Economic Effects of Climate Change
Climate change is moving to the top of humankind's priorities list as the debate over whether it exists or not gives way to the debate over how best to forestall and counteract its more onerous effects. In this regard, the possible economic impacts of action or inaction have been discussed far less than the science, for the fact of the matter is that no one really knows for sure what changes lie in store for producers, markets, and consumers. That there will be profound structural changes is less in doubt than whether we collectively are up to the task of successfully dealing with global warming. Here, fortunately, we have a large body of research to fall back on, most notably the welfare economics of Pigou and Hicks and sustainable-development theory, to guide our decision making.
Keywords Coase Theorum; Cost-Benefit Analysis; Externalities; Kaldor-Hicks Compensation Principle; Praeto Optimality; Sustainable Development Theory
Economics: The Economics of Climate ChangeOverview
Although skeptics still contest that climate change exists and is a result of human action, the scientific evidence overwhelmingly supports these conclusions. As the perils of "irreversible" climate change loom ever larger and more imminent in the public's imagination, the calls for action grow ever louder, with good reason. As little as a two degree centigrade increase in the earth's average temperature by 2100 might well make fertile land arid, submerge densely populated coastal regions, and magnify the destructiveness of extreme weather. And therein lies a dilemma of the first order, because ours is a carbon economy. Humankind has prospered far more since the late eighteenth century from industrialization, powered first by coal and then by oil, than it ever did over the preceding millennia. To halt global warming, atmospheric emissions of carbon dioxide (CO2) must be severely curtailed. But how can this happen without sacrificing the very productive capacity responsible for the high standard of living many enjoy and others aspire to? It is a daunting question.
Economics examines how resources are allocated in conditions of scarcity, so the ideas of constraints and trade-offs are hardly new. Nor, for that matter, are concerns about the potentially disastrous consequences of unrestrained economic growth. Early nineteenth-century economic theorists like Malthus and Ricardo feared such growth would bring a precipitous rise in population that would quickly deplete available food stocks. Pessimists like Malthus held that only war and famine could right the balance again; optimists like Ricardo believed agricultural imports and farm machinery might postpone but ultimately would not prevent widespread calamity. Convinced that future events can never be predicted with any real certainty, John Stewart Mill was more circumspect. He thought one of three outcomes possible (Pressman, 1999b):
- Increasingly expensive cultivation would continue to keep pace, with prices paid by workers and profits earned by landowners both rising;
- The division of labor and new technologies would more than keep pace, and workers' wages would increase; or
- Capital-intensive farming would keep pace, though just barely, with wages remaining constant, profits declining, and overall economic growth slowly grinding to a halt.
Economists pondering the likely economic impact of climate change face a far more complex problem set. To begin with, though there is growing agreement about why climate change is occurring, beyond sweeping generalities, the when, the where, and the how are still far from clear. What is clear is the sheer scale of the structural change the global economy faces, be it in heavy industry, energy, transport, or agribusiness. And with it will come new opportunities as well as threats. Though the impetus for change may in the end be political, the mechanism will always be economic. New green industries will supplant existing smokestack ones, renewable energy will replace fossil fuels, and so on—provided, that is, that the necessary changes are undertaken before the damage is irreversible and the social, political, economic, environmental, and humanitarian distress it brings becomes too great. But before this can happen, the very real question of who pays for the enormous upfront investments required must first be settled, and as yet no clear-cut consensus has emerged about the how to go about this. Fortunately or not, climate change is a just a rather dissonant variation on a recurring theme in twentieth-century economics; the problem of externalities and a workable solution may well lie there.Applications Externalities
The term "externalities" was coined in 1920 by the English economist Arthur Pigou, welfare economics' first major theorist. This term stems from the fact that manufacturing any good creates not one but two outputs, a physical commodity and a waste byproduct, for matter can never be destroyed, only transformed. As long as the effect of these waste byproducts on the larger community is benign, the material and economic benefits of production outweigh its social costs. Customers pay for the former but rarely for the latter. Nor do producers whose prices cover only the private costs of production—the raw materials, plant, equipment, labor, and capital required to make a profit. What happens when the social costs, measured as the investment necessary to counter the harmful side effects of a given production process, outstrip manufacturers' private costs (Pressman, 1999a)?
Strictly speaking, externalities arise whenever consumers not party to a transaction either benefit or lose as a result of it. A lighthouse is a much-discussed example of a positive externality: shipping firms and their passengers benefit directly from something paid for from the public purse. Air pollution is an example of a negative externality: emitters profit at the expense of the public at large. The emitters' behavior is countenanced in the first place because the utility of the goods they produce exceeds or equals the utility of cleaner air. However, this seemingly straightforward trade-off is often much more one-sided. The benefit to the producer and the producer's customers is immediate; the cost to the community in worsening air quality is cumulative.Negative Externalities & Free-Market Economies
Early proponents of welfare economics, such as Pigou and Hicks, saw negative externalities as market failures of the first order, ones that only government regulations, taxes, subsidies, or court action could correct. Laissez-faire marketplaces, they argued, have no built-in mechanism to effectively counter the so-called free-rider problem. This problem arises whenever too many economic agents ask, Why foot part of the bill for some...
(The entire section is 2974 words.)