The Social Cost of Carbon Economists!

When you fly on an airplane or eat steak or take an Uber Honda Civic to a restaurant, you contribute to the climate change challenge as you use fossil fuels to achieve your goal. Your fossil fuel consumption can be measured in tons of carbon dioxide. Americans have a bigger “carbon footprint” than people from poorer nations. How much damage (social costs) are we causing to the world when our actions produce another ton of carbon dioxide?

You might think that economists could do a good job here measuring this Social Cost of Carbon. Plenty of economists are happy to report this number but what is the basis for their knowledge? How confident should you be that they know what they are doing here?

Consider Matthew E. Kahn. I am one person currently living on this planet. I have a willingness to pay (WTP) to not be exposed to one more ton of carbon dioxide. As I discuss below, my willingness to pay to not be exposed to these emissions depends on how such emissions raise my mortality risk, lower my income, and lower my quality of life in places where I live and own assets. I am a father and a Uncle and I worry that this extra ton could pose risks to my child and niece. There are 8 billion other people on this planet. To estimate the world’s $ Social Cost of Carbon we need to estimate each person’s $ WTP at each point in time and add them up. This yields the $ SCC.

THERE are reasons to believe that the SCC is rising over time.

#1 There are more people on the planet so we add up this algebra for more people.

#2 As we grow richer, our willingness to pay to avoid risk increases. Take a look at my 2004 paper with Dora.

#3 As the global concentration of CO2 continues to rise, the marginal damage from more emissions can certainly rise under “business as usual”.

Controversy; I believe that the Social Cost of Carbon is declining.

Let’s start with some mechanical economics.

The Nobel Laureate William Nordhaus wrote out a model that yields a Social Cost of Carbon and many younger scholars have extended his model. I love that these climate economic models are explicit about their assumptions. Let’s review these building blocks;

Equation #1: A Global Emissions function that increases as population and per-capita income rises.

Equation #2: A global temperature sensitivity equation such that global average temperature rises as a function of global cumulative emissions.

Equation #3; A GNP Damage function such that the world economy becomes poorer as global average temperature increases.

The typical physicist will like the Nordhaus model because it is an “orderly” set of mathematical equations. It is a low dimensional system that can be solved on a computer. There is a capital stock, a population, a per-capita income, a global emissions intensity and a temperature sensitivity parameter and a calibrated damage function.

I deeply respect that this model is honest about its assumptions.

How does the Social Cost of Carbon emerge here? Take the damage function and evaluate it any point in time by plugging in the temperature at that given moment and calculate what is the marginal lost GNP as an extra ton of Carbon dioxide is emitted. This extra ton raises temperature by a little bit and this gets plugged into the damage function to yield the lost GNP. Nice and tidy!!

Yet, this is bad microeconomics. There is little economic geography in this setting. The whole world could live in Texas if the U.S opened up our borders. Market structure and market prices play a key role in determining how place based weather shocks impact our quality of life.

The funny irony is that Nordhaus shared the Nobel Prize with Paul Romer and Romer’s ideas explain why this mechanical 3 equation Model is a terrible prediction model.

Why? Over the last 15 years, I have argued that the mechanical equation #3; the damage function is a lousy representation of how an economy featuring diverse people and firms adapts to an anticipate threat.

There are 8 billion people on this planet.

We are not passive victims as the world warms. Each of us has strong incentive to seek out solutions as we seek to be healthy, comfortable safe and to rear flourishing children. As Paul Romer has taught us, ideas are public goods. Through experimentation and learning, we will discover new ways to adapt to every challenge that climate change poses. Such innovators will grow rich selling these products to us. Mass production will give us better housing, better food, better transport and robust strategies to be productive in the midst of extreme weather. The irony here is that the worse the challenge is expected to be —- the more innovation will occur.

This messy innovation process is missing in the mechanical Nordhaus model. Milton Friedman has a great YouTube video on where the Pencil came from. This is my question for Professor Nordhaus; Where is the adaptation “pencil”?

The world’s population is growing richer and rich people want less risk in their lives. This demand side push creates incentives for firms to deliver safety.

The world is urbanizing. We are building great universities all around the world. Young people choose what to study in school. There will be great future careers in urban resilience. These will be private sector jobs. These won’t be public sector jobs. Urban real estate’s value is partially based on resilience to extreme weather.

The human capital embedded in 8 billion people in a world awash with Venture Capital offers enormous adaptation possibilities.

Young people can always move to new places. If older people are stuck in place or refuse to leave, then they can move to higher ground in areas where we are retreating from.

Do you really believe that Southern Florida will need to be evacuated because of sea level rise? What will occur is that areas below sea level will either be protected or developers will build structures on higher floors with exit and entry strategies for entering such buildings. Do you doubt the power of civil engineering? You get on an airplane several times a year.

In the American West, I do believe that PM2.5 spikes due to wildfires will get worse. We will adapt to that by changing our forest management strategies and investing more in better windows and air filter systems. Information technology will provide pinpoint geography and time stamps concerning when the risks are higher.

We can adapt to any threat that we anticipate. This is why imagination is so important here.

So, the reason that I believe that the Social Cost of Carbon is declining over time is due to the following checklist;

#1 The death risk from disasters, heat and PM2.5 is declining over time due to innovation and information provision

#2 Our economy’s resilience in the face of disaster shocks will continue to rise. Our productivity will be less sensitive to weather shocks. This includes the agricultural sector. International trade and storage decouples consumption from production so that any production shocks have less of a scaring effect on the population.

#3 Our real estate will become more robust in the face of disaster risk. I have written several Substack columns on this point.

#4 The world economy is urbanizing and we have many different cities and locations to choose from. Those who are more risk loving will find more affordable housing in relatively risky areas. Such adults are “free to choose”.

The Social Cost of Carbon economists view us as passive victims who do not use our wits, markets to make progress solving the serious problems we face. Such SCC economists embrace the Paul Ehrlich mindset that there are “limits to growth” and that climate change will slow our growth. I might go so far as to argue that the fear of climate change will accelerate world economic growth as the world’s poor nations urbanize at an extra fast rate and as we focus on needed innovation to address the challenges we face.

Hayek not Nordhaus! If this discussion interests you, read my 2010 Climatopolis book and my 2021 Adapting to Climate Change books.

Why don’t the young economists incorporate my points into their mathematical models? The truth is that they can’t. There almost an infinite number of adaptation margins and they can’t handle all of those state variables in their math so they simply ignore all of these margins and then predict what the world will be like in 2080 under “business as usual”. Such an approach represents the “social cost of carbon economists”. Their work highlights what costs we may suffer if we FAIL to adapt but the journalists and advocates ignore this nuance and run with the headline numbers.