Dora subscribes to the Financial Times. This morning I read this quote by an important Norwegian.
Nicoloi Tangen is a CEO and I am just a humble academic but permit me to investigate his interesting claim. There are two pieces to it. One part of his claim is false and one part of his claim is true.
The True Claim: The pursuit of decarbonizing the world economy will raise consumer prices in the short run and the medium term. The price of electricity and the price of durables will all rise because of the global decarbonization push. There is “no free lunch”. Our fossil fuel intensive economy has offered all of us cheap, polluting energy. As we pursue a “green economy”, the levelized cost of supplying this power to power hungry urban consumers will be higher. Now if nations introduce dynamic pricing, these costs will be lower. Our existing durable capital stock will require trillions of dollars of investments to transition our economy and the price of these upgrades will be incorporated into the costs of all goods.
The False Claim;
Climate change will cause “large food price inflation”. Mr. Tangen talks about the price of olive oil and potatoes. All development economists know that with economic development that people spend a smaller share of their budget on food. In the United States, we spend roughly 10% of our income on food. So, a 20% increase in food prices (a huge increase) would reduce our real incomes by 2%. Suppose the price of olive oil increases by 20% per year, would people search for substitutes? Inflation is the wrong word for price increases when relative prices change. Some goods will become relatively cheaper as the price of olive oil rises as extreme weather shrinks olive crops. Some consumers are always at the margin and will substitute from olive oil to these ten alternatives.
If food prices rise, this actually enriches farmers in the developing world. So, are higher food prices good or bad? Yes, they hurt urban consumers in the developing world but they can lobby their governments to reduce agricultural tariffs and urbanites earn more money and spend a lower % of their incomes on food. See Dora’s JPE paper on Engel Curves and Bruce Hamilton’s AER paper.
What I find interesting about Mr Tangen’s quote is that he is trying to use his financial expertise to make the case for global decarbonization. He has every right to do this but he is conflating two claims. He is implicitly saying; “We will face inflation because climate change shocks raise the price of stuff we consume (the olive oil) and because our upcoming mitigation efforts will further drive up prices.”
The exaggeration in his quote is that the first statement accounts for roughly 2% of the total decomposition of how “climate change causes inflation”. I would restate his argument and instead say; “enormous climate change mitigation efforts cause inflation”. These may still prove to be good investments for future generations but it is important to be honest about where the bulk of the costs occur.
From basic supply and demand, I agree with Mr. Tangen that negative weather shocks raise agricultural produce prices but these price hikes are limited for nations with low tariffs and quotas on international imports. Consumers have multiple substitution possibilities. Do not forget the Stigler Diet problem. Even economists these days implicitly assume that we have “Leontief preferences” such that we are unable to substitute away from our past product choices and are price gouged as prices increase.
Suppose for old people this is true. There is always a new generation of young people who are more “flexible” and if they adapt by not eating a heavy olive oil diet (or whatever’s price that has increased) then aggregate demand eventually declines as their generation ages. Economists studying the climate change adaptation issue can’t forget substitution possibilities and the overlapping generations model. We are more flexible as we seek to be healthy, happy and comfortable. A 40% increase in the price of olive oil would you what loss in consumer surplus? Why does it cause you such a loss? This is the deep structural economics issue that interests me. Read John Rust’s 2014 JEL review of the Wolpin book to think more about this issue. How structural are utility functions? If are preferences adjust, then what is the damage from climate change if climate change risk does not cause survival risk or destroy our key productive assets? This is what I am researching now.
A point to include in the mix: Increased CO2 increases agricultural productivity. This is why people have greenhouses. That implies a reduction in food prices. In practice, it's a bit more complicated because some crops do better and some worse -- although we are talking about very small changes in temperature. David Friedman has a good discussion of this on his blog.