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Special Edition Magazine, Fall 2019: Sustainability

English

The Necessity of Climate Economics

Economics must recognize the central role of negative externalities in the growth process, and integrate the costs and benefits of environmental stewardship and climate action. By doing so, economists could make an enormous contribution to tackling global warming – the biggest challenge facing the world today.

SINGAPORE – The economics profession has failed to anticipate the rapidly escalating climate crisis, just like it missed the looming global financial crisis back in 2008. True, some influential economists are starting to add to the chorus of concern about the threat global warming poses to sustainable economic growth. But mainstream macroeconomic-growth models have yet to integrate the scientific evidence for climate change. They must do so urgently if governments are to take the crucial step of shifting to low-carbon growth paths.

The traditional macroeconomic models used by governments and their development partners, including multilateral lenders such as the International Monetary Fund and World Bank, underestimate or ignore climate effects in forecasting growth, even as some now mention the climate challenge. As a result, governments have many incentives to boost short-term growth and far fewer to invest in climate mitigation, which generally takes a long time to yield visible results.

To begin changing this perilous state of affairs, growth economics must factor in the failure of businesses and governments to tackle global warming. Fortunately, economists have the concepts to do this, in the form of so-called externalities. These spillover effects can be positive, as when a vaccination program provides secondary benefits to an entire community. But climate change involves negative externalities, because firms do not account (or pay) for the societal harm caused by their operations – such as a power plant emitting carbon dioxide.

Unfortunately, externalities are currently not central to research and teaching in growth economics. As a consequence, its models can be used to support extreme deregulation, improving the “business environment” at the expense of the natural one and society. Recent policies, for example, have encouraged the deforestation of the Amazon in Brazil, neglected damage to public health in India from unsafe drinking water and poor sanitation, and increased carbon dioxide emissions in the United States, thereby aggravating global warming.

US policy under President Donald Trump represents an alarming failure to consider the climate crisis. By replacing the previous administration’s Clean Power Plan with the much weaker Affordable Clean Energy rule, and promoting more coal-based energy, the Trump administration is encouraging higher CO2 emissions. US emissions from energy sources alone increased by 2.7% from 2017 to 2018, and were 4.5% higher in the first three months of 2019 than in the same period last year.

These numbers should also dispel the notion that climate effects accrue only in the distant future and with great uncertainty. The world’s three largest CO2 emitters – China, the US, and India – all discharged more in 2018, a year in which global warming also rose. CO2 emissions in the air were a high 415 parts per million in mid-May, compared to 412 ppm a year earlier – part of a disturbing upward trend triggering unacceptable global warming. The global temperature in May was 1.53°F above the twentieth-century average, continuing a record rising trend.

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Some say awarding the 2018 Nobel Prize in Economics to Yale University economist William Nordhaus signaled greater awareness of the public harm caused by global warming. But when Nicholas Stern’s groundbreaking 2007 report on the need for urgent climate action was released, Nordhaus and many mainstream economists regarded it as overly alarmist. Stern’s analysis implied that a dollar of economic damage prevented a century from now is as valuable as a dollar spent reducing emissions today. Nordhaus and others, on the other hand, implied at the time that the economic gains from growth would make future generations rich enough to redress climate damage. But, crucially, this view did not recognize that climate externalities involve rapidly accumulating ecological damage that is pervasive and irreversible.

A few influential bodies realize this – including the Network for Greening the Financial System, a group of 34 central banks. Many economists, Nordhaus among them, support the introduction of a carbon tax, and about 40 countries, including China, now use carbon-pricing mechanisms. But such measures still cover only about one-half of these countries’ emissions, representing some 13% of the global total. If negative externalities really were central to economics, policymakers would apply carbon taxes far more widely and intensely to guide growth.

The current climate debate reveals a vast gulf between the latest scientific knowledge and the myopic growth economics used by policymakers. Bridging this gap will require a new mindset across the economics discipline – from schools and universities to the highest levels of economic policymaking.

Economics must recognize the central role of negative externalities in the growth process, and integrate the costs and benefits of environmental stewardship and climate action. By doing so, economists could make an enormous contribution to tackling global warming – the biggest challenge facing the world today.

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