Since the early 1970s, William Nordhaus has been studying climate change and its economic impact. Yesterday, the Yale University professor won the Nobel Prize in economics (jointly with NYU’s Paul Romer) for his decades of work, especially the efforts that led to a model used widely to understand the effects of climate change and energy- and environmental-policy interventions.
Even while giving this prize, the Royal Swedish Academy of Sciences went to lengths to note that the work it was honoring is not complete (pdf). Nordhaus does not offer “conclusive answers,” according to the Academy, but does provide a foundation for future economists. The gaps in our understanding about the economic impact of climate change is plaguing economists and breeding a whole new area of research.
Nordhaus’s Nobel work
Nordhaus’s path appears to begin in 1972 when he wrote a paper (pdf) that asked “how good are measures of output currently used for evaluating the growth of economic welfare?” and “does the growth process inevitably waste our natural resources?”
In 1994, Nordhaus published the now-famous Dynamic Integrated Climate-Economy (DICE) model. This was the first major effort to develop a method of estimating the economic costs of climate change, and one of the first Integrated Assessment Models (IAMs). It aims to measure the impact of environmental degradation on economic growth and to calculate the social cost of carbon, a key metric used by governments to design climate policy. It became one of the main analytical tools used to asses the damage posed by climate change.
Nordhaus’s work is so celebrated because it took on the challenge of examining the feedback loop between human activity and the climate. He understood that nature is a constraint on economic activity but economic activity is also a constraint on nature. “Nordhaus became the first person to design simple, but dynamic and quantitative models of the global economic-climate system,” the Academy said. These models allow for other researchers to simulate how the climate and economy will evolve together under different future assumptions, including the impacts of specific policy actions.
Nordhaus modelled out the global emissions of carbon under four universal policies. The first scenario is a baseline estimate, in which no policies are adopted. In the second scenario (“Opt,” which stands for “optimal,” meant in the economic sense of maximizing welfare), carbon taxes start out at around $30 per metric ton of carbon dioxide and rise over time at about the same rate as global GDP. The third and fourth scenarios show would would happen with carbon taxes six to eight times higher than the “optimal” level—and lead to far more drastic drops in CO2 emissions. This work led Nordhaus to become an early advocate for a universal carbon tax.
Nordhaus is very critical of current climate policies. In 2016, he said that the target of not letting global warming exceed 2°C above pre-industrial levels—the goal agreed in the Paris accord—was unlikely to be achieved “even if ambitious policies are introduced in the near term.” Instead, “a target of 2.5°C is technically feasible but would require extreme, virtually universal, global policy measures,” he wrote.
The Nobel Prize was awarded on the same day that the Intergovernmental Panel on Climate Change (IPCC) released a report saying that to meet the world’s more ambitious goal of 1.5°C there needs to be “unprecedented changes” when it comes to carbon emissions. Nordhaus’s model is used by the IPCC and in an interview with the Nobel Prize organization Nordhaus said the IPCC report was an “important reminder of the dangers we face and the work that needs to be done.”
“My most recent work has made me somewhat concerned that we are doing so little,” Nordhaus said yesterday. “The policies are lagging very, very far—miles, miles, miles—behind the science and what needs to be done. It’s hard to be optimistic.”
Critics say IAM models are too simplistic and founded on unrealistic assumptions. “Current economic models tend to underestimate seriously both the potential impacts of dangerous climate change and the wider benefits of a transition to low-carbon growth,” Nicholas Stern, a UK leader in climate-change economics, wrote in 2016.
A review of the current state of climate-change economics by the Bank of England (pdf) published in January 2018 said there were still “severe challenges” in getting to a “meaningful qualification” of the macroeconomic impact of climate change. These challenges arise because climate change is an externality with uncertainties unlike those of any other externality that macroeconomics has had to deal with. These include how sensitive the climate is to greenhouse gas emissions and what will really happen after passing a tipping point, when the effects of climate change are expected to spiral out of control. The Swedish academy agrees: “Naturally, the IAMs developed by Nordhaus cannot eliminate this uncertainty.”
While early IAMs were valuable in getting economists to think about climate change, there needs to be “a new generation of climate-economic models based on empirical evidence,” says Felix Pretis, the co-director of the Climate Econometrics project at the University of Oxford.
But efforts to build these new models have hurdles. One serious issue is that historical data are hard to adapt for use in projections.
“Most projections of future impacts assume that the relationships between climate and economic growth remain constant,” says Pretis. There are two problems with that: First, the historical impacts of climate change on the economy that have been documented are unlikely to be similar to future impacts. One example is sea-change levels. Historically, there has been little increase sea levels. But this is expected to be a major risk for small island states and coastal areas, which isn’t captured well by empirical models. In other words, those models risk understating the true, global economic impact of climate change.
Second, empirical models don’t take into account efforts to adapt or mitigate climate change. Adaptation (like reducing air travel) and mitigation (like instituting carbon-reducing technologies) to a changing climate don’t to show up in long-term forecasts, which tend to only show what will happen if the status quo is maintained.
The reason all this wonky debating about models matters is because they are the basis for climate policy. Even as the evidence mounts about the negative impact of climate change, flawed models are ammunition of climate-change deniers or people who don’t think it’s worth making the necessary investments. Economists are working to improve their models to make the case for intervention stronger. But as Nordhaus’s pessimism highlights, decades of evidence haven’t done ensured policy changes, so it’s unclear whether that could be accomplished by slightly more precise models.