At the annual World Economic Forum (WEF) in Davos, Switzerland, world political and business leaders are meeting to discuss pressing economic issues of the day. This year, one of the key themes is climate change and “how to save the planet”.
The approaches of leaders to the climate crisis, however, differ enormously. At the one extreme there are those who deny that emissions have caused climate change, or who reluctantly acknowledge climate change but think that governments need to do nothing and that technological advances in green energy and transport will be sufficient to curb global warming. This has been the approach of President Trump, President Bolsonaro of Brazil and Prime Minister Scott Morrison of Australia. They may claim to support the general goals of reducing greenhouse gases, but are keen to protect their coal and oil industries and, in the case of Brazil, to continue cutting down the Amazon rain forest to support mining, ranching and the growing of crops.
At his speech at the WEF, President Trump said that he supported the initiative to plant one trillion trees worldwide to act as a carbon sink. However, he gave no details of just what the nature of the support would be. Would there be subsidies or tax breaks, for example, for landowners to plant trees? In the meantime, his administration has relaxed regulations to curb air and water pollution. And he has withdrawn the USA from the Paris climate agreement.
Other leaders, urged on by activists, such as Greta Thunberg, have talked about tougher action to tackle emissions. Countries such as Canada, Norway and the EU countries have adopted a number of initiatives. Policies range from taxing emissions, capping/regulating emissions with penalities for those breaching the limits, tradable permits, subsidising green alternatives, setting local emissions targets with incentives for meeting them, investing in green infrastructure such as roadside charging points for electric vehicles, making environmental education part of a national curriculum, investing in public transport, and so on. But, say, activists, only large-scale measures that truly recognise the scale of the climate emergency will be sufficient.
The year starts with climate being addressed at Davos; it ends with the annual Conference of the Parties (COP26) to the United Nations Framework Convention on Climate Change (UNFCCC). This year it will be in Glasgow. There is much hope pinned on this conference, given the growing realisation of the effects of climate change, from bush fires in Australia, to floods in Indonesia and other parts of southeast Asia, to more extreme hurricanes/typhoons, to rapidly melting glaciers and retreating sea ice, to rising sea levels, to crop failures and the displacement of humans and the destruction of wildlife and habitat.
COP25 in Madrid made little progress; it is hoped that COP26 will be much more successful. Sir David Attenborough has warned that the world faces a ‘climate crisis moment’. He hopes that the world will be ready to take much stronger action at COP26.
But there remains the fundamental economic problem of the tragedy of the commons. As long as the atmosphere and other parts of the environment are free to ‘use’ to pollute, and as long as the costs of doing so are borne largely by people other than the direct polluters, the market will fail to provide a solution. Australia’s bush fires can be directly attributed to climate change and climate change is exacerbated by coal-fired power stations. But Australia’s use of coal as a power source is only a tiny contributor to global climate change. Presumably, the Australian government would rather get a ‘free ride’ off other countries’ policies to cut emissions rather than bearing the economic cost of reducing coal-fired generation itself for little gain in terms of reduced global emissions.
However, people are not entirely selfish. Many are willing to make personal sacrifices to lead a more environmentally sustainable life. Many people, for example, are choosing electricity tariffs that are slightly higher but where the electricity is generated with zero carbon emissions. Firms have shown a readiness to respond to demands from their consumers for more sustainable products.
There is increasing recognition that the world is facing a climate emergency. Concerns are growing about the damaging effects of global warming on weather patterns, with increasing droughts, forest fires, floods and hurricanes. Ice sheets are melting and glaciers retreating, with consequent rising sea levels. Habitats and livelihoods are being destroyed. And many of the effects seem to be occurring more rapidly than had previously been expected.
Extinction Rebellion has staged protests in many countries; the period from 20 to 27 September saw a worldwide climate strike (see also), with millions of people marching and children leaving school to protest; a Climate Action Summit took place at the United Nations, with a rousing speech by Greta Thunberg, the 16 year-old Swedish activist; the UN’s Intergovernmental Panel on Climate Change (IPCC) has just released a report with evidence showing that the melting of ice sheets and rising sea levels is more rapid than previously thought; at its annual party conference in Brighton, the Labour Party pledged that, in government, it would bring forward the UK’s target for zero net carbon emissions from 2050 to 2030.
Increasingly attention is focusing on what can be done. At first sight, it might seem as if the answer lies solely with climate scientists, environmentalists, technologists, politicians and industry. When the matter is discussed in the media, it is often the environment correspondent, the science correspondent, the political correspondent or the business correspondent who reports on developments in policy. But economics has an absolutely central role to play in both the analysis of the problem and in examining the effectiveness of alternative solutions.
One of the most influential studies of the impact of climate change and means of addressing it was the study back in 2006, The Economics of Climate Change: The Stern Review, led by the economist Sir Nicholas Stern. The Review reflected economists’ arguments that climate change represents a massive failure of markets and of governments too. Firms and individuals can emit greenhouse gases into the atmosphere at no charge to themselves, even though it imposes costs on others. These external costs are possible because the atmosphere is a public good, which is free to exploit.
Part of the solution is to ‘internalise’ these externalities by imposing charges on people and firms for their emissions, such as imposing higher taxes on cars with high exhaust emissions or on coal-fired power stations. This can be done through the tax system, with ‘green’ taxes and charges. Economists study the effectiveness of these and how much they are likely to change people’s behaviour.
Another part of the solution is to subsidise green alternatives, such as solar and wind power, that provide positive environmental externalities. But again, just how responsive will demand be? This again is something that economists study.
Of course, changing human behaviour is not just about raising the prices of activities that create negative environmental externalities and lowering the prices of those that create positive ones. Part of the solution lies in education to make people aware of the environmental impacts of their activities and what can be done about it. The problem here is that there is a lack of information – a classic market failure. Making people aware of the consequences of their actions can play a key part in the economic decisions they make. Economists study the extent that imperfect information distorts decision making and how informed decision making can improve outcomes.
Another part of the solution may be direct government investment in green technologies or the use of legislation to prevent or restrict activities that contribute to global warming. But in each case, economists are well placed to examine the efficacy and the costs and benefits of alternative policies. Economists have the tools to make cost–benefit appraisals.
Economists also study the motivations of people and how they affect their decisions, including decisions about whether or not to take part in activities with high emissions, such air travel, and decisions on ‘green’ activities, such as eating less meat and more vegetables.
If you are starting out on an economics degree, you will soon see that economists are at the centre of the analysis of some of the biggest issues of the day, such as climate change and the environment generally, inequality and poverty, working conditions, the work–life balance, the price of accommodation, the effects of populism and the retreat from global responsibility and, in the UK especially, the effects of Brexit, of whatever form.
In 2015, at the COP21 climate change conference in Paris, an agreement was reached between the 195 countries present. The Paris agreement committed countries to limiting global warming to ‘well below’ 2°C and preferably to no more than 1.5°C. above pre-industrial levels. To do this, a ‘cap-and-trade’ system would be adopted, with countries agreeing to limits to their emissions and then being able to buy emissions credits to exceed these limits from countries which had managed to emit below their limits. However, to implement the agreement, countries would need to adopt a ‘rulebook’ about how the permitted limits would be applied, how governments would measure and report emissions cuts, how the figures would be verified and just how a cap-and-trade system would work.
At the COP24 meeting from 2 to 15 December 2018 in Katowice, Poland, nearly 14 000 delegates from 196 countries discussed the details of a rulebook. Despite some 2800 points of contention and some difficult and heated negotiations, agreement was finally reached. Rules for targeting, measuring and verifying emissions have been accepted. If countries exceed their limits, they must explain why and also how they will meet them in future. Rich countries agreed to provide help to poor countries in curbing their emissions and adapting to rising sea levels, droughts, floods and other climate-induced problems.
But no details have been agreed on the system of carbon trading, thanks to objections from the Brazilian delegates, who felt that insufficient account would be made of their country’s existing promises on not chopping down parts of the Amazon rainforest.
Most seriously, the measures already agreed which would be covered by the rulebook will be insufficient to meet the 2°C, let alone the 1.5°C, target. The majority of the measures are voluntary ‘nationally determined contributions’, which countries are required to submit under the Paris agreement. These, so far, would probably be sufficient to limit global warming to only around 3°C, at which level there would be massive environmental, economic and social consequences.
There was, however, a belief among delegates that further strong international action was required. Indeed, under the Paris agreement, emissions limits to keep global warming to the ‘well below 2°C’ level must be agreed by 2020.
Climate change is a case of severe market failure. A large proportion of the external costs of pollution are borne outside the countries where the emitters are based. This creates a disincentive for countries acting alone to internalise all these externalities through the tax system or charges, or to regulate them toughly. Only by countries taking an international perspective and by acting collectively can the externalities be seen as a fully internal problem.
Even though most governments recognise the nature and scale of the problem, one of the biggest problems they face is in persuading people that it is in their interests to cut carbon emissions – something that may become increasingly difficult with the rise in populism and the realisation that higher fuel and other prices will make people poorer in the short term.
Last week was a rough week for Britain. The “Beast from the East” and storm Emma swept through the country, bringing with them unusually heavy snowfall, which resulted in severe disruption across nearly all parts of the country. Some recent estimates put the cost of these extreme weather conditions at up to £1 billion per day. The construction industry suffering the biggest hit as work came to a halt for the best part of the week. Losses for the industry were estimated to be up to £2 billion.
Closed restaurants, empty shops and severely disrupted transport networks were all part of the effect that this extreme weather had on the overall economy. According to Howard Archer, chief economic adviser of the EY ITEM Club (a UK forecasting group):
It is possible that the severe weather [of the last few days] could lead to GDP growth being reduced by 0.1 percentage point in Q1 2018 and possibly 0.2 percentage points if the severe weather persist.
As the occurrence of freak weather increases across the globe due to climate change, so does the economic cost of these events. The figure above shows the estimated costs of extreme weather events in the USA between 1980 and 2012 and it is reproduced from Jahn (see link below), who also fits a quadratic trend to show that these costs have been increasing over time. He goes on to characterise the impact of different types of extreme weather (including cold waves, heat waves, storms and others) on different sectors of the local economy – ranging from tourism and agriculture, to housing and the insurance sector.
Linnenluecke et al (linked below) argue that extreme weather caused by climate change could influence the decision of firms on where to locate and could lead to a reshuffle of economic activity across the world and have important policy implications. As the authors explain:
Climate change-related relocation has been given consideration in policy-oriented discussions, but not in management decisions. The effects of climate change and extreme weather events have been considered as peripheral or as a risk factor, but not as a determining factor in firm relocation processes…. This paper therefore [provides] insights for understanding how firms can enhance strategic decision-making in light of understanding and assessing their vulnerability as well as likely impacts that climate change may have on relocation decisions.
The likelihood and associated costs of extreme weather events could therefore become an increasingly important matter for discussion amongst economists and policy makers. Such weather events are likely to have profound economic implications for the world.
With first Houston, then several Caribbean islands and Florida suffering dreadful flooding and destruction from Hurricanes Harvey and Irma, many are questioning whether more should be spent on flood prevention and reducing greenhouse gas emissions. Economists would normally argue that such questions are answered by conducting a cost–benefit analysis.
However, even if the size of the costs and benefits of such policies could be measured, this would not be enough to give the answer. Whether such spending is justified would depend on the social rate of discount. But what the rate should be in cost-benefit analyses is a highly contested issue, especially when the benefits occur a long time in the future.
I you ask the question today, ‘should more have been spent on flood prevention in Houston and Miami?’, the answer would almost certainly be yes, even if the decision had to have been taken many years ago, given the time it takes to plan and construct such defences. But if you asked people, say, 15 years ago whether such expenditure should be undertaken, many would have said no, given that the protection would be provided quite a long time in the future. Also many people back then would doubt that the defences would be necessary and many would not be planning to live there indefinitely.
This is the familiar problem of people valuing costs and benefits in the future less than costs and benefits occurring today. To account for this, costs and benefits in the future are discounted by an annual rate to reduce them to a present value.
But with costs and benefits occurring a long time in the future, especially from measures to reduce carbon emissions, the present value is very sensitive to the rate of discount chosen. But choosing the rate of discount is fraught with difficulties.
Some argue that a social rate of discount should be similar to long-term market rates. But market rates reflect only the current generation’s private preferences. They do not reflect the costs and benefits to future generations. A social rate of discount that did take their interests into account would be much lower and could even be argued to be zero – or negative with a growing population.
Against this, however, has to be set the possibility that future generations will be richer than the current one and will therefore value a dollar (or any other currency) less than today’s generation.
However, it is also likely, if the trend of recent decades is to continue, that economic growth will be largely confined to the rich and that the poor will be little better off, if at all. And it is the poor who often suffer the most from natural disasters. Just look, for example, at the much higher personal devastation suffered from hurricane Irma by the poor on many Caribbean islands compared with those in comparatively wealthy Florida.
A low or zero discount rate would make many environmental projects socially profitable, even though they would not be with a higher rate. The choice of rate is thus crucial to the welfare of future generations who are likely to bear the brunt of climate change.
But just how should the social rate of discount be chosen? The following two articles explore the issue.