Climate change - A tragedy in three parts
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Estimated reading time ~ 9 mins
There are three tragedies at the heart of climate economics: the commons, the horizon, and inertia.
The tragedy of the commons arises when individuals, acting in their own self-interest, over-exploit a scarce resource, contrary to the common good. The tragedy of the horizon reflects the fact that we tend to weigh the wellbeing of those alive today as worth more than those born tomorrow. Lastly, the tragedy of inertia refers to the situation in which as energy demand goes up, and our economies become increasingly complex, so the chance to improve on the status-quo becomes ever more constrained.
It’s important to understand the tragedies. Solving climate change demands that we tackle all three.
The tragedy of the commons
The tragedy of the commons is a classic problem in environmental economics. It occurs when a public resource (also called a commons) is over-exploited as individuals, acting in their own interest, ultimately deplete the resource, to the detriment of others. Although the theory was first conceptualised in 1833 by British writer William Forster Lloyd, it wasn’t until 1968 that the term “tragedy of the commons” was used for the first time by Garret Hardin in an article in Science Magazine:1
The tragedy of the commons develops in this way. Picture a pasture open to all. It is to be expected that each herdsman will try to keep as many cattle as possible on the commons. Such an arrangement may work reasonably satisfactorily for centuries because tribal wars, poaching, and disease keep the numbers of both man and beast well below the carrying capacity of the land. Finally, however, comes the day of reckoning, that is, the day when the long-desired goal of social stability becomes a reality. At this point, the inherent logic of the commons remorselessly generates tragedy.
As a rational being, each herdsman seeks to maximize his gain. Explicitly or implicitly, more or less consciously, he asks, "What is the utility to me of adding one more animal to my herd?" This utility has one negative and one positive component.
1) The positive component is a function of the increment of one animal. Since the herdsman receives all the proceeds from the sale of the additional animal, the positive utility is nearly +1.
2) The negative component is a function of the additional overgrazing created by one more animal. Since, however, the effects of overgrazing are shared by all the herdsmen, the negative utility for any particular decision-making herdsman is only a fraction of -1.
Adding together the component partial utilities, the rational herdsman concludes that the only sensible course for him to pursue is to add another animal to his herd. And another; and another.... But this is the conclusion reached by each and every rational herdsman sharing a commons. Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit--in a world that is limited. Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons. Freedom in a commons brings ruin to all.
Of course, the term ‘tragedy of the commons’ has subsequently been used to identify multiple instances in which individual incentives lead to the over-exploitation of the commons. Examples of ‘commons’ that have been over-exploited include the ocean (over-fishing, plastic pollution), medicines (over-use of antibiotics), the road network (congestion, air pollution), rainforests (deforestation, desertification, pollution), and the atmosphere (greenhouse gases, air pollution).
The solution to the tragedy of the commons lies in property rights, supply management and pricing the externality. Assigning property rights (or privatisation) should mean that resources are managed more sustainably, but it raises issues of inequality of wealth and access. Members of a community can also come together to prevent scarce resources from being exploited. Political decisions such as those agreed at COP are an example, but of course they come with the need for consensus, and that takes time. The third solution is to price the externality. A cap-and-trade scheme is an example of a policy tool that seeks to override the tragedy of the commons. By allocating permits to emit carbon dioxide through a competitive auction, individual emitters have an incentive not to exhaust the carbon budget (see The great sulphur dioxide allowance bull market).
The tragedy of the horizon
The term ‘tragedy of the horizon’ was coined by Mark Carney, former Governor of the Bank of England. First outlined in a speech to Lloyds of London in September 2015, and then subsequently expanded on in Carney’s book, Values: An Economists Guide to Everything That Matters, it refers to the tendency to let subsequent generations bear the burden of climate change. Carney warns that once climate change becomes a defining issue for financial stability - the outer boundary of the credit cycle is only about a decade - it may already be too late to do anything about it:2
“Climate change is the tragedy of the horizon. It’s catastrophic impacts will be felt beyond the traditional horizons of most actors - imposing a cost on future generations that the current generation has no direct incentive to fix. That means beyond the business cycle, the political cycle and potentially the horizons of technocratic authorities, like central banks, which are bound by their mandates.”
The key factor underpinning the tragedy of the horizon is how much weight we assign to the welfare of future generations. One argument is that the returns to climate mitigation should be compared against other investments, in healthcare, adaptation, energy security, and so on. Here the discount rate will reflect the long-term risk free real interest rate. However from a climate risk perspective it also implies that the wellbeing of those alive today is worth more than future generations. Alternatively, the discount rate should be based on ethics. For economists such as Nicholas Stern, the discount rate need to be very low, possibly even zero, reflecting the fact that those likely to be impacted the most by climate change do not have a voice in the decision.
Carney suggests that the tragedy of the horizon can be broken “if the transition to a low-carbon economy begins early and follows a predictable path.” However, markets can only anticipate and smooth the adjustment to net zero if they have “the right information, proper risk management, and coherent, credible public policy frameworks.”
It’s why companies are now publishing data regarding their climate impact (many voluntarily, but increasingly mandated), remote monitoring equipment and AI are tracking emissions, banks are benchmarking their robustness across a variety of climate scenarios, and investors are increasingly using climate policies to guide their capital allocation decisions - at least in regions where its not politically contentious (see Full disclosure).3
The tragedy of inertia
Newton's first law, the law of inertia states that if a body is at rest or moving at a constant speed in a straight line, it will remain at rest or keep moving in a straight line at constant speed, unless it is acted upon by a force. Inertia is one of the defining properties of the modern economy, and energy is at its core.
The tragedy of inertia is that as overall energy consumption rises, the demand for infrastructure (pipelines, refineries, transmission lines, etc.) necessary to achieve economies of scale also goes up. Yet this innate need to achieve scale embeds inertia, preventing the economy from transitioning to other forms or carriers of energy with improved characteristics (i.e. cleaner, more secure, and more efficient). In turn, ever higher levels of human ingenuity are required to break the hold that inertia has on the economy.
Humanity has undergone three energy transitions since the 19th Century, as first coal, then crude oil, and most recently natural gas supported the acceleration of economic development. The fourth transition, the one humanity is currently experiencing, involves the transition to energy sources that emit zero carbon. It takes at least 50 years for an energy transition to play out according to Vaclav Smil, a scholar of energy systems at the University of Manitoba. But Smil also notes that the speed at which energy transitions are taking pace has slowed, with every subsequent transition taking longer to establish a sizeable share of overall energy demand.
Consider the zero carbon energy transition. The foundation of our modern economy is built on electricity generated from spinning turbines. Whether it is coal, natural gas, nuclear or hydro, every single turbine is spinning at exactly the same frequency, 50hz. That inertia has value. If all the power generation turbines are spinning at the same rate it helps maintain grid frequency, and rapidly counter the impact of a power outage. Unfortunately, renewable energy such as wind and solar have too little inertia. When the wind stops and the sun stops shining there is no inertia to keep the grid balanced. Its one of the reasons why we are likely to need some conventional power generation as backup.
The tragedy of inertia also manifests itself downstream from the source of the energy supply. It is cemented for decades or even hundreds of years in the buildings that we construct, and in the systems and appliances that we use to heat and cool them. For example, high upfront costs and uncertain payoffs can be a significant barrier to replacing a gas boiler with a heat pump, or retrofitting a building with improved insulation.
The tragedy of inertia can be overcome, but as I note earlier, the more complex the energy requirements of the economy, the greater the need for human ingenuity. The acceleration in the pace at which innovations have reached mass adoption - whether it be telephone, cars or smartphones - gives reason for optimism. Artificial intelligence and machine learning may help to accelerate progress, perhaps enabling renewable energy to capture a higher share and reducing the need for conventional generation (see Exponential).
The rapid pace of technological change over the past few decades may have also led to unrealistically high expectations. Smil coined this phenomenon ‘Moore’s Curse’, a nod to ‘Moore’s Law’ and the time for microchip components to double. Rather than expanding at the breakneck pace seen in software, technological improvements in the physical world have been much more pedestrian. For example, the efficiency with which steam turbogenerators convert thermal power to electricity generation increased was a mere 1.5% per year during the 20th century.
Hardin’s writing about the role of eugenics in controlling population growth would put Malthus to shame https://www.science.org/doi/10.1126/science.162.3859.1243
https://www.bankofengland.co.uk/-/media/boe/files/speech/2015/breaking-the-tragedy-of-the-horizon-climate-change-and-financial-stability.pdf
https://www.bis.org/review/r190322a.pdf