Tuesday, January 13, 2015

Review of Richard Tol on climate change economics

This is a draft of a proposed review.

Richard S. J. Tol, Climate Economics: Economic Analysis of Climate Change and Climate Policy, Edward Elgar, Cheltenham UK, 2014.

This is a text on climate change and its economics.  It is written in a brisk, lecture note format with much material tersely presented. It contains exercises, reading lists and utilizes a supplementary website which contains lecture notes, quizzes, lecture slides and supporting databases.  As someone who teaches classes on climate economics I found this useful.  Particularly those early parts of this book that involve describing the science and in establishing a conceptual policy setting.

Early chapters summarize the physical science basis of climate science with a emphasis on the physical uncertainties, the difficulties of projecting climate trends and of devising future emissions scenarios.   Then abatement costs are discussed. They are seen as low provided adjustments are given enough time to be implemented. Carbon taxes work best if they are implemented broadly and double-dividend benefits are utilized.

The choice of market-based policy instruments – taxes, subsidies, tradable permits - for emission reduction is then analyzed in both static and dynamic contexts.  The dynamic efficiency conditions are presented tersely assuming that the carbon price equals a costate variable from an optimal control task reflecting the shadow price of emissions. With respect to choosing between taxes and tradable permits under uncertainty the standard Weitzman result is provided. Since costs depend on stocks of emissions not flows, using a tax instrument will outperform tradable permits.  Tol rejects the realist political argument that “grandfathering” permits admits greater political feasibility than subjecting emitters to taxes.   He also discusses problems of making permits internationally tradable and discusses the EU scheme and the CDM mechanism.  Technological innovation in the energy sector is best driven by a credible abatement policy.  These are all sensible views and well argued.

Approaches to valuation of various climate impacts are then provided along with a useful discussion of willingness-to-pay and willingness-to-accept compensation for climate changes.  This binds the way climate policy discussions are formulated and impacts on the way climate impacts are valued.

Chapter 6, which looks at empirical estimates of climate impacts, is more problematic.  This is the start of a sequence of chapters that downplay the need for a stringent activist climate policy.  The claim is that moderate climate change is most likely which will have small aggregate impacts mainly in poor countries where limited adaptation capacity creates extra costs. Hence, it is argued, economic development is the best means of addressing climate issues since it best improves this capacity.  The probabilities of severe climate events are minute so such events can be disregarded.  The unstated hypotheses here are that economic development will occur in time to prevent extreme climate change and that the probabilities of “fat tail” extreme climate change are low.  These hypotheses are rejected by many, for example, by the 4th IPCC Assessment Reports.

This type of argument is developed further in Tol’s view of “optimal” climate policy which is seen as involving a modest emissions reduction that will not end  use of carbon-based fuels anytime soon.  Tol correctly points out that climate policy objectives should be posed in terms of emission stocks in the atmosphere not emission rates.  To make this clear, the world could emit at maximum rates for a hundred years and then cut emissions significantly – hitting any pre-assigned emissions target but still leaving a devastated environment.   This is a confusion of the UNFCC and many policy makers (including those in Australia). It is a straightforward stock/flow confusion.  But it is a long step from endorsing this view to asserting the case for limited action to address climate change. Tol’s case is based entirely on his interpretation of the Nordhaus DICE model.  It is a strong, controversial argument derived from such a narrow ideas base.

Tol goes further. Climate change only matters at all if you care about the distant future, faraway lands and remote probabilities.  Some nice economics is exposited as a precursor to these claims – the Ramsay rule for discounting, the role of equity weights, Weitzman’s dismal theorem and so on - but I could find no empirical or theoretical justification provided for the claims.  Of course the Stern Review using low discount rates came up with a strong presumptive case for addressing climate change decisively and now.

Indeed in a subsequent chapter, Tol shows himself how risk and irreversibility intensify the case for a more stringent climate policy. This is a major practical policy concern.

On the strategic issues involved in climate policy, Tol asserts that game theory and “free riding” explain why cooperative agreements such as Kyoto have not yet had a large impact and why future attempts at negotiation will also be futile.   The implication Tol draws is that most policies will, of necessity, be nationally-based, adaptation policies that do not require international agreements.  This seems an overly pessimistic assessment given current initiatives world-wide (in Europe, China and the United States) to mitigate emissions.

Tol provides an Excel-based integrated assessment model that can be numerically explored by students.  Although highly aggregative this is a useful way of illustrating how the various science and economic components of modelling need to be put together to determine policy impacts.

In a final brief chapter Tol sets out his bottom line on policy.  The climate issue is seen as a minor problem that can be efficiently resolved with a limited carbon tax.  Views that the problem is more serious than this are identified as climate “alarmism” fostered partly by the self-interest of politicians and bureaucrats.  The potential for international action is limited by right-wing conspiracy fears and the free-riding issue.  Domestic actions are expensive but politically sought even though they have relatively high cost compared to a cooperative global response.  These views can be debated but what is non-debatable is that these views do not reflect the worthwhile discussions of climate science and climate economics that lie elsewhere in this book. There is much sound analysis in this book but this analysis does not seem to drive the author’s policy views.

Harry Clarke
La Trobe University and the University of Melbourne.

January 2015.


  1. Harry: As far as I know, we have never met. I am therefore surprised that you claim to know my views on things, let alone that something would be inconsistent with those views.

    If instead you want to say that (a) a particular conclusion does not follow, or (b) a particular assumption is unrealistic, then please do so.

  2. Hi Richard, I know very little of your views other than in this book. I don't think your analysis or evidence presented backs up the policy view that climate change is a minor problem that can be dealt with mainly by adaptation measures. I'd be interested in clarifications as to where in your book you establish these views. Or I have mis-judged your policy bottom line. I did try to be careful.

  3. Harry
    I had hoped that the book clear lays out that the optimal policy mix consists of adaptation, mitigation and R&D; and that the composition of the mix depends on many assumptions about which reasonable people can disagree.

    If we use the received wisdom about these parameters, then we find mitigation that is lower than the political rhetoric but larger than the political reality (with perhaps an exception for Australia where rhetoric and reality seem to have swapped roles).