How much will climate change impact the economy? I don’t know (Part III)

In Parts I and II of this series, Tony waded into the unfolding debate among economists on how a hotter planet will eat into global output.  His timing was prescient, as this week the debate boiled over in the financial press, courtesy of some choice remarks from a senior UBS banker.

Reporting by Alistair Marsh at Bloomberg recounts how Judson Berkey, the Swiss firm’s group head of engagement and regulatory strategy, went off at central bankers for asking lenders to align their business activities with a 1.5°C temperature pathway, which he claimed would cause economic upheaval across the globe.

Berkey’s beef here is with the implied climate transition risk associated with the global shift to a low-carbon model.  Put simply, the argument is that if countries move too fast to a net zero world, they could leave sizable chunks of the global economy in the dust.  This is the “disorderly transition” scenario popular among banks and regulators.  

The reason why a “disorderly transition” is even discussed – and indeed why society may be willing to disrupt itself so powerfully – is that it may be the only way to stave off the potentially even more disastrous economic, social, and environmental impacts of a “hot house” world, one where the transition doesn’t happen fast enough.

This brings us back to Tony’s articles – which focus on the back-and-forth between Nordhaus, whose 2018 paper suggests runaway climate change will have but a modest impact on global GDP, and Keen et al, whose rebuttal Tony called “fundamentally unscientific.”

The revolt of Keen and co against Nordhaus is long and storied.  The reason for their ire? Nordhaus’ conclusion that climate change will lead “to a damage of 2.0 percent of income at 3°C, and 7.9 percent of global income at a global temperature rise of 6°C.” In one of several posts on the subject, Keen argues the claim fails the “smell test.” Or in other words, common sense.

Keen et al’s critique takes issue with many parts of Nordhaus’ approach, some of which can be read here and here. However, arguably the most salient is their deconstruction of the damage function used to conjure the above numbers.  

Nordhaus’ assessment of the economic impacts of climate change is informed by his Dynamic Integrated Climate-Economy (DICE) model, the sort that economists get misty-eyed over for its simplicity and assumed mathematical robustness.  It uses a simple quadratic function to link rising temperatures and impacts on economic output. The result is all smooth gradients and gentle curves, projecting the fairly tame adjustments to GDP referenced earlier.

The problem is, much of what climate science says will happen to the planet is left out or glossed over in this construction.  For sure, complex models have problems of their own, but models that are too simplistic are of no use to anyone.  In this case, the DICE model’s preoccupation with the relationship between average global temperature increases and GDP is the problem.  

Why? Because the increase in average global temperature is just one product of climate change, and not one particularly relevant for forecasting potential economic impacts.  As the world is starting to see, higher average global temperatures are giving rise to localized climate shocks with massive economic impacts. Climate science also shows that longer-term shocks are likely, from sea-level rises that could swallow cities to epic droughts that render equatorial regions uninhabitable.  Furthermore, rising temperatures may precipitate “tipping points” that accelerate warming and instigate devastating positive feedback loops.

It’s hard to square the idea that a 6°C world would have a GDP just 7.9% below the baseline, when in such a world huge amounts of capital would have to be sacrificed to protect coastal cities from inundation and help massive populations recover from multiplying climate-driven natural disasters. A world where New York and London would have to be essentially relocated if they wanted to survive.  

A climate scientist that Nordhaus himself interviewed for a 1994 paper collating expert opinions on the economic impacts of climate change sums up the problem with the DICE methodology succinctly:

“I marvel that economists are willing to make quantitative estimates of economic consequences of climate change where the only measures available are estimates of global surface average increases in temperature. As [one] who has spent his career worrying about the vagaries of the dynamics of the atmosphere, I marvel that they can translate a single global number, an extremely poor surrogate for a description of the climatic conditions, into quantitative estimates of impacts of global economic conditions.”

Now as Tony points out, humanity’s awesome capacity to adapt to a hotter environment shouldn’t be discounted. It’s true, air conditioning and underground infrastructure allow economic activity to continue in otherwise inhospitably hot climes – take a bow, Singapore.  But this kind of adaptation isn’t feasible everywhere.  If your climate-ravaged city or region is immensely energy (and cash) rich, economic activity may putter along even as temperatures rise. But if it isn’t… 

Furthermore – going back to tipping points and local versus global impacts – it’s important to remember that if climate change causes a city, say Jakarta, to be permanently hotter, it’s not just the temperature that’s going to be a problem. This overheating will bring with it catastrophic acute physical risks, like typhoons and floods. Indeed, Jakarta is likely to literally sink into the sea thanks to climate change before it becomes “permanently fatal” to humans from higher temperatures.

Nordhaus’ model is blind to these kinds of effects.  His quadratic function allows for no discontinuities, no sharp breaks in the relationship between temperatures and GDP – no tipping points.  It’s an approach that fails to account for the volatility and regime shifts that characterize our past. 

Tony’s argument is that until we observe the impact of a climate tipping point, it’s no good trying to estimate the impacts one or several may have on economic growth.  My counter is that giving the mantle of scientific robustness to a Nordhausian model myopic to the point of uselessness is folly. Common sense, like that employed by Keen et al, can be used to disprove its outputs. This being the case, we all need to go back to the drawing board.

I have much more to say on the Nordhaus debate, but since persuasive force is diluted by verbosity, I’ll save additional critiques for next weeks’ post.