How have economists thought about climate change?

Greenhouse gases – water vapour, carbon dioxide, methane, ozone, nitrous oxide and chlorofluorocarbons – are what have made our planet habitable. They let sunlight pass through the atmosphere and prevent heat from the sun escaping.

But human actions such as developing land, raising livestock and burning fossil fuels have affected the earth’s climate by increasing the concentration of these greenhouse gases in the atmosphere, blocking outward heat and warming the planet. In many regions of the world, temperatures are already more than 1.5°C warmer than pre-industrial levels, which makes heatwaves, droughts and extreme weather events more likely. The more the planet warms, the greater the frequency and severity of these phenomena (NASA, 2019).

Climate change economics

Protection from the risk of climate change is a global challenge. But encouraging governments, businesses and individuals across the world to take action isn’t always straightforward. Some may be reluctant as the benefits of mitigation accrue globally, but the costs are borne by specific firms or countries that cannot stop others from ‘free riding’ on their investment. Economists refer to this as a public goods problem.

Further, efforts to halt climate change are likely to benefit future generations the most, while it is the current population who will incur the costs. In this regard, climate change is also an intergenerational public good. The net result of this public goods problem is that markets will not provide the public good cost effectively, as not all will be motivated to take action. This makes international cooperation – through protocols and aligned policies – necessary to address the problem.

The 2015 Paris Agreement (at COP 21) is an example of international cooperation, where it was agreed to limit warming to well below 2°C. This emblematic target has been traced to the early work of the Yale economist William Nordhaus. He based the target on observed historical average temperatures, noting ‘if there were global temperatures more than 2 or 3°C above the current average temperature, this would take the climate outside of the range of observations which have been made over the last several hundred thousand years’ (Nordhaus 1975, 1977).

The view that temperatures had not previously gone over this threshold was later supported by evidence from ice cores (Jaeger and Jaeger, 2011). Recent studies suggest that warming over 2°C could increase the risks of moving elements of the climate system beyond critical thresholds, and this could have severe consequences for ecosystems and humanity as a whole (Wunderling et al, 2021).

Some economists have been at the forefront of debates about climate change. For example there were several early studies published in the American Economic Review (Nordhaus, 1977; D’Arge et al, 1982; Lave, 1982; Kokoski and Smith, 1987).

But there have been some high profile attacks within the economic research community of its track record in addressing the issue of climate change (Oswald and Stern, 2019; Smith, 2021). For example, one study that analysed articles appearing in top economic research journals, pointed to the silence of economists on the topic, highlighting that by August 2019, only 57 articles tackled the subject out of around 77,000 published (Oswald and Stern, 2019).

Things have improved somewhat since Oswald and Stern’s call to arms. Compared with the 57 articles on the topic by 2019, using the same search terms on the Web of Science database, 141 articles focusing on ‘climate’, ‘carbon’ or ‘warming’ had been published by September 2021.

Something crucial that Oswald and Stern did not mention was that the coal face of research related to climate change is in the field journals of environmental economics and the related (but distinct) field of ecological economics, where more innovative research tends to be undertaken (Heckman and Moktan, 2020). These journals were omitted in their original search and have been included here. There were 1,595 articles on topics related to climate change published in these journals.

Table 1: Bibliometric search results

Source: Web of Science
Note: September 2021 search results also include papers and proceedings as these are based on papers presented at the annual conference

As Figure 1a and 1b show, there has been an increase in the publication of papers on climate change since the turn of the millennium. This is also reflected in the significant increase in publications in the fields of environmental and ecological economics over the past 20 years (Rath and Wohlrabe, 2015).

Analysis of four decades worth of publications in the top environmental economics journal shows an increase in articles related to climate change and citation of these studies from leading general interest economic journals (Kube et al, 2018). In addition, because of the increased demand there is also now a bespoke journal devoted exclusively to Climate Change Economics.

Figure 1: Number of journal articles on climate change

Panel A: Economics journals

Panel B: Environmental economics journals

Source: Web of Science
Note: Search terms (TS= (‘climate’ or ‘carbon’ or ‘warming’) and SO=(‘Journal Title’)), refined by: ‘document types: articles or proceeding papers’

Since the early 1990s, climate change has spurred a large body of economic research. Much of it focuses on the linkages between weather and economic outcomes in order to understand the possible economic consequences of future climate change (see Dell et al, 2014, for a review). One example is a study of the monthly relationship between weather and the crime rate across the United States over a 30-year period, used to predict the likely future relationship between increases in temperature and crime (Ranson, 2014).

Studies also use the historical record to examine the impacts of natural disasters and mitigation efforts in order to understand how past societies have adapted to changes in climate (Kahn, 2006 and Hornbeck, 2012). For example, one looks at how local economies adapted to the American Dust Bowl, an environmental catastrophe that resulted in severe soil erosion (Hornbeck, 2012).

Has there been any evolution of economic thinking about the climate?

In July 1991, the Economic Journal published a policy forum specifically on the Economic Aspects of Global Warming. With notable contributions from William Cline, the future economics Nobel laureate William Nordhaus, and the late David Pearce, of the three only Pearce would typically be identified as an environmental economist.

This timely publication came hot on the heels of the publication of the first Intergovernmental Panel on Climate Change (IPCC, 1990), which acknowledged the earth’s warming and that human activity is substantially increasing atmospheric concentrations of greenhouse gases. The themes covered are still relevant: assessing the scientific evidence; when to take action; and how to achieve efficient reduction in emissions. Each theme is addressed below to see how understanding of the issues has evolved since the early 1990s.

Global warming, then and now

The scientific consensus on global warming from the first IPCC report was that there was ‘unambiguous evidence’ of build-up of carbon dioxide in the atmosphere (Cline, 1991). Carbon concentrations had increased by 25%, from 280 parts per million (ppm) by volume before the Industrial Revolution to around 350 ppm by the late 1980s. Since the first IPCC report, the amount of carbon dioxide in the atmosphere has increased to 410ppm, a 46% increase from pre-industrial levels, predicting warming exceeding 1.5°C and 2°C by the end of the present century (IPCC, 2021).

Crucially, the research highlighted that carbon dioxide accumulation was irreversible in the short run. Reducing emissions to zero tomorrow will reduce the flow of greenhouse gases but will not reduce their concentration in the atmosphere (Cline, 1991).

In effect, climate change is a long-run problem. Cline critically assessed the evidence supporting the nascent theory of global warming and concluded that the ‘greenhouse science holds up well to scrutiny’, although he was critical of the time horizon of analysis to arbitrary doubling of greenhouse gas concentration rather than a specified time period. The 1991 IPCC report concluded that a ‘business as usual’ scenario would see warming of 2.5°C by 2025. This gave a horizon of 35 years compared with Cline’s proposed analysis of 250-300 years.

Although Cline highlighted the uncertainty evident in the first IPCC report, he noted that ‘uncertainty is not necessarily grounds for policy inaction’. The policy implications from Cline’s perspective depended on the attitude of policy-makers towards risk. If policy-makers were very concerned about the future risks, then they should attach higher weight to upper-bound warming risks. He concluded that if further evidence showed the greenhouse effect to be as serious as it appeared in 1990, that by the end of the decade ‘it will be time to fish or cut basin on the more painful process of implementing measures to cut carbon dioxide and other trace gas emissions’.

The issue of uncertainty is still a significant topic. While climate models have improved significantly, there is still ambiguity about the likely impact of further climate change and whether future damages will be modest, catastrophic or somewhere in between. For example, the 2021 IPCC report includes five estimates of likely warming – 1.9°C , 2.6°C, 4.5°C, 7°C, and 8.5°C – based on different scenarios of trends in carbon dioxide and other greenhouse gas emissions, as well as cooling from aerosols and land use.

The two highest warming scenarios assume that increases in carbon emissions are two or threefold by the end of the present century, while the lower bound ranges require substantial reduction (in the region of 150%) in annual emissions below current levels.

Some studies assign a low, but non-negligible, probability to the outcome in which climate change poses a direct existential threat to humanity, although with the proviso that climate change is more likely to have indirect effects on other existential risks, such as future pandemics and wars (Ord, 2020). Likewise, some economists urge caution when making policy based on low probability but high impact events such as human extinction from future climate change (Weitzman, 2009), although there is disagreement on the extent of the risk of catastrophe (Nordhaus, 2012).

When to take action?

Climate mitigation (reducing greenhouse gas emissions) is not costless. Cleaner technology requires substantial resources both for installation and future research and development (R&D). It also requires governments to make difficult decisions on spending and allocating resources – increased spending on climate mitigation may result in cuts to health or education spending.

Take the example of ‘robot trees’ recently installed in Cork in Ireland, which act as air purifiers. Each tree costs €350,000, which has sparked a huge debate over whether this was an effective use of resources or whether a more cost-effective solution would have been either to plant real trees or enforce traffic bans.

There is also a trade-off in terms of the fact that technological solutions to climate change might be more expensive to implement today but, as we learn how to develop technology, the costs fall over time; and, with economic growth, future generations will be wealthier. This means that there is a trade-off between investing today versus investing in the future when costs are lower.

Take the example of photovoltaic solar energy. In 1968, the economist Kenneth Boulding  noted that ‘up to now, certainly, we have not got very far with the technology of using current solar energy, but the possibility of substantial improvements in the future is certainly high’. Prices, per unit wattage and adjusting for inflation, fell from $100 in 1975 to under a $1 in recent years (Kavlak et al, 2018). This fall in price has led to wider adoption of PV solar globally, something that was prohibitively expensive in the 1970s.

Determining the most efficient (or lowest cost) approach to slowing emissions has been the central debate in climate economics. To do so, a simple model is used to weigh up the costs (of carbon reduction) and benefits (avoidance of future damages) of climate mitigation (Nordhaus, 1991). The approach follows what is now conventional wisdom: that the incremental cost of reducing emissions (marginal abatement costs) rise with each reduction in emissions.

This is thought to be the case because the ‘low-hanging fruit’ options are implemented first – such as switching from incandescent to LED lighting or insulation retrofits – although recent work has challenged the conventional wisdom (Vogt-Schilb et al, 2018). From the vantage of 1991, the low-hanging options were using low-carbon alternatives to coal, such as natural gas or nuclear power and energy conservation. Today, the emphasis is on renewable energy and replacing combustion engines with electric vehicles (ideally powered by renewables).

As the climate mitigation decisions involve a comparison of similar monetary investments today or at some point in the future, economists look at the cost of both decisions. To get the current value of a future sum of money, economists use discounting. The higher (lower) the discount rate, the lower (higher) the present value of future investments.

Using different discount rates from 0% to 4%, Nobel laureate William Nordhaus calculated the present value of climate damages from carbon dioxide equivalent emissions 200 years into the future (Nordhaus, 1991). The net result was a small cost to the US economy of 0.25% of total output and a global damage cost of 2% of total output.

Since 1991, much more sophisticated ways have been developed to estimate the future cost of climate change (for example Nordhaus and Boyer 2000). One of the most widely used is Nordhaus’s Dynamic Integrated Climate Economy (DICE) model, which is a tool for evaluating different climate economy scenarios (Nordhaus, 1992 and Nordhaus, 2017).

In this decision-making paradigm, the discount rate continues to be a key parameter. Within economics, the debate primarily relates to the choice of discount rate: whether we use lower discount rates (which dictates whether we should cut emissions now) or higher discount rates (wait and cut emissions later). Estimates of future damage costs vary enormously – equivalent to $350 versus $35 per tonne of carbon (Stern, 2007; Nordhaus, 2007; see Tol’s 2009, 2011, 2021 regular survey of estimates of future damages). In effect, the Stern Review raised the cost of doing nothing.

Recent meta-analysis of estimates of future damages lends support to the idea that the future damage costs are higher than currently assumed (Howard and Sterner, 2017). These estimates of future damages (including catastrophic risk) are 9-10% of GDP versus 2.4% from the DICE model. While direct damages to advanced economies have been interpreted as being relatively low because of the composition of economic activity, recent work has emphasised that likely economic damage comes from indirect exposure (de Winne and Peersman, 2021).

Deciding to tackle future problems today or letting future generations worry about the problems is a difficult decision as there are ethical arguments to be made for either side (Boulding, 1968). Supporting discounting the future at the lowest possible rate can be said to be favourable because of the uncertainty surrounding likely impacts centuries from now. Standard discounting would reduce the value of taking action to benefit the distant future to zero (Weitzman, 1998).

There are also grounds for considering other ethical issues such as inequality, risk and population ethics when choosing discount rates (Fleurbaey et al, 2019). Some uphold that discounting wellbeing over long time horizons is an incorrect application of economic methodology as it conflates monetary value with human wellbeing (Ord, 2020). The future benefits that are being considered in the case of a catastrophic risk are not monetary in nature, but they are much more fundamental values, such as whether civilisation is thriving, in ruins or extinct.

How to take action?

Economists have also discussed market-based policies to control pollution. Carbon taxes, such as a charge on the carbon content of fossil fuels, are possibly the most widely known of these. An alternative to this is tradable carbon emissions permits that work by placing a limit on the total amount of carbon that can be emitted and requires firms to hold permits for any emissions.

Research has highlighted how taxes would lead to an outcome that would minimise the cost of carbon control for society because it would enable firms to choose how to respond to the tax rather than imposing blanket regulatory standards across the economy (Pearce, 1991). Firms with lower costs of reducing emissions (for example, by adopting energy saving light bulbs) would reduce emissions rather than pay the tax.

Firms with higher costs of abatement (for example, if low-cost options had already been used and more costly options required greater investment) would pay the tax in the immediate term. By putting a cost on pollution, it would also act as an incentive to adopt less polluting technology and conserve energy in the future, what is known as the least cost theorem (Baumol and Oates, 1971).

Yet there are disadvantages to such taxes. Examples include the lack of a clear target for emissions reduction, deadweight losses created by market inefficiency and inequality in terms of who ultimately bears the burden of paying the tax. There are issues that are still barriers to adoption both domestically (fears of increased cost) and internationally (lack of cooperation and fear of being uncompetitive) (Pearce, 1991).

Taxes of this nature are now widely supported by most economists (Maiello and Gural, 2019). This was most strikingly shown by a letter signed by 50 eminent economists in the Wall Street Journal on 17 January 2019, advocating the introduction of carbon taxes.

In practice, emissions trading appears to have wider support from policy-makers and environmentalists – see, for example, International Carbon Action Partnership (ICAP). The basic premise of pollution permits originated with the idea of creating property rights (permits) to emit and a total emissions allowance for a country or region (Crocker, 1966; Dales, 1968; Banzhaf, 2020).

Emissions trading operates on a similar principle as the least cost theorem, and permits can create value for business with lower costs of reducing emissions. This means that firms with lower costs of reducing emissions can sell their excess permits to firms that have higher costs of reducing emissions. By putting a price on emissions, this also creates an incentive to invest in R&D to find ways of reducing emissions.

The European Union (EU) has led the way in this area, introducing an Emissions Trading System (ETS) in 2005 in response to obligations agreed at COP3 in Kyoto in 1997. The EU ETS places a cap on the total amount of greenhouse gas emissions that can be emitted by installations covered by the system and the cap is gradually reduced each year. Participating firms throughout Europe are required to monitor their emissions and have permits (allowances) in place to cover their emissions by March of the following year (see the European Commission’s guide to EU ETS reporting and monitoring).

Non-compliance with the EU ETS carries a heavy fine (€100 per tonne) and given that the prices of permits are less, this provides incentives for compliance. The EU ETS was subject to uncertainty in its initial years but after reforms to the system, it has found its feet; permit prices have risen to new highs this year (see Figure 2). There are now several ETS programmes operating across the globe, with China the latest country to adopt this approach.

Figure 2: ICAP allowance price explorer

Source: International Carbon Action Partnership

Conclusion

Writing in the American Economic Review in 1977, William Nordhaus concluded that ‘unlike many of the wolf cries, this one [climate change], in my opinion, should be taken very seriously’. This is reflected in the latest IPCC report: without doubt, the world is on a precipice with regards to future climate change.

Economists have engaged with the debates surrounding climate change for over 30 years and there is consensus that action is required (Howard and Sylvan, 2021). The main quarrel was not whether action was necessary to mitigate climate change, but when exactly it should be taken.

Thirty years ago, when the first IPCC report was published, the future seemed a long way away. But to quote Boulding, ‘tomorrow is not only very close, but in many respects it is already here’. Action at COP26 never seemed more pressing.

There is hope. International agreements are possible, most evidently from the 1987 Montreal Protocol, which led to the phasing out of chlorofluorocarbons, an industrial product that was harming the ozone layer but was also a dangerous greenhouse gas. The ozone layer is recovering, and this should give faith that future international agreements are possible when the world recognises the real and apparent danger of uncontrolled climate change and acts accordingly.

Where can I find out more?

• Ten facts about the economics of climate change and climate policy
• Stern Review: The Economics of Climate Change
• 10 years on, Climate Economists Reflect on the Stern Review

Who are experts on this question?

• Carolyn Fischer
• William Nordhaus
• Nicholas Stern
• Gernot Wagner
• Ottmar Edenhofer

Author: Eoin McLaughlin

PPhoto by NOAA on Unsplash