In the Climate Change series, we have covered international negotiations on climate change under the aegis of the United Nations Framework Convention on Climate Change (UNFCCC), mitigation and adaptation measures, climate finance, climate justice, and carbon dioxide removal (CDR). In the article The Science of Climate Change, published on January 4, 2026, in this paper, I also discussed the contributions of the pioneers in this field: Fourier, Tyndall, Arrhenius, and Keeling. In the next two articles, we will discuss the economics of climate change and related issues.
Greenhouse Gases, Carbon Cycle, Climate Change and Global Warming: A Recap
To recap, the central issues in climate change are as follows:
• Greenhouse gas emissions (mainly carbon dioxide) are a result of economic growth, which has been fuelled largely by fossil fuels.
• The annual flow of greenhouse gases contributes to the build-up of the stock of greenhouse gases. The stock of greenhouse gases at any time is a function of the carbon cycle, which is essentially the exchange of carbon atoms between the atmosphere, Earth, oceans, and living organisms through the processes of photosynthesis, respiration, decomposition, combustion, sedimentation, and weathering. In other words, much of the carbon emitted by anthropogenic activities is absorbed by the oceans and forests, while the rest finds its way into the atmosphere.
• The stock of greenhouse gases leads to the “greenhouse effect”, whereby these gases trap heat from the sun, making the Earth habitable. However, the stock of these gases has reached unsustainably high levels, leading to global warming, which in turn drives climate change and its adverse effects.
The Economics of Climate Change: Key Issues
Samuelson’s public goods theory informs the economics of climate change at the outset: the reversal of global warming is a public good and therefore has two characteristics—(a) non-excludability, i.e. once a good is provided, the benefits flowing from it cannot be denied to anyone, and (b) non-rivalry in consumption, i.e. one person’s consumption does not reduce the quantity available for others. Since public goods are consumed jointly or collectively, their supply poses a problem: everyone wants such goods, but no one is willing to pay for them. This is the free-rider problem, which is widespread in climate change negotiations—everyone wants to stop global warming, but no one is willing to pay for it.
As noted above, global warming caused by climate change is a public “bad” and a negative externality. To prevent this “bad” from occurring—that is, to prevent greenhouse gas emissions—there must be a disincentive for the polluter. Economists often prescribe fiscal policy, which includes taxes or subsidies, the setting of regulations and standards, and cross-border measures.
i) Fiscal Policy:
This includes a carbon tax on emissions, suggested long ago by A. C. Pigou, who propounded the “polluter pays” principle. A carbon tax on producers and consumers of goods and services would increase the prices of such goods and services, leading to a fall in demand.
Another fiscal policy intervention is a cap-and-trade scheme, wherein a cap is set on the total emissions permitted in an economy, and industries or producers of emissions are allotted a certain number of emission permits. These permits are then traded among industries at a carbon price discovered by the market. The purpose of such a scheme is to incentivise reduced emissions. Cap-and-trade schemes are operational in the European Union, China, and in the state of California in the United States.
The third type of fiscal policy intervention is the provision of outright subsidies to renewable energy sources such as solar and wind power, as well as electric vehicles.
ii) Regulation and Standards:
Another economic policy intervention is the setting of regulations and standards in various areas, such as efficiency standards for electrical appliances, building codes, and emission standards for industries and vehicles.
Putting Theory into Practice: William Nordhaus and Nicholas Stern
The economic theory that informs climate change was further developed by many economists, but the contributions of William Nordhaus and Nicholas Stern stand out. Nordhaus was the winner of the Nobel Prize in Economics in 2018, while Stern was an adviser to the Prime Minister of the UK and the author of The Stern Review, a 700-page document submitted to the UK government to help understand and frame policies on climate change. In the next article, we will examine the work of Nordhaus and Stern in greater detail.
Conclusion
Stabilising the stock of greenhouse gases and reducing emissions of such gases is a global public good and is therefore characterised by collective action problems, such as free riding, that arise in the supply of such goods. Samuelson’s public goods theory informs our analysis here. Several economic interventions, including fiscal policy (taxes and subsidies) and regulations and standards, can help address these challenges. Well-known economists William Nordhaus and Nicholas Stern have also proposed a range of policies, which we will take up in the next article.