(Bloomberg) -- What if climate change turns out to be worse than we think? That anxiety is now commonplace, but a decade ago it took an influential paper by a Harvard professor to convince the insular world of climate economists to focus more of their attention on worst-case scenarios.
Martin Weitzman, who passed away this week at the age of 77, forever connected the notion of “fat tails” to the economics of climate risk. Before his 2009 paper overturned standard thinking, researchers looking at greenhouse-gas pollution and subsequent warming had focused on the climate futures that are most likely to happen. This is the hallmark of traditional cost-benefit analysis: Figure out the benefits of keeping the climate stable, compare that to the costs of preventing change, and then determine which policies make the most sense.
Weitzman used technical math to make the case that climate change is different because what’s most likely to happen doesn’t matter as much when there’s a possibility of total catastrophe. “Even when you have a low probability of a highly consequential event, those consequences—when they’re of a significant enough magnitude—can really overwhelm your thinking,” said Richard Newell, chief executive of the research nonprofit Resources for the Future and a former Weitzman teaching assistant.
The “fat tails” Weitzman’s work refer to the far right end of a bell-curve graph, where low-probability, high-impact scenarios live. Climate economists had been looking to the top of the bell curve—average-case scenarios—when they should be looking out to the extremities. That’s the potential horror outcomes.
Weitzman’s analysis was influential in helping convince global diplomats to adopt a goal for limits on warming—1.5 and 2 degree Celsius—in the 2015 Paris Agreement. Robert Stavins, director of the Harvard Environmental Economics Program, said the Paris targets may not have passed “an economic analysis, unless you take account of Weitzman’s fat tails.”
His impact on climate economics started decades ago. At the heart of many of today’s climate policy debates is a question Weitzman tackled in 1974 study called “Prices and Quantities.” That work looks at pollution-control policies to determine how a guaranteed price on polluting compares to a guaranteed cut in emissions. Before Weitzman’s work, economists thought the two approaches would have the same outcome. Not the case: When there’s incomplete information or uncertainty about the price and quantity of pollution, he found, their values diverge.
This difference maps onto today’s debates about how to dramatically reduce greenhouse-gas emissions. Carbon taxes, which Weitzman supported, make explicit the price of pollution, rather than focusing on the total quantity of it. Market-based programs go in the reverse direction, putting a stringent “cap” on the quantity of emissions while allowing buyers and sellers to figure out the price by trading permits to meet quotas.
Gernot Wagner, an environmental economist at New York University, took Weitzman’s class as an 18 year old at Harvard and went on to complete a PhD with him. The two co-authored Climate Shock: The Economic Consequences of a Hotter Planet, the 2015 book that reframed the risks of climate change. Anybody facing a 10 percent chance of having a car accident would try to prevent it, the economists argued, yet the world faces at least a 10 percent chance of climate catastrophe and isn’t behaving accordingly.
“His fat-tail story in many ways was the story,” Wagner said, “of how those uncertainties could potentially drive everything. He called it the Dismal Theorem. The burden of proof is on those who think that those risks don’t matter. It’s not the other way around.”
Weitzman also made significant contributions to another question at the heart of climate policy: What’s the future worth? Economists refer to “discounting” as the rate at which the value of money declines over time. The assumption made about this rate, when projecting where climate change may take the economy, has a dominant influence over the results of forecasting simulations. Weitzman argued against the standard view that the discounting rate is constant, instead demonstrating that it declines the further out projections go in time.
Newell said one of Weitzman’s biggest accomplishments was “challenging historical orthodoxy concerning long-term discounting, and doing so in a way that has had direct influence on government policy.” President Barack Obama’s team cited Weitzman’s work in technical material supporting its cost estimates for each metric ton of emitted C02.
William Nordhaus, the Yale economist who won the Nobel Prize in economics for pioneering work on climate-economic models, credits Weitzman with far-reaching impact. “He was the outstanding innovator in environmental economics of the last four decades and has left his mark on everything from measuring national accounts to managing fisheries to measuring biodiversity,” Nordhaus said.
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