Climate Economics: The State of the Art

by Frank Ackerman

January 23, 2013

Cross-posted from Triple Crisis.

Climate science paints an ever-more-detailed picture: irreversible, catastrophic events are becoming increasingly likely as greenhouse gas emissions continue to rise. Climate economics, particularly in its policy applications, lags behind: leading models and analyses frequently ignore the extreme risks and the intergenerational aspect of the problem – and rely on simplistic and dated interpretations of the underlying science. Yet the state of the art has progressed rapidly, in the research literature on climate economics as well as science.

To address this problem, Liz Stanton and I wrote Climate Economics: The State of the Art, which has just been published by Routledge. Our book grew out of a request from the World Wildlife Fund for an update on climate economics since the Stern Review. In that 2006 review, commissioned by the British government, Nicholas Stern argued persuasively for a new approach to the economics of climate change, emphasizing arguments for a very low discount rate and a focus on catastrophic risks.

As we explain, both science and economics have continued to advance since Stern’s path-breaking work. After a review of “climate science for economists,” we examine three major areas: the treatment of climate damages in economics; new developments in economic theory; and the economics of mitigation and adaptation. Here are a few highlights from our book:

Recent studies suggest that peak temperatures, once reached, will persist for centuries, if not millenia. Mitigation scenarios have often assumed that the world can “overshoot” a target such as 2°C of warming and then come back to it through later emission reductions; since this option is not available, much more stringent reductions are needed for climate stabilization.

There is essentially no basis for the projection of future climate damages in many models. The use of simple, often quadratic, “damage functions” shapes the results of leading climate economics models, solely on the basis of modelers’ guesses. Empirical research, meanwhile, is finding increasingly ominous evidence of climate damages in agriculture, forestry, ocean acidification, and other areas.

Innovative new approaches to the economics of catastrophic risk have proliferated, especially in the debates around Martin Weitzman’s “dismal theorem.” Weitzman proved that if climate outcomes are sufficiently uncertain and the costs of worst-case outcomes (such as extinction of the human race) are unbounded, then the marginal benefit of emission reduction is literally infinite. This conclusion is hard to refute, but impossible to incorporate into standard economic methods for policy analysis. Responses to Weitzman’s 2009 publication have examined conditions under which benefits of climate mitigation might be finite, and have proposed new frameworks for understanding extreme risk.

Other areas of theoretical advances, to date found largely in research articles, include new approaches to discounting and intergenerational policy analysis; applications of frameworks for decision-making under uncertainty; and, perhaps less successfully, attempts to deal with the global nature of the climate externality and the need for international cooperation.

How much will it cost to reduce emissions and stabilize the climate? The economics of mitigation depends on the future costs of emission-reducing technologies, which are in part endogenous – since they are subject to learning effects, of uncertain strength. The net costs of mitigation also depend on the notoriously volatile prices of fossil fuels, a key uncertainty that is often overlooked in climate economics.

One much-debated area has been addressed by empirical research: the “rebound effect,” in which energy efficiency lowers costs and allows increased energy consumption, turns out to be real but relatively small in practice. There is no reason to believe that the rebound effect negates the value of energy efficiency.

The widespread interest in the economics of adaptation has led to relatively little research to date. Analysis is often stymied by the extremely site-specific nature of adaptation, and the difficulty of distinguishing between climate adaptation and other goals such as resilience, disaster preparedness and recovery, and economic development.

These and countless other topics are explored in Climate Economics: The State of the Art, with more than 500 citations to the recent research literature. Anyone involved in climate economics, science, or policy will find it to be an invaluable resource


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Frank Ackerman is a Senior Economist at Synapse Energy Economics.

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