What has Economics got to do with Climate Change?

When most people hear the word ‘economics’ they assume you are referring to money, recessions or the stock market. This wide misconception has therefore limited conversations surrounding Environmental Economics, the study of the empirical effects of environmental policies on the economy, especially in the mainstream media.

Before we cover the application of Economics to solving climate change, let’s first cover the basics. In Economics, the earth’s atmosphere is generally defined as a ‘public good’, giving it two key characteristics. Firstly, it is defined as ‘non excludable’, meaning no citizen can be prevented from accessing the good (i.e. everybody has access to the air we breathe), and secondly it is ‘non rival’, meaning use of the good won’t deplete supply for future consumers. Although few resources are true public goods, many will possess the non excludability aspect, while still being rival. For example, take forests. Although in theory nobody can be prevented from felling trees, deforestation will certainly decrease the future availability of trees. This is where the problem begins, and the famous Hardin’s ‘tragedy of the commons’ is induced.

So what does this actually mean? The tragedy of the commons refers to the fact that when concerning common pool resources, e.g. our example of forests above, there is significant incentive for citizens, firms and governments to free-ride. Essentially, despite the rational option that would lead players to actively conserve forests, if there is no guarantee that other players will do the same: any motive to conserve is destroyed. This thought pattern works exactly the same way concerning climate action: why should I act if there is no guarantee that others will? Furthermore, with the climate emergency being trans frontier, and there being a lack of an international regulatory agency to regulate climate action, it is essential that mechanisms are put in place to facilitate global cooperation.

Generally, economists advocate for either purely market based or state controlled policies to battle the climate catastrophe. Market based mechanisms involve policies such as cap and trade schemes, where emissions are priced and traded by firms. On the flip side, state interventionist schemes include regulation and legislative policies. However, over the past three decades, since the Rio Earth Summit, progress has emerged in the area of a potential collective action policy. My personal favourite research paper in this area has to be Elinor Ostrom’s ‘Governing the Commons’, which led her to become the first woman to be awarded the Nobel Prize in Economic Sciences in 2009.

In her book, Ostrom argues that institutions are rarely either strictly private or public, therefore purely market or state based policies are often ineffective in the long term. Instead, she advocates for collective activity, designed in a non-cooperative Game Theory framework. For those not familiar with Game Theory, it is the study of strategic behaviour (where the actions of each player affect the payoff for other players) between independent decision makers via mathematical models. When used in the context of climate action, a non-cooperative framework is used, as there is no external administration.

To summarise the results of the game without getting into too much detail concerning the mathematical formulas, Ostrom proposes that the contract for climate action won’t be enforceable unless agreed unanimously by all players. This means that unless the responsibility of climate action is shared equally by all players, the contract would be vetoed by those left worse off. Therefore, the only feasible agreement results in all players sharing any costs for climate action equally between them. Although Ostrom admits that her theoretical alternative to centralisation and privatisation still needs ‘much more work to develop the theory of collective action into a reliable and useful foundation for policy analysis’, the game does solve many of the problems that come with the free-rider problem. Because the players themselves have designed their own contracts, we can ensure that the global climate deal will lead to the best possible outcomes for each participant (in this case governments of countries) and that the policy will be enforced and regulated by the players themselves.

Some important factors the game doesn’t consider include issues with inequality, uncertainty and tipping points. A game conducted by Alessandro Tavoni at LSE concluded that equality and good communication are essential factors needed for an effective climate policy. In a world where just six countries make up 65% of CO2 emissions, and 100 companies emit 71% of emissions, it cannot be ignored that inequality is a huge barrier to successful negotiations, as it is often the countries who are less developed and emit less that end up suffering from the consequences of climate change disproportionately more. Nevertheless, with more research and development, non-cooperative game theory will without a doubt lead to the creation of an alternative mechanism to solve climate change.

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