Economists looking at climate change face a difficult task, with uncertain climate models, chaotic climate systems and possible catastrophic threshold effects. Often, when looking at the impacts of climate change different mitigation/adaptation options and emission scenarios will be looked at, and the economist will recommend a certain range of policy measures or course of action (and sometimes inaction) as the most economically sound.
When you see this, there are two important economic principles that, when understood, can help change how much faith you put in the economist’s recommendation.
The first, and most important in my view, is the discount rate.
The discount rate is an important and sensible part of any sober economic analysis. Basically, it can be explained thus: would you rather have €10 now, or €20 euro in 10 years?
Most people will choose €10 euro now – a rational and sensible choice. To reflect this decision making in their models, economists discount future values – this can be a range of values – the higher the discount rate, the more the immediate (€10 now) is valued over the long term (€20 in 10 years).
This makes good sense and reflects how we make decisions.
When looking at the long term, discounting has one important effect: it discounts the future! This seems to be stating the obvious, but over the long term impacts of this can be severe. While any individual would prefer €10 now to €1000 in 100 years,(due mainly to the fact that they think they will be dead) and economics reflects this rational individual choice, if you are looking at it from a societal point of view perhaps discounting the future is not such a good choice. Why should the future be valued as less important than today?
At this point, some form of value judgement needs to be made. If you believe that those who will live in the future should be valued as much as those currently alive, pay very close attention to the discount rate in economics.
The second important thing to pay attention to in climate economics is the very nature of economic models. Normally, these are denominated in dollars or euros. Again, economists build models of the future (discounted, obviously) and look at different options based on emissions scenarios, mitigation and adaptation options. Often they will then model global GDP in the future and recommend policy actions on this basis.
This is a sensible way of doing things, however looking at global GDP can have one very important effect. While economists working on climate change and it’s impacts are careful not to value people’s lives according to the GDP they produce, any economic model looking at the impacts of climate change can have a tendency to favour those who are already rich and produce a significant proportion of global GDP.
Again a value judgement is necessary here. If you believe all people are equal, looking at Global GDP can mean that those in rich wealthy states – generally global north, so less affected by climate change, initially at least, and with most money to adapt – who produce most GDP in dollars will be ‘valued’ much more than a poor African farmer on a subsistence wage free pokies online, whose contribution to global GDP is negligible.
Given the current huge levels of inequality in the global system, any model that primarily looks at GDP means that economic model will favour those are already wealthy, and are likely to remain so. Making policy decisions on this basis will tend to perpetuate this inequality, and valuing people solely by the dollars they contribute to global GDP in a discounted future is not a value system I would want to base my decision making on – at least not without first understanding the underlying principles being used in these models.
To counteract the effect of widely differing GDP between countries on economic modelling, often economists will use what is called ‘equity weighting’. With this method, emphasis is put on the increase and decreases in GDP in specific countries or regions, with this then fed back into models on a weighted basis, as opposed to the world as a whole just being examined for absolute changes in GDP.
For example:- many of the initial effects of climate change on the wealthy developed countries (mainly those in the global North) will be positive e.g. less deaths due to cold in winter. As the developed countries takes such a huge chunk of global GDP, any positive effects on the north will have a significant positive effect on global GDP, at least for the initial impacts of climate change.
Conversely, as the global south controls a small portion of GDP, any negative effects there – even if very large for those countries individual GDP – would not have a large effect on overall global GDP. However, the effects on the people in these countries could be catastrophic, especially for those already on the margins of society.
The effects of climate change are already being felt by those in the south, and they will continue to be the ones who bear the worst impacts of climate change first, even though they can afford it least, and are least responsible for the CO2 causing the problem.
Equity weighting can partially correct for this inherent bias towards countries which are already rich.
Any good economist knows this, and will flag it in their work on the economic impacts of climate change. Often however, it will not be given the prominence that some feel it might deserve – for example, in this paper “Checking The Price Tag On Catastrophe: The Social Cost Of Carbon Under Non-Linear Climate Response” – the following is the final note, on the final page:
“Although not discussed in reference to the scenarios presented here, with equity weighting the projected damages of climate change increase significantly, including in explorations of severe climate change damages (Tol, 2003). Choices about discount schemes are critical to the final 21 marginal damage projections, and these are partly ethical decisions about how to treat future generations that can only be made by policy-makers”
I am not sure if the final note on the final page is the best place for this information, but at least this is highlighted in the paper. Let’s hope policymakers are paying close attention to the papers they are presented with, including the very last note on the very final page.