We should have paid closer attention when Daron Acemoglu, one of today’s most influential economists, said that climate change requires “a fundamental reconsideration of some of the most fundamental assumptions in economics.” The truth is that, whether economists are prepared or not, the climate problem demands a brutal restructuring of economics as a research field.
First, economic theory tends to focus on small changes in the market for goods and services in the short run. At the heart of economic analysis is still the same utility function that an undergraduate student learns in a microeconomics course: a curve that captures the choice relationship between consumption today or in the future. It is a tool that helps determine how much consumption a decision maker (for example, a government official, but also an ordinary individual) should be willing to sacrifice today to obtain more value at some point in the future (depending on the return of some investment), taking into account that R$ 1 today will have less value than in, for example, ten years, depending on a discount rate. There are many applications where the utility curve is useful, such as understanding individual consumption, investment and public spending decisions, tax policy planning, and much more.
However, while applying a discount rate to reflect this dynamic effect of intertemporal consumption decisions may make sense in the short term, is it reasonable to try to model decisions taking into account a future that will arrive in a hundred years? What’s more, climate change is a brutal event that will force a complete restructuring of consumption and living patterns, which cannot be captured in a utility curve.
In recent years, in fact, there have been theoretical advances in the incorporation of risks and costs by thinking about climate change in macroeconomics, mainly under the leadership of the 2018 Nobel Prize in Economics winner, William Nordhaus. There are several models that today relate neoclassical economics, the carbon cycle, climate science and the prediction of climate impacts, and thus allow the weighing of costs and benefits of taking measures to delay climate change.
However, these costs and benefits are still highly hypothetical, mainly because we are talking about things that do not have a market, that is, they do not have real value. What value should be attributed to a project that intends to conserve a forest? Maybe you can even try to monetize the benefit from the carbon that will be sequestered by the trees, thinking that this carbon can become credits that will be traded in a carbon credits market. But what about the benefit of biodiversity? Is it possible to put a value on it? These are still unanswered questions, which limit how useful these models are for understanding reality.
Another important point is that, in economic theory, there is a very relevant principle, called the Tinbergen principle in honor of the economist who articulated it. The Tinbergen principle establishes that the best way to neutralize a market failure (or specifically a negative externality) is through a policy instrument designed specifically for this purpose. This means that an intervention that is not focused on a single well-defined problem may not be justified.
Thinking about the negative effects of greenhouse gas emissions, the Tinbergen principle suggests that the solution is to formulate a tax on carbon emissions and implement that tax consistently. It’s not hard to see why this falls short: if mitigating the climate problem requires a rapid transition to cleaner technologies, a carbon tax will have to be supplemented with subsidies and other incentives to push innovation and deployment in the right direction. .
More than that, we know that a carbon tax can have distortionary effects, that is, affect more populations with lower incomes. It is true that these populations have their consumption power even more reduced, considering that historically they are the population segments that have contributed least to climate effects, and that will probably be the most affected by the increase in temperatures (since, unlike groups of greater economic power, have a limited capacity to invest in climate adaptation)?
The climate crisis demands that we consider more radical ideas. If we reach a consensus on the need for strong investments in the transition to clean energy and taxes on more polluting industries, perhaps we can also agree to orient these expenditures towards job creation, or towards income transfer programs for populations affected by the economic measures. This may violate the Tinbergen principle. But if it helps to prevent the deepening of social, economic and political failures, it will be important.
More than anything, however, the economy is lagging behind when it comes to communicating with other areas. Solving the climate problem is something complex, which will require complex economic interventions. For these interventions to be well designed, it will be necessary for economists to collaborate with, for example, natural scientists, so that the dynamics of ecosystem flows are well captured. It will also be necessary for economists to talk to specialists in the field of psychology so that they understand what people’s behavioral reaction to these instruments may be, that is, if they will in fact change consumption and investment patterns in the desired way. And many others.
Although there are multidisciplinary areas of economics, such as environmental economics or behavioral economics, dialogue between economists and other scientists is still very limited, and economics tends to be a closed area in itself. That is why it is very important that economists also invest in scientific dissemination, in knowing how to explain and discuss economic theory with non-economists. It is fundamental that the new generation of economists not only recognize the limited capacity of economic theory to be relevant in the face of climate change, but also make an effort to integrate academics from other areas in the creation of a new economy, adequate to understand, predict and solve the climate problem.
This text was inspired by recent article by Daron Acemoglu, “What climate requires of economics”, published in the newspaper Jordan Times.
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