Tackling the Economics of Climate Change

No other topic demonstrates the interdependence of our own surroundings with global developments as saliently as climate change does. Economists from all backgrounds agree that climate change will have an unprecedented effect on economic and societal development and should be one of our top priorities. We talked to David Hémous about the challenges economists and politicians face when trying to work out our best response to climate change – fast.

Interview with David Hémous

Why does research on the effects of climate change come to such varying predictions?
Firstly, there is a lot of uncertainty. We do not know precisely how temperatures will rise based on CO₂ emissions and we do not know the economic effects of these changes in temperature. How much does an increase in sea level or an additional tornado cost society? Secondly, climate change policies involve a trade-off between the present and the future. Depending on how much you value the future compared to the present, you will set different discounting parameters in your economic models and arrive at vastly different results.

You study innovation. Global response to climate change has surely spurred innovation, which is a good thing for the economy...
The desire to fight climate change and the corresponding policies can be a driver for innovation. When the gas price goes up, there is more innovation in clean cars, electric and hybrid engines etc., and less in regular combustion motors. However, it is difficult to say that policies will increase the total amount of innovation. Typically, you shift resources from one area to another. If you do R&D in clean technologies, then you are not doing R&D somewhere else, e.g. in Artificial Intelligence.
We saw a lot of innovation into cleaner energy production in the 2000s, however, this trend somewhat reversed in the 2010s.

Why?
I am currently working on research that suggests that this decline may be due, at least in part, to the effect of the shale gas revolution in the US. The cheap access to shale gas (fracking) makes the natural gas sector cheaper. This increases innovation in the area of turbines for gas power plants, but not for solar panels. Now although the innovation in natural gas energy production decreases emissions in the short term, as shale gas is cleaner than coal, it reduces green innovation and leads to an increase in emissions further down the line. Natural gas energy is still dirtier than solar energy.

What environmental policies should we be considering?
If we are able to implement and enforce global policies, then a carbon tax should definitely be part of the answer. In addition, you will also want to subsidize innovation in clean technologies. So far, we have been a society that depends on fossil fuels, so we have seen a lot of innovation in that area. With subsidies, you can move innovation away from fossil fuels to other forms of energy.  
In practice, however, it is going to be very hard to implement a global carbon tax. Imagine you implement a carbon tax on production in Switzerland. Some of the production will move away to countries that do not have such a tax. That would harm the Swiss economy and give an unfair advantage to countries that are emitting CO₂. Therefore, we will also need to consider some measures to apply to countries that do not participate in the carbon taxation. For example, you could implement carbon tariffs on products that are produced in countries that do not tax carbon emissions.

That sounds quite impossible to implement.
It is not impossible but it’s not easy either. The tariff would need to be based on the amount of carbon that is embodied in the good that you import, which is not always easy to measure. In addition, tariffs would have to be compatible with WTO rules. At this stage, it is not clear how this would be done. Nevertheless, there are many areas in which a carbon tax is easy to implement and will lead to direct results, i.e. when CO₂ emittance and end-user consumption happen in the same place, such as heating your house or driving your car.

If global answers are required, what can a small country like Switzerland do?
Even if Switzerland becomes zero carbon, it won’t really make a difference, as long as the rest of the world keeps emitting a lot of carbon. Therefore, I believe that, the smaller you are, the more you will want to push in the area of innovation. As a small country, you can take on a leading role in clean technology innovation. You can sell this to the rest of the world and thereby reduce emissions not only at home but also abroad. Through innovation power, even a small country like Switzerland can create a significant impact on global emissions. It is the same on the individual level. Admittedly, catching one’s own C0₂ emission will only have a limited impact. However, the social movement surrounding individual action can have an effect on efficient policy, because politicians have to react to it. 

Why do we need more research in the area of Economics of Climate Change?
In addition to climate scientists and engineers, we need economists to quantify costs and model alternative approaches. Economists are well equipped to tackle the central questions regarding policy design, taxations, tariffs, questions of redistribution, political economy challenges, etc.