‘We are at the beginning of mass extinction, and all you can talk about is money and fairy tales of eternal economic growth’. Intense and evocative claims made by the now infamous Greta Thunberg at the 2019 climate summit. The statement indicates two fundamental propositions, the first is quite clear; eco-systems are about to collapse. The second is somewhat more ambiguous and perhaps more concerning; economics and the approach associated, not only fail to provide insight into solving the issue but should be exempt from the discourse as a cause of the supposed impending Armageddon. Yet there are two significant issues with this view of markets relationship with climate change; the first is if climate change is the looming disaster it is oft presented as it’s the cost can be contextualised in the world economy. Secondly, removing markets from the debate is in effect to remove incentive structures, to the point of dramatically limiting types of policy choice.
The True Cost of Climate Change
The IPCC (International Panel on Climate Change) estimates ‘Human-induced warming reached approximately 1°C above pre-industrial levels in 2017, increasing at 0.2°C per decade (high confidence)’.
Such anticipated change in temperatures are difficult to interpret, but at some point, they must incur a cost. That much is difficult to dispute. Rising sea levels for example are, of course, a cost to individuals who lose homes and a depletion of capital stock. More significantly though climate change and its effects played out to maximisation, generally decreases everyone’s utility of almost all goods and services.
If it is Armageddon, and the World Economy freezes, the likely cost would be, logically, close to 100% of GWP (Gross World Product, often referred to as Global GDP). As a very long run issue; the effects of global warming will be felt decades often centuries after their causes. The climate is unlikely to degrade all at once; the IPCC itself calculates to 2100 in most of its reports, as the margins for error over larger time periods expand to such a point as to erode reliability.
Climate change and the associated issues present a Hardinian nightmarish reality of the ‘Tragedy of the Commons’ (1968); not only is climate a shared-resource system where the user’s self-interest depletes the utility for the collective, but also for future collectives. The question then arises, if we are to think of climate change in terms of cost; how?
Nobel Laureate William Nordhaus (awarded in 2018) created the Dynamic Integrated Climate-Economy (DICE), model. The model is founded along the lines that “economies make investments in capital …thereby reducing consumption today, in order to increase consumption in the future. The DICE model extends this approach by including the “natural capital” of the climate system… it views concentrations of GHGs [Green House Gasses] as negative natural capital, and emissions reductions as investments that raise the quantity of natural capital (or reduce the negative capital).” (Nordhaus, 2013,.pp.4)
Nordhaus estimates that Global warming, by the end of the century will incur a cost of within the margin of 2-4% of Global GDP (2017). It is important to note this is not 2-4% of current global GDP, but GDP in 2100. Nordhaus using 2010 as the base year, estimates likely GWP in 2100:
The ‘DICE Best guess’, represents the most probable GWP. If climate change does indeed subtract 4% from the global economy. The largest amount Nordhaus predicts; by 2100, then the global economy remains 470.14% better off, in real terms, than today.
Current Policy
A discussion of current climate change policy, barring simple regulatory frameworks mostly surrounding the worst forms of pollution, is essentially a discussion of taxes and subsidies. The current structure of such policies seems not only to be rigid but expanding; with the most politically palatable, and likely, policy propositions being of the same ilk. The Paris Climate accord, for example, highlights Article 2; “(a) Holding the increase in the global average temperature to well below 2°C above pre-industrial levels. Pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels”.
Total spending is inevitably driven by varying policy from varying bodies from multiple nations; inevitably the total global climate change budget and it’s break-down is tricky to estimate. Donald Trump claimed the Paris accord would cost the “United States $3 trillion in lost GDP and 6.5 million jobs” (2016). Meanwhile, in terms of actual costs, the accord pledged to raise $100 billion in finance every year following 2020. Meanwhile, the International Energy Agency estimate over $101 Billion dollars was paid in subsidies to green energy in 2011, yet by 2035 the subsidy bill is likely to increase to $223 Billion.
Comparing Cost-Benefit Analysis: Why are the Politically Palatable Policies Inefficient
The last section outlined a rough estimation of the current policy, expenditure and somewhat a prediction of the most likely, politically palatable (at least in the west) policy choices. The giants of which being carbon taxes and current green energy source subsidies. Yet to be explained is why are they inefficient.
In comes cost-benefit analysis, the principles of which are simple and closely follow an intuitively economic approach; they involve estimating the total benefit of a certain policy or transaction in relation to the actual cost (not including opportunity cost, as the opportunity cost is found later by comparing multiple cost-benefit results) to approximate the economic rent per dollar spent on, in this context, a policy.
Only when cost-benefits are compared with between policies as are the opportunity costs, and relative yields, of the policies estimated. The limits of cost-benefit analysis must also be outlined, it is a useful tool but not unlimited, and needs to be used in conjunction with other instruments of analysis. As Weitzman puts it “The economics of climate change is mainly about decision-making under extreme uncertainty. Climate-change analysis is hampered by many unknowns in the science combined with an inability to evaluate meaningfully the welfare losses from increased global temperatures” (2010., pp1)
Let’s, however, start with the seemingly most discussed policy, the carbon tax. The first costs to efficiency come from the methodology in estimating an appropriate levy. Firstly, an accurate measure of the resident level of atmospheric carbon-dioxide is required, along with estimating the current and future impacts of man-made climate change, minus any costs of natural climate shifts. This is required to estimate social welfare cost; which could be conceived of as roughly equivalent to the cost required to repair health, per marginal tonne. Finally, climate change as a non-static, long-run issue, as opposed to other external diseconomies, means a discount rate is required to place weighting on a tonne of carbon. Essentially this is to account for the fact that a tonne of carbon in a carbon saturated atmosphere is more costly than in one in a low-carbon atmosphere.
Prof. Dr. Richard Tol (2010) produced a detailed examination of carbon-tax structure alternatives, all having basis’ in the aforementioned literature. There were 5 policies discussed (1) $2.5 trillion expenditure for emission reduction in OECD nations before 2020 (2) Global expenditure of $2.5 trillion (3) The same structure as (2) but continued across the century until 2100 (4) $2.5 trillion investment into a fund to finance emission reduction until 2100 (5) a trust fund twenty times as small, but utilised to fund a $2 per tonne carbon tax globally, with the tax-rate rising with rate of discount.
The findings of Tol’s model (Figure 10, provided in Tol’s paper), shows that policy (5) has the best benefit-cost ratio, but is also the only policy where the benefits outweigh the costs. Part of the reason why this is, is that the reduction yielded from a dollar spent in reducing carbon in a non-OECD nation, say in emerging markets is far great than in developed, as OECD nations are moderate to low GHG contributors. This, however, is obviously problematic, as those nations which are underdeveloped are far less politically inclined to accept carbon-taxes as it’ll inhibit growth rates. While such nations bring with their growth the largest contributions of GHGs, each tonne of GHGs produced although contributing to external diseconomy, also likely represents a certain population being brought out of absolute poverty as a result of economic growth. Stunting poverty decline in such nations in the name of decreasing future costs thus yields little popularity domestically. What is then left is a very expensive policy in terms of the costs/benefits ratio for only moderate contributors.
Public Choice; How economic analysis can describe why governments select an inefficient policy and how to implement more efficient policies
Although blanket carbon taxes are clearly inefficient in terms of cost/benefit ratio they remain popular in the west yet unpalatable in countries, as such a tax threatens chances for growth already experienced in more advanced economies.
A challenge in conceptualising the issue of climate policy is the idealism of some economists that as a market inefficiency exists, this alone is justification for the implementation of economic rent-seeking policy. There is little evidence to suggest those in office will act such a fashion
Politicians tend to receive a political rent by supporting if not actually implicating popular climate change policy; to be seen to be acting. As the information costs to voters are so high, especially compared to the benefit they receive from voting; they are unlikely to be well informed. This is especially the case if they see climate change as just one issue amongst many. Politicians, at least at a national level then, seek only to maximise votes. As such they are by their very nature unlikely to seek out complex technocratic measures. They will instead advocate for marketable solutions; providing the issue of climate change is even popular among their individual constituency.
Thus, policies such as subsidies of wind production are popular; easily marketed, yet as a policy fundamentally flawed; the technology as of today is comparatively inefficient, especially compared to less politically popular sources such as fracking, which is more cost/benefit efficient. The comparative costs to benefits of wind-sourced energy are also high, yet the policy remains popular as it is visible and marketable. Subsidising inefficient sources however will simply deplete limited funds, for little gain.
This logic holds true across the political dimension of climate economics. While indeed a moderate yet increasing with the rate of the discount, carbon tax is necessary, there are more dynamic alternatives. Further inefficiencies are to be found in subsidies, with most funds being placed in uncompetitive but easily marketed technology. Innovation, however, should be the focus of policy, as the creation of competitive cheap green energy will once provided, be demanded globally, as a result of lower-cost alone, in underdeveloped high GHG contributors as well as advanced economies.
