Economics of Climate Change
Image from wikipedia article “Climate Change”; indicates average temperature changes around the globe from 1973 - 2023.
In 2nd semester of the 2019-20 school-year, I was assigned to teach a one semester economics course. The course was intended to be a social studies elective for 11th and 12th grade students not in the IB Diploma Program. The course was new, was intended for only a small cohort of students, and was a one-semester elective, so this allowed me a little flexibility in developing the course curriculum. In the fall of 2019, youth-led action on climate change protests garnered a lot of attention globally. On my school's campus, students organized a class walk-out and march around the campus to draw attention to the need for more climate action. In the follow up of that, a group of students and teachers started meeting to explore ways in which the school could take more action, and a student and teacher committee was formed to explore the school's carbon footprint.
In view of this student attention around climate action, I decided to focus the economics elective course on the economics of climate change. The course was a completely introductory economics course, so we still needed to deal with the basics, but I hoped that framing our learning around climate change would make the study of introductory economics more applicable. The goal was twofold: a) to explore how economics can help us understand the problem of climate change, and b) to look at certain economic policy responses to address climate change. This was pretty new learning territory for me, so a couple of books that were helpful resources were:
The Climate Casino: Risk, Uncertainty, and Economics for a Warming World by William D Nordhaus.
The Behavioral Economics of Climate Change by S. Niggol Seo.
Below is a brief outline of some of what I learned about the economics of climate change. Remember, this is high school level introductory economics.
The Problem of Climate Change: The Natural Science Perspective
Carbon is a naturally occurring element and the building block of all organic compounds, which are the basis for all living things on Earth (“Carbon”). Carbon is continually recycled and reused on Earth in the process known as the carbon cycle, which is a key feature of Earth that makes it capable of sustaining life. While carbon has developed a negative connotation in discussions about climate change, the problem is not with carbon itself. Without carbon and the carbon cycle, life on Earth would not exist. The problem for climate change is more specifically carbon dioxide (CO2), which is a gas molecule of a carbon atom bonded with two oxygen atoms, but it’s important to note that CO2 in itself is also not the problem (“Carbon dioxide”). CO2 is a natural part of the carbon cycle, a key molecule in the Earth’s atmosphere, and is vital to photosynthesis in plants.
it’s important to note that CO2 in itself is also not the problem (“Carbon dioxide”). CO2 is a natural part of the carbon cycle, a key molecule in the Earth’s atmosphere, and is vital to photosynthesis in plants.
To better understand the problem of climate change, it’s helpful to differentiate between “biogenic carbon” and “fossil carbon.” Biogenic carbon refers to the organic compounds and carbon molecules that exist naturally within the Earth’s carbon cycle, and remain in balance through that cycle (“Fossil vs biogenic”). Fossil carbon, on the other hand, is the carbon from ancient organic materials that has been stored for thousands of years in fossilized forms. The most notorious of these fossil carbon sources are oil, natural gas and coal, which we often call “fossil fuels.” When humans extract these fossil fuels and burn them, the chemical reaction breaks the hydrocarbon bonds of the fossil fuels, which interact with oxygen in the atmosphere, releasing, among other molecules, CO2. This additional CO2, released into the Earth’s atmosphere from carbon that has been stored in fossils for thousands of years, is the leading contributor to climate change. This additional CO2 remains in the Earth’s atmosphere and contributes to the “greenhouse effect,” whereby the Earth’s atmosphere releases less of the Earth’s infrared radiation over time, leading to a warming planet (“Greenhouse gases”). This global warming then alters the Earth’s climate; these climatic changes have the potential to dramatically alter life on Earth, including making large portions of the planet less habitable, or even inhabitable, to humans, not to mention other species.
Because CO2 contributes to this greenhouse effect on our planet, it is considered a greenhouse gas (GHG). It is not the only GHG; methane, for example, is another potent GHG, which is released into the atmosphere in large quantities from human agricultural practices, including from livestock -- especially cattle -- raised for human meat consumption (“Methane”). It is also worth pointing out that cement production is another major contributor to CO2 GHG emissions (Rossi). Limestone, a primary material used in the production of cement, is a carbonate sedimentary rock, meaning that it’s composed in part of organic material and formed over time through sedimentation of those carbon-based materials (Bissell). The chemical process of converting limestone into cement, the binding agent in concrete, releases large quantities of CO2. Despite these other GHGs, the largest cause of GHG emissions, by far, is CO2 from the burning of fossil fuels. In the US in 2018, for example, 75% of anthropogenic (human-caused) GHG emissions were from the burning of fossil fuels (“Where greenhouse gases”).
The environmental impact of a particular individual or institution in terms of its GHG emissions is sometimes referred to as its “carbon footprint,” though as was pointed out above, this is a misnomer of sorts; the problem is not carbon itself, but rather greenhouse gas emissions, most notably CO2 from the burning of fossil fuels. Nonetheless, the term “carbon footprint” is commonly used as meaning "GHG emissions footprint." One’s carbon footprint is typically measured in metric tonnes of CO2 or CO2 equivalency emitted per year. CO2 equivalency is expressed as CO2e, and refers to, for the sake of one common measurement, the greenhouse effect potency of other GHGs as compared to CO2 (Brander). For example, 1 kg of methane is equal to the greenhouse effect of 25 kg of CO2 and thus, in terms of carbon footprint, is measured as 25 kg CO2e.
The Problem of Climate Change: The Economics Perspective
The discipline of economics can provide valuable insights to help understand the problem of climate change. The causes are largely anthropogenic and thus it's worth looking at the problem through the lens of the social sciences, such as economics. Why do humans, individually and in society, continue the behavior that is leading to dramatic climatic change despite all of the evidence from the natural sciences? The following economic concepts can provide some insight into this self-destructive human behavior. The field of economics can also provide some policy solutions that can alter human behavior and decrease GHG emissions.
Market Failure
Despite the big ideological debates of the 20th century between “free-market capitalism” and “command-economy socialism,” those two extremes on the economic spectrum are really a false dichotomy for the 21st century. Nearly every economy in the world today is a “mixed economy,” meaning there are some elements of the economy where the laws of the market are left to operate freely, while there are other elements where the state intervenes in the market, or simply controls it. Even in the United States with all of its promotion of the free market, there are plenty of examples of government intervention and control in the economy, and all but the most extreme economic libertarians have no problem with this. It’s illegal for liquor stores to sell alcohol to 12 year-olds, for example, or states levy high taxes on cigarettes intentionally to drive up the price and discourage people from smoking. Most ideological debates in economics today are a matter of degree. What is the ideal degree of free market versus government control along the spectrum of a mixed economy? In other words, most economists today would agree with the concept of “market failure,” which refers to the idea that markets, as complex social entities, left on their own (“laissez faire”), sometimes fail; by failure, economists mean that the market fails to efficiently and fairly distribute scare resources for the benefit of society. Most economists then agree that it’s at these points of market failure that a government should step in to correct or control the market in some way. The big political-economic debates arise around how the government should intervene and to what extent.
Negative Externalities
The economic concept of a negative externality is one example of market failure. A negative externality refers to a production cost that is not properly accounted for within the market law of supply and demand. The law of supply and demand stipulates that the free interplay between consumer demand and producer supply will naturally determine the optimal price and quantity of a given product. In a perfect model, the law of supply and demand should lead to the most efficient allocation of resources through the natural back and forth between consumers and producers.
A perfect model of the law of supply and demand, however, requires full transparency and accounting of all production costs; this is not always the case. When the market fails to account for a production cost, economists say that the cost is “externalized.” An externalized cost is an example of market failure because without an appropriate accounting of all costs within production, the market conveys an equilibrium where the product is underpriced and overproduced; such a market is inefficient and is misallocating resources. Externalized costs and over production can have negative consequences on society and / or the environment, and thus they are called “negative externalities.”
A leather tannery that dumps toxic chemicals, such as chromium, directly into the river that flows behind the tanning factory can provide an example of negative externalities (see Gessesse for an Ethiopian example of this). If the tannery operates in an economy free from any government regulations on its industry, the costs associated with the disposal of the toxic chemicals are externalized by the factory. It dumps these chemicals directly into the river, which, by the simple flow of the river, carries the toxins away from the factory. The factory itself does not suffer from its externalizing of these costs, and therefore has no incentive to change its behavior. Because these costs are externalized from the production process, the prices on leather are lower than they should be, demand is greater than it should be, and production quantities are higher than they should be. This all means that the factory continues to dump ever greater quantities of chromium into the river in a vicious cycle.
Meanwhile, these costs don’t just vanish into thin air; rather, the costs are born by the communities downstream of the factory, who must deal with the carcinogenic chromium that contaminates the river, the soil, their crops and their livestock, not to mention the larger impact on the ecosystem of the river downstream from the factory. To protect its citizens and natural resources from this negative externality, a government must intervene to address this market failure. It must impose regulations upon the factory that force it to assume the responsibility -- and costs -- of appropriately disposing of the chemicals, and it must levy heavy fines if the factory does not comply. This government intervention forces the tannery to “internalize” the formerly externalized costs, thus correcting the market failure and protecting the downstream communities and natural resources.
From an economic perspective, global warming and its resultant climate change are examples of negative externalities writ large. All of the producers in our global economy using fossil fuels, have, since the dawn of the industrial age, externalized some of the costs -- such as the costs of CO2 emissions -- associated with using those fuels. Much like with the chromium in the tannery, the CO2 is released into the environment where it is “carried away.” But as with the toxins in the river, those costs do not just disappear. They are borne somewhere by someone. In the case of the global-warming-causing CO2 emissions from fossil fuels, the costs of past emissions are being borne by us in the world today, and the costs of today’s emissions will be borne in devastating ways by future generations. As William McDonough says: “We used to be able to throw things away. Remember that? Things went ‘away.’ Where is ‘away’ now? ‘Away’ is here. ‘Away’ is someone’s backyard… ‘Away’ has become very close indeed.”
Climate change is the result of the long-term, global-scale, negative externalities of fossil fuel burning CO2 emissions. It’s a market failure. Fossil fuel-based energy is often viewed as relatively cheap, but this is because of externalized costs. The economies of the world have underpriced and overproduced fossil-fuel-based energy and all that depends upon this energy for over two centuries. Interventions are needed to correct this massive market failure and there are economic intervention options; policies like a carbon tax, cap and trade, or carbon offsets are all ways that governments can force producers to internalize the costs of GHG emissions. But as climate change involves a common global resource -- the atmosphere -- interventions in the market by a single government, or even several governments, are not sufficient. This problem is related to another economic concept: “the tragedy of the commons.”
The Tragedy of the Commons
The tragedy of the commons refers to when individuals, acting in their own self interest, behave in a way that negatively impacts the common good, by exploiting shared resources. Ironically, this self-interested behavior eventually also negatively impacts the individual perpetrators of the exploitation, but because the economic incentives are all wrong, individuals are motivated to exploit the resources for themselves while they can, rather than risk losing out while others benefit from the exploitation instead. In a laissez faire approach to this situation there are no incentives to protect the common resource for the benefit of all, and thus, tragically, the resource is destroyed and all parties lose.
Overfishing is a frequently used example of the tragedy of the commons. Ocean waters are a common resource; they are not, nor can they be, privately owned and controlled. This creates a situation where the ocean’s natural resources are easily exploited. Each individual fishing boat has an incentive to take as much as it can from the ocean now before it’s all gone. Fishing Vessel A may have a conscience and may abide by sustainable fishing practices, but Fishing Vessel B doesn’t care. By responsibly limiting its own catch, Vessel A puts itself at a short-term competitive disadvantage compared to Vessel B that doesn’t have the same self-imposed catch limit. Meanwhile, Vessel B takes full advantage of Vessel A’s responsible fishing practices by taking even more for itself. This means there is no long-term net benefit on fish stocks, despite the efforts of Vessel A. Because of its sustainable practices Vessel A loses both in the short-term and in the long-term; in other words, there are no incentives for Vessel A to continue acting responsibly. As a result, global fish stocks plummet, destroying the common resource for everyone. To prevent this tragedy of the commons a government must intervene, impose fishing quotas, police those quotas, and levy consequences upon those caught not abiding by them.
Climate change is an example of the tragedy of the commons on a global scale. The Earth’s atmosphere is a common resource that cannot be privately owned or controlled. The economic incentives on this common resource are all wrong; the incentives are all aligned for individual actors to exploit, rather than for any collective effort to protect. Regarding the individual motivation factors to solve climate change, Dan Ariely, behavior economist at Duke University, quipped in a TedTalk, “Let me create a problem that people would not care about, that would maximize human apathy. You would come up with global warming. Think of all of the reasons: a long time in the future, will happen to other people first, we don’t see it progressing, we don’t see anybody suffering, and anything we can do is just a drop in the bucket.”
Furthermore, because of the global nature of this common resource of the Earth’s atmosphere, even interventions by a single national government are insufficient. It’s not unlike that good-intentioned fishing vessel. Responsible and sustainable interventions by one government only puts its overall economy at a short-term competitive disadvantage against the irresponsible actors of the world, and, as long as there continue to be lots of irresponsible actors exploiting the common resource of the atmosphere, interventions by a single national government do not yield long-term net benefits. The incentives all align for the exploitation of the common resource, rather than for its protection for the common good.
While there are economic concepts and policy solutions that can alter the incentives and nudge human individuals, governments, organizations and institutions towards actions, to truly be effective, these need to be implemented at a global level. This is why commitments and cooperation at the global level are necessary and it’s why the large economies of the world must lead on this, while also recognizing the additional economic challenges to implementing climate action policies for developing economies.
Economic Policy Responses to Climate Change: Pricing Carbon
If climate change-causing GHG emissions are an example of market failure (failure to account for negative externalities and failure to protect and efficiently distribute scarce common resources), then some sort of intervention in the market is needed to correct this failure. Governments need to be involved in such an intervention in order to make it enforceable through law. One economic strategy for correcting this market failure is to force GHG emitters to internalize the eternalized cost of GHG emissions. In order to ensure that all externalized costs of GHG emissions are accounted for, one needs to put a value on those emissions; one needs to put a price on carbon ("What is carbon pricing?").
The economic question of carbon pricing (or, more precisely, GHG emissions pricing) has been hotly debated by economists. Some economists advocate for a carbon tax. This is a tax levied on GHG emitters, calculated for every tonne of CO2e emitted. In order for such a tax to force emitters to fully internalize the cost of GHG emissions, a carbon tax must be set at the appropriate level. How much tax should an emitter be forced to pay for its GHG emissions? In other words, what is the price of one tonne of CO2e? One approach involves economists running models on all the costs to society (the negative externalities) from GHG emissions and the impacts of climate change (Evans et al.). These models tend to vary widely depending on the various political and economic assumptions built into the model. To accurately model the costs of emissions on society, one must not only consider the costs to society today, but also consider the costs on future generations, and consider how the risks increase in the future. The Interagency Working Group of the Obama Administration ran models on, what it called, the Social Cost of Carbon (SCC). Using 2007 dollar values, it placed the SCC within a range of $12 - $123 per tonne of CO2e, under different modeling scenarios (Evans et al.). The Biden Administration recently reconvened that Interagency Working Group. Based on the average of the different models, and accounting for inflation, the group pegged the SCC at $51 / tonne of CO2e for 2020, based on 2020 dollar values, rising to $62 / tonne of CO2e by 2030 ("What is the SCC?"). A UN report from the Intergovernmental Panel on Climate Change (IPCC), released in 2018, suggested a cost of carbon at a minimum of $135 / tonne of CO2e by 2030 (Davenport). In fact, that UN report put the range from $135 - $5,500 / tonne of CO2e by 2030.
Another model for putting a price on GHG emissions, advocated by some economists, is to allow the market itself to determine the price. This is partly the idea behind cap and trade policies, such as the EU Emission Trading Scheme (EU ETS). The idea of cap and trade is that a government will put an absolute cap on the amount of CO2e that can be emitted (and then gradually reduce that cap over time to decrease emissions), and then issue permits that allow for emissions (1 permit = 1 tonne of CO2e). For entities that require permits beyond what they've been allotted, they must purchase those permits on the emissions trading market from entities willing to sell. The market itself will determine the price of a permit, meaning that the market will determine the price of carbon (or, at least, the price of carbon beyond one's allotment). Many assumed for a number of years that this model wasn’t working. From most of 2012-2018, emissions permits with the EU ETS were trading at less than $10 per tonne of CO2e, bottoming out below $3 in 2013 (“Daily EU ETS”). However, since the spring of 2018, the cost of these permits have been on the rise, hitting and continually breaking all time highs (it hit $44 / tonne of CO2e during the week of April 12, 2021).
Carbon offsets (sometimes referred to as “carbon crediting schemes”) are another means for putting a price on carbon (Selin). The idea is that when one must emit GHGs, one can balance out those emissions by contributing to programs that sequester CO2 (take it out of the atmosphere) or promote GHG emission reductions elsewhere. The goal is to contribute in some way to the sequestering or reducing of an amount of CO2e at least equal to the emissions caused. In essence, carbon offsets put a price on carbon emissions by forcing the emitter to pay for the cost of offsetting that same amount of GHG emissions somewhere else. Carbon offsets tend to come in two different forms: compliance and voluntary (Nasralla and Twidale). The compliance versions involve producers who purchase carbon offsets to comply with GHG emission caps in certain economies, such as the EU’s Emissions Trading Scheme (“EU ETS”). The voluntary form often involves consumers who choose to purchase carbon offsets to compensate for their GHG-emitting activities, such as airplane travel.
There are a couple of reasons why carbon offsets are controversial. First, it's very difficult to follow up on the carbon offset programs to see if one’s funds actually increased CO2 sequestering or reduced GHG emissions elsewhere. Second, some people argue that carbon offsetting merely creates a means to assuage the guilt or avoid the consequence for an unsustainable lifestyle or industrial practice (Nasralla and Twidale). Instead of actually changing behavior to reduce GHG emissions, carbon offsets allow one to just pay some money to maintain the status quo. Finally, a critique of voluntary consumer-side offsets is that, by the nature of them being voluntary, they do not change demand and therefore do not reduce the supply of the product or its GHG emissions. Despite these critiques, advocates of carbon offsets argue that they can still be effective if one is able to track data on the following questions: How exactly were the offset funds spent? Would the CO2-sequestering or emissions-reducing program have existed without those funds? How much CO2e was removed from or reduced from the atmosphere through the program?
As for the price placed on carbon offsets, typically, the cost of the carbon offset should be equal to the cost of whatever action sequesters or reduces the equal amount of carbon as was emitted. This means that the price will be different depending on the offset program and the location of the offsetting activities. Some airlines, for example, provide links to organizations through which passengers can volunteer to buy carbon offsets for their flight. Many of these organizations offer carbon offset options within the range of $10 - $20 to offset one tonne of CO2e. Many of these programs contribute to efforts at preventing deforestation, or actively engaging in reforestation. Programs include planting trees, or distributing improved cook stoves to rural communities that rely on wood and charcoal for cooking fuel. Studies suggest that, depending on its type, a tree planted in the tropics can sequester up to one tonne of CO2e within its lifetime of 25 years (“Agroforestry Carbon Sequestration”). Advocates of improved cook stoves argue that they can reduce a household's consumption of wood or charcoal by up to 50%, which, for a typical household in sub-Saharan Africa, could reduce GHG emission of one tonne of CO2e per year (Edwards). Depending on the type of tree or stove and the location, often a tree can be planted or a stove distributed to a household for $10 - $20 each.
The Economics of Climate Change Class: What we did with this learning
In the Economics of Climate Change class we ultimately conducted research on several key contributors to the school's carbon footprint and assessed the economic viability of different methods for reducing the school's carbon footprint. We gathered data to determine the carbon footprint of the school's electricity sources (the Ethiopian electric power grid and the campus back-up diesel generator), the emissions from school vehicles, the emissions from school-related plane travel (student school trips, and faculty conferences and workshops), and, finally, GHG emissions associated with red meat consumption in the school cafeteria. We then gathered information on the financial costs to the school of installing a grid-tied photovoltaic power system (solar power) sufficient to meet 80% of the campus electricity needs, and we assessed the carbon footprint reduction that the school could achieved with such a system. Finally, we surveyed key school stakeholders regarding their willingness to contribute to a carbon offset program for school-related plane travel (parents and faculty). Because the class was small, each student was assigned a different role in the research, so that each student contributed individually to the final class report. The class presented the final written report to several parties, including a student club on campus called Students for Sustainability (SFS), and to the Executive Leadership body of the school, which overseas future campus facility planning.
References
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