Two Models, One Planet

There are two well-known economists, whose contributions have stood out in climate change: William Nordhaus and Nicholas Stern. While Nordhaus had highlighted the adverse effects of greenhouse gases as far back as 1977, Stern is best known for the Stern Review: a report he authored for the UK government to help in its response to climate change.

Nordhaus is best known for his Dynamic Integrated Model of the Climate and the Economy (DICE), which is a type of Integrated Assessment Model, where greenhouse gas emissions and climate change are integrated into a neoclassical growth model. There have been three iterations of DICE: the simplest one in 1992, and later in 2016 and 2023. The basic arguments remain the same: the world invests in capital goods or in technologies that reduce emissions, which in turn reduces consumption/welfare/utility today, so that future consumption/utility/welfare can be increased. These climate investments reduce consumption today but also prevent damage from climate change and increase consumption possibilities in the future. More technically, the DICE models have the following components:

The objective function, which is the global welfare or utility, depends on per capita consumption.

A Production Function (Cobb-Douglas), in which output is a function of Capital and Labour, with increasing total factor productivity. Further, output is reduced by damages caused by greenhouse gas emissions and abatement costs incurred for reducing greenhouse gas emissions.

A Damages Function, which represents damages caused by greenhouse gas emissions and climate change. Damages are a function of the global mean temperature increase since pre-industrial times (it is a quadratic function).

An Abatement Cost Function where costs of emissions reduction are a function of the rate of reducing emissions: this is a convex function, which means that the marginal cost of emissions reduction rises non-linearly with the quantity of emissions reduction.

An Emissions Reduction Function which represents the fossil fuel and industrial emissions, emissions from land-use change and emissions from permafrost.

The Geophysical equations which link emissions to radiative forcing (change in net flow of energy due to greenhouse gas emissions and solar radiation), temperature change and the carbon cycle.

Nicholas Stern also used an Integrated Assessment Model similar to Nordhaus’ DICE model described above. His Review is best known for the conclusion that climate change, if left unabated, will have a considerable impact on economic growth and human welfare. Further, the abatement costs will be far lower than in a ‘Business as Usual’ scenario. The key takeaways from the Stern Review are:

Since the stock of greenhouse gases has a direct impact on global mean temperature, a stabilisation target for the stock of such gases is the best way to frame policies.

From this stock target, a flow path for emissions reductions (which is a flow) can be chosen, depending on the costs: from here, the Marginal Abatement Cost can be determined. This, in turn, can lead us to the marginal price for damages caused by greenhouse gases.

The economics of risk and uncertainty, intergenerational trade-offs and discounting the future and international economic policy would inform the above.

The stock of greenhouse gases was 430 ppm in 2007 (it is about 480 ppm today) and had already led to a global warming of 0.5°C (it has risen by about 1.2°C today).

A working target for the stock of CO2 equivalent by 2050 would be 550 ppm.

To reach this target would require a 30-50 per cent cut in emissions by 2050

This would cost about 1 per cent of world GDP. The carbon price required for this would be USD 30/ton of CO2.

It is better to incur this cost now, rather than wait for 30 years, by which time the ask would have risen to 4 per cent of GDP, which would be far more difficult to garner.

Even with a target of 550ppm, the probability of hitting 3°C is 69 per cent, 4°C is 24 per cent and 5°C is 7 per cent. If we go with ‘business as usual’, the greenhouse gases would hit 750ppm by 2100, where a 5°C warming has a 50 per cent probability (This happened 35-50 million years ago in the Eocene period, when the world was a swampy forest and alligators used to roam the areas near the North Pole).

Conclusion

Both Nordhaus and Stern used Integrated Assessment Models of Climate Change and Economics and made policy prescriptions based on the findings of these models. However, their policies differed because of the way they value the future and issues of inter-generational equity. We will undertake a more detailed comparative analysis of their approaches in the next article.