Almost unnoticed inside the Beltway, where attention is focused as usual on politics and the ins and outs of legislation, economic thinking about climate policy has undergone a fundamental shift. In the past, economists who worked on climate usually were interested in balancing the costs against the benefits of reducing greenhouse gas emissions. The economic debate centered on issues such as how to measure the macroeconomic impact of cap-and-trade or carbon taxes, how large is the potential for energy savings that would be profitable even without accounting for their environmental benefits, and measuring the effects of climate change on agriculture, recreational opportunities, land values, health care expenditures, electricity demand, and other specific sectors of the economy.
The scientists who study climate change have always been aware of the possibility that climate change might set off discontinuous or catastrophic changes in earth systems. Collapse of the Antarctic or Greenland ice sheets, shutdown of the Atlantic ocean current that brings warm water to European latitudes, and the nightmare scenario of higher temperatures triggering massive release of the methane trapped in offshore seabed clathrates all are low probability events, but those probabilities are not zero. A global temperature increase of 2º C or more might very well bring us closer to the tipping points that would make these or other irreversible catastrophes much more likely.
Economists did not pay much attention to these low-probability disasters, partly because there was no easy way to quantify their effects. The conventional cost-benefit framework was familiar, and has a professional and institutional infrastructure supporting it. But how can the economic consequences of changes that lie far beyond human historical experience be measured? There is no econometric method for estimating the price and income effects of unprecedented events that bear little or no resemblance to anything that has been observed to date.
The new economic approach is to recognize that it is more appropriate to think about climate policy as taking out insurance against disaster than as trying to equate marginal costs and marginal benefits. Healthy parents buy life insurance to protect the well-being of their children in the unlikely event that the parents die, and feel that their purchase has been worthwhile if the insurance policy never pays out a penny. The insurance premiums are a real cost, and the “benefit” is zero, if benefit is defined as a tangible payoff to the buyer. Of course, the probabilistic expected value of the insurance payout is positive, but the money would accrue to the next generation, not the purchasers of the insurance.
This shift in perspective has been moved to the forefront of climate economics by the theoretical work of scholars like Martin Weitzman, Graciela Chichilnisky, Richard Howarth, and others. It does not diminish the contributions of these thinkers to recollect Ronald Reagan’s quip to the effect that an economist sees something working in practice and then seriously wonders if it works in theory. Academia is characterized by tremendous inertia. Advances in economic theory are essential to changing applied practices over time. The new perspective of climate economics as a matter of risk management rather than cost-benefit analysis is working its way through the peer-reviewed journals, and will soon become dominant in the policy debate.
By Stephen J. DeCanio, Professor Economics, Emeritus, University of California, Santa Barbara