The Chronicle Review

Gambling on Climate Change

Jon Krause for The Chronicle Review

April 06, 2015

1. Do you think climate change is an urgent problem?
2. Do you think getting the world off fossil fuels is difficult?

Those are the questions with which Gernot Wagner of the Environmental Defense Fund and Martin L. Weitzman of Harvard begin Climate Shock: The Economic Consequences of a Hotter Planet (Princeton University Press). The way people answer those questions tells us much about why climate change has proved so bitterly divisive. The questions are logically independent, so we might expect to see all four possible combinations of answers well represented. In reality, hardly anybody answers no to both.

While experts who have looked at Question 2 are deeply divided, almost no one who has looked honestly at the issue answers no to Question 1. Those who do have a combined unwillingness to contemplate the measures required to mitigate climate change (which is why no on 1 is always accompanied by yes on 2) and culturally based hostility to the scientists and environmentalists who have done most to raise concern.

Answering the questions requires a bit of interpretation, too. What exactly does "urgent" mean, and how difficult is "difficult"?

There is general agreement that, to prevent dangerous climate change, it is necessary, by 2050, to reduce emissions of carbon dioxide and other greenhouse gases by at least 80 percent. Any sensible approach to such a task requires an immediate start. Indeed, a much earlier start would have been preferable. There’s the urgency.

Defining "difficult" is trickier, but not as tricky as you might think. The economists Wagner and Weitzman give a hint when they say "solar panels and bike lanes alone won’t do." Low-cost measures taken so far, such as modest subsidies for renewables and fuel-efficiency standards for motor vehicles, fall far short of what’s needed. But that leaves open a wide range of possibilities.

Opponents of taking action to mitigate climate change claim that it will require a radical reorganization of the economy and drastic reductions in living standards. The same claim is endorsed, with satisfaction rather than fear, by some leftist critics of capitalism who welcome the idea that mitigation efforts will end our consumeristic way of life.

Mitigation of global warming is a rational, common-sense safeguard even for those who doubt the seriousness of the situation.

But a more-expansive interpretation of "solar panels and bike lanes" would be the replacement of fossil fuels by renewables and of gasoline-­driven cars by electric vehicles, bicycles, and public transport. Those are the two essentials in any program of decarbonizing the economy. A variety of other sources and sinks of greenhouse gases need to be managed, but electricity and transport are crucial.

How difficult would it be to revamp power stations and transportation? Unfortunately, having raised the question, Wagner and Weitzman don’t answer it, focusing instead on the problem’s urgency. But while Nicholas Stern also focuses on immediacy, as indicated by his title Why Are We Waiting? The Logic, Urgency, and Promise of Tackling Climate Change (MIT Press), he considers difficulty, too. Stern, a professor of economics and government at the London School of Economics and Political Science, points to estimates suggesting that the additional investment required to decarbonize the economy is in the range of 1 to 3 percent of global output, usually measured by gross domestic product.

It’s hard for anyone not immersed in the world of national accounting to get a grip on numbers like theses. They can easily be made to look very big or very small. The total value of global output is around $75 trillion, so 3 percent of that is more than $2 trillion. Over the 35 years to 2050, therefore, the investment required to decarbonize the economy would be in the tens of trillions of dollars.

On the other hand, during that period, an increase of 0.1 of a percentage point in the global rate of economic growth would raise output by more than 3 percent. There are a wide variety of policy interventions, from tax reform to improvements in education, that could boost growth by that much, but that have been deemed, for one reason or another, to be politically "too hard." Many economists have argued that if the revenue raised by imposing a price on carbon-dioxide emissions were used to fix other problems in the tax system, such as the employment-­reducing effects of payroll taxes, the net economic impact could be beneficial, even before the effects on climate change were considered.

But Stern points to a preferable way of viewing the problem, namely that of managing an economic transition.

A modern dynamic economy is continually undergoing transitions both large and small. The 19th-century shift from an agricultural economy to an industrial one and its 20th-century replacement by a service economy are examples of large-scale economic transitions. The replacement of landline phones with cellphones is an example of a small one. The transition from carbon-based to renewable energy is on a scale intermediate between those two: big enough to require major investment and to disrupt existing ways of doing things, but not so large as to transform most people’s way of life.

Consider a couple of examples of sectors of the economy that are comparable in size to energy — that is, around 5 to 10 percent of total output — and that are similarly pervasive in their interactions with the economy as a whole.

One is education. In the aftermath of World War II, the United States emerged as the world’s first knowledge-­based service economy, requiring a substantial level of education for the great majority of workers. Completion of high school, previously an aspiration of the middle and upper classes, became the norm, and universities were transformed from elite to mass institutions. The change required huge public investments (the GI Bill a notable and symbolically important example) and big adjustments in household budgets, as the period during which young people were dependent on their parents extended into adulthood.

Another example is retail and wholesale trade. Looking ahead to 2050, the transformation of those sectors, already well under way, seems certain to reshape not just their economics but the urban and suburban environments to which they are central. Shopping malls and department stores will be largely, if not entirely, displaced by online transactions, with major consequences for employment, transport systems, and housing choices. This will no doubt be a difficult adjustment for many, as indeed it already has been for the most directly affected sellers, like bookstores.

Hard transitions invariably provoke opposition from those whose economic interests are harmed. More significant, such transitions can arouse resistance in people whose personal identity is bound up in the old way of doing things. Those factors have combined to generate resistance to policies designed to stabilize global carbon-­dioxide emissions. Such resistance is reflected in the large number of people who would answer no to Wagner and Weitzman’s Question 1 and yes to their Question 2.

A majority of those who answer Question 1 by denying the need for an urgent response to climate change view themselves as skeptics regarding the science of global warming. But despite its political potency, climate "skepticism" has no basis in evidence. For that reason, it can’t be refuted, and neither Wagner and Weitzman nor Stern attempts to.

What the authors of both books do argue is that investing in the mitigation of global warming is a rational, common-sense safeguard even for those who doubt the seriousness of the situation.

And curbing the use of greenhouse gases, the authors argue, is indeed affordable. To understand their approach, a little history is useful.

Early attempts to model the economics of climate change, of which the most notable was the Dynamic Integrated Climate-­Economy framework developed by William Nordhaus at Yale University, treated climate mitigation as being analogous to a commercial investment. Nordhaus evaluated future benefits and costs using discount rates — the interest rates used to convert future values to present-day equivalents — based on the private-sector cost of capital, which is typically at least four percentage points higher than the rate of inflation, and substantially higher than the rate of interest on government bonds. The effect is to greatly reduce the value of benefits realized in the future. For example, with a 4-percent real discount rate — that is, the interest rate taking inflation into account — it would cost $36,000 today to avoid $1 million of climate-related damage (at today’s prices) in 2100.

On the basis of the DICE discounting procedure, Nordhaus initially concluded that it would be desirable to delay substantial action on climate change. That conclusion was seized on by advocates of inaction, most notably Bjørn Lomborg. Nordhaus changed his view as the model was updated, but his earlier work is still being cited by those resisting action.

In his Economics of Climate Change, released for the British government in 2006, Stern rejected the DICE approach to discounting. The core problem in DICE is that the private-sector cost of capital includes a large risk premium — a higher expected return demanded by equity investors — associated with the cyclical nature of business earnings. Profits are higher in booms than in recessions, but income is more valuable in recessions. By some estimates, an extra dollar of business income in a recession has the same value as an extra two dollars in a boom. But, Stern reasoned, there is no reason to impose such a risk premium when evaluating the benefits of mitigating climate change’s negative effects.

Stern’s approach to discounting was based instead on the theory of economic welfare, in which the value of additional income in the future is smaller than that of income today because we expect incomes to rise. Stern advocated a real discount rate — one taking account of inflation — of around 1.5 percent. Not coincidentally, this is about the average rate of return on government bonds over the long term.

Neither DICE nor the 2006 Stern report paid a great deal of attention to uncertainty. That omission turns out to be a crucial point first made by Weitzman soon after the publication of the Stern review. Stern has picked it up in his latest book, but it is addressed most comprehensively by Wagner and Weitzman.

The analysis in DICE focused mainly on the central estimate that a doubling of atmospheric CO2 levels would raise global temperatures by around 3.5 degrees Celsius. That estimate has remained largely unchanged since the early 1990s, but it is subject to a substantial range of uncertainty. To complicate matters further, there is considerable debate over how wide the range of uncertainty should be.

Advocates of inaction have long used uncertainty as a central argument. Any hint of disagreement among climate scientists is presented as a reason to do nothing. Economists have generally taken the opposite view, on the basis that uncertainty implies higher expected damages.

Consider this example. By the usual estimates, the damage associated with 3.5 degrees Celsius of warming rather than the globally agreed target of 2 degrees would be 5 to 10 percent of global income, while the cost of achieving the 2-degree target would be 1 to 3 percent of global income. Taking the midpoints of those ranges, the net benefit would be around 5.5 percent of global income.

Suppose, however, that climate change turned out to be unrelated to CO2 emissions, or so weakly related that a doubling of CO2 led to only a 1-degree increase in global temperatures. The scientific consensus is that this is extremely unlikely (less than a 5-percent possibility) but not impossible. In that case, there would be no damage to prevent, so a mitigation policy would produce a loss equal to the total cost of the mitigation itself (2 percent of global income). Even were this unlikely possibility to prove true, the investment lost would be small.

But errors go both ways. Warming of 6 to 7 degrees Celsius is also a highly unlikely consequence (5-­percent probability or less) of a doubling of CO2 concentrations. But such warming would be catastrophic, threatening the complete breakdown of the food and water systems on which we depend. Any sensible analysis of a risky situation must take such possibilities into account. The expected loss from a "business as usual" policy is driven, to a large extent, by the relatively low probability of a "tail event" like the 6-to-7-degree rise. Wagner and Weitzman take this line of thinking further, arguing that the distribution of possible consequences of warming is "fat-tailed," so that no meaningful expectation can be derived. Even if this conclusion is regarded as too extreme, the disastrous risks associated with extreme climate change represent an important argument for action.

Many of the risks with which we are concerned in everyday decision making are realized with probabilities in the range of 0 to 5 percent or 0 to 1 percent — that is, in the terminology of the Intergovernmental Panel on Climate Change, "extremely unlikely" or "exceptionally unlikely."

Here are a few examples:

■ A 60-year-old smoker’s 10-year risk of dying of lung cancer is 5 percent.

■ The one-year risk of death from any cause in the United States is less than 1 percent.

■ The 10-year risk of dying in a road crash in the United States is 0.1 percent.

To take the first example, 95 percent of 60-year-old smokers will either live to 70 or die of some cause other than lung cancer. It would be absurd, however, for a 60-year-old to evaluate a decision to quit or continue smoking without taking account of the risk of lung cancer. (Sadly, of course, some do employ that kind of reasoning, along the lines of "my uncle smoked two packs a day and lived to the age of 90.")

The critical point here is that a small risk of a severe outcome may have a substantial effect on the expected costs of an individual or public-policy choice. Unlikely events cannot be disregarded if their outcomes are exceptionally severe.

Combine the Wagner-Weitzman view of uncertainty with Stern’s on discounting, and, in worst-case scenarios, living standards will be below those of today, producing a negative discount rate. That would make investment in global-warming mitigation even more compelling.

The takeaway from both books is that uncertainty about the science of climate change should not keep us from finding common ground on the economics. One person’s obvious conclusion may be another’s precautionary one. But only fools are reckless with their one and only planet.

John Quiggin is a fellow in economics at the University of Queensland; a columnist for The Australian Financial Review; a blogger for Crooked Timber; and the author of Zombie Economics: How Dead Ideas Still Walk Among Us (Prince­ton University Press, 2010).