An Introduction to the Economics of Climate Change

When most people think about climate change, they focus on the physical impacts on various parts of the planet.  Economists understand that there can be benefits as well as costs to climate change.  This article should be an introduction to the economics of climate change.

“Benefits from global warming? I’ve never heard of such a thing.”  At this point my inner wine economist asserts itself.  There are people in British Columbia buying property suited to growing wine grapes.  They are speculating that global warming will make it possible to grow those grapes in the not-too-distant future.  Economists generally find that, like so many things, climate change produces winners and losers.  The real question for us is the net present value of future benefits and costs.  One of our findings is that actions to mitigate carbon emissions will, at best, slow the economic growth rate of less-developed countries.  At worst, those countries are condemned to perpetual poverty.

Holtz-Eakin , Douglas and Selden, Thomas M. “Stoking the fires? CO2 emissions and economic growth.” Journal of Public Economics 57 (1995) 85-101.
Abstract: “We examine the relationship between economic development and carbon dioxide emissions, a greenhouse gas central to global warming predictions. Estimates derived from global panel data suggest a diminishing marginal propensity to emit (MPE) carbon dioxide as GDP per capita rises. Despite this, global carbon dioxide emissions growth will continue at 1.8 percent per annum for the foreseeable future, a result that is not sensitive to average output growth. Instead, emissions growth continues because output and population will grow most rapidly in lower-income nations with high MPEs. This latter feature emphasizes the distributional consequences of policies to reduce emissions.”
Summary: the authors find that economic development reduces carbon emissions per capita.  “Third, the source of continued growth is the fact that economic and population growth will be most rapid in the middle-to lower-income nations that have the highest MPE. For this reason, care must be taken to avoid conflicts between policies to control greenhouse gas emissions and those to improve the global distribution of income.” Translation: to really cut greenhouse gas emissions you will need to heavily regulate the less-developed countries.  That pretty much condemns the world’s poor countries to indefinite poverty.

Leach, Andrew J. ” The welfare implications of climate change policy.” Journal ofEnvironmental Economics and Management 57 (2009) 151–165.
“Abstract: The response to three different climate change policies is measured within a general equilibrium model of world output, technological change, greenhouse gas emissions, and climate-driven changes in productivity. The proposed policies, including an approximation to the Kyoto protocol, are shown to differ greatly in how they mitigate climate change, support economic growth, and allocate rents across generations. Benefits of alternative policies, relative to the status quo, do not necessarily accrue to the generations that bear the costs. The results also show that the chosen rent distribution rule has a profound effect on policy evaluation. In particular, policies which allocate rents on a per-capita basis are shown to be systematically welfare-preferred to situations where emissions rights are grandfathered to emitting firms. This implies that both the optimal level of emissions and the welfare cost of reaching a given target of emissions or atmospheric concentration would be lower under a per-capita allocation of emissions permits or carbon tax revenues.”
Summary: ” The most important results shown are in terms of the welfare implications of revenue recycling and discounting of future benefits. While most policies implemented or considered so far world-wide have grandfathered rights based on previous emissions, I show that the NPV of a policy such as the Kyoto protocol may be more than twice as high if the scarcity rents are captured on a per-capita basis rather than by firms. Perhaps more important still, I show that stringent climate change mitigation policies may be rejected on the basis of having a negative NPV where firms or older agents capture the rents, while the same emissions constraints would have positive NPV were the rents they generate allocated to the population as a whole. Regardless of the chosen policy or the severity of climate change, total abatement costs, in welfare terms, are reduced significantly by a per-capita allocation of rents. On the issue of discounting, my results show that when using the 10% rate of discount common in the IAM literature, none of the climate policies considered have positive NPV even in the worst-case scenario for climate change. Conversely, using a 1.4% rate of discount comparable to that used in the Stern Review, even the most stringent policies considered may have positive NPV under the least severe scenario for climate change.”

Eboli, Fabio, Ramiro Parrado, and Roberto Roson. “Climate-change feedback on economic growth: explorations with a dynamic general equilibrium model.” Environment and Development Economics 15: 515–533.
Abstract: “Human-generated greenhouse gases depend on the level and emissions intensity of economic activities. Therefore, most climate-change studies are based on the models and scenarios of economic growth. Economic growth itself, however, is likely to be affected by climate-change impacts. These impacts affect the economy in multiple and complex ways: changes in productivity, resource endowments, production and consumption patterns. We use a new dynamic, multi-regional computable general equilibrium (CGE) model of the world economy to answer the following questions: Will climate-change impacts significantly affect growth and wealth distribution in the world? Should forecasts of human-induced greenhouse gas emissions be revised, once the climate-change impacts are taken into account?We found that, even though economic growth and emission paths do not change significantly at the global level, relevant differences exist at the regional and sectoral level. In particular, developing countries appear to suffer the most from the climate-change impacts.” [Emphasis added by me.]
Summary: “We found that macroeconomic effects are sizeable but, most importantly, there are significant distributional effects at the regional and industrial level. In particular, we found that climate change works against equity and income convergence in the world. This result is perfectly consistent with Dell et al. (2008), though it uses a completely different methodology, based on numerical general equilibrium modelling [sic] of the global economy, rather than on the establishment of basic facts about the climate–economy interaction.” [Emphasis added.]

This is a big job.  I have nothing but admiration for the economists who have done this analysis.  Below are citations for three articles along with abstracts and summaries.  I have each of the articles as pdf files and will happily e-mail them to anyone who asks.  That’s

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About Tony Lima

Retired after teaching economics at California State Univ., East Bay (Hayward, CA). Ph.D., economics, Stanford. Also taught MBA finance at the California University of Management and Technology. Occasionally take on a consulting project if it's interesting. Other interests include wine and technology.