Reducing greenhouse gas emissions helps the economy

Potential solutions to climate change are often framed as a tradeoff between reducing our impact on the environment and harming the economy. More specifically, it is thought that we can reduce our climate-change-related impact by reducing emissions of greenhouse gases but that this will inevitably harm the economy by making energy more expensive. Under this framing, it is natural for people to strongly disagree about climate-policy prescriptions since individuals will inevitably diverge in the relative value they place on environmental vs. economic concerns.

However, the issue of whether or not it is in society’s collective best-interest to reduce greenhouse gas emissions is not as complicated and subjective as the above framing makes it seem. In fact, as long as climate change costs the economy anything (and the cost increases steadily with emissions), then it is in our collective best interest economically to reduce emissions. In other words, you don’t need to care about any non-monetizable environmental impact in order to be in favor of reducing greenhouse gas emissions. All you have to be in favor of is maximizing global economic production.

Richard Tol has a nice description of this in Chapter 8 of his Climate Economics textbook. The figure below is adapted from his book. It shows the relationship between global economic gain and the level of emissions of greenhouse gases.

The blue line indicates that the higher the level of greenhouse gas emissions, the more total economic benefit is accrued to individuals. However, there are diminishing returns to this economic gain, since at some point it becomes unnecessary and thus economically inefficient to emit additional greenhouse gases. In other words, emitting for the sake of emitting will not help the economy. This means that there is a level of emissions that is economically optimal from the standpoint of individuals (represented by the blue dot).

However, there are economic costs (social losses) to greenhouse gas emissions since climate change imposes negative impacts via changes in things like crop yields, mortality, worker productivity, electricity demand and damage from coastal flooding (e.g., Hsiang et al., 2017). On net, the climate change impact on the economy is very likely to be negative, especially beyond 1C of global warming. These climate-impact-related costs on the economy are illustrated in the figure with the orange line.

Reducing GHG Emissions Helps the Economy

Thus, the true relationship between global collective economic gains and global emissions of greenhouse gases is represented by the grey line which is the sum of the total private gains and the total social losses. The grey line indicates that if we emit at a level that maximizes private economic gains (where the blue dashed line intersects the grey line) this will not maximize collective net economic gains. Because there are climate-change-related costs, it is economically optimal to reduce emissions from the point that maximizes only private gains.

When thinking about the cost-benefit analysis of climate change policy, it is tempting to think that it would only be wise to reduce greenhouse gas emissions if the climate-related economic costs of the emissions are greater than the economic benefits. But this is not the case. In the above situation, the benefits of emissions are always greater than the costs, no matter the emissions level (this is presently the case in the real world as well; Tol, 2017). All that is required for emissions reductions to be wise is that there comes a point on the emissions curve where additional emissions increase the costs more than they increase the benefit. This point is represented by the grey dot in the figure.

This type of calculation is made more sophisticated in so-called Integrated Assessment Models that bring in the elements of time and explicitly consider the cost of reducing emissions through, say, a carbon tax. These additional elements, however, do not change the main story illustrated above: It is optimal from a collective economics standpoint to reduce greenhouse gas emissions from the point that maximizes only private gain.

It is relevant to point out that Integrated Assesment Models do not tend to show that it is best for the economy to reduce emissions as quickly and stringently as is proposed by the Paris Climate Accord (e.g., Fig. 6 in Nordhaus and Sztorc, 2013). So, our best estimates at this point indicate that being in favor of the Paris Accord implies that one is implicitly in favor of trading off economic gain for reducing environmental impact (or that one is very risk-averse to low-probability, high-impact outcomes; e.g., Cai et al., 2015).

This highlights that the recommended magnitude of emissions reductions will depend on peoples’ subjective value judgments and will thus be controversial. However, the choice of whether or not we should reduce emissions should be much less controversial. Reducing emissions from the level that maximizes private economic gains will result in higher net economic gains for society overall.

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2 Responses to Reducing greenhouse gas emissions helps the economy

  1. Isn’t this basically an argument for internalising externalities? If I understand the argument (which I may not, but that would be my confusion, rather than your explanation) then if you do not include the future costs of carbon emissions you will follow a higher emission pathway that maximises private gains, but ignore social costs. If you include a social cost, then you would follow a lower emission pathway that, in theory, should be optimal (in a cost benefit sense, but not necessarily in an environmental sense) if the market responds as economic theory would suggest.

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