Emanuele Massetti: “Integrating Climate Change into Long-Run Macroeconomic Analysis”

By Kelsey Abernathy · Published Feb 05, 2019

On Tuesday, November 27, 2018, the Global Change Program hosted a lecture by Dr. Emanuele Massetti, Assistant Professor of Public Policy at Georgia Tech. In this lecture, entitled “Integrating Climate Change into Long-Run Macroeconomic Analysis,” Dr. Massetti discussed the work of William Nordhaus, winner of the 2018 Nobel Prize in Economics. Nordhaus’ main contribution to economics is the integration of climate change into long-run macroeconomic analysis; his pioneering work on climate change began in the 1970s and is at the foundations of now popular concepts in climate policy, such as the carbon tax and the social cost of carbon.

Following Dr. Massetti’s talk, the Global Change Program spoke with him at length. Below, he expands on the topics he discussed in his lecture:

Your talk focused on the main contributions of William Nordhaus. What implications do you think this will have on the future of climate policy?

There are two important implications for climate policy in Professor Nordhaus’ work on climate change economics. The first is that policy makers should study climate policy using a cost-benefit framework. This means that the economic cost of reducing Greenhouse Gas emissions should be equal to the economic gain, in terms of reduced climate change damages to the economy. With all its limitations, cost-benefit analysis is the best tool we have to frame climate policy. The second important and consistent message from Nordhaus’ work is that a global carbon tax on all Greenhouse Gas emissions is the least cost policy tool to achieve any climate policy goal. Cap-and-trade programs and carbon taxes are conceptually very similar, but according to Nordhaus, taxes are a better practical solution, because they are less costly to implement. The carbon tax has more chances in the US. But I am not optimistic, because policy makers fear to pronounce the T[ax] word. In the best case scenario, there will be a mix of subsidies to clean energy and regulation. Both of these policy tools lead to emission reductions, but at a much larger policy cost than carbon taxes or even emission trading. This means that for the same cost, we will reduce emissions less than we could.

In your talk, you discussed the carbon tax and the social cost of carbon. What role do you see these playing in future U.S. policy?

If we look backward, starting from the early 1990’s when climate change was officially recognized as a global threat, we have basically done nothing to reduce GHGs emissions. Nordhaus calculated that the implicit carbon tax that we observe after accounting for all climate policies developed at global level is about $1 or $2. Estimates of the social cost of carbon suggest that we should be taxing carbon at something between $30 and $100. We celebrate short-term reductions of emissions as a success of the modest policies that we implement, but in the long run, they look like random noise around a trend that is basically not affected by policy, simply because there are no really stringent climate mitigation policies. Looking forward, there are no strong reasons to expect something radically different. I think a carbon tax that recycles tax revenues as tax rebates or credits to low-income households has the best chance to receive political support, but the chances are low. Fundamentally, you have to find policy makers that are able to convince the average voter that it makes sense to give up some income today, so that people alive 50 or 80 years from now will have income gains that compensate our present losses. Not only that, but about 80% of the gains will go to other countries. In short, I am not optimistic.

You are one of the authors of WITCH (an Integrated Assessment Model to study optimal climate mitigation policies), and your current work focuses on methods to estimate impacts of and adaptation to climate change. In your opinion, what is the number one way to adapt to climate change while stimulating the economy?

Adaptation to climate change will mostly be a natural autonomous adjustment to different environmental conditions. Individuals and firms will adapt without even noticing they are adapting to climate change. If we look backward, 80 years ago, the world was a very different place. Most of the capital stock was not even built 80 years ago. Most of it will be re-built during the next 80 years. It is very likely that, as the climate changes, we will adapt the new capital stock to new environmental conditions. The best way to promote private adaptation is to ensure that individuals and firms will bear the cost of not adapting. That will push them to adapt. For example, we should not subsidize flood insurance. Flood insurance reduces the cost of future floods and thus reduces the incentive to adapt. Poor people certainly face barriers to adaptation. The problem, however, is not that they are not able to adapt. Poor people know how to adapt, but they lack the financial means. Thus, we should focus on poverty alleviation programs in general. Which is something we should do with or without climate change.

In your previous answer, you seem to indicate that governments play little to no role in promoting adaptation. Can you elaborate on this?

Ensuring that markets are efficient and that individuals pay the true cost of not adapting is not a trivial task because it requires deep changes. I used the example of subsidized flood insurance, but there are many inefficient markets, often due to misguided government policies. For example, farmers receive subsidized insurance against negative weather shocks. This leads to excessive risk taking and to a net loss for society. Would you worry about locking your car if the government provided a subsidized car theft insurance? With these subsidies in place, farmers will not efficiently adapt. However, removing the subsidies is a very difficult policy task.

Governments also have a very important role in promoting public adaptations. Public adaptations are adaptations that are beneficial to a large number of individuals or firms. Individuals, markets, will not provide the efficient amount of public adaptations because they act selfishly. It is the role of governments to provide the efficient amount of public adaptations. The role of governments is to aggregate benefits across individuals in cost-benefit analysis. For example, local governments will have to plan coastal protection. Other examples include emergency preparedness, building codes, ecosystem management, and basic research into new seed varieties.

What implications do you think Nordhaus’ recent Nobel Prize win will have on the future of climate policy?

Unfortunately, in the short-term I expect that nothing will change. The public overestimates the influence of economists on policy makers. Typically, policy makers choose economic theories based on their preferences rather than changing their preferences based on economic theories. In the short-run, I do not see any strong interest for aggressive climate mitigation policies and a Nobel Prize does not change this. However, I am more optimistic for the long-run. Powerful ideas eventually become part of mainstream thinking. They change the choices of policy makers because they change how voters think. The Nobel Prize to Nordhaus will cement in the public the idea that Nordhaus’ policy prescriptions are sensible solutions to an extremely complicated problem.