A Nobel Prize for the creator of an economic model that underestimates the risks of climate change

The 2018 Nobel Prize for Economics has focused a spotlight on the ongoing controversy surrounding estimates of the potential impacts of climate change.

On 8 October, The Royal Swedish Academy of Sciences announced that it was awarding the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2018 to Professor William Nordhaus of Yale University and Professor Paul Romer of the Stern School of Business at New York University.

Professor Nordhaus was recognised “for integrating climate change into long-run macroeconomic analysis”.

He has made an enormous contribution to the field of environmental economics. In 1991, he published a landmark paper, ‘To slow or not to slow: the economics of the greenhouse effect’, which presented the first analysis of the costs and benefits of policies to abate emissions of greenhouse gases.

Professor Nordhaus subsequently created the first integrated assessment model to explore the interactions between the economy and climate, which he called the ‘dynamic integrated climate‐economy’ (DICE). The first published results of his model in 1992 suggested that no action would result in global warming of 3°C, but an “optimal policy” in which the discounted value of the benefits of action were slightly more (US$199 billion) than the costs of action, would slow the rate of warming only marginally.

The DICE model has been updated many times and remains widely used in environmental economics, because of its simplicity and ease of use. Professor Nordhaus has encouraged and helped other researchers to use his model with a respectfulness and professional courtesy that is not shared by all other developers of integrated assessment models (IAMs).

Unfortunately it has become increasingly obvious that the results of the DICE model, which have changed relatively little over the past 26 years, are at odds with the scientific consensus.

A paper by Dr Frank Ackerman and co-authors in 2010 concluded that the damage function, which describes how economic costs would increase as global warming advances, in the ‘default’ setting of the earlier DICE-2007 version of the model does not include potentially catastrophic consequences of global warming. They found that it forecast that global gross domestic product would only be halved by a rise in global mean surface temperature of 19°C.

One of Professor Nordhaus’s most recent papers indicates that the latest version of the DICE model includes an equation for calculating the damage from climate change impacts that “assumes that damages are 2.1% of global income at 3°C warming and 8.5% of income at 6 °C warming”.

On 8 December, Professor Nordhaus delivered his Prize Lecture in Stockholm. He outlined the latest results from DICE, suggesting that “optimal policy” would result in global warming of about 3°C by 2100 and 4°C by 2150.

Professor Nordhaus stressed during his lecture that climate change is a very serious problem and that a universal carbon price should be introduced to curb greenhouse gas emissions.

Nevertheless, Professor Nordhaus’s latest results have been seized upon by climate change deniers and so-called ‘lukewarmers’, who deny the risks of climate change. For instance, Dr Bjorn Lomborg, who has a track record of misrepresenting the results of climate research, recently wrote in another inaccurate and misleading article for ‘Project Syndicate’ that Professor Nordhaus’s showed “aiming to reduce temperatures more drastically, to within 2.5°C of preindustrial levels, would drive the cost beyond $130 trillion, leaving us $50 trillion worse off”.

In fact, the journal paper by Professor Nordhaus to which Dr Lomborg claims to have been referring shows clearly that unabated climate change would lead to damages of US$134.2 trillion (discounted present value, 2010 prices) as a result of global warming that would exceed 4°C by the end of the century. By contrast, limiting global warming to 2.5°C would cost US$134.6 trillion, but would still lead to damages of US$43.1 trillion.

However, Professor Nordhaus’s results are inconsistent with other economic analyses and incompatible with the latest assessment by the Intergovernmental Panel on Climate Change (IPCC).

The IPCC special report on ‘Global warming of 1.5°C’ did not include a formal comparison of the economic costs and benefits of limiting the rise in global mean surface temperature. However, it did conclude that across five main ‘reasons for concerns’, there would be high or very high risks and impacts from global warming of more than 2°C.

A detailed recent survey of the economics literature, led by my colleague Professor Simon Dietz, also arrived at a very different conclusion from Professor Nordhaus’s “optimal policy” case. It stated: “The economic case for limiting warming to 1.5°C is unclear, due to manifold uncertainties. However, it cannot be ruled out that the 1.5°C target passes a cost-benefit test.”

So why are the results of the DICE model so much out of step with other evidence about the impacts of climate change? It appears that the model has not incorporated the biggest risks of climate change.

Professor Nordhaus has not yet published the ‘User’s Manual’ for the newest version (DICE-2016R’ of his model. However, the Manual for the previous version (DICE-2013R) acknowledged that estimating economic impacts is “the thorniest issue in climate-change economics”. The Manual indicates that the damage function of the DICE-2013R model was based on estimates of impacts by numerous authors that had been collected by Professor Richard Tol and published in 2009. The survey has subsequently been found to contain numerous errors. Nevertheless, the Manual had recognised the limitations of constructing a damage function in this way, stating:

“However, current studies generally omit several important factors (the economic value of losses from biodiversity, ocean acidification, and political reactions), extreme events (sea-level rise, changes in ocean circulation, and accelerated climate change), impacts that are inherently difficult to model (catastrophic events and very long term warming), and uncertainty (of virtually all components from economic growth to damages)”

Professor Nordhaus’s solution was to add “an adjustment of 25 percent of the monetized damages to reflect these non-monetized impacts”, while recognising that “this is largely a judgmental adjustment”. He added: “The current version assumes that damages are a quadratic function of temperature change and does not include sharp thresholds or tipping points”.

The failure to adequately take into account ‘tipping points’, beyond which the impacts of climate change become unstoppable, irreversible or accelerate, is a weakness of all current IAMs, as my co-authors and I pointed out in a paper last year, and as other authors have also highlighted, particularly Nicholas Stern.

A recent paper by Professor Stern and Professor Dietz attempted to adapt the DICE model to address some of its shortcomings in terms of the endogeneity of economic growth, the convexity of the damage function and the scale of climate risks. The paper concluded that when these are taken into account, “optimal policy comprises strong controls”.

A new generation of models is needed to generate much more accurate estimates of the economic impacts of climate change that are consistent with the scientific evidence. Until then, we should recognise the seminal contribution of William Nordhaus to this field, but be very cautious about using his model.

 

Bob Ward is policy and communications director at the Grantham Research Institute on Climate Change and the Environment and the ESRC Centre for Climate Change Economics and Policy at the London School of Economics and Political Science.