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By Jessica Wilson

Derek Lemoine Photo by Thomas Veneklasen.

Derek Lemoine
Photo by Thomas Veneklasen.

Economists like markets because they are efficient, but, according to assistant professor of economics Derek Lemoine, they only work when prices convey the right information.

When it comes to the cost of carbon dioxide emissions, he said, “We know right now that prices aren’t accurate.” The cost of carbon dioxide emissions to firms is zero, while the cost to broader society is not.

In his paper, “Watch Your Step: Optimal Policy in a Tipping Climate,” published in the American Economic Journal: Economic Policy, Lemoine and coauthor Christian Traeger attempt to calculate both the true cost of carbon dioxide emissions and the factors that are most important in determining the true cost.

The goal is to bring into line the cost of carbon dioxide emissions for firms with the cost of them for society. The result could be used to calculate the optimal tax on carbon emissions or to value the emission reductions from energy policies.

Climate change policymakers evaluate policies after running scenarios through economic models that will estimate the cost of carbon dioxide emissions to society. Lemoine and his team have created the first model that takes into account the possibility of crossing an environmental tipping point and what that would mean for the carbon tax rate. A tipping point occurs when the earth system crosses a threshold such that environmental changes cannot be reversed and such that the damage spirals at an increasing rate if nothing is done. “Previous models capture small nudges, but there were no good models that captured the spiral effect of tipping points,” Lemoine said.

Lemoine’s model differs because it assumes that welfare loss is endogenized and the hypothetical policymaker has the capacity to learn. “We are not assuming how much worse off we would be after crossing a tipping point,” he said. “We are not assuming it is the end of the world. The model decides. We are not assuming the probability of it happening. We are allowing the fictional policymaker to learn. As the policymaker learns, the estimated probability of crossing the tipping point changes.”

An important conclusion he and his coauthor drew is that, “The benefit of decreasing emissions is greater than we had thought when we weren’t taking into consideration tipping points.” Such a conclusion has repercussions, namely, that learning about climate change tipping points is economically valuable.

“We didn’t put an exact price tag on the value of having more precise information, but we showed qualitatively that it would be valuable,” Lemoine said. “From an economist’s side, it is important that scientists provide us with the knowledge that will make our models more insightful and more accurate.”

He believes that two pieces of information could go a long way toward making carbon tax models more accurate: “One, we have to learn what the probability of a tipping point is. For example, how likely is it that one would have occurred by the time you get to some degree of warming?” In addition, part of figuring out the carbon tax necessitates understanding the damage done, so, he believes scientists should answer, “What does it mean for it a tipping point to occur? What changes? It would help to have scientific work that says we are worried about this kind of change happening at this temperature.”

While Lemoine values economic models, he also believes that “It’s important to learn how to learn from models. Any one model simulation is fragile, but we’re wondering how robust our policy is….We’re trying to determine which dimensions are important to focus on because we have a limited number of minds and time and research capacity.”

His work points to two areas of research where those minds, time, and research could best be used: finding when a tipping point will happen and what it will look like when it does. Such information is key to determining the true cost of carbon dioxide emissions to society and, thus, how emissions should be priced.

Top image of chemical plant/power station air pollutions courtesy Shutterstock.