The Climate Crisis as Seen by the Economics Mainstream

August 28, 2017

This article from 2014 by Brian Davey – part of his book Credo – critiques the ways in which economists generally try to calculate the costs associated with climate change. Unfortunately, it is still relevant now.

Mainstream economics frames the climate crisis in a particular way but this approach is not at all helpful. There have been a variety of controversies which show clearly how economists think – like the “price ofcost a life” controversy. The findings of the Stern Review were widely quoted but how were they calculated? Much of the controversy about the Stern Review among economists was about the discount rate to be applied to future projections. These issues are explained.

Although the effects of climate change seem to be near to apocalyptic over the long term, over the
short term taking significant action to cut emissions also appears to be a tremendous challenge. The magnitude of this challenge is indicated by a statement in the Stern Review of the Economics of Climate Change: “Experience suggests that it is difficult to secure emission cuts faster than 1% per year except in instances of recession…” (Stern, 2006, p. 231)

When the Soviet Union was wound up the Russian economy collapsed. Between 1989 and 1998, fuel related emissions fell in that country by 5.2% per annum because economic activity halved. However, this was no model to copy. It was a period of deep crisis. The death rate, particularly among young Russian men, soared. (Stern, 2006, p. 232)

This brings us to the climate policy response so far, or the lack of it, and how mainstream economists frame the climate debate.

  • Any policies have to be consistent with growth
  • Optimal policies are supposed to be based on cost benefit calculations in which gains and losses for different people through time are held to be commensurable in money terms
  • An appropriate discount rate must be charged when making policy calculations
  • It is assumed that climate change, its impacts and their costs are predictable, at least in probability terms, and controllable. The assumption of policy is that we are facing calculable risks instead of “Strong uncertainty”
  • The appropriate goal of policy it to find the “correct carbon price” imposed by a carbon tax and/or cap and emissions trading systems to drive the evolution of techno innovation solutions

The game that neoclassical economists think that they are in is one of finding the best deal for humanity in regards to “costs” and “benefits”, calculable in a money unit of account, on a continued growth path. The neoclassicals see themselves as trying to find the optimal trade-off between states of the climate system and states of economic system which can be thought of as a kind of “optimal insurance deal”. This is one huge global cost benefit calculation in which to get it wrong entails one of two possible outcomes – either the “insurance premiums” (ambition and scale of the mitigation costs) are set too high, or they are set too low when compared to the damage costs caused by the climate impacts that are eventually suffered.

Two examples can be given of the cost benefit approach, that of William Nordhaus and that of the Stern Review. The latter was the report produced by a research team commissioned by the UK Treasury under the leadership of Nicholas Stern, now Lord Stern.

The approach of Nordhaus is called a Dynamic Integrated Climate Economy model, or DICE for short. The underlying assumption of DICE is that the degree to which climate change takes place depends upon the magnitude of mitigation efforts. For each degree of possible climate change, there will be a degree of impact damages with a corresponding cost of these impacts. The averting of these costs by mitigation efforts (e.g. technological change in the energy system) can be thought of as the benefits of mitigation. However, mitigation efforts also entail implementation costs. The aim of the exercise with DICE is to calculate all the costs and benefits arising from different amounts of mitigation, now and in the future. The costs and benefits of different levels of mitigation ambition are calculated and discounted back to current monetary values using an appropriate discount rate. (Hamilton, 2010, pp. 60-61)

The greater the mitigation effort the less the climate change impact costs (the greater the benefits in averting these impact costs). However, the greater the mitigation efforts the greater the money costs of mitigation. So for Nordhaus, the aim of the exercise is to do the sums and find the level of climate mitigation effort that minimises the costs of climate change AND the costs of mitigation when added together – all discounted back to present values. This is the optimal trade off point.

In a paper of 2008, Nordhaus argues that a business as usual policy (i.e. no climate mitigation) would give rise to damages of $23 trillion. However, by spending $2 trillion on mitigation climate impact costs would fall to $18 trillion, $5 trillion less. Thus, the world would be saved $5 trillion minus $2trillion = $3trillion net in climate impact costs. According to the Nordhaus calculations, this is the optimal trade off point – minimising cost of mitigation and cost of climate change impacts together.

Clive Hamilton is not impressed:

By any reasonable criterion Nordhaus’s analysis is mad. He behaves like the ultimate economic technocrat with his hand on the global thermostat, checking his modelling results and fiddling with the knob, checking again and adjusting further, all so that the planet’s atmospheric layer may be tuned optimally to suit the majority of human inhabitants (Hamilton, 2010, p. 62)

A key point in Hamilton’s critique is the delusion that it is possible to predict and calculate the impacts of climate change for the century ahead – indeed the assumption that it is precisely controllable like a thermostat. This ignores the many unknowns in climate science, how these will translate into actual historical events and the possibility of dynamic reinforcing feedbacks.

As Hamilton puts it the climate is “more like a wild beast than a thermostat that can be controlled”.

The “Price of a Life” controversy

For the Nordhaus approach to have any meaning all, things must be comparable and measurable in money terms. Money must be trusted as an appropriate unit of account which is able to make all things commensurable. Changes in health, education, and environment are all reduced down to change in income that is measurable in GDP terms. Thus, the underlying ethical choices are hidden behind mathematical calculations of various categories of loss and gain. For example, Nordhaus speculates that there will be some benefits of extra recreation in the US from a warmer world, but some loss of life elsewhere. Another ecological economist, Clive Spash, explains how a methodology like this, that aggregates gains and losses in money figures, means that dead people in China and India are compensated for by extra golfing holidays in Florida.

This has not been well received in poor countries. Great controversy arose at the time of the 1995 International Panel on Climate Change Report when some economists varied the “dollar value of life” in their climate calculations on the basis of income differences which meant that a rich person’s life was valued at 15 times the value of a poor person’s life. “On this basis if you kill 14 poor people to save one rich person there is a “net gain”. (Spash C. L., 2008) ( Thematic Guide to Integrated Assessment Modeling of Climate Change [online]., 1995)

Why Kaldor Hicks doesn’t work for climate economics

The method used assumes the Kaldor-Hicks compensation principle. However, as already explained, Kaldor Hicks does not require that losers actually get any money or goods in real compensation payments. The “potential” ability to compensate is supposed to be enough.

Quite apart from the evident injustice of this approach, there are other reasons why this “lowest common denominator utilitarianism” does not work for climate policy. In so far as climate change policy is about the relations between people living in different time periods, the required Kaldor-Hicks transfers are physically impossible. People living in the future cannot send goods back into the past to compensate present day individuals who may have to give something up to avert dangerous climate change. Those living in the present can to some degree determine the future’s endowment of produced and natural capital but causation in the reverse direction cannot happen.

Meanwhile, in the here and now, golfers in Florida need not worry that they will be paying extra taxes to compensate families dying from droughts, floods or sea level storm surges in the third world. As long as golfers are judged better off by more than the families of the dead (and the dead themselves) are worse off, that is all that matters. Clearly, asking the opinion of those involved is not on the agenda.” (Spash, 2008)

The quote by Spash reminds us what is involved in the neoclassical style of reasoning. Mainstream economists replace what should be a subject for human communication – between various communities of affected people, who are winners and losers, in a process of deliberation – with a calculation by a professional priesthood in which the real ethical issues and power relations are hidden behind obscure calculations. The premise of welfare economics is that the utility gains and losses of people (measured in money) must be aggregated and it is assumed that the gains of some can be added to the losses of other people.

Equity calculation weightings

It will be recalled from earlier in this book that neoclassical economists set great store by the idea of declining marginal utility. is is notion that as one gets more of a good the additional satisfaction or utility from each additional unit possessed declines. The fifth slice of pizza does not add as much to satisfaction as the first. The logical corollary of this is that an additional dollar to a rich person, who already has plenty of everything, will not add as much as a dollar to a poor person who has very little. Applying this kind of logic to climate change impacts and costs implies the need to recognise that marginal gains or losses to a poor person are greater than to a rich person. Yet most climate cost benefit analyses ignore this and implicitly assume that the income distribution in society is justified. “Ths means if a person who lives on $2 a day loses $1 and a millionaire gains $2 the world is a better place” (Baer & Spash, 2008)

There are, however, a few studies that make calculations to adjust climate cost benefit analyses with an “equity weighting”. These include a study by Nordhaus and Boyer. The effect of adjusting with equity weighting leads to a significant change in the quantification of climate damage. In a Nordhaus and Boyer study, the measure of damages at 5 degrees C increases from 6% to 8% of GDP. A 2002 study by Richard Tol found that damages double at 5 C degrees when an equity weighting adjustment is made. (Baer & Spash, 2008, p. 17)

The Stern review

The Stern Review received much international publicity. It was published in 2007 after a number of studies, like those of Nordhaus and Tol, had suggested that the cost of climate change impacts was likely to be relatively small. A study by Richard Tol had even claimed that there could be overall benefits for small increases in temperature, particularly in rich countries. Stern, however, found that the cost of climate impacts would be much larger and came to the conclusion that it was worth paying 1% of world gross production each year in climate mitigation investment in order to prevent overall costs of climate change equivalent to losing at least 5% of world GDP each year, now and forever.

The 5% loss figure related to global per capita consumption, and Stern noted it would increase further if three other issues were taken into account:

“Non-market” impacts on environment and human health which would bump up the 5% of global GDP to 11%; the effects of reinforcing feedbacks in the climate system which could further increase the impacts – increasing the 11% to 14%; and an equity weighting figure reflecting the greater impact on poorer countries which would increase the overall impact figure from 14% up to 20%. (Stern, 2006, pp. 161-162)

The abatement cost conceived of like an insurance premium

Stern later increased his cost gure for necessary mitigation from 1% costs to 2% of world GDP. He described this abatement cost as being like an insurance premium.

What are these figures and where do they come from? As we saw with the critique of Nordhaus, using aggregate GDP numbers measures life by the ability to consume. Stern approached the issues in much the same way. He too is primarily calculating “consumption” – though the idea of consumption is an expanded one, including health, education, the environment and the like. Here again is the assumption of commensurability made possible by money valuations. Although, to be fair, there is a lengthy discussion of the ethical issues of doing this – adding up, aggregating, the monetary measures of the consequences of climate change.

The stripped down approach that we shall adopt when we attempt to assess the potential costs of climate change uses the standard framework of welfare economics. The objective of policy is taken as the maximisation of the sum across individuals of social utilities of consumption. Thus, in this framework, aggregation of impacts across individuals using social value judgements is assumed to be possible. In particular, we consider consumption as involving a broad range of goods and services that includes education, health and the environment. e relationship between the measure of social well-being – the sum of social utilities in this argument – and the goods and services consumed by each household, on which it depends, is called the social welfare function. (Stern, 2006, p. 33)

So, the authors of the Stern Review were aware of the criticisms and diffculties of their approach, for example, of how to value health. They were aware of the debates about the “value of a life”. They were aware that characterising “broader dimensions of welfare” in money terms “should be viewed with circumspection”.

However, after making their caveats, they went ahead and used the approach anyway.

The appropriateness of equity weightings to adjust aggregate figures was also acknowledged. However, the Stern team said that they lacked the time to do their own equity weighting calculations. Instead, the review quotes adjustments in the study by Nordhaus and Boyer as “indicative” of the sort of change that they too should be making. This led to their assertion that a reasonable equity weighting change in the estimate of maximum damages would be an increase from 14.4% to 20% of GDP. (Stern, 2006, p. 187)

Baer and Spash comment:

The Stern Review follows Nordhaus in producing a figure (for damages) with a calculated deceptive precision which is simply arbitrarily rounded up to another number. (Baer & Spash, 2008, p. 18)

Results that are “illustrative only”

The figures from the Stern Review are “ball park”, little better than guesstimates of what might happen in a largely unknown and unknowable future. Stern seeks to tame uncertainty by turning his future projections into a range of probabilities about future climate states and their impacts. To do this, he used a model called PAGE 2002 (Policy Analysis of the Greenhouse Effect 2002) with 30 crucial inputs, each of which has a supposed “probability density function”. (Inputs are things like the ratio of climate damages in different regions for each temperature increase, or the figure to calculate the sensitivity of temperature increase to different levels of CO2 increase). (Stern, 2006, pp. 173-175)

In practice, as Spash argues, only the “climate sensitivity” has any significant scientific literature. (Climate sensitivity is a figure for how much global temperatures increase for a doubling of CO2 in the atmosphere). For the other inputs the PAGE authors used their judgement based on scanty evidence. Guesstimates are subjected to a sophisticated mathematical process and, to cover their backs the researchers write caveats that few people will read:

Integrated assessment models can be useful vehicles for exploring the kinds of costs that might follow from climate change. However, these are highly aggregative and simplified models and, as such, the results should be seen as illustrative only. (Stern, 2006, p. 124)

This did not stop these results being used as headline figures in many mass circulation newspapers, TV and radio reports. Anyone not knowing might have thought that the figures that got the press coverage were grounded in precise science.

Climate policy and the discount rate

It was the discount rate used in the Stern Review that really upset a lot of economists. They thought it was too low and they were not impressed by a chapter where Stern discussed the ethics of discounting.

It will be remembered that when calculations occur for situations evolving over time, economists
like to discount future money values in order to make them comparable with current money values. Discounting assumes that people have time preferences for money now, rather than money in the future, and that is what the payment of interest is all about. It is a payment for relinquishing money to a borrower and only getting it back later. The practice of discounting is very controversial when it comes to making comparisons across dfferent generations, which is what climate change and sustainability is all about. I argued earlier that the mind set of many indigenous peoples would reject this practice.

There is a lengthy ethical discussion in the Stern Review on the topic of discounting which concludes:

… while we do allow, for example, for the possibility that, say, a meteorite might obliterate the world, and for the possibility that future generations might be richer (or poorer), we treat the welfare of future generations on a par with our own. It is of course possible that people actually do place less value on the welfare of future generations, simply on the grounds that they are more distant in time. But it is hard to see any ethical justification for this. (Stern, 2006, p. 35)

The significance of future generations being richer or poorer is explained below, but the strange reference to a meteorite perhaps needs to be explained too. The idea contained here is: why be concerned about future generations if there is a chance that they might not be there anyway? This would be the case if a meteorite hits the earth and wipes everyone out. It’s only a small chance perhaps, but that small possibility needs to be counted in as part of the calculation.

Stern, therefore, decided to use a discount rate of 1.4%. This was lower than rates used in other climate studies so William Nordhaus and Richard Tol became very upset. Nordhaus argued that the present generation will have to forgo a large amount of consumption now for the benefit of future generations, who will be much richer than the present generation.

If future generations are richer, then they will be able to afford to carry the costs of climate change impacts. This gets to the heart of the issue. At the risk of over-simplifying, behind all the sophisticated mathematical projections about the future the differences of view can be described as either “degrees of complacency” or “degrees of alarmism” depending on which side you stand.

To the “growth optimists”, whatever happens to the climate, the economy will continue growing and future generations will be in good shape to cope in terms of technology, resources and human made capital (if not natural capital). In this view, it seems justified to calculate with a high discount rate. This will tend to discourage spending now to achieve future mitigation benefits which, when they are heavily discounted, don’t appear to be worth a lot. The rationale is that, after all is said and done, the future generations are going to be fabulously wealthy and should easily be able to cope.

On the other hand, to those like the current author, whose world view is framed within a “limits to growth” perspective, climate change is one of a number of problems that threaten to lead to, or already are leading to, a dangerous ecological overshoot. In this perspective, future generations may not be better off at all. They are likely to be much worse off and in a much inferior position to cope with the climate problems bequeathed to them. This is the case for dealing with the problem now to head it off.

Huge problems facing humanity are given to the economists to judge. Perhaps after all, Gregory Mankiw is right. The economists are like wizards with magical divinatory powers. They look at huge existential threats facing humanity and, instead helping to organise collective deliberative processes to draw in all of society to discuss how to cope with a vast common threat, the economists withdraw to do complicated mathematical calculations. They re-emerge having performed the calculations in accordance with the magical rites.

If you look closer though, what they have mostly done is pulled ball park guesstimates out of a hat, applied a discount rate that is completely subjective and entirely inappropriate to protecting future generations, and published reports with deceptively precise figures. The reports may contain caveats about the figures in the small print but only a tiny number of people notice.

Having performed the magical rites on our behalf, which most people are nowhere near qualified to understand let alone do, the media reassures the masses that our betters are still in control and know what they are doing. The consensus trance remains intact. It is yet closer to midnight and nothing has actually been done to reduce emissions.

Seven years after the Stern review

Seven years after the Stern Review little has changed. Nicholas Stern, now a Lord, is playing a leading role in a “Global Commission on Environment and Climate”(GCEC) which involves ex-heads of state, bankers, leaders of international organisations like the World Bank and a team of mainstream economists to back them up. Late in 2014 they produced a lobbying document titled Better Growth. The New Climate Economy ahead of the UNFCCC Conference of the Parties to be held in Paris in December 2015. (GCEC. 2014.) The hope is that, inspired by this 15 year strategy, civil society organisations will fall in line and back the technocratic solution.

The chief priority of this group is already clear from their document title. As it says on page 9, “In the long term, if climate change is not tackled, growth itself will be at risk” (page 9)

With small differences the thinking is the same as that of the Stern Review. In a critique of the “Better Growth” document Clive Spash draws attention to the familiar features of mainstream economics. What follows draws heavily on the critique of Stern by Spash. (Spash, Clive L 2014)

The approach frames the issues in a “risk management” perspective. It is as if the costs are to pay for an “insurance deal” – all of which is based on the confident assertion that risks are predictable. This is contrary to a ‘strong uncertainty’ view of climate change and its effects. As Spash explains, strong uncertainty “calls for precaution and avoided pathways that lead to disastrous scenarios, not deliberately walking down them on the basis of a gamblers role of the risk management dice.”

The approach is based on the consequentialist utilitarian perspective. This conceptually reduces harm to innocent victims as lost output that can be measured with income statistics – a form of ‘commensurability’ that allows calculation and comparison of losses and gains, costs and benefits. As Spash comments: “Economics has become a profession where more dead people can be compensated by better growth, that is a net benefit can be calculated if the value of the growth in output makes consumption goods worth more than the people killed in their production”.

There is the usual fixation on growth – with the assumption that its benefits will trickle down, the arrogant belief that the kind of development delivered by the corporations is what the poor need and the complete failure to question what vision for society is needed – as Spash puts it “inequitable material affluence in a competitive individualistic society or human flourishing which enables a good life in communities of sharing and caring for others”.

Given its authorship it is not surprising that the climate crisis is assumed to be best understood as market failure in which ‘external’ climate costs and benefits have not internalised by market actors. A predictable carbon price is needed and carbon trading arrangements are needed to deliver this price. Who is to blame for the market failure? Ironically, it is the states that are at fault because weak politicians have not shown enough political will to intervene in the market. What is neglected here, of course, is the ubiquitous character of externalities and the sheer scale of the task of changing them all – as if we had all the information needed to know what the adjusted prices should be. The report also ignores the power of the corporations to block these market corrections when it does not suit their interests – a power that has rendered carbon markets completely ineffectual anyway.

Meanwhile there is effectively nothing in this report about the Jevons paradox or rebound; about the scarcity and depletion of particular raw materials like rare earths that would be needed to extend out the technological options envisaged; about energy return on energy invested; about global real-politik and strategic military contests for resources; about the problems associated with fracking and so on.

So what is it that really agitates the groups that are behind this document? Since 2007 it has become increasingly clear that if climate change is to be tackled then most fossil fuels will have to remain in the ground – and there has been a recognition too that this would mean a lot of very big, very influential companies losing a lot of money. The fossil fuel reserves are their assets and their value would have to be written down. Many companies would go bust. As explained earlier in this book because there is a strong interpenetration between the state and the energy companies many states would lose out too – for example on important sources of taxation. This is why the question of how to deal with the “carbon bubble”, as it is called, has become a concern for those in the elite who do recognise that something must be done. As the finance report of the GCEC says:

“The financial impact of stranded assets is not about lost production, but lost value. For example, under our evaluation scenario, even oil producers whose output is unaffected by the [GCEC recommended] transition could see the value of their oil production fall by up to 60% due to falling wholesale oil prices that result when demand declines.” (GCEC 2014b)

What then is the solution? Surprise, surprise! It is technological innovation by the big corporate players achieved by “getting the market prices right” as well as channelling resources raised through taxation to subsidise and encourage techno-innovation and R&D. Carbon capture and storage has been the big idea so far but it looks as if it will be too expensive and has been effectively shelved by Britain and Norway. However, as Spash explains the view of the “Better Growth” authors:

“Promoting massive R&D holds the hope that a miracle technology will appear and all those toxic fuel assets will suddenly be valuable again”.

This is what a group of powerful people look like when they lose touch with reality. As we have already seen the techno-innovations that are supposed to mitigate climate change are largely granfalloons. The elite fantasy of growth combined with R&D and techno-innovation to resolve the climate crisis can do a lot of damage by diverting us from the reality of the catastrophe that humanity faces.

Brian Davey

I now live in Nottingham in semi-retirement. This means doing much the same as when I was 64 but with a state pension and tiny private pension as well. In 1970 I got a 1st in Economics at Nottingham University – and then in 1974 an M.Phil. for a thesis on a Marxist approach to the economic development of India. This led to a varied career working with mainly community projects both in the UK and abroad. In 2003 John Jopling of Feasta followed a suggestion of Richard Douthwaite's and invited me to a yearly group discussion by the sea – at Rossbeigh in Kerry. I have been going virtually every year since then and have spent much of my spare time involved in the ecological and economics discussions of Feasta, particularly in its climate work. After Richard's passing I stepped into part of a teaching role that he had had at Dublin City University teaching on a degree in Religion and Ecology. This teaching led, in turn, to this book.

Tags: climate change, environmental costs, neoclassical economics