Economics of global warming

Economists are not trained in climate science, so there is no reason to ask one of us about how much carbon dioxide will warm the planet, but economics is an important part of climate policy–this is our collective response to the threat of global warming.  There are at least three important areas where economists have contributed to the debate about what to do about the threat of global warming that most climate scientists are predicting.

  1. Examining the economic damage of higher temperatures.
  2. Modelling how to trade off present costs versus future benefits such as a costly investment in carbon abatement now versus its future benefits in terms of the healthier, more productive world people will enjoy later.
  3. Showing why free markets don’t solve the problem. 
  4. Explaining the political economy of why special interest groups, like Big Oil, are able to prevent popular actions to fight global warming, particularly in the three biggest oil producing nations: the United States, Russia, and Saudi Arabia.

This post will examine the first three of these areas. The fourth area, political economy, will be examined in a later post.

1. The Economic damage of higher temperatures.

The tropics have noticeably different weather from the temperate zone because in the temperate zone, the sun never climbs up to be straight up in the sky in the summer. The summer is warmer not because the earth is farther from the sun (as many people erroneously believe) but because the sun shines on the land more directly when it is closer to vertical in the sky and that is why the topics are hotter than the temperate zone. Because excessive heat has been bad for productivity, the topics are noticeably poorer than the temperate zone. The richest part of South America, Africa, and Australia are in their southern parts in the temperate zone. Africa has a second rich region which is the temperate Mediterranean coastal nations. The richest part of India is the temperate north and the richest part of East Asia are the temperate zones of China, Japan, and Korea.

Landlocked areas are also cursed because they are blocked from trade, so central Asia is poor due to being cut off from trade by sea and central Africa and the landlocked middle of South America are doubly cursed by tropical heat and being cut off from trade. Sachs, Mellinger, and Gallop wrote a popular essay for Scientific American about this research that is one of my all-time favorite essays in economics.

There are some exceptions in the tropics where landlocked regions are more productive than coastal regions such as the mountainous plateaus of Mexico and Central America, the Andes, the mountains of Indonesia, and the mountainous region around the Great Lakes of Africa. The reason again is temperate climate. Every thousand feet of elevation reduces temperatures by 3.3 to 5.4 degrees Fahrenheit depending on the humidity.

Higher temperatures reduce both agricultural productivity and human productivity. They increase disease burden because there is an entire class of deadly tropical diseases and parasites like malaria and dengue fever that are easy to eradicate outside of the tropics. Of course, excessively cold temperatures are bad too, but excessive heat is worse. Here are some studies:

The optimal average temperature for total national income (GDP) is about 55 degrees Fahrenheit.

Another study found that the optimal average temperature for per capita income within the USA is about 58 degrees Fahrenheit:

The optimal average growing-season temperature for corn productivity is about 80 degrees Fahrenheit:

The optimal average temperature for math student productivity is about 70 degrees Fahrenheit. Air conditioners have had a dramatic effect at raising productivity in warm states like Arizona and Florida.

Profanity is minimized at about 72 degrees Fahrenheit.

Colder is almost always better for preventing rape!

Fortunately, the invention of the air conditioner has revolutionized society and made people much better at dealing with hot weather as the following graph shows. Before 1959, temperatures over 89 degrees Fahrenheit in America caused deaths to spike as the red line shows below. Since then, the spread of air conditioners and improved medical care has dramatically reduced the mortality rate during hot summers as demonstrated by the yellow line.

Here I have just looked at research into the effects of different temperatures in the past, and we can see that higher temperatures are costly even across the normal variation that the world has previously experienced.  The conclusions of this body of research is that a hotter planet would be less productive overall and nearly everyone agrees that hotter temperatures reduce global productivity.  For example:

A 2006 report from the United Kingdom predicted that “if we don’t act, the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year, now and forever,” with the largest burden falling on poor countries. A recent and, given its source, somewhat miraculous example is a report from the Trump administration’s Environmental Protection Agency warning of significant losses to hours of work, heat-related deaths, property loss, destruction of roads, rail, bridges, and so on, valued at over $200 billion per year, by the end of this century.

Even a small amount of global warming will make more of the tropics uninhabitable and it will make most of the Unites States more like the tropics.  However, the costs won’t be spread out equally in every region.  There is a possibility that a warmer planet might be fine for the economic productivity of arctic regions like Canada, Russia, Scandinavia, and Antartica.  That helps explain why the Russian government has promoted the idea that global warming is a hoax.  

But there are lots of other enormous costs that will even affect the near polar regions: worse storms, rising sea levels, higher food costs, massive immigration from refugees, and air pollution.  If global warming gets as bad as the more pessimistic half of climate scientists think, much of the globe could become nearly uninhabitable.  I hope Canada, Russia, and Scandinavia are getting ready to welcome a lot of immigrants!

Below is a map from a Stanford University study of moderate global warming showing the countries that might possibly gain (in blue) versus the nations that are expected to lose (in shades of pink).  

econ impact of climate.PNG

That map is simply based on the historical response of economic output to temperature and projections from the more optimistic climate scientists of a modest increase in temperature.  This is an extrapolation of how rising temperatures would affect the world’s income.  If the more pessimistic climate scientists are right, then every country on earth could ALL lose in a big way.  It is a gamble.  On the other hand, if the most optimistic climate scientists are right about future climate changes being modest AND if people develop unforeseen new technologies to build seawalls, deal with more extreme weather events, and maintain agricultural production then perhaps things will work out. Perhaps.  

But if we are going to develop those new technologies for dealing with global warming, then we’d better get busy investing in basic research and development.  

2. How to trade off present costs versus future benefits.

Neil DeGrasse Tyson thinks that global warming is merely a scientific issue. He wrote that the “earth needs… a one-line constitution: All policy should be based on the weight of evidence.”

Global warming policy has to begin with weighing the evidence that it is happening, but after we see that it is happening, we still have to make economic judgments about weighing the costs and benefits of doing something about it. That isn’t merely a scientific issue and requires ethical judgments about what is the best action.  For example, Drawdown.org put together a list of the most cost effective ways to reduce global warming which hinges on scientific evidence.

drawdown

I’d guess that they are optimistic about not including any cost for some of these solutions, but to have a significant impact, we’ll need to spend money now which will produce benefits for decades in the future.  How do we evaluate costs that are going to have to be borne in the present versus benefits will be garnered across the eternal future of the planet.

Economists have spent lots of time thinking about how to trade off costs now versus benefits later because this is the same question for every investment–an investment always costs money in the present and the hope is that it will be worth it because it will generate future profits that will more than pay for the present cost. How much future profits an investor should demand is determined by the net present value formula which hinges upon the selection of a discount rate.

The discount rate is the percent of the future that one just doesn’t count at all. For example, suppose you know that you will be fined $100 in ten years. How much do you value that future cost right now? One way of answering that question is to think about how much you would pay today in order to eliminate the future cost.

If you would pay $95 today to avoid the $100 cost in ten years, then your discount rate is VERY low because you value the future more than most people. If you would only pay one cent today to avoid $100 in ten years, then you don’t count most of the future value relative to today.

If this is the maximum you would be willing to pay now to avoid a $100 cost in ten years…

…Then this is your annualized discount rate. =The percent (per year) that you don’t count future costs and benefits.

1 cent

150%

$7

30%

$16

20%

$40

10%

$50

7%

$75

3%

$85

1.4%

$95

0.5%

$99

0.1%

This esoteric question about discounting rates is the crucial issue that makes the biggest difference in the economic cost benefit analysis of whether or not it is prudent to pay money now to reduce the future costs of global warming. Most economists think the discount rate we should use in these calculations should be between about 1% and about 3% and 75% of expert economists think it should be below 2%. President Obama took little action against global warming partly because he used Bill Nordhaus’ preferred discount rate of 3% which means that he thinks we should care about the future over 33% less than most economists. Nordhaus is a bit of an outlier in having a higher discount rate than most economists, but he is considered an expert in the field and won the 2018 Nobel Prize largely for his work on it.

Trump’s administration eliminated the problem of global warming from official US cost-benefit analysis by simply raising the discount rate to 7% which means that we simply don’t care about most people who will be alive after fifty years in the future. The graph below shows how much difference the choice of discount rates makes.

In 50 years, today’s college students will be about 70. The above graph means that:

  • Stern values your future life as 50% less valuable than lives today. That is what the red line means.
  • Obama values your future life as 72% less valuable than lives today. That is what the purple line means.
  • Trump values your future life as 97% less valuable than lives today. That is what the green line means.

The graph below shows what difference the discount makes for what climate policy we should use. If we use Stern’s discount rate of 1%, then it would be prudent to take dramatic action now to reduce greenhouse gas emissions. If we use Nordhaus’ number, then we should take modest action. If we use Trump’s number, then burn, baby, burn!

3. Why free markets don’t solve the problem.

Friedrich Hayek and Milton Friedman emphasized the importance of prices as information that coordinate the work of billions of people in the global economy without any central planner needed.  Problems arise when the prices don’t reflect real costs and benefits. 

Miss-pricing was an enormous problem under communism, and it is still a challenge under capitalism when prices are sending the wrong signals to people.  Fossil fuels are too cheap for consumers and that is why we consume too much of them.  For example, when China burns coal, that imposes costs on America and the rest of the world and vice versa.  

This is known as the externality cost of pollution because it is the part of the cost of the production and consumption of coal that is imposed on external people to the market transaction between the coal producer who profits from producing the coal and the consumer who benefits from burning it.  

Not only are the prices of fossil fuels much lower than the true cost they are imposing on people, the prices of fossil fuels have actually been going down in real terms as improvements in extraction technologies have made it cheaper to produce.  The average price of gas in America in September 2019 was $2.55 which was lower than it was a decade earlier (adjusted for inflation).  

The second reason why markets fail to solve the problem of global warming is that markets are strongly biased towards the present and don’t care about future generations because markets display a very high discount rate (explained in #2, above).  

Finally, markets allocate political power not to our children who are relatively poor, but to our elders who have more money and connections to acquire influence.  In particular, markets allocate power to the people who have acquired wealth in the past rather than to the people who will be generating wealth in the future.  Because fossil fuels have created some of the richest individuals and corporations in the world, those fossil-fuel interests have a lot more political power to influence government and the media than the innovators who are already inventing the clean power technologies that will power the world in the future long after we run out of fossil fuels.  But that is the topic of the fourth key insight of economic analysis to be explained at the link below: 

4. Explaining the political economy of special interest groups like Big Oil.

Posted in Environment, Globalization & International
One comment on “Economics of global warming
  1. […] more about the economics of climate change or the political economy of the biggest global environmental success in human history, click on the […]

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