Climate Change: A Question of Caves and Mansions 2?

In my last post, I looked at the neoclassical economist’s view of a world undergoing climate change. The consensus within the profession is that global mean temperature rise will become a growing cost to humanity. Further, such a cost is not being borne by those causing it (a so called externality in the economics literature) and therefore justifies a carbon tax. Finally, and most controversially for some, the standard recommendation is for a slow and steady ramp in taxation from a very low starting point. This rests on the recognition that any investment to mitigate carbon emissions now will translate into lost economic output in the future. So the logic goes: it is often better to get rich and dirty first (before cleaning up), rather than staying clean and poor.

In sum, the economics profession calls for a calm, considered but, above all, slow response to climate change.  This is in stark contrast to the position of many climate scientists; for example, the sentiment expressed in the following statement by the climate scientist Lonnie Thompson:

Why then are climatologists speaking out about the dangers of global warming? The answer is that virtually all of us are now convinced that global warming poses a clear and present danger to civilization.

Since the scientific and the economics communities inhabit completely different academic silos, it is rare to find any intelligent discussion that analyses this dichotomy of opinion. Economists cite scholarly articles published in the leading economics journals, and scientists cite scholarly articles in the leading scientific journals. The one exception is perhaps the Intergovernmental Panel on Climate Change’s periodic assessment reviews, which has provided a communal market place of ideas for a variety of disciplines to meet. However, the last report was published in 2007 and was based on an information set available a few years even earlier. Therefore, many economists are not very well placed to tap into the rising alarm of climate scientists as new data comes in and reports get published.

If I were a climate scientist trying to install a sense of urgency among economists, how would plan my avenue of attack?

First of all, we can go back to the Nordhaus model and try to find where the greatest uncertainties lie. Nordhaus, himself, is well aware of the limitation of his approach as the following passage indicates:

In the present context, we have a complex system that is imperfectly understood in the sense that we are unsure how the system will evolve in the future. The uncertainty is based on incomplete knowledge about external variables and the system itself.

We are uncertain about the growth of output over the next century and beyond, about what energy systems will be developed in the decades ahead, about the pace of technological change in substitutes for carbon fuels or in carbon-removal technologies, about the climate reaction to rising concentrations of GHGs, and perhaps most of all about the economic and ecological responses to climate change.

Amplifying this caveat, Nordhaus goes on to further describe the eight critical uncertainties that are highly influential on the model outcomes and policy recommendations:

  1. Growth rate of total factor productivity (broadly technological progress)
  2. Rate of decarbonisation
  3. Population growth
  4. Cost of backstop technology (fossil fuel replacement)
  5. Damage-output coefficient
  6. Atmospheric retention fraction of carbon dioxide
  7. Temperature sensitivity coefficient
  8. Total availability of fossil fuels
Now, most climate scientists would probably feel most secure talking about factors six and seven, but in those areas the economists defer to the scientists and there is little room for disagreement. Accordingly, I believe it is factor five, the damage function, that is the Archilles’ heel of the econometric models (which comes near the bottom of the following flow diagram).
But but before looking at Nordhaus’ damage function, I must defend myself from the accusation that I have set up a straw man through emphasising a model in my last post that is already six years old. However, we can see from a more recent Nordhaus paper (here) that his updated damage function still only produces a very limited hit to GDP:

Understanding the market and nonmarket impacts of climate change continues to be the thorniest issue in climate-change economics. The RICE-2010 model provides a revised set of damage estimates based on a recent review of the literature (20, 21). Damages are a function of temperature, SLR, and CO2 concen- trations and are region-specific. To give an idea of the estimated damages in the uncontrolled (baseline) case, those damages in 2095 are $12 trillion, or 2.8% of global output, for a global temperature increase of 3.4 °C above 1900 levels.

It is worth following up Nordhaus reference in the quote above, as it takes us to Richard Tol’s literature review entilted “The Economic Effects of Climate Change” (here). And the summary Table 1 I have highlighted here:
The table summarises a range of academic papers, which overall show a relatively well-behaved warming of around 2 to 3 degrees Celsius and relatively limited GDP impacts. What will happen, however, if we stray into the territory of 3 degree Celsius plus levels of warming?

If we follow the internal logic of the Nordhaus economic model, we can get a sense of CO2 concentrations. For Nordhaus, the baseline scenario is the ‘do nothing’ one for which atmospheric CO2 concentration reaches 800 parts per million (ppm) by century end. Further, in the ‘optimal’ policy scenario CO2 concentrations still reach a high 600 ppm (current level is 395 ppm and pre-industrial level was round 280 ppm) before peaking out—the kind of level that makes NASA’s James Hansen fear for the lives of our grandchildren (see for example here).

Yet Nordhaus, and the majority of the profession, seem relatively sanguine about a 600 ppm plus CO2 outcome. True, climate damage (measured as a percentage of global output) is seen as reacting in a non-linear manner with respect to forecast mean temperature rise, but the steepness of the curve (degree of convexity) is deemed to be relatively low. This chart from Nordhaus’ book  ‘A Question of Balance’ shows only two extra percentage points of GDP lost output if global mean temperature rises from four to five degrees Celcius—in other words, a temperature level that would witness a mass panic among the scientific community is regarded as almost a side show for many in the economics profession. Just read the papers presented at the ‘4 Degrees and Beyond Conference’ held at Oxford University in 2009 (here) to get a sense over whether such limited GDP impacts could be true.
Thankfully, natural scientists have as allies a few economists who are looking at the damage function in a more sophisticated manner which incorporates heterodoxy, complexity, non-linearity and tipping points. One of these is Michael Hanemann from Arizona State/University of California, Berkley. In this presentation, Hanemann brings out the potential for damage functions to exhibit a far greater ‘curve’ than the traditional economic models—which have defined the policy debate—suggest. If you view the presentation, clearer slides are available to accompany the video here.
Hanemann’s entire presentation is worth watching, but I will pull out a couple of charts for those who do not have the time to go through the video. First, as we move into a new man-made ‘anthropocene’ climate, not only will mean temperature rise but also the variance of temperature.
Second, the response of individual sectors to temperature change will eventually cross highly negative thresholds. For example, in the chart below we see corn, soybean and cotton production benefitting to a mild degree from climate until at a certain point yields plummet.
I would also add that Hanemann does not even bring up systemic effects or the spillover of economic impacts into sociology and geopolitics. As regard the former, the separation of sectors of the economy that are vulnerable to climate and those that are insulated from climate appears spurious. Drought and extreme temperature will ultimately reduce the attractiveness of the Southern California for office development as well as oranges. Moreover, we have just seen how the current state of macro-economic modelling was blindsided by the feedback mechanisms set in motion by higher oil prices and over-leveraged consumers in the US (just go and read some IMF, OECD and Federal Reserve reports from late 2007). The complex system that is our economy appears to have emergent properties. Can we really be confident that if certain sectors of the economy are devastated by extreme weather after crossing non-linear thresholds the rest of the economy will carry on growing regardless?
Political structures and societies also have the potential to collapse if subject to enough economic stress, setting in train a feedback loop that further amplifies economic weakness. Read Gwynne Dyer’s book ‘Climate Wars’ and follow the references to a variety of reports from military establishments across the world that detail ‘what if’ studies of geopolitical turmoil set off by climate change. The economics profession again appears totally silent on the subject. Note that this is a profession that has been highly vocal on the institutional and social underpinnings of growth in less-developed countries, yet remains totally mute on how those same underpinnings will be stressed in the face of climate change.
The silver lining is that consensus economists like William Nordhaus are at least aware of some of their critics. A good article on the site Yale Environment 360 records the type of engagement taking place. When it comes to policy influence and implementation, however, the ‘no need to be alarmed’ economic consensus view dominates.
While economists like Hanemann and Martin Weitzman are flagging the tail risk, their voices are hardly heard outside their own discipline. Accordingly, it is left to a few outspoken scientists such as Hansen and Thompson to inform the wider world of the risks humanity runs with climate change. Unfortunately, such voices are frequently characterised as being ‘alarmist’ by those in the social sciences. Frankly, those natural scientists who have gone over the top WW1 style in the face of the climate skeptic machine gun fire could do with more vocal and active support from within the economics community.

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