John Cochrane recently posted an important blog post sketching out his claim that climate change will only have a small impact on world GNP over the next 75 years.   He argues that the trend growth (3% growth for 60 years) will swamp the effect of climate change).  As I discuss in my 2010 Climatopolis book, Singapore in recent decades has been highly productive despite the nation's heat and humidity.  This one data point offers a "Paul Romer blueprint" for how to adapt through indoor activity and shifting outdoor time allocation to nights and early mornings.

But, do not forget the Sen and Stiglitz report on expanding GNP accounts to reflect non-market factors.They argue that GNP is an incomplete measuring rod of a society's progress.

My teacher Sherwin Rosen developed his compensating differentials approach to build on the Tobin and Nordhaus Is Growth Obsolete?  See Table 2

Since Tobin, Stiglitz, Nordhaus and Cochrane are all great macroeconomists, they abstract away from the spatial variation in how climate change shifts the attributes bundled into locations.  They ignore the spatial hedonic equilibrium and how climate change shifts this equilibrium. Intuitively, if Matt loves to walk on snowy mountains and if climate change raises all winter temperatures above 32 F then no more snow and matt cries.  What is his next best alternative?  He has lost non-market services that Mother Nature used to supply. If an indoor mall walk is a close substitute , then Matt loses little.   Spatially tied real estate prices will capitalize these amenity changes but in an economy featuring diverse consumers, these price changes will not capture the full distribution of lost consumer surplus.  Those who only love walking on snowing mountains and enjoy nothing else are "inframarginal" and they will have more trouble adapting to the change in lost snow.  GNP accounts do not capture the "paradise lost" for such individuals.  In contrast, GNP could rise if more snow walkers substitute and go to the mall and buy Starbucks coffee!!

This simple Becker example of Leisure production that uses one's time and local weather conditions as  complements is the key logic of my Climatopolis book and my Adapting to Climate Change book.  On his own terms, John Cochrane is right but he abstracts away from the key issue of non-market local public goods (beautiful weather near Stanford) and global public goods (a calm weather system)  and how heterogeneous individuals value them.   Sherwin Rosen's work needs to make a comeback here.  The hedonic real estate pricing gradients reflect key information but when the population is diverse in terms of tastes, information and adaptation strategy access, then the hedonic price gradients shifts do not tell us enough to trace out the population's lost consumer surplus caused by climate change.    The microeconomics research agenda is to trace out this expenditure function approach.  See my slides here starting on slide 9.

Some readings;

2008 Urban Growth and Climate Change

2010 Climatopolis

2021 Adapting to Climate Change

 Consider a University of Chicago Econ 301 homework assignment situated in Summer 2021 in the American West.

"You own a $500,000 home in a fire zone in the American West.  You owe $X on your mortgage.  It is common knowledge that your property now faces greater air pollution exposure and a higher probability of burning down.   You are not alone.  You have Z neighbors who live near you who face the same challenge.  You have access to the following adaptation strategies;

1.  You can invest in private adaptation strategies such as vegetation trimming and buying a PM2.5 air filter for your home and spending less time in your home during the fire season.

2.  You can invest in private club goods with your neighbors (such as a private fire protection service).  Note that Kim Kardashian invested in this.  

3.  You can lobby State officials for subsidies to enhance public fire protection of your area.  (this includes stricter building codes).

4.  You can sell your home and move away.

5.  You can default on your mortgage and move away.

The Econ 301 Question

Use the Becker Household production function framework to write out a microfounded model based on equivalent variation of which of these strategies will yield you the lowest present discounted value expenditure on adaptation.   Assume that the Value of a Statistical Life = $10 million and the person suffers $Q in lost time when she is sick.   Adaptation investment lowers the probability of death and the probability of being sick.  Such investment lowers expected damage caused by climate change.

Note that climate change induced wildfire risk is a local public bad.     How do the different factors listed above influence how many people seek to live in the fire zone (extensive margin) versus the protective actions they take once in the fire zone?  In a dynamic programming sense, how are these two margins related?

How would you use your model to calculate the social cost of carbon?  Is this object a stationary object as has been claimed by Norhaus in his Nobel Prize research?  Discuss the comparative statics here concerning how the SCC is affected by some of the adaptation parameters listed above.

Remarks

(the perceptive reader will see that one will need to be explicit about the health and survival functions. How much does PM2.5 lower a specific person's health and lower the probability of survival?).  The Becker approach immediately highlights that this is almost an infinite dimensional problem with many , many adaptation strategies.   

My claim in my 2021 Yale Press book is that the lost $ to the affected household is shrinking over time because #1 is getting cheaper and cheaper and the transaction costs for the Coasian #2 are also shrinking.  When one thinks hard about the microeconomics of the climate change challenge, one realizes that the social cost of carbon is shrinking over time as we improve in our ability to adapt.   The mechanical SCC macro models (see Nordhaus) miss all of this because of their aggregation assumptions.  

As I discuss in a later chapter of the book, if we change land use zoning to up zone close to productive, high amenity cities then fewer people would live in the fire zones and this would further reduce the social cost of carbon induced fires.

 John Cochrane has posted an important blog post about adapting to climate change.  His piece mainly focuses on macroeconomic issues.  For decades, John was colleagues with Bob Lucas and those familiar with Robert Lucas's optimistic work on economic growth will see a correlation.  While John makes many points, his main point is;  "if a world's economy grows by 3% per year out to the year 2100 --- it will be rich enough to handle any of Mother Nature's shocks at that point or along the way".   He points to the growth of China's economy as an example.  John is optimistic about our future;

"The share of the world population in extreme poverty is plummeting. No plausible estimate of climate damage comes close to this kind of change.  And this change comes in part from increasing diffusion of fossil fuels. People who used to hoe by hand now use tractors."

John's piece really focuses on misallocation.  He wants nations to remove misallocation road blocks such as land use restrictions to unleash economic growth so that more nations and their citizens have the income to take the steps they deem necessary to handle the harder punches thrown by Mother Nature.  

As a macroeconomist, John views decarbonization as one strategy that raises our real income in the year 2100 and he wants this strategy to be compared to other pro-growth strategies.  Another quote from JC;

"But reducing carbon is thus, logically, just one item on the list of answers to "What can we do to raise GDP in 2100?," and especially "What can we do to raise GDP in currently-poor countries by 2100?" Asked that way, you can see that "lower carbon emissions" is about #100 on the list, even admitting the 5-10% of GDP thumb-on-the-scale estimates. It's like asking whether removing that "Go Bears" flag from your radio antenna will improve your gas mileage and lower your overall expenses. Well, yes, maybe, but it's hardly first on the list." 

My Thoughts;

1.  Take a look at David Sattherthwaite's 2010 tough review of my 2010 Climatopolis book.  You will see that John and I share many thoughts in common on this topic.  I have working on the costs of climate change for 15 years now going back to my 2005 Death Toll paper.    Once I estimated that richer nations suffer fewer deaths per-capita in natural disasters , I immediately saw the implications for climate change adaptation.  Robert Lucas hadn't connected his economic growth work to a nation's non-market quality of life. He was implicitly assuming that there are complete markets and was not incorporating ideas from his buddy Sherwin Rosen on non-market quality of life.  

2.   John does not discuss rare disasters at fat tail risk.  Martin Weitzman's key research was really about macro-economics.  Marty argued that rising global GHG emissions pose new ambiguous risks for economy.  Such fat tails could be quite disruptive if there are supply chain networks to the economy (intuitively think of a domino chain).  While I greatly respect Marty's work, here is my response.   Marty was my friend and we would debate.  I am a microeconomist and I said to Marty; "Many of us know that we do not know what risks climate change will pose.  Those of us who are risk averse will seek out implicit insurance schemes and those that feature option value so that we can move ourselves and our capital to "higher ground" (i.e safer places) if climate change turns out to be as bad as you claim.  Firms can build in redundancies in supply chains and use hedging markets to reduce their risk exposure. " 

Weitzman's great work didn't engage with Townsend's work on risk sharing and Ehrlich and Becker's work on self protection. Climate change represents a set of spatial shocks and we can always re-optimize as we learn.  This is a key theme of my Climatopolis book and my 2021 Yale University Press book Adapting to Climate Change.

3.  John sets society's goal as maximizing per-capita income in the year 2100.  Would Greta agree with him?  The answer hinges on whether there are complete markets. If there are complete markets then the separation theorems hold.  With complete markets, the loss we suffer in terms of lost natural capital would be subtracted from GNP to calculate per-capita income net of depreciation to natural capital.   If there are incomplete markets, then one must be more explicit about whether the loss of natural capital imposes losses on us that $ can't offset.  An example. The recent heat wave may have killed a billion creatures.    Is this loss of natural capital reflected in market prices?  Yes, if these are market commodities.

4.  John's blog post doesn't sketch out any Gary Becker household production functions, what does extra $ in 2100 buy us in terms of safety, comfort or health or protection of our children?  This is a key theme of my 2021 book.  John's optimism (that I share) hinges on knowing that money will buy inputs that can offset Mother Nature's stronger punches caused by climate change.  The Beatles sang that "money can't buy me love".  IO economists continue to try to estimate structural production functions of making goods. What do we know about structural production functions of producing health and safety?   How do these production functions of Beckerian goods change over time due to new information and new goods?   At a conference in 2019 that honored Frank Wolak, I presented these slides to make these points clear.  

5.  John does not discuss the feedback loop.  If economic growth accelerates, then GHG emissions will accelerate (given current technologies).   See the paper by Davis and Gertler in PNAS 2015 for an example.  John would counter that per-capita income growth will accelerate decarbonization as the Paul Romer green innovation effect will kick in so that Universities such as Uchicago and Stanford do more basic research and this leads more Elon Musks in the future to launch more green firms selling great green products that richer people voluntarily buy.   Such innovation means that the Lucas Critique is key here. One will over-estimate future damage caused by climate change using recent estimates of the "climate damage function".  The Autstrian critique of empirical economics is correct in this case.

My Bottom Line

For 15 years, I have argued that capitalism caused climate change (the GHG Engel Curve associated with fossil fuel consumption) and capitalism will solve the climate change challenge through fueling innovation and accelerating our adaptation capacity.    The old generation of Uchicago economists think alike.  Here is 2012 video where I elaborate.  

My 2009 piece; "Urban Growth and Climate Change" fleshes this out.

I reject the view that climate shocks are global macro shocks.  They are spatial shocks (such as the Texas Freeze in February 2021).  Such place based shocks impose costs and trigger cross-elasticities (flows of capital and labor to other places).  Spatial prices adjust and a new dynamic compensating differentials equilibrium is achieved.  The set of strategies that people have to adapt at any point in time pins down these price adjustments but the strategy set is always growing.  See my 2014 lecture.

Abstract

In an urbanizing world economy featuring thousands of cities, households and firms have strong incentives to make locational investments and self protection choices to reduce their exposure to new climate change induced risks. This pursuit of self interest reduces the costs imposed by climate change. This paper develops a dynamic compensating differentials model to explore how the “menu” offered by a system of cities insures us against emerging risks. Insights from urban economics offer a series of testable hypotheses concerning the economic incidence of spatially tied climate change risk.

UPDATE

One interpretation of John's blog post is that climate change mitigation should not be the world's top priority right now and instead we should focus on policies that maximize economic growth.   I think that many people who are worried about climate change would claim that we can achieve both goals through embracing the "green economy".  This claim merits more research.

In my own microeconomic research on the climate change challenge, I have not emphasized policy priorities today because I believe that the political economy is such that global greenhouse gas emissions will continue to rise.  This is why I started to work on the adaptation issue.  I discuss this point at length in chapter 1 of my 2021 Yale Press book and in the 2009 piece "Urban Growth and Climate Change" linked to above.  To repeat this point, I approach the climate change issue from a Nash Equilibrium perspective;  given that emissions are rising and that the free-rider problem at the global level is only going to get worse, how do individuals and firms adapt?  

 A nuanced blog post about the damage that we will suffer because of climate change.

Given all of the uncertainty associated with climate change, it is important to distinguish a few dimensions of this uncertainty;

#1

Will we face more frequent and more severe weather events going forward in time?

I believe that the answer is yes because I believe that global GHG emissions will continue to rise.

#2

Will such punches thrown by Mother Nature cause more damage over time in terms of lives lost and $ of damage destroyed?

I believe the answer is "no" .  Each day we are becoming better at adapting to such shocks because of rising human capital, our rising income, and our access to better information and markets.  I believe that the Social Cost of Carbon is declining over time (Holding the atmospheric GHG level fixed).  So my prediction here is  a first cousin of Julian Simon's in his famous bet with Paul Ehrlich.  

Over time,  the world's GHG emissions grow but our ability to adapt to shocks increases.  This means that a researcher who graphs the economic damage caused by climate change with respect to time can actually observe lower damage over time if our adaptation progress exceeds the growth in GHG emissions.  

 Cliff Winston sent me a copy of his forthcoming book Gaining Ground --- so I read it.  This is an optimistic book that celebrates the constructive role that markets play in improving our quality of life.  A theme throughout the book is the synergy between market forces and government activity.  Cliff does a great job surveying the recent empirical literature to inform his discussion.

Here is an important paragraph that packs in several of his "big ideas" in this U.S focused book.

"Most government policy inefficiencies appear to reflect status quo bias caused by some combination of policymakers’ preferences/ideology and resource constraints. Status quo bias inhibits policymakers from learning about the effects of their policies and how they could be improved, and enables X-inefficiencies in one area to persist and interact with inefficiencies in other areas. The self-selection of people who choose to work in government and the legal process undoubtedly strengthen status quo bias and make it less likely that government will reform inefficient policies and implement efficient ones."   (Gaining Ground page 186)

On many occasions, I have blogged about urban policy with a focus on the failure of Coasian ideas. Why don't congested cities have road pricing? Why don't productive, high amenity cities feature less single family housing in order to more efficiently use scarce land?  If the Heckman early intervention program for helping children achieve their full potential is so cost effective, why don't home owners in cities figure out a payment mechanism to offer this program to reduce urban poverty and local crime?

In cases where the winners win more than the losers lose from policy reform, why doesn't policy reform occurs?  Cliff's answer merits new research and discussion and debate.

Cliff's quote above raises the question of why elected officials prefer to stick with the status quo.  A simple Peltzman Type I versus Type II error model can explain why career concerned government officials do not want to "rock their boat" with new ideas that may not work.

Most government officials do not "want to make waves".  The simplest way to achieve this goal is to not introduce new policies that may not work.  In Peltzman's typology ; type I errors are not implementing good ideas that would work.  Type II errors are implementing new policies that don't work.  Since Type II errors are seen by the world , they pose more risk for the incumbent government official and thus are less likely to be implemented.

Let's not forget market competition. While leaders in a private firm face the same tradeoffs, they face two additional incentives. Their pay may be directly tied to compensation and their firm may face an innovative hungry and disruptive rival. In this sense, the private leader faces greater incentives to innovate.