discount rates actually used (e.g. private rates being several times public discount rates). Hasselmann’s reply (1999) also anticipates the emerging resolution of the post-Stern debate discussed here, specifically the conclusions in (Hoel and Sterner 2007) from a two-sector model.
- 27.
It is not the only reason. Dietz et al. (2007a) provide four reasons for the higher costs in the Stern Report. Previous studies, with important exceptions, have “(i)…mostly omitted to adequately employ the probabilistic results of recent science; (ii)…tended to consider a narrow range of impacts, a product of focusing largely on 2–3 °C warming, whereas we now know that there is a possibility of far higher temperatures; (iii)…not used the economics of risk to the extent appropriate; (iv)…not paid adequate attention to the underlying ethics.” The overall effect has been to give “on average, strong downward bias on damage estimates in the previous literature”. (pp. 156–157)
- 28.
Nordhaus (2007b) claims that his 1.5%pa pure rate of time preference is “designed to provide the most accurate projections rather than to be normative in nature.” (p. 40).
- 29.
Like Broome, Dasgupta (2005) is an authority on economics and ethics, but he argues that traditional economics has solved the ethical problems. However, Dasgupta does not mention the ethical problems involved with the averaging done in CBA, when the assumed monetary estimates of health and lives are discounted.
- 30.
Broome’s view on discounting is supported by the utilitarian philosopher R M Hare, who likewise argued that a discount rate above zero cannot be justified ethically (Hare 1981, p.100–101).
- 31.
Dasgupta (2007) supported Nordhaus’s approach, but not his adopted pure rate of time preference. In contrast, Stern argues that human lives and environmental quality should be treated separately (p. 165), although the PAGE model (used to calculate the 5–20 % range on costs) appears to include valuations of human life and health implicitly in its damage functions. Dasgupta (2008) no longer supports Nordhaus, and concludes that “an optimum policy may not exist”, and (implicitly) that CBA is “an overly formal analysis” leading to “misplaced concreteness” in its conclusions (since 1991) on climate change.
- 32.
- 33.
The second law of thermodynamics is an expression of the universal law of increasing entropy, stating that the entropy of an isolated system which is not in equilibrium will tend to increase over time, approaching a maximum value at equilibrium. (Wikipedia, 15.01.08)
- 34.
- 35.
The traditional cost-benefit analysis has been taken up by Lomborg in the “Copenhagen consensus” to promote the idea that global problems other than climate change (e.g. HIV) are more worthy of funding. It is inherently unlikely that the national interest can be identified with the functions for aggregate utility in the equilibrium models and then solved to obtain ‘optimal’ set of policies. If an attempt were made to elicit the function by asking a series of hypothetical questions of governments, rather than Lomborg’s selection of economists, it would fail because the answers would most likely be inconsistent in terms of the equation. In any case, politicians would usually refuse to commit themselves on hypothetical questions.
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Acknowledgements
I would like to thank Frank Ackerman, Eric Beinhocker, John Broome, Simon Dietz, Klaus Hasselmann, Richard Lewney, John McCombie, John Quiggin, Serban Scrieciu, David Taylor and Rachel Warren for providing helpful comments on earlier versions of this paper. I also acknowledge the support of the UK Research Councils in funding my work as part of the Tyndall Centre for Climate Change Research.
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Barker, T. (2017). The Economics of Avoiding Dangerous Climate Change. In: Shmelev, S. (eds) Green Economy Reader. Studies in Ecological Economics, vol 6. Springer, Cham. https://doi.org/10.1007/978-3-319-38919-6_11
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