Module 4: Climate Change Economics

Welcome to Module 4

Climate change is often called the greatest market failure in history and the ultimate challenge for economics. It combines nearly every difficult problem we've discussed: global commons, long time horizons, irreversibility, uncertainty, intergenerational equity, and massive externalities.

This module applies the economic tools you've learned to understand climate change—its causes, consequences, and potential solutions. By the end, you'll understand why climate change is so economically challenging and what economics tells us about addressing it.

Note: This module focuses on economic dimensions. Climate science itself (how greenhouse gases trap heat, feedback loops, etc.) is assumed background knowledge, though we'll touch on key physical realities as needed.

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Climate Change as an Economic Problem

Why Climate Change Is Economics' Ultimate Challenge

Climate change violates nearly every condition for markets to work well:

1. The Ultimate Externality: When you burn fossil fuels, you capture all the benefits (energy, transportation, heating) but impose costs on everyone globally—including people who haven't been born yet. The atmosphere is a global commons with no price signal.

2. Global Scale: No single country can solve it alone. Every country has incentives to free-ride on others' mitigation efforts while enjoying a stable climate that everyone benefits from.

3. Long Time Horizons: Emissions today cause damages over decades and centuries. Traditional economic discounting dramatically reduces the present value of distant future harms.

4. Irreversibility: Once emitted, CO₂ stays in the atmosphere for centuries. Temperature increases are largely irreversible on human timescales. Some impacts (ice sheet collapse, species extinctions) can't be undone at any price.

5. Uncertainty and Risk: We know warming is happening and will worsen, but precise damages, timing, and regional effects are uncertain. Low-probability catastrophic scenarios (tipping points) are possible.

6. Stock Pollutant: Unlike local pollutants that disperse, greenhouse gases accumulate. It's the total stock in the atmosphere that matters, not annual flows. This means historical emissions constrain current options.

7. Distributional Injustice: Those who contributed least to the problem (poor countries, future generations) suffer most. Those who contributed most have the most resources to adapt.

8. Missing Markets: No market exists for climate stability. No one owns the atmosphere. Future generations can't participate in today's markets.

The Basic Physics-Economics Connection

The Physical Reality:

• Human activities emit greenhouse gases (primarily CO₂ from fossil fuels, but also methane, nitrous oxide, and others)
• These gases trap heat, raising global temperatures
• Higher temperatures disrupt climate patterns, raise sea levels, intensify storms, shift ecosystems

The Economic Reality:

• Virtually all modern economic activity involves energy use
• About 80% of global energy comes from fossil fuels
• Economic growth historically correlates strongly with emissions growth
• Reducing emissions requires transforming the entire energy-economic system

The Core Tension: Fossil fuels have powered unprecedented economic growth and prosperity. Climate stability enables agriculture, habitable cities, and stable societies. We need both prosperity and climate stability—but our current economic model threatens the latter.

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The Social Cost of Carbon

How much damage does emitting one ton of CO₂ cause? This question is crucial for climate policy.

What Is the Social Cost of Carbon (SCC)?

The Social Cost of Carbon is the present value of all damages caused by emitting one additional ton of CO₂. It represents the externality cost that isn't reflected in market prices.

Conceptually: If gasoline is $3/gallon but the SCC from burning it adds $1/gallon in climate damages, the true social cost is $4/gallon. The $1 is the externality.

How SCC Is Estimated

Calculating SCC requires integrated assessment models (IAMs) that link:

1. Emissions Scenarios: How much CO₂ will be emitted under different policy scenarios?

2. Climate Models: How do emissions translate to atmospheric concentrations and temperature changes?

3. Damage Functions: How do temperature changes translate to economic damages?

4. Discounting: How do we value future damages in today's terms?

5. Aggregation: How do we sum damages across regions, sectors, and time?

Major Integrated Assessment Models

DICE (Dynamic Integrated Climate-Economy model) - William Nordhaus:

• Relatively aggregated global model
• Moderate damage estimates
• Higher discount rates (≈4%)
• SCC estimates: $30-50 per ton CO₂

FUND (Climate Framework for Uncertainty, Negotiation and Distribution):

• Regional model with more detail
• Lower damage estimates (includes some adaptation)
• SCC estimates: $20-40 per ton CO₂

PAGE (Policy Analysis of the Greenhouse Effect):

• Used in Stern Review
• Higher damage estimates
• Lower discount rate (≈1.4%)
• More emphasis on extreme risks
• SCC estimates: $80-100+ per ton CO₂

U.S. Government (Interagency Working Group):

• Combines insights from multiple models
• SCC estimates (2020): $51 per ton CO₂ at 3% discount rate
• Range: $14-76 per ton depending on discount rate and scenarios

Why Estimates Vary So Much

Discount Rate: The single biggest driver of variation. As discussed in Module 3:

• High rates (5%): Future damages matter little → Low SCC
• Low rates (1.4%): Future damages matter more → High SCC
• This isn't a technical question—it's an ethical choice about intergenerational equity

Damage Functions: How much does 2°C or 4°C of warming actually cost?

• Some models predict modest impacts (2-5% of global GDP for 3°C warming)
• Others predict severe impacts (10-20% of GDP or more)
• Catastrophic risks (tipping points) are very hard to model

Adaptation: Will societies adapt to reduce damages?

• Optimistic view: substantial adaptation reduces damages
• Pessimistic view: adaptation is costly and limited

Equity Weighting: Should we weight damages to poor countries more heavily (since marginal utility of income is higher for the poor)?

• Without equity weighting: one dollar of damage in a poor country = one dollar in a rich country
• With equity weighting: damages to poor countries count more → higher SCC

Non-Market Impacts: How do we value:

• Biodiversity loss
• Cultural heritage sites lost to sea level rise
• Human lives lost to heat waves, storms, disease
• Ecosystem services degraded

What SCC Tells Us

The Bottom Line: Even conservative estimates suggest substantial damages from carbon emissions. Current carbon prices in most jurisdictions ($20-40/ton where they exist) are below most SCC estimates.

Policy Implication: Economically optimal climate policy would tax carbon at the SCC rate, making polluters internalize the externality. This would:

• Make fossil fuels more expensive
• Make clean energy relatively cheaper
• Incentivize efficiency and innovation
• Generate revenue for adaptation or tax reductions

The Uncertainty: Given the wide range of estimates, should we:

• Use the middle estimate and risk under-response?
• Use high-end estimates to be precautionary?
• Acknowledge that SCC can't capture everything and supplement with other decision frameworks?

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Climate Damages: What Are the Costs of Inaction?

If we don't mitigate climate change, what will it cost? Let's examine damage categories.

Agricultural Impacts

The Good:

• Some cold regions become more suitable for agriculture
• CO₂ fertilization effect (plants grow faster with more CO₂)
• Longer growing seasons in some areas

The Bad:

• Many currently productive regions become too hot or dry
• Increased drought frequency
• Water stress in key agricultural areas
• New pest and disease patterns
• Extreme weather damages crops

The Complex: Net global effect uncertain for moderate warming (1-2°C). Above 2-3°C, clearly negative. Distribution matters: gains in Russia/Canada, losses in tropics/subtropics where many poor people depend on agriculture.

Economic Estimates:

• Moderate warming: -5% to +5% of agricultural output
• Higher warming (3-4°C): -10% to -30% of output
• Food prices likely rise significantly

Sea Level Rise and Coastal Impacts

The Physics:

• Thermal expansion (warmer water takes more space)
• Melting glaciers and ice sheets
• Committed for centuries even if emissions stop today

Current Trajectory:

• 0.3-0.5 meters by 2100 (if strong mitigation)
• 0.5-1 meter by 2100 (moderate scenarios)
• 1-2+ meters by 2100 (high emissions scenarios)
• Multiple meters over centuries

The Damages:

• Coastal infrastructure inundated
• Major cities threatened (Miami, Shanghai, Mumbai, Lagos, and hundreds more)
• Low-lying nations face existential threats (Bangladesh, Pacific Island nations)
• Productive agricultural land lost (river deltas)
• Forced migration of hundreds of millions

Economic Estimates:

• Protection costs (seawalls, relocation): hundreds of billions annually
• Asset losses: trillions of dollars of coastal property
• Difficult to quantify: cultural sites, displacement trauma, political instability

Example: Even modest sea level rise threatens trillions in coastal real estate. Miami alone has over $400 billion in at-risk property with 1-2 meters of rise.

Health Impacts

Direct Heat Effects:

• More frequent and severe heat waves
• Heat-related mortality, especially elderly and poor
• Reduced labor productivity in hot conditions
• Infrastructure failures (power grids, roads)

Vector-Borne Diseases:

• Expanded range of malaria, dengue, Zika
• Longer transmission seasons
• New populations at risk

Air Quality:

• More ground-level ozone on hot days
• Increased respiratory illness
• Allergies worsen (longer pollen seasons)

Water and Food-Borne Diseases:

• Contamination from flooding
• Pathogen proliferation in warmer water

Mental Health:

• Climate anxiety and eco-grief
• Trauma from extreme weather events
• Displacement and community disruption

Economic Estimates:

• Healthcare costs: tens to hundreds of billions annually
• Lost productivity: significant but hard to quantify
• Lives lost: valued using VSL (value of statistical life), reaching hundreds of billions

Extreme Weather

The Pattern: Climate change intensifies:

• Hurricanes/cyclones (more Category 4-5 storms)
• Flooding (heavier rainfall events)
• Droughts (longer, more severe dry periods)
• Wildfires (longer seasons, larger fires)
• Heat waves (more frequent, longer, more intense)

The Damages:

• Direct destruction (buildings, infrastructure)
• Business interruption
• Agricultural losses
• Loss of life
• Displacement and migration

Economic Reality: Disaster costs already rising dramatically:

• 1980s: $50-100 billion annually (inflation-adjusted)
• 2010s: $200-300 billion annually
• Trend accelerating

Attribution: Not every extreme event is caused by climate change, but climate change makes many events more likely and more severe. This "loading the dice" is now well-established scientifically.

Ecosystem and Biodiversity Loss

The Problem:

• Species can't migrate fast enough to track changing climate zones
• Coral reefs bleach and die (1.5°C warming threatens most reefs)
• Forests face stress, die-back, and altered composition
• Ecosystem regime shifts (sometimes irreversible)

Economic Value:

• Ecosystem services worth tens of trillions annually
• Fisheries collapse: billions in lost food production and livelihoods
• Tourism losses: coral reefs, wildlife viewing, ski resorts
• Genetic resources lost: potential medicines, crop varieties

The Immeasurable: How do we value the permanent extinction of species? The loss of the Great Barrier Reef? The transformation of the Amazon from rainforest to savanna? Economic valuation struggles here.

Tipping Points and Catastrophic Risks

What Are Tipping Points? Thresholds beyond which systems change abruptly and irreversibly:

Potential Tipping Points:

1. Greenland Ice Sheet Collapse: Committed to multi-meter sea level rise
2. West Antarctic Ice Sheet: Similar impacts
3. Amazon Rainforest Dieback: Transforms to savanna, massive carbon release
4. Permafrost Thaw: Releases huge amounts of methane and CO₂
5. Arctic Sea Ice Loss: Reduces albedo (reflectivity), accelerates warming
6. Atlantic Meridional Overturning Circulation (AMOC) Collapse: Dramatic regional climate shifts
7. Coral Reef Death: Already underway
8. Boreal Forest Dieback: Large carbon stores released

Economic Challenge:

• Low probability but catastrophically high impact
• Essentially infinite damages if civilization collapses
• Standard cost-benefit analysis breaks down
• Argues for strong precautionary approach

The Logic: Even if catastrophic scenarios are only 5-10% likely, their expected cost (probability × magnitude) could be enormous. Would you get on a plane with a 5% chance of crashing?

Aggregate Damage Estimates

What Do Models Say?

Nordhaus (DICE):

• 2.5°C warming: 1-2% of global GDP loss
• 3°C warming: 2.5-5% of GDP loss
• 6°C warming: 8-10% of GDP loss

Stern Review:

• Business as usual: 5-20% of global GDP loss (including catastrophic risks)
• Higher end if equity-weighting and catastrophic risks included

Recent Studies: Suggest earlier models underestimated damages:

• Productivity losses from heat
• Conflict and migration costs
• Non-linear effects and tipping points

Distribution: Poor countries suffer more despite contributing less:

• Already hot (additional warming more damaging)
• Agriculture-dependent economies
• Less resources for adaptation
• More vulnerable infrastructure

Example: A 3°C warming might reduce global GDP by 5% on average, but:

• Rich temperate countries: -2% to +1%
• Poor tropical countries: -10% to -20%

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Mitigation: The Costs of Climate Action

What would it cost to reduce emissions enough to avoid dangerous warming?

The Mitigation Challenge

The Goal (Paris Agreement): Limit warming to "well below 2°C" above pre-industrial levels, preferably 1.5°C.

Current Trajectory: Without new policies, we're headed for 3-4°C by 2100 and more beyond.

What's Required:

• Global emissions must peak and decline rapidly
• Net-zero emissions by mid-century (for 1.5°C) or 2070 (for 2°C)
• Negative emissions needed after mid-century

The Scale: This requires transforming:

• Energy systems (electricity, heat, industry)
• Transportation (vehicles, aviation, shipping)
• Buildings (efficiency, electrification)
• Agriculture and land use
• Manufacturing processes

Mitigation Cost Estimates

IPCC (Intergovernmental Panel on Climate Change):

For 2°C target:

• Global costs: 1-4% of GDP by 2050
• Annualized: 0.06-0.2% of GDP per year
• This accounts for co-benefits (health, innovation)

For 1.5°C target:

• More challenging and costly
• Requires faster transition
• Costs uncertain but higher than 2°C path

What's Included:

• Clean energy infrastructure investment
• Energy efficiency improvements
• Industrial process changes
• Forest protection and reforestation
• Carbon capture technologies
• Economic disruption and transition costs

What's Not Included (or underestimated):

• Innovation benefits (new technologies, industries, jobs)
• Co-benefits (air quality, health, energy security)
• Avoided climate damages (the flip side of inaction costs)
• Learning curves (technologies getting cheaper over time)

The Learning Curve Effect

Historical Pattern: Clean energy technologies have gotten dramatically cheaper:

• Solar PV: 90% cost reduction since 2010
• Wind power: 70% cost reduction since 2010
• Batteries: 90% cost reduction since 2010

Why This Matters: Early estimates of mitigation costs assumed static technology costs. Reality: costs fall with deployment due to:

• Economies of scale
• Learning by doing
• Innovation and competition
• Supply chain development

Implication: Mitigation may be much cheaper than early estimates suggested. Some analyses now suggest net economic benefits from climate action when all factors are considered.

Sector-by-Sector Mitigation

Electricity Generation:

• Challenge: 40% of global emissions from power generation
• Solutions: Wind, solar, nuclear, hydro, geothermal, biomass with CCS
• Costs: Solar and wind now cost-competitive with fossil fuels in many locations
• Issue: Intermittency requires storage or backup

Transportation:

• Challenge: 25% of global emissions
• Solutions: Electric vehicles, public transit, biofuels, urban planning
• Costs: EVs reaching price parity with conventional vehicles
• Issue: Aviation and shipping harder to decarbonize

Industry:

• Challenge: 20% of emissions, some processes inherently emit CO₂
• Solutions: Electrification, hydrogen, carbon capture, efficiency, material substitution
• Costs: Variable; cement and steel particularly challenging
• Issue: Competitiveness concerns without global coordination

Buildings:

• Challenge: 10% of direct emissions, more if electricity included
• Solutions: Insulation, efficient heating/cooling, heat pumps, smart systems
• Costs: Often cost-effective with energy savings
• Issue: Existing building stock slow to turnover

Agriculture and Land Use:

• Challenge: 15% of emissions, deforestation adds more
• Solutions: Reforestation, improved practices, reduced food waste, dietary shifts
• Costs: Some solutions have co-benefits (food security, biodiversity)
• Issue: Population and diet trends working against mitigation

Carbon Pricing: The Central Economic Tool

The Logic: Put a price on carbon to internalize the externality. Make polluters pay the social cost of their emissions.

Two Main Approaches:

Carbon Tax

• Set a price per ton of CO₂
• Tax fossil fuels based on carbon content
• Provides price certainty
• Emissions outcome uncertain

Examples:

• Sweden: $130/ton (among highest globally)
• Canada: $65/ton (rising to $170/ton by 2030)
• Many European countries: $30-80/ton

Revenue Use Options:

• Reduce other taxes (income, corporate)
• Fund clean energy investment
• Return as dividends to households
• Support affected industries and workers

Cap-and-Trade (Emissions Trading)

• Set total emissions cap
• Issue tradable permits
• Provides emissions certainty
• Price uncertain (determined by market)

Examples:

• EU Emissions Trading System (EU ETS): 40% of EU emissions
• Regional Greenhouse Gas Initiative (RGGI): U.S. northeast states
• California Cap-and-Trade
• China national carbon market (launched 2021)

Design Challenges:

• Setting appropriate cap stringency
• Initial permit allocation (auction vs. free)
• Preventing market manipulation
• Avoiding competitiveness concerns

Carbon Pricing: Does It Work?

Evidence:

• BC Carbon Tax: Reduced emissions 5-15% while economy grew
• Sweden: Emissions down 25% since 1990 while GDP doubled
• EU ETS: Mixed results; effectiveness improved over time
• RGGI: 50% emissions reduction in power sector

Limitations:

• Most existing prices too low ($20-40/ton vs. SCC of $50-100+/ton)
• Coverage incomplete (many sectors exempted)
• Leakage concerns (production moves to non-taxed locations)
• Political resistance keeps prices low

The Political Economy: Carbon pricing is economically efficient but politically challenging:

• Visible cost increases (gas, electricity)
• Concentrated costs on fossil fuel industries
• Diffuse benefits (avoided future damages)
• Regressive without compensation (hurts poor more)

Beyond Carbon Pricing: Other Mitigation Policies

Regulations and Standards:

• Fuel economy standards for vehicles
• Building codes and appliance efficiency standards
• Renewable energy mandates
• Phase-outs (coal plants, gas vehicles)

Subsidies and Investment:

• Renewable energy subsidies and tax credits
• R&D funding for clean technologies
• Public infrastructure (charging stations, transit)
• Green banks and climate finance

Information and Voluntary:

• Energy labels and disclosure
• Corporate sustainability reporting
• Voluntary commitments and targets
• Consumer awareness campaigns

Innovation Policy:

• Research funding
• Demonstration projects
• Procurement policies
• Prizes and challenges

Why Multiple Instruments? No single policy tool suffices. Optimal policy mixes carbon pricing (for overall efficiency) with targeted policies for specific barriers:

• Technology development (R&D)
• Infrastructure lock-in (regulations)
• Behavioral barriers (information)
• Distributional concerns (subsidies)

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Adaptation: Living with Climate Change

Even with aggressive mitigation, some warming is unavoidable. Adaptation reduces damages from climate change we can't prevent.

Types of Adaptation

Anticipatory vs. Reactive:

• Anticipatory: Planning and preparing before impacts occur (seawalls, drought-resistant crops)
• Reactive: Responding to impacts after they occur (disaster relief, migration)

Autonomous vs. Planned:

• Autonomous: Individuals and markets adapt without policy (farmers switch crops, people install AC)
• Planned: Government-led adaptation infrastructure and policies

Hard vs. Soft:

• Hard: Physical infrastructure (seawalls, irrigation systems, cooling centers)
• Soft: Policies, behavior change, ecosystem-based approaches (wetland restoration, urban forests)

Adaptation Strategies by Sector

Coastal Protection:

• Seawalls, levees, and storm surge barriers
• Managed retreat from vulnerable areas
• Natural defenses (dunes, wetlands, mangroves)
• Building codes and land use restrictions

Water Resources:

• Reservoir expansion and management
• Desalination
• Water conservation and efficiency
• Groundwater management
• Drought planning

Agriculture:

• Drought and heat-resistant crop varieties
• Shifted planting dates and crop choices
• Improved irrigation efficiency
• Crop insurance
• Diversification

Health:

• Heat wave early warning systems
• Cooling centers
• Disease surveillance and vector control
• Healthcare infrastructure resilience
• Emergency preparedness

Infrastructure:

• Climate-proofing roads, bridges, utilities
• Cooling for transportation systems
• Flood-resistant design
• Grid resilience
• Redundancy in critical systems

Ecosystem-Based:

• Wetland restoration (flood control, water filtration)
• Urban forests (cooling, air quality)
• Green infrastructure (rain gardens, bioswales)
• Biodiversity conservation (resilience)
• Nature-based coastal protection

Adaptation Costs

Global Estimates:

• Developing countries: $140-300 billion per year by 2030
• Global: $300-500 billion per year by mid-century
• Could reach trillions annually by 2100 without mitigation

For Context:

• Current adaptation spending: ~$30-50 billion per year
• Massive adaptation finance gap
• Poor countries least able to afford needed adaptation

Limits to Adaptation

Physical Limits:

• Can't adapt to multi-meter sea level rise in low-lying regions
• Some agricultural regions become uninhabitable
• Coral reefs can't adapt to rapid warming
• Some ecosystems cross irreversible thresholds

Economic Limits:

• Adaptation extremely costly beyond certain warming levels
• Poor countries can't afford needed adaptation
• Compounding impacts exceed adaptive capacity

Social Limits:

• Massive displacement and migration politically destabilizing
• Loss of cultural heritage and identity
• Psychological and social impacts of constant adaptation

The Threshold: Most analyses suggest adaptation becomes extremely difficult and costly above 3-4°C warming. Beyond this, we're in unmanageable risk territory.

Adaptation vs. Mitigation: Not Either/Or

The Relationship:

• More mitigation → less adaptation needed
• Less mitigation → more adaptation required (and more expensive)
• Both are necessary
• Mitigation has limits (we've already warmed ~1.2°C)
• Adaptation has limits (beyond certain warming, adaptation fails)

Resource Allocation: How much to spend on mitigation vs. adaptation?

Economic Logic:

• Mitigation: High upfront costs, benefits accrue over long term globally
• Adaptation: Ongoing costs, benefits local and near-term

Equity Consideration:

• Rich countries can afford adaptation but should mitigate (they caused the problem)
• Poor countries need adaptation funding but shouldn't bear mitigation costs alone

Optimal Strategy: Significant investment in both, with mitigation as primary strategy and adaptation as necessary complement.

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The Economics of Climate Policy Design

Timing: When to Act?

The Gradualist View (Early Nordhaus):

• Start with modest policies
• Gradually increase stringency over time
• Let technology improve and make mitigation cheaper
• Minimize near-term economic disruption

The Urgency View (Stern and others):

• Act aggressively now
• Carbon budget limited (cumulative emissions matter)
• Delay makes problem harder and more expensive
• Risk of irreversible tipping points
• Earlier action allows smoother transition

Current Scientific Consensus:

• Carbon budget rapidly depleting
• Need rapid emissions reductions this decade
• Delay closes the window to ambitious targets
• Every ton of CO₂ avoided now matters

Economic Reality of Delay:

• Stranded assets (fossil fuel infrastructure retired early)
• Rushed transition more expensive than planned
• More adaptation costs
• Higher risk of climate damages

Equity and Burden Sharing

The Challenge: Who should bear mitigation costs?

Principles in Tension:

1. Grandfathering (Status Quo):

• Each country reduces from current emissions
• Favors high emitters
• Perpetuates historical inequality

2. Equal Per Capita:

• Everyone entitled to same per capita emissions
• Requires massive reductions in rich countries
• Allows growth in developing countries

3. Historical Responsibility:

• Countries responsible proportional to cumulative emissions
• Rich countries caused the problem, should pay for solutions
• Politically controversial

4. Capacity to Pay:

• Countries contribute based on wealth and ability
• Rich countries can afford more
• Helps overcome free-rider problem

5. Egalitarian:

• Everyone bears equal sacrifice (% of income or GDP)
• Different from equal per capita outcomes

Paris Agreement Approach:

• Nationally determined contributions (each country sets own target)
• Developed countries should "take the lead"
• Financial support for developing countries
• Differentiated responsibilities based on capabilities

The Equity-Efficiency Trade-off:

• Economically efficient: reduce emissions where cheapest (often in developing countries)
• Equitable: rich countries bear more burden
• Solution: Rich countries finance mitigation in poor countries while meeting their own targets

Technology and Innovation

The Role of Innovation: Climate mitigation requires massive technological transformation. But should we wait for breakthrough technologies or act with current tools?

The Waiting Trap: "We shouldn't act yet—wait for better technology to make it cheaper."

Problems with Waiting:

• Carbon budget depleting
• Technologies improve through deployment, not waiting
• Lock-in to fossil infrastructure
• Risk of irreversible damages

Induced Innovation: Climate policies (carbon prices, regulations) incentivize innovation:

• Create demand for clean technologies
• Make clean R&D more profitable
• Accelerate learning curves
• Build supply chains and expertise

Directed Innovation: Public R&D investment crucial:

• Basic research (high risk, high reward)
• Demonstration projects
• Early-stage support
• Mission-oriented innovation programs

Historical Analogies:

• Manhattan Project
• Apollo Program
• Green Revolution
• Internet development

All combined public investment, private innovation, and supportive policies.

International Cooperation: The Free-Rider Problem

The Challenge: Climate is a global public good. Each country benefits from others' mitigation but has incentives to free-ride.

The Logic:

• Mitigation is costly
• Benefits are global
• If others mitigate, I benefit without paying
• If others don't mitigate, my efforts won't matter much anyway

Result: Without coordination, everyone free-rides, no one mitigates enough, we all suffer.

Cooperation Mechanisms:

Treaties and Agreements:

• Framework Convention on Climate Change (1992)
• Kyoto Protocol (1997): Top-down binding targets
• Paris Agreement (2015): Bottom-up pledges with review

Why Cooperation Is Hard:

• 195+ countries with different interests
• Enforcement difficult (no world government)
• Verification challenges
• Distributional conflicts
• Short-term costs vs. long-term benefits

Why Cooperation Can Work:

• Repeated interaction builds trust
• Reputational concerns
• Side payments and linkages
• Tipping points in technology and policy
• Climate clubs (coalitions of willing)

Emerging Strategies:

• Carbon border adjustments (tariffs on imports from non-compliant countries)
• Climate clubs (benefits for members, pressure on non-members)
• Green industrial policy (clean tech competitive advantage)
• Fossil fuel subsidy elimination
• Methane pledges (faster-acting greenhouse gas)

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Controversial Debates in Climate Economics

Discount Rates: The Most Consequential Disagreement

We've discussed this, but it's worth emphasizing: the choice of discount rate drives policy recommendations more than any other factor.

High Rate (≈5%) - Nordhaus Approach:

• Based on market rates of return
• Future damages heavily discounted
• Recommends gradual mitigation
• Avoids large near-term costs

Low Rate (≈1.4%) - Stern Approach:

• Based on ethical considerations
• Future damages matter substantially
• Recommends aggressive immediate action
• Justifies high near-term costs

Declining Rates - Compromise Approach:

• High rates near-term (reflect opportunity cost)
• Low rates long-term (reflect intergenerational ethics)
• Middle ground on policy urgency

The Stakes: This technical-seeming debate embodies fundamental ethical questions: How much do we value future generations? Are their lives worth as much as ours?

Climate Sensitivity and Damage Functions

Climate Sensitivity: How much warming results from doubled CO₂ concentrations?

• Low estimates (2°C): Less urgent action
• High estimates (4-5°C): Very urgent action
• Uncertainty range substantial

Damage Functions: How much economic harm from each degree of warming?

• Optimistic: Modest damages, significant adaptation
• Pessimistic: Severe damages, limited adaptation capacity
• Non-linear: Small initial impacts, then accelerating

The Debate: Are damage functions well-founded or speculative? Do they adequately capture catastrophic risks?

Geoengineering: Economic Wildcard

What Is It? Deliberately manipulating Earth's climate system to counteract warming:

Solar Radiation Management (SRM):

• Reflecting sunlight (stratospheric aerosols, marine cloud brightening)
• Cheap ($1-10 billion per year)
• Fast-acting (cools within years)
• Doesn't address ocean acidification
• Potential severe side effects
• No off switch (sudden termination would be catastrophic)

Carbon Dioxide Removal (CDR):

• Removing CO₂ from atmosphere
• Multiple approaches (forests, BECCS, direct air capture, ocean fertilization)
• Expensive (hundreds of dollars per ton)
• Slow-acting (takes decades)
• More like "real" solution

Economic Arguments For:

• Insurance policy against worst outcomes
• Buys time for mitigation
• Could be cost-effective compared to damages

Economic Arguments Against:

• Moral hazard (reduces mitigation efforts)
• Unknown risks and side effects
• Governance challenges (who decides?)
• Doesn't address root cause
• Could worsen inequality (different regions affected differently)

Current Consensus: CDR necessary at some scale (especially for 1.5°C target). SRM extremely controversial; research useful but deployment very risky.

Economic Growth and Degrowth

Standard View: Climate action compatible with continued economic growth through:

• Technology and efficiency
• Decoupling growth from emissions
• Green growth

Degrowth View: Rich countries should deliberately reduce material throughput and energy use:

• Efficiency insufficient (Jevons paradox)
• True decoupling at necessary scale not demonstrated
• Growth imperative drives consumption and emissions
• Focus on wellbeing, not GDP

The Debate:

• Is green growth possible at needed scale and speed?
• Can renewables fully replace fossil fuels and support growth?
• Do we need degrowth in rich countries?
• How does this affect developing countries' right to develop?

Practical Middle Ground: Regardless of whether growth continues:

• Emissions must rapidly decline (non-negotiable physical constraint)
• Wellbeing should be the goal, not GDP growth itself
• Different pathways possible for different countries

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Reflection Questions

1. Discounting Ethics: You choose the discount rate for climate policy in your country. What rate would you choose and why? How do you balance current economic costs against future climate damages?

2. Mitigation vs. Adaptation: If you had $100 billion to spend on climate policy, how would you allocate it between mitigation and adaptation? What factors influenced your choice?

3. Global Equity: Should rich countries that historically emitted the most CO₂ bear more responsibility for mitigation? Should they fund adaptation in poor countries? Why or why not?

4. Personal Trade-offs: What climate-related changes would you accept in your own life? Higher energy prices? Dietary changes? Less flying? How do personal costs affect your views on policy?

5. Uncertainty: How should we make decisions when climate impacts are uncertain but potentially catastrophic? Is cost-benefit analysis sufficient, or do we need additional principles?

6. Technology: Should we invest heavily in unproven technologies (like carbon capture or fusion energy) or focus on deploying existing technologies? What's the right balance?

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Key Takeaways

✓ Climate change is economics' ultimate challenge, combining massive externalities, global commons, long time horizons, irreversibility, and distributional injustice

✓ The Social Cost of Carbon (SCC) estimates damages from emitting one ton of CO₂, with estimates ranging from $30-100+ per ton depending primarily on discount rate choice

✓ Climate damages span agriculture, sea level rise, health, extreme weather, ecosystems, and potential catastrophic tipping points, with costs potentially reaching 5-20% of global GDP

✓ Mitigation costs are estimated at 1-4% of GDP by 2050 for 2°C target, but may be lower than expected due to rapid technology cost declines and co-benefits

✓ Carbon pricing (taxes or cap-and-trade) is the central economic tool for mitigation, internalizing the externality, though political challenges keep prices below optimal levels

✓ Adaptation is necessary but has limits; costs could reach hundreds of billions annually and some impacts are simply not adaptable beyond certain warming levels

✓ Timing matters: Delay makes mitigation more expensive, increases adaptation needs, and risks irreversible tipping points

✓ Equity challenges are central: Those who caused the problem have most resources to address it; those who contributed least suffer most

✓ International cooperation is essential but difficult due to free-rider incentives, distributional conflicts, and enforcement challenges

✓ Discount rates drive policy conclusions more than any other factor, representing fundamental ethical choices about intergenerational equity

✓ Multiple policy instruments are needed: carbon pricing for efficiency, regulations for specific barriers, subsidies for technology development, and international cooperation mechanisms

✓ The economic case for climate action is strong: Even moderate estimates suggest mitigation costs are far less than damage costs, especially when catastrophic risks are considered

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Glossary

Adaptation: Actions to reduce vulnerability to climate change impacts that are unavoidable

Carbon Budget: The cumulative amount of CO₂ that can be emitted while limiting warming to a specific target

Carbon Capture and Storage (CCS): Technology that captures CO₂ from emission sources or air and stores it underground

Carbon Dioxide Removal (CDR): Technologies and practices that remove CO₂ from the atmosphere

Carbon Pricing: Policies that put a price on carbon emissions, either through taxes or cap-and-trade systems

Climate Sensitivity: The amount of warming expected from a doubling of atmospheric CO₂ concentrations

Damage Function: The relationship between temperature change and economic damages in climate models

Decoupling: Separating economic growth from environmental degradation or resource use

Degrowth: The deliberate reduction of material and energy throughput in wealthy economies

Geoengineering: Deliberate large-scale intervention in Earth's climate system to counteract warming

Integrated Assessment Model (IAM): Economic model that combines climate science, economic impacts, and policy to evaluate climate strategies

Mitigation: Actions to reduce greenhouse gas emissions or enhance carbon sinks to limit climate change

Net Zero: Achieving a balance between greenhouse gas emissions and removals

Social Cost of Carbon (SCC): The present value of all damages caused by emitting one additional ton of CO₂

Solar Radiation Management (SRM): Geoengineering approach that reflects sunlight to cool the planet

Stranded Assets: Fossil fuel infrastructure or reserves that lose value due to climate policies or energy transitions

Tipping Point: A threshold beyond which a climate system changes abruptly and potentially irreversibly

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Looking Ahead to Module 5

You now understand the economic dimensions of climate change—arguably the most important application of environmental economics. In Module 5, we'll shift focus to Circular Economy and Resource Management, exploring how we can redesign economic systems to eliminate waste, extend product lifespans, and create closed-loop material flows.

The circular economy represents a different approach to sustainability—focusing not just on reducing carbon emissions but on fundamentally rethinking how we design products, use materials, and organize production systems. You'll learn about industrial ecology, lifecycle thinking, and business models that prove profitability and sustainability can align.

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Additional Resources

Books:

• "The Climate Casino" by William Nordhaus (economist's perspective on climate change)
• "Climate Shock" by Gernot Wagner and Martin Weitzman (uncertainty and risk in climate economics)
• "Drawdown" edited by Paul Hawken (comprehensive solutions analysis)
• "The New Climate War" by Michael Mann (overcoming obstacles to climate action)

Reports:

• IPCC Reports (especially Working Group III on mitigation)
• Stern Review on the Economics of Climate Change (2006)
• Global Commission on the Economy and Climate reports
• World Bank climate reports

Academic Papers (Classics):

• "The Economics of Climate Change" by Nicholas Stern (2007)
• "A Question of Balance" by William Nordhaus (2008)
• "Climate Sensitivity Estimates" - various IPCC summaries

Data and Tools:

• Carbon pricing dashboard (World Bank)
• Climate Action Tracker (tracks country commitments)
• Global Carbon Project (emissions data)
• Our World in Data - CO₂ and Greenhouse Gas Emissions

Online Courses:

• Climate Change Economics (various universities on Coursera, edX)
• Project Drawdown resources
• Climate Interactive (En-ROADS climate simulator)

For Deeper Exploration:

• "Journal of Environmental Economics and Management" - climate economics research
• "Nature Climate Change" journal
• Resources for the Future (RFF) climate policy analysis
• Brookings Institution climate economics research

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Congratulations on completing Module 4! Climate change is the defining environmental challenge of our time, and you now understand its economic dimensions—why it's so hard, what it will cost, and what economics tells us about solutions. The good news: economically optimal climate action is feasible and far less costly than inaction. The challenge: political will and international cooperation. Take a break to process these complex topics, and when you're ready, we'll explore the circular economy in Module 5.