On Climate Change: “you need all the economics you ever learnt – and more”

From the Financial Times:

Economists price the ravages of climate change, by Scheherazade Daneshkhu and Fiona Harvey, Financial Times: The price of the US’s “addiction to oil” goes far beyond the dependence on politically volatile states cited by President George W. Bush this week. According to the world’s leading climate scientists, reliance on fossil fuels is creating a global warming disaster that could end up costing the earth. ... But there is little appeal in taking costly action in the short term to stave off a long-term threat – especially one that, by its nature, is hard to calibrate.

Persuading individuals and businesses to take the action necessary to tackle climate change caused by economic activity itself requires an economic argument. But how to put a price on the world’s climate and the catastrophes that may follow from global warming?

Attempts to fill a policy vacuum as the expiry of the Kyoto protocol in 2012 looms are suddenly turning environmental economics into one of the hottest areas of the discipline. ... It has taken some time for the economics of climate change to enter the mainstream. ... Economists find it hard enough to make an accurate forecast one year ahead, let alone 100. Yet environmental economics must grapple with a plethora of uncertainties – scientific and political – over a dauntingly long timescale. Small wonder then that Michael Grubb, chief economist of the UK’s Carbon Trust, a government-funded organisation that advises business, declares: “Understanding the economics of climate change is like trying to understand the Big Bang without Newtonian mechanics.”

Dieter Helm, a fellow of economics at New College, Oxford, adds: “The usual economists’ toolbox looks puny against the scale of this challenge.” Just as the experience of the unemployment of the 1930s required the reinvention of much of macroeconomics, so climate change needs new thinking too, he says. ...

The UK can claim to be at the forefront of the debate, thanks in part to a decision by Gordon Brown ... to commission a review of the economics of climate change, headed by Sir Nicholas Stern, a former World Bank chief economist and senior Treasury official. ... The findings will carry weight internationally since they will be part of the basis for UN discussions, due to begin this year, on the future of Kyoto.

Sir Nicholas spoke publicly about his review for the first time earlier this week, in a lecture to the Oxford Institute for Economic Policy.  ... The simple standard theory of externality” – on the spillover effects of production or consumption for which no payment is made – “is useful but not a fundamental answer to the problem”. The first step, he said, was to convince all the governments involved of the need to take urgent action on climate change. The difficulty of achieving an international consensus is reflected in the history of the Kyoto protocol, which has been rejected by the US and Australian governments, and dogged with delays and disagreements. ...

As Mr Helm points out, climate change is a global public “bad”, creating incentives for individual countries to free-ride on others’ emissions reductions: if one country reduces its emissions, the effect on global warming will be negligible but the effect on that country’s competitiveness could be significant.

Jonathan Köhler, of the Department of Applied Economics in Cambridge, thinks it is not necessary for everyone to sign up to an international agreement for progress to be made on emissions reductions. Market forces will do some of the work, he indicates. “If you think climate change is a big problem and the world will have to do something, at some point there will be gigantic markets out there and big export opportunities for low carbon production technologies.” He cites the example of Denmark, which captured a large slice of the market in wind turbines through its early investment in that sector. ...

The policy instruments available to governments traditionally include a carbon tax, limits on emissions and incentives to encourage the development of clean fuel technologies. Most economists favour market-based solutions... Mr Helm believes that an alternative to subsidising a particular technology, such as nuclear fuel, in order to provide low carbon generation is to auction long-term carbon contracts. ...

Sir Nicholas ... hinted the road to knowledge would not be easy: To understand the issues, “you need all the economics you ever learnt – and more”. ...

Comments

[Ronnie Horesh]

I am trying to interest people of influence in my Climate Stability Bonds idea. Essentially this is about rewarding people for stabilising the climate however they do so. Our knowledge of the scientific relationships is expanding rapidly, but Kyoto assumes that reducing our greenhouse gas emissions is the best way of solving the problem. Kyoto offers no incentives to explore other ways that might prove to be far cheaper. It is divisive, expensive - and worst of all - ineffectual. I believe my proposal would minimise the cost of stabilising the climate because it would use market forces to both evaluate the problem and direct resources into where they will do most good.

[Robert Metcalfe]

I think that within the current economic toolbox, we are constrained in how to examine climate change. To use CBA, or the like, would seem intuitive since "how (would you)...put a price on the world’s climate and the catastrophes that may follow from global warming?". The costs would be close to infinite, which would obviously skew CBA.

We do not have another Earth (or earthlings) available to ask how much of a price they would put on our climate – which is roughly how you do it when valuing a (statistical) life. Therefore, the economics of climate change will have to be an innovative area unless all prescriptions will be normative as opposed to positive.

So there could be exciting times ahead for the econ. of climate change. I am glad that the Treasury and Stern have really gone into this debate wholeheartedly since the field of economics will benefit from it.

For a link to Stern’s papers on this issue see: http://environ-econ.blogspot.com/