Prize lecture: William D. Nordhaus, Prize in Economic Sciences 2018

TL;DR

Climate change requires policy because markets assign a zero price to carbon dioxide emissions even though they impose social costs across the planet and over long periods. Integrated assessment models connect economic growth, emissions, climate processes, damages, and policy responses, helping economists evaluate tools such as carbon taxes, cap-and-trade systems, and regulations.

Transcript

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Key Insights

• Climate change is a market failure because carbon dioxide from fossil-fuel energy use is an unintended byproduct that markets price at zero, while its true social cost is higher. This mismatch allows private economic decisions to impose costs that market prices do not capture.
• An externality is an unintended byproduct or spillover of economic growth that occurs outside markets and is not included in market prices. Global warming is an especially extensive environmental externality because it arises from many ordinary activities and affects the entire planet for decades or centuries.
• Individual ethical action is insufficient to slow climate change because no person acting alone can materially solve a problem produced by activities across the planet. The scale and persistence of the externality create a need for coordinated policies among nations and across economic sectors.
• Integrated assessment modeling is a framework that combines knowledge from multiple disciplines, including atmospheric chemistry, geophysics, glaciology, ecology, economics, political science, game theory, and international law. These models are based on scientific theories and are generally implemented as computerized systems of varying complexity.
• The DICE model links economic growth to emissions, emissions to rising carbon dioxide concentrations and climate change, and climate change to ecological and economic impacts. Policy responses then feed back into emissions and may also affect the path of economic growth.
• Climate impacts include lower corn yields, coastal flooding, sea-level rise, changing precipitation, and ocean acidification. The framework treats climate change as more than rising temperature by recognizing several physical processes and their ecological and economic consequences.
• Climate policy can reduce emissions through mechanisms such as cap-and-trade systems, carbon taxes, and regulations. These interventions complete the model's feedback loop by changing emissions, which then changes the degree of climate change and can influence economic growth.
• Mathematics is a central language for analyzing climate economics because it allows complex relationships to be expressed as a constrained maximization problem. The computerized model discretizes that formulation, while its underlying structure resembles a familiar economic growth model.

Questions & Answers

Q: Why does climate change represent a market failure?

Climate change represents a market failure because fossil-fuel energy use produces carbon dioxide as an unintended byproduct, yet markets place a zero price on that emission. The resulting market price does not include the true social cost imposed through climate change. Economic decisions therefore fail to account fully for their effects on people, ecosystems, and the broader environment.

Q: What is an externality in climate economics?

An externality is an unintended byproduct or spillover of economic activity that occurs outside the market and is not captured in market prices. Carbon dioxide emissions are an environmental externality because they accompany activities such as driving, heating, cooking, and air travel, while their wider climate costs are not automatically included in what consumers or producers pay.

Q: What is an integrated assessment model for climate change?

An integrated assessment model combines knowledge from several connected disciplines within a single analytical framework. For climate change, these disciplines include atmospheric chemistry, geophysics, glaciology, ecology, economics, political science, game theory, and international law. Such models are based on scientific theories and are generally computerized, with their complexity varying according to their intended analytical purpose.

Q: How does the DICE model connect the economy and climate?

The DICE model begins with economic growth, which generates emissions through activities including transportation, heating, cooking, and air travel. Emissions raise carbon dioxide concentrations and contribute to climate changes involving temperature, precipitation, sea level, and other processes. Those changes create ecological and economic impacts, while policies feed back by reducing emissions and potentially affecting economic growth.

Q: What climate impacts are included in Nordhaus's framework?

The framework connects climate change with both ecological and economic impacts. Examples named in the lecture include lower corn yields, coastal flooding, sea-level rise, changing precipitation, and ocean acidification. Ocean acidification is described as another carbon dioxide problem that harms crustaceans. These examples show why the model treats climate change as a collection of connected physical and economic processes.

Q: Which policies can governments use to reduce emissions?

The lecture identifies cap-and-trade systems, carbon taxes, and regulations as mechanisms for reducing emissions. Each policy intervenes in the economic process that otherwise leaves carbon dioxide unpriced. Within the integrated framework, these measures affect emissions, which then influence atmospheric concentrations, climate change, ecological damages, economic damages, and potentially the subsequent course of economic growth.

Q: Why can individuals not solve climate change alone?

Individuals cannot solve climate change alone because the problem involves many everyday activities, affects the entire planet, and persists for decades or even centuries. A single ethical person's actions cannot materially slow the overall change. Its global scale and shared causes make coordinated policy necessary, especially because ordinary market transactions do not include the social cost of carbon dioxide emissions.

Q: Why is mathematics important for climate economics?

Mathematics provides a language for representing the complex links among economic growth, emissions, climate processes, damages, and policy. Nordhaus describes the model mathematically as a constrained maximization problem that can be discretized for computerized analysis. This formal structure lets researchers organize relationships from several disciplines and examine how policy choices feed back into both emissions and economic activity.

Summary

In this video, Professor William Nordhaus discusses the challenges nations face in devising policies to slow climate change. He explains the importance of understanding the interaction between the economy and the natural world, and emphasizes the need to raise the price of carbon dioxide emissions in order to effectively address climate change.

Questions & Answers

Q: What is the main focus of William Nordhaus' work on climate change?

William Nordhaus focuses on the interaction between the economy and the natural world, specifically the impact of human activity on resources, particularly through climate change. He has developed the field of integrated assessment of this interaction.

Q: How does the failure of markets in the energy sector contribute to climate change?

One of the main reasons markets fail in the energy sector is that they do not price or underprice the unintended byproduct of using energy, namely carbon dioxide emissions. This leads to the unregulated and excessive use of fossil fuels, causing climate change.

Q: How have integrated assessment models helped in dealing with climate change?

Integrated assessment models integrate knowledge from various disciplines and provide a framework to analyze and understand the complex interactions and impacts of climate change. These models have evolved over time and are based on fundamental scientific theories.

Q: What is the significance of mathematics in understanding and analyzing climate change?

Mathematics plays a critical role in modeling climate change and understanding its dynamics. It provides a language to study complex phenomena and is essential in designing computerized models that can simulate the impact of various policies and variables on climate change.

Q: What are the three main strategies to slow climate change?

The three main strategies to slow climate change are abatement or emission reduction, removing carbon dioxide from the atmosphere, and managing solar radiation. Among these, abatement is currently the most realistic and safe option. However, it can be expensive, especially if ambitious emission reduction targets are set.

Q: What are the challenges in predicting and estimating damages caused by climate change?

Estimating damages caused by climate change is a difficult task because it involves projecting long-term impacts that are not fully understood. It requires integrating economic, ecological, and scientific knowledge, which is challenging given the lack of historical experience in dealing with such complex processes.

Q: How do the damages caused by climate change compare with the costs of reducing emissions?

The damages caused by climate change can be substantial and include ecological and economic impacts. On the other hand, the costs of reducing emissions through abatement policies can also be significant. Economists analyze the trade-offs between these costs and benefits to determine the best balance in terms of developing effective climate change policies.

Q: Why is it necessary to raise the price of carbon dioxide emissions?

Economics highlights that to effectively address climate change, it is necessary to increase the price of carbon dioxide emissions. By putting a price on carbon, either through carbon taxes or market-based mechanisms like cap-and-trade, the externalities of unpriced emissions are corrected, providing an incentive to reduce emissions and move towards a low-carbon economy.

Q: What has been the effectiveness of international climate change treaties?

International climate change treaties, such as the Kyoto Protocol and the Paris Agreement, have been largely ineffective in reducing carbon emissions. This is primarily due to the problem of free-riding, where countries benefit from other countries' efforts without contributing equally. As a result, the global carbon price remains significantly lower than what is necessary to address climate change.

Q: What is the concept of a climate club?

A climate club is a model proposed by William Nordhaus to overcome the issue of free-riding in international agreements on climate change. The idea is to create a club-like agreement where participating nations take steps to reduce emissions, while non-participating nations face penalties, such as tariffs on their imports. The aim is to create a balanced system where the costs and benefits of emissions reduction are shared more equitably.

Takeaways

In conclusion, Professor William Nordhaus highlights the gravity of climate change and the need for urgent action. He stresses the importance of understanding the economic challenges posed by climate change and proposes raising the price of carbon dioxide emissions as a crucial step. Nordhaus also suggests the establishment of a climate club, where nations actively participate in emissions reduction efforts and penalize non-participants. Ultimately, addressing climate change requires harnessing human ingenuity and embracing low-carbon technologies.

Summary & Key Takeaways

• Economic activity affects nature, particularly through climate change, because fossil-fuel energy produces carbon dioxide as an unintended and unpriced byproduct. Markets therefore fail to reflect its true social cost. Economics offers an analytical toolbox for addressing such externalities through policies that change incentives and reduce emissions.

• Climate change connects atmospheric chemistry, geophysics, glaciology, ecology, economics, political science, game theory, and international law. Integrated assessment models bring knowledge from these disciplines into one computerized framework. They represent the links among economic growth, emissions, atmospheric concentrations, climate changes, resulting impacts, and policies intended to limit emissions.

• Nordhaus began developing models of energy and climate in 1974, testing several approaches before arriving at the DICE model in 1992. Its basic analytical structure remained in the version discussed in the lecture, although parameters and sector details evolved. Mathematics provides the language for expressing and computing this constrained optimization problem.