How economists have underestimated the benefits of action to prevent the climate crisis for decades * The economy does not have the tools to handle economies in transition and has missed the economic viability of transitioning to clean energy
By Dimitri Zanghalis Special Adviser to the Bennett Institute, University of Cambridge, University of Cambridge. Dimitri Zanghalis previously headed the Stern Review team at the Office of Climate Change, London, and was a senior economist at the Stern Review on the Economics of Climate Change.
The costs of doing nothing far outweigh the costs of decarbonizing the global economy, which since the industrial revolution has been fueled by fossil fuels. These are orders of magnitude, that is, even a thousand times.
This may seem obvious today, with catastrophic fires and floods giving us daily reminders of how costly our continued inaction is in the fight against climate change. But 15 years ago, this insight was groundbreaking.
I participated in the Stern Review of the Economics of Climate Change in 2006 as a senior economist, the first time the G7 organization of the most powerful economies used economic analysis to outline the reasons for the urgent need to reduce greenhouse gas emissions. After a decade and a half, her conclusions and recommendations are more valid than ever.
Missing economic transformations
The review also revealed the limitations of using conventional economic models to answer transformation questions. This caused an unhealthy race between economists who each introduced their own cost assumptions and thus reached conflicting results.
The case points to an ongoing problem in the economy. Conventional models assume that economists know in advance what the costs of new technologies, preferences and behavior will be in the future. These are the things that will determine the cost of each green transition. In other words, our assessments of the things we are most interested in are pre-determined by assumptions that may not be accurate.
The fact is that the technique known as "static cost-benefit analysis", the workhorse of economic models, was simply not designed to assess the large risks and transitions involved in dealing with climate change. This is important because conventional approaches have consistently underestimated the risks of unaddressed climate change and overestimated the costs of transitioning to a low-carbon economy, thus delaying the required policy changes.
Predicting the cost of a system transition is extremely complex. Early adoption of new and clean technologies stimulates creativity and innovation throughout the economy and produces new learning and experience along the way. The early adoption will release the size advantage of discovery and production, and businesses that made sure to move to efficient and smart distribution have reduced costs dramatically. This in turn makes the deployment of new technologies even more attractive, generating a cycle of innovation, investment and cost reduction.
Already today it is much cheaper to generate electricity from the sun
The cost of producing electricity using solar panels and the cost of storing it in lithium-ion batteries has decreased by more than 80% in the last decade. Regardless of the need for carbon reduction, people should now enjoy cheaper electricity and better performing cars than those common today. Economists never predicted this and markets alone would never have provided it.
Graph depicting the decrease in costs of different types of electricity production, 2010-2020.
Renewable energy production costs have fallen sharply since 2010. Climate Change Commission/IRENA (2020) Renewable electricity production costs in 2019.
What has happened is that renewable energy production capacity has increased faster than expected, because the costs of installing and operating renewable energy have fallen sharply. And costs have come down sharply as capacity has grown faster than anyone expected.
Conventional economic models cannot deal with the destabilizing dynamics created by these amplifying positive feedbacks, so they miss them entirely, along with the rapid cost cutting that can result from them. As a result, standard economic and energy forecasting models have been demonstrably wrong for decades.
A prophecy that fulfills itself
No cost-benefit analysis can adequately answer the question "What is the cost of carbon in the long run?" The answer depends on the choices and actions taken today and taken in the future.
Once a tipping point is reached, such reinforcing feedbacks make the transition to new technology networks a self-sustaining process. If people expect the low-carbon transition to be cost-effective, they will invest in it.
In this way, expectations of rapid change are realized. This reinforces the need for credible and predictable government policies to provide investors and companies with assurance that a low-carbon future will be profitable.
An ambitious policy to create a clean energy transition can be carried out at no cost and will very quickly return the costs of the initial investment, providing considerable savings compared to the current situation.
Once the clean innovation machine has been activated, it has the potential to become more efficient, innovative and productive than the conventional alternative. It will enable the promotion of extremely low prices for disruptive technologies. Growth in new sectors will have a positive effect on productivity growth.
Instead of making a futile attempt to predict the future using the wrong economic tools, it is better to try to navigate and shape it. The economics profession is in a better position to deal with the risk and uncertainty involved. 15 years after the Stern Review, we can say with great confidence that the risks of action are much lower than the risks of inaction. Moreover, these risks are of the order of a thousand times greater.
The global community has the power to make the economy cleaner, safer and more sustainable, but also more efficient, innovative and productive. As world leaders gather in Glasgow for the latest UN climate summit, the call to action has never been more urgent.