All Together Now... Integrated Assessment

So, we have a framework to help us choose today the path that gets the most economic value (the utility of consumption) by estimating the current value of various future events. With the appropriate numerical model, a skilled economist can test various possibilities to find the optimal path, the one that gives the most good from the things we use.

The modeling is normally done with integrated assessment models. We enjoy consumption today, but investing rather than consuming now gives more consumption in the future. Writing the equations for this, as they work through the whole economic system, is a well-developed branch of economics. The integrated assessment models add a representation of the climate system, its response to the CO₂ generated by the greenhouse gases that now power most of the economy, and how those climate changes, in turn, affect the economy.

Video: Earth System (1:29)

Click for a video transcript of "Earth System".

PRESENTER: This complicated figure comes to us from the US Global Change Research Program-- USGCRP-- in 2006. And this is a diagram showing an integrated assessment model. And we talk a good bit in the course about what integrated assessment models are and what they do.

This is a cartoon of one of them. And what it does is to take natural causes of climate change-- but also human causes of climate change, such as CO2 and other things-- and ask, how do these interact with the ocean, with the land, with the living things, with the atmosphere, with air pollution, and with the things that we grow to eat, the logging we do, and other things to make economic activity that in turn affects so many of these other things? What you end up with out of this are estimates of what is happening to living things, what is happening to the world's climate, and what is happening to the economy as they interact with each other?

You should not try to memorize all the pieces of this. But you should see what goes into providing us the knowledge base to make wise decisions about these things.

A diagram of the elements of an Integrated Assessment Model. Do not worry about the details, but notice how much goes into such an effort.

Source: US Global Change Research Program, 2006. Image from Our Changing Planet FY 2006 Integrated Assessment Models

For example, if we decide to ignore climate change, then the economy will hum along making greenhouse gases, we will initially consume a lot (good, in the model). But, the damages from the CO₂ will cause economic losses that rise rapidly, so as the model is run into the future it projects greatly reduced consumption (bad, in the model). Hence, ignoring climate change is not an optimal path.

However, if we outlawed fossil fuels today, thus avoiding much future climate change and its associated costs, we would greatly reduce economic growth. (Actually, we would have an economic crash.) This would lower consumption (bad, in the model). So, the optimum must be somewhere between do-nothing and do-everything to stop climate change from our greenhouse gases. (We’ll return in Module 11 to the possibility that modern policies are actually serving to accelerate global warming by promoting fossil fuels, and thus are further from the optimum than simply doing nothing.)

Looking at all the possible choices (or at least a representative sample, using sophisticated techniques to narrow the search) between consuming, investing in actions that will slow climate change, and investing in other ways, the integrated assessment models can be used to find the best path. In the great majority of published cases, and including cases that explore the uncertainties in our knowledge, the models find that a measured response to reduce global warming is best. The result from William Nordhaus’ DICE model is probably the best known and is quite representative: put a small price on emitting carbon dioxide into the atmosphere now, and increase it at a specified rate per year (2-3% in recent work). In his book A Question of Balance (Yale University Press, 2008), this spends $2 trillion to avoid $5 trillion in damages but allows $17 trillion in damages to occur. (We will revisit these issues! Bear with us. And, all of this is in present value.)

Please note that because the model attempts to simulate the whole economy, other possible uses of that $2 trillion (curing malaria, or feeding starving children) are implicitly included in the assessment. If curing malaria is an investment (it would greatly increase the economy, for example), it is part of the investment portfolio; if we want to spend more on curing malaria than would be justified on purely economic grounds, that is a choice we make and so is a type of consumption. Any use of money, whether it is curing malaria or heading off climate change, can be treated in the same way, as long as the use is not a large fraction of the whole economy. Thus, use of the $2 trillion to head off climate change over the coming decades is appropriate because other money is available from the whole huge economy to do other things.

Activate Your Learning

You may hear arguments that we should not invest in efforts to reduce climate change because curing malaria is more important. Have you ever had to choose between taking care of an immediate need and investing against bigger losses in the future? How did you decide what to do in that situation?

Click for answer.

ANSWER: Answers will vary. As an example, we can imagine someone who has both a sick child and a leaky roof. When faced with paying the doctor and fixing the roof, many people work through the issues and find ways to afford both health care and housing, even if it comes at the expense of comforts like cable TV or a planned vacation.

Whether or not to invest $2 trillion to reduce climate change more or less depends on the discount rate used. Let’s go back to your house, as a simpler case, and suppose instead of 20 years, we think about 100 years, a time-scale that matters in climate change. Suppose that there is a problem in your house that in 100 years will cost $1000 to fix. Our equation for calculating present value, from above, is P=F/(1+D/100)^t. With t=100 years, and F=$1000, if the discount rate is D=4%, then the present value is $19.80. Bizarre as it may seem, spending $20 now to fix a problem that will cost $1000 is not a wise investment; better to invest the money and let future generations solve the problem with the wealth you give them. Raise the discount rate to 7%, and the current value is down to $1.15; if you have a pocket full of change, you would be economically inefficient if you spent it to head off a $1000 problem. But, drop the discount rate to 1% and you should spend as much as $370 to head off the problem. Changing the discount rate from 1% to 7% changes the current value more than 300-fold. And, you can find reasons why either value might be used.

This highlights the reality that in these integrated-assessment economic-optimization exercises, the discount rate is typically the most important issue. We will look at that soon, including the perhaps surprising result that our uncertainty about the discount rate translates into a lower discount rate over longer times. But first, a word about costs of emitting carbon.