Economics of Climate Change

One of the key questions in the economics of climate change is how to measure the social cost of carbon (SCC), which is the monetary value of the damages caused by an additional ton of carbon dioxide (CO2) emitted into the atmosphere. The SCC reflects the present value of the future impacts of climate change on human welfare, such as health, agriculture, ecosystems, and infrastructure. Estimating the SCC requires making assumptions about the physical effects of CO2 emissions, the economic impacts of those effects, the discount rate used to convert future values into present values, and the distribution of costs and benefits across regions and generations. Different models and approaches can yield widely varying estimates of the SCC, ranging from a few dollars to hundreds of dollars per ton of CO2¹.

Another important concept in the economics of climate change is the marginal abatement cost (MAC), which is the cost of reducing one unit of greenhouse gas emissions. The MAC depends on the type and level of mitigation action, such as switching to renewable energy sources, improving energy efficiency, or planting trees. The MAC can also vary across countries and sectors, depending on their emission sources, technologies, and policies. Comparing the MAC with the SCC can help determine whether a given mitigation action is economically efficient, meaning that it generates more benefits than costs. Ideally, the MAC should be equal to the SCC for all emission sources, implying that society is achieving the optimal level of emissions reduction.

However, in reality, there are many market failures and barriers that prevent the efficient allocation of resources for climate change mitigation and adaptation. For example, there are externalities, which occur when some costs or benefits of an activity are not reflected in its market price. CO2 emissions are a negative externality, since they impose damages on others without being paid for by the emitters. To correct this externality, economists often recommend imposing a carbon tax or creating a cap-and-trade system that puts a price on carbon emissions and creates incentives for emission reduction. Another market failure is the public good nature of climate change mitigation, which means that its benefits are non-excludable and non-rivalrous. This creates a free-rider problem, where individuals or countries may prefer to enjoy the benefits of mitigation without contributing to its costs. To overcome this problem, economists suggest that international cooperation and coordination are needed to achieve a fair and effective distribution of mitigation efforts and costs among countries.

Besides market failures, there are also other factors that influence the decision-making process and behavior of individuals and organizations regarding climate change. These include uncertainty, risk aversion, time preferences, bounded rationality, social norms, and moral values. For example, uncertainty about the future impacts and costs of climate change may lead to underestimation or overestimation of the SCC and affect the willingness to pay for mitigation or adaptation actions. Risk aversion may imply that people prefer to avoid or reduce exposure to potential losses from climate change rather than pursue potential gains from adaptation or innovation. Time preferences may indicate that people discount future outcomes more heavily than present ones and thus give less weight to long-term consequences of climate change. Bounded rationality may imply that people have limited information and cognitive capacity to process complex and uncertain information about climate change and make optimal choices. Social norms may influence how people perceive and respond to climate change based on their cultural values, beliefs, and expectations. Moral values may motivate people to act on climate change based on ethical principles, such as justice, responsibility, or stewardship.

The economics of climate change is a dynamic and interdisciplinary field that draws on insights from natural sciences, social sciences, and humanities. It aims to provide rigorous and relevant analysis and advice for policy makers and stakeholders who face complex and urgent challenges related to global warming and its impacts. Some of the current research topics and debates in this field include:

- How to incorporate non-market values, such as biodiversity, ecosystem services,

and human rights, into the estimation of the SCC and other economic indicators

of climate change?

- How to account for tipping points, thresholds, and irreversibilities in the physical

and economic systems that may lead to abrupt and catastrophic changes due

to climate change?

- How to evaluate the co-benefits and trade-offs of mitigation and adaptation

actions for other policy objectives, such as poverty reduction, economic growth,

and social equity?

- How to design effective and efficient policy instruments and institutions for

climate change mitigation and adaptation at different levels of governance,

from local to global?

- How to foster behavioral change and social innovation for low-carbon

and resilient development in different contexts and sectors?

- How to enhance public awareness, engagement,

and participation in climate action and decision-making?

The economics of climate change is not only a scientific endeavor, but also a normative and political one. It involves making value judgments and ethical choices about the goals and criteria for climate policy, the distribution of costs and benefits among different groups and generations, and the trade-offs and synergies between climate change and other societal issues. Therefore, the economics of climate change should be informed by and responsive to the diverse perspectives and preferences of the stakeholders and the public, as well as the best available evidence and knowledge.

(1) The Economics of Climate. https://www.imf.org/external/pubs/ft/fandd/2019/12/pdf/fd1219.pdf.

(2) The Economics of Global Climate Change - Boston University. https://www.bu.edu/eci/files/2019/06/The_Economics_of_Global_Climate_Change.pdf.

(3) Economic analysis of climate change - Wikipedia. https://en.wikipedia.org/wiki/Economic_analysis_of_climate_change.

(4) How Climate Change Impacts the Economy - State of the Planet. https://news.climate.columbia.edu/2019/06/20/climate-change-economy-impacts/.

(5) undefined. http://ase.tufts.edu/gdae.