Thoughts on economics and liberty

Transcript of William Nordhaus’s Nobel lecture

The slides he uses – here.

TRANSCRIPTION

William Nordhaus. He was born in 1941 in Albuquerque in New Mexico and in 1967 he received his PhD from MIT Cambridge Massachusetts USA.

And at that point he moved to Yale University as an assistant professor and then you climbed in the ranks and you’ve been at Yale University ever since if I understand correctly and that’s 51 years, a pretty impressive tenure record. And I don’t know if you’re a broken record but I hope you will break the record whatever it is.

William Nordhaus has focused on the one part of our resources he has focused on nature, a crucial resource for us. The point is that human activity, economic activity, effects our resources effects us through climate change in particular. So he built up the area that we refer to as integrated assessment of the interaction between the economy and the climate. So ladies and gentlemen please welcome Professor William Nordhaus. [Applause]

NORDHAUS

In the interest of modern technology I will use an iPhone to time myself. Tank you very much. The 2018 award and economic science recognizes the significance of technological change and climate change. These two fields are closely related because both grapple with externalities or spill overs associated with economic growth. They both examine what are known as market failures, in other words they deal with the inability of unfettered or unregulated markets to ensure that economic growth effectively satisfies human needs while protecting ourselves and our environment.

My lecture will focus on part of that which is climate change and the challenges nations face in devising policies to slow climate change.

Now, while I’m here today and talking today and on the podium today – I’m just one person representing what I think of as an invisible college of people around the world and over time – not just in economics but in many disciplines (‘ll talk about that in a minute) dealing with this broad set of problems having to do not just with climate change but with the interaction of the economy with the natural world and our interactions with that.

I’m here thanks to my parents, to my wife Barbara who’s been my companion for my entire adult life, my children who are with me, my grandchildren who are with me, my teachers who have been such inspiration and a substantial number of whom have been on the equivalent of this stage over the years, my colleagues many of whom are here, my students some of whom are here, and my critics I think some of whom are here – and I want I want to say a special word of thanks to my critics because those are the people you learn from the most.

And finally thanks for the institutions. I want to emphasize something that’s particularly important to me and I think actually although we don’t always recognize that the institutions that have supported us – our schools, our families, our universities, our national academies (of Sweden and the United States and other places) and these are the places that we live – in a magnificent hall like this, in prosperous democracies rather than in caves and dying at an early age. And without these I would be a hot carrier (???) in Albuquerque or something the equivalent of that.

So coming back to the talk today we have a climate problem because markets fail and fail badly in the energy sector. They fail because one of the byproducts of the use of energy in particular, fossil fuels, is unpriced and therefore underpriced. Markets put a zero price on this by-product this unintended by-product this externality whereas the true social cost of carbon dioxide and as in the particular case is as we’ve learned high. Just how high how to put a price on carbon and how to deal with this is the subject of an extensive body of research and that’s also the subject of this talk today.

rest not transcribed

Economics has developed a toolbox and analytical toolbox to deal with externalities as I said these externalities are the unintended by pilot products or spill overs of economic growth they occur outside the market they’re not captured in market prices and global warming is the closest of all environmental externalities and I have a very terrible picture here of this is the colossus of Goya but I use this because many of you know this it’s in the Prado but I think of I think of climate change as a menace to our planet to our future it’s particularly pernicious because it involves so many activities of daily life it affects the entire planet it does so for decades and even centuries and it’s challenging most of all because none of us acting alone as ethical individuals can do anything about it to slow the change and so like the people huddling there some of us anyway are very frightened by the prospect so let’s let’s turn from this this art this art to another art which is economics and to the sign the sciences of climate change and so maybe we’ll turn there so climate climate change involves many many sectors or disciplines such as atmospheric chemistry geophysics Glaciology ecology economics political science game theory international law just to mention some of the most significant ones and because these climate change it’s so interconnected the parts are so interconnected we need integrated what was mentioned earlier is integrated assessment or integrated assessment modeling to deal with this problem in a you know rigorous way and there are there are things I’ll talk about them in a minute called integrated assessment models they integrate now knowledge from multiple disciplines into a single framework or single model and these these the models are based on fundamental scientific theories they’re increasingly computerized they are computerized we have analysis as well but they’re the models themselves are generally computerized models of various levels of complexity my own work on integrated assessment models began in a very simple model of first energy and then later on including climate and it began in 1974 when I was at the International Institute in Vienna and then I I think of myself as stumbling along for almost two decades trying different approaches the first one wasn’t right the second wasn’t right the third one wasn’t ride they didn’t they couldn’t capture the things partly it was I didn’t know the analysis partly it was some of these areas weren’t developed empirically or analytically until in 1992 I finally landed on like land on the moon I landed on that what’s known as the dice model which is just the name of a model but I think it captures it’s the name of a model but also captures some of the riskiness that that is involved and I’ll talk I’ll talk about a little bit later today the current version of that which is updated to roughly two today which has the same basic analytical structure as the earlier model but has evolved both in terms of parameters in terms of some of the details of the sector’s but the structure is basically the same as it was in 1992 and the structure of the model is shown in the figure here I’ll just describe it briefly you have economic growth leading to emissions on the upper left and that’s from our driving or heating or cooking our airplane dharia travel this leads to rising co2 concentrations and other forces leading to climate change and climate change is not just temperature but it’s precipitation and sea level rise and many other processes and then that to the next arrow it has impacts Tarot it has impacts of ecological impacts economic impacts lower corn yields coastal flooding ocean acidification which is actually the other carbon dioxide problem which I won’t talk about very much but it’s bad for crustaceans and then the next is so the next link is climate clay and change policies to reduce emissions and these would be through different mechanisms such as cap-and-trade which you know here in Europe but carbon taxes which you know in Sweden regulations which are all countries know and then that then through the policies leads back up to affecting emissions reducing emissions and then affecting more you know a greater or lesser degree climate you can AMA growth itself and I put those arrows there to see in the end the first to error is that ones we know about and actually exist the other two we don’t actually all lives don’t actually exist in all cases so this is the lot this is the circular flow that is part of the modeling that we’re talking about today so I want to say a word see what we’re doing here I was saying a word about mathematics for just a little bit of mathematics as a language particularly for people for young people and students and who are thinking about what they’re going to study my first teacher and and mentor and co-author Paul Samuelson was also the first American Merrick laureate in economics and he was responsible for the introduction of mathematics into economics and his view was mathematics is necessary if we were to understand and analyze complex phenomena and it’s something that point is now part of my brain it’s it’s actually built in just as much as the English language is it’s it’s is part of my brain and it’s an interesting the great American physicist John Willard Gibbs in a Yale faculty meeting when there was debate about foreign languages he stood up and he said mathematics is language and he sat down and and he’s right the language and that language is increasingly part of our lives it’s from the design of the computers that are running this the show here to our power plants to the medical scans that save our lives and I think mathematics is our future that’s all I mean I think we need to study foreign languages we need to study all kinds of things poetry art but mathematics is is key to so many areas of our future the math the language of mathematics is also central to our modeling of climate change economics I’ll just show you a little picture here I thought I’d show you the mathematics of the model and here it is that’s all that’s all it is it’s a maximization constrained maximization problem it’s kind of simple so there’s a lot of vectors here and times and integrals and so on and it’ll be discretized for the actual computerized model but any of you who know the modeling and know mathematical economics will say oh yeah that’s just that’s a simple old growth model that we know and love for so many years ago and those of you who know mathematics will say well that’s kind of interesting and those of you don’t just view it as a it’s just it’s a counterpoint of goya it’s just a picture here okay maybe not so frightening I don’t know maybe more frightening but don’t don’t be frightened don’t be frightened so economists have focused on the strata so let me just turn out of to a little bit of the actual results so economists have focused on the economists and others have focused on strategies to slow climate change and they’re they’re basically three but strategies abatement or reduction of emissions is the one I’ll focus on the second one is removing carbon dioxide from the atmosphere which would be running wonderful but actually you could grow trees to do that for example but but well I won’t say but and then there’s management of Soto solar radiation through say putting dust in the stratosphere abatement the first one I mentioned is the only realistic and safe option at present others may come along but at present it’s all that we have so I’m gonna concentrate there but after to say well realistic it’s also expensive particularly in if we are ambitious and just to give an example a common goal of the international negotiations and policies is to limit temperature to two degrees C above pre-industrial levels and estimates are that that would might cost about four percent of our income over the next next century or two this may be good for nature but it’s not actually all that attractive to voters to reduce their income that sharply so it shows some of the trade-off now that’s abatement I’ll say a word about just a word about damages because you know economics what we’re going to do is weigh the costs of reducing emissions and slowing climate change or limiting temperature on the one hand with the reduction in damages on the other so we have to you have to go out and do the modeling you have to determine what the damages are and you might say well that’s impact sound easier because our babymoon do you need the physics and the chemistry and all that but actually damages and damages is just economics and ecology but actually damages are much much more difficult and it’s probably the most difficult task and all of processes that were on that last slide because it’s so far in the future the things we don’t understand very well there we don’t have historical experience of this so it’s actually the probably the most difficult so what I’ll do is I’ll show you some illustrative results I suppose these slides will be available so that they will be available well they’ll be I guess they will be available on the website so some of you I know this goes by very fast but some of you who want to look at them in detail can go back and and find them but I want to show you an example of the results from the the dice model and this I want to emphasize this is only one of many models there there are people in the room who do who do I won’t point you out but you know who you are who are doing my other models and they’re they’re wonderful models and people around the world who are doing this the only reason I present well the main reason I presented is cuz I know it but also it’s a simple model has a virtue of simplicity and comprehensiveness in the sense that it does close that all the boxes the links in that and another model some do and some don’t but I would emphasize that these are very simplified models and so for example the climate sector two equations whereas if you go to some of the large climate models they’ll have a million equations and so these are very very these don’t have the resolution of the most the the most comprehensive and up-to-date models so he let me do pews me so I want to talk about four sets of policies and I’ll just mention these briefly one is what a business-as-usual which is basically no policies or minimal policies a second one is where you balance the costs and the benefits a third is where you limit temperatures over time to say one and a half degrees which is the latest objective or two degrees or two and a half degrees and a third is is my modification of that where you don’t limit it as an absolute cap but you’re limited over an average period the idea being that actually makes more sense because a lot of processes are function of averages rather than just the absolute level at point time so those are the four that I’ll I’ll show you some results from so one is you you take these and I’ll just one other thing so you take this business as usual what happened and then let’s say if you want to limit the temperature to two degrees C which is in the third bullet there how can you do that most efficiently so it’s not just any old way but if that you’ve got costs of doing it and you’ve got the systems and you want to find how can I limit it to two degrees in the way that’s the most caught the least costly and in the economic sense so here’s a here’s a picture that shows it’s a little it’s a little crowded but I’ll give you a quick rundown so the top so on the this is time from 0 to I’ve gone to 2150 just to give it a little further depth and this is then from 0 to 6 degrees C above pre-industrial we’re already at about 0.8 0.9 so and then this shows you different paths doing this and the top path is if we do nothing and you can see that just keeps climbing and it’s it’s pretty pretty substantial by the 20 120 150 and then there are other paths there’s one that have say economic cost-benefit path where you balance costs and benefits and then there’s this green one where you limit it to two degrees C and then some of the other ones are where you limited say two degrees C with the 200-year averaging two degrees C with a 100 year averaging or one and a half degrees with a one year 100 year averaging they all look pretty much this so if you go out and you they actually don’t look very different for quite a while and then they begin to diverge after 2050 or so but they’ll have a very different path but the main thing I’ll show you is actually if you take steps now to implement these you have quite different futures from very very high temperatures on the one hand to relatively low for the for the temperature limiting paths the next slide I want to show you it shows you the of the economics of this so the the green align the green bars show you and don’t worry too much about the the the units here on the left they’re their present values but but they’re just the bars or what I want to emphasize on so you can see the damages from doing nothing to the optimal to the temperature limiting and the damages obviously as you limit temperature increase the damages are going to go down from from left to right and these are increasingly stringent policies from left to right increasingly ambitious policies and then so the damages go down but then what are the costs well they’re not not much cost if you don’t do anything but as you become increasingly ambitious the cross rise and so you wanted but economics says well how are you going to balance these and if you if you were if your manukan see that the extremes you have a lot of damages and no cost at one extreme and a lot of costs and very low damages or the other and somehow in between you can balance the two and what you want to think of in economics or in more generally is what’s the best balance between these two is that the optimal is that a to degree is a averaging period what different averaging period so you want to find some balance between the costs and the bending the damages no economics yep so economics points to one inconvenient truth about climate change policy and that is to be effective the policies have to raise the price of carbon or co2 and by doing that correct the externality of the marketplace and so one of the I think one of the insights of economics that I feel very strongly about is if you’re going to be effective you have to raise the price because putting a price on our activities is the only way I mean we have to we have to get billions of people in now and in the future millions of firms thousands of governments to take steps if we’re going to move in the direction we want and the only way that you’re going to do that effectively is to increase the price of carbon and I would say something about the history of that because is I think it’s an interesting scientific story the idea on carbon pricing flowed from the research on what are known and technically is dual variables in linear programming from the pioneering work of kantorovich and Koopmans for which then they won the Nobel Prize in 1975 and it’s if you do this the optimization I showed you a little earlier and you just Rock grind and you just grind through it and you look well we used to be computer printouts we don’t have those anymore you would see the dual variables there and I remember when I looked at I just scratched my head I had no idea what this dual variable on the carbon constraint was and there were different ones on different different different reservoirs and then eventually I realized and I’ll quote when when I first realized this is what I what I wrote in 1977 and it’s it’s I haven’t gone much further than this because of the externalities there are no market or political mechanisms which ensure that the appropriate level of control will be chosen to implement the efficient path implies that we are implicitly putting a positive price on emissions of carbon into the atmosphere quote carbon taxes as a way of implementing the global policy on a decentralized level so that that that that was the first time it really occurred to me that to think of this in this way and so what basically I it is evolved over time and I won’t i won’t spend much more time on that i’ll just mention that this actually disappeared for a long time and then re-emerge about 20 years later in the idea of the social cost of carbon which is how much it costs to put a ton of carbon in the atmosphere and that’s actually central now to national policies it’s central to the design of carbon instead of climate institutions as a setting a carbon price or carbon tax so over the years nations have negotiated many international climate treaties the Framework Convention the Kyoto Protocol the Copenhagen Accord the Paris Accord how are we doing you might ask how we doing we we is the carbon price where it should be or is it lower or higher the answer that question is that the world carbon price is nowhere near where anyone thinks it ought to be it’s maybe 1/10 of the most modest estimate of the social cost of carbon the actual global carbon price is essentially zero and I I’m not going to go through the various proofs of that but I want to talk about what why that’s a problem and what we might do about it enough so as I think about this the the read the problem here is the that these treaties have been ineffective in limiting carbon emissions I’ll just show actually I’ll show you one graph here which is the trend in global emissions from 1970 to 2017 policies have been really ineffective in dealing with climate change and the reason is because of free riding and freeriding is where you receive the benefit of collective activity collective action without paying the cost without contributing and the case of international climate policy what it means is you ways you get the reduction and damages due to people’s efforts but you don’t have to do any costly steps at home and so I’ll just talk that’s the free rider problem in economics in climate change so in in research on this issue and following much the brilliant studies of the economics of treaties and game theory I came to a solution that I called a climate club and want to talk about that in my last three minutes so what is the idea of a climate club the idea that nations can overcome the syndrome of free riding in international agreements if they adopt the the model of a club and a club is an agreement where you you know what clubs are we’re all in clubs of various kinds but they’re also international clubs is the club of the EU to which which you remember there’s the club of NATO which you’re not a member but the Sweden is not a member but is a beneficiary there’s the club of the World Trade Organization of which we’re all beneficiaries and the idea for club here is to change the way we think of international agreements which are essentially voluntary for climate to make them ones where you you not only benefit but you pay and for the example that I’ll suggest is an international climate club to overcome free-writing is the idea is that you would have club played ooze through abatement but members but non-members are penalized by having tariffs on their imports into the club region and so let’s say you set a target carbon price of $50 a ton then nations would have their domestic price through whatever mechanism they would choose at $50 a ton but if you weren’t a participant then you would have a penalty attack a penalty tariff into the club region so the dues are abatement and penalties are the tariff and I’ll just show you a very simple example this is from my during my presidential address to the American Economic Association and it’s a very simple idea here the bars from left to right are the tariff rates of a club there are 15 regions in this and the height of the bar is how many participants there are as a function of each tariff level and the first tariff level is zero and that’s the basic structure where there’s no penalty to non participation and there no participants but in this simple example for a $50 tongue as the tariff rates gets up to two three four five percent you see more and more nations participate and then it is high enough all nations participate so we are obviously a long way from the climate club or analogous arrangements but I think that I I think that we should we should look at this as a kind of model for future going forward so I think I’ll just wrap up here and I’ll just make four points to end up where we need to go next first we need to accept and understand the gravity of climate change scientists must continue their research and citizens must reject politicians who spread falchion tendentious reasoning that’s a very important step we must establish policies that raise the price of co2 and other greenhouse gas emissions we must act locally and nationally both actions must also be coordinated on a global level and it that’s it and it’s clear that finally that we need rapid technological change in the energy sector for the transition so this concludes my discussion of the economics challenges posed by climate change and I would emphasize the solution ultimately lies in harnessing human ingenuity to develop and deploy low-carbon technologies and with that thought with that thought I’d like to turn to the extraordinary insights on the economics of technological change that have been developed by my fellow laureate Paul Romer so listen up thank you you [Applause]

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