What’s New in Climate Economics

Cross-posted from Real Climate Economics.

Economic analysis has become increasingly central to the climate policy debate, but the models and assumptions of climate economics often lag far behind the latest developments in this fast-moving field. That’s why Elizabeth Stanton and I have written Climate Economics: The State of the Art, an in-depth review of new developments in climate economics and science since the Stern Review (2006) and the Intergovernmental Panel on Climate Change’s Fourth Assessment Report (2007), with more than 500 citations to the recent research literature.

We begin with a survey of climate science that is potentially relevant to economic analysis, including uncertainties in climate dynamics, the role of black carbon, temperature thresholds for irreversible losses, a new understanding of climate impacts on agriculture, and projections that temperatures could remain near their historical peak for centuries or millennia after greenhouse gas concentrations start declining.

We then focus on innovations in the economic theory and analysis of climate change, including new approaches to uncertainty that build on Weitzman’s “dismal theorem,” which shows the marginal benefit of emission reduction can be infinite. We also cover new developments in the longstanding debate about discount rates and intergenerational economic analysis, and the problems of international equity, which are central to climate negotiations but barely visible in the economics literature.

Finally, we turn to research on mitigation and adaptation. We look at cost projections for various mitigation scenarios, such as those that aim to keep warming below 2°C; the analysis of the pace of endogenous technical change; the interpretation of negative-cost energy savings opportunities; the expected future price of fossil fuels; and potential rebound effects. The economics of adaptation, meanwhile, remains in its infancy, due to a paucity of data and the highly site-specific nature of adaptation measures.

We conclude with several recommendations for improving the economic analysis of climate change:

• Climate-economic models should use an up-to-date representation of the climate system, and current scientific findings on the expected physical and ecological impacts of climate change. This will require substantial changes in the often dated and incomplete economic models that are in widespread use today.
• Climate outcomes are uncertain, with disastrous worst-case risks, and economic modeling results should reflect this uncertainty. A best-guess or average result is no substitute for a range of economic outcomes corresponding to the underlying scientific uncertainties.
• If damages cannot be accurately reflected in welfare-optimization models, economists should instead use a standards-based approach. Cost-effectiveness analysis of, for instance, the least-cost strategy for staying under 2^oC of warming would fit well with much of the climate policy discussion, while avoiding the pitfalls of cost-benefit analysis.
• The discount rate is decisive, and explains many of the differences between rival economic analyses. All work in climate economics should explain what discount rate is being used, and why.
• Modeling of abatement costs should include endogenous technical change (e.g. learning curves), analysis of negative-cost savings options, fossil fuel price projections, and recognition of real but limited rebound effects.
• Policy relevance in climate economics requires discussion of global equity, including the international distribution of obligations and resources to overcome the climate challenge. International negotiations focus on these topics; it is high time for economists to catch up.

In the end, analyzing climate change is not an academic exercise. The climate crisis is an existential threat to human society: It poses unprecedented challenges and demands extraordinary levels of cooperation, skill, and resource mobilization to craft and enact policies that will create a sustainable future. Getting climate economics right is not about publishing the cleverest article of the year but rather about helping solve the dilemma of the century. The tasks ahead are daunting, and failure, unfortunately, remains quite possible. Better approaches to climate economics will allow  economists to be part of the solution rather than part of the problem.