The Changing Economic Paradigm
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TTTHHHEEE CCCHHHAAANNNGGGIIINNNGGG EEECCCOOONNNOOOMMMIIICCC PPPAAARRRAAADDDIIIGGGMMM By Hans Hoegh‐Guldberg ORIGINALLY WRITTEN AS APPENDIX 5, CLIMATE CHANGE AND THE FLORIDA KEYS JULY 21, 2010 SOCIOECONOMIC RESEARCH AND MONITORING PROGRAM FLORIDA KEYS NATIONAL MARINE SANCTUARY (FKNMS) NATIONAL ATMOSPHERIC AND OCEANIC ADMINISTRATION (NOAA) This study was funded by NOAA’s Coral Reef Conservation Program CONTENTS THE CHANGING ECONOMIC PARADIGM ............................................... 1 INTRODUCTION ................................................................................................................ 1 ANIMAL SPIRITS AND THE GLOBAL FINANCIAL CRISIS ................................................................ 3 The heart of Akerlof and Shiller’s message ........................................................................ 3 Origin and neglect of the animal spirits ............................................................................. 3 Keynes’ General Theory of Employment, Interest and Money ....................................... 3 How the animal spirits came to be neglected ................................................................. 4 Five expressions of animal spirits .................................................................................... 6 Eight key questions and the influence of animal spirits ................................................. 9 Stiglitz and other economists on a parallel course ........................................................... 11 A strategic business view of the crisis .............................................................................. 12 Scientists offer to re‐define economic theory ................................................................... 13 New economics of uncertainty and risk ........................................................................... 15 ECONOMICS OF CLIMATE CHANGE...................................................................................... 17 The Stern climate change model ...................................................................................... 19 Scientists agree that climate change is real .................................................................. 19 The greatest market failure ever .................................................................................. 19 Emissions differ fundamentally from congestion or local pollution ............................. 19 The risk for future generations is a crucial ethical issue ............................................... 20 Criteria for shaping policy ............................................................................................. 20 The cost of inaction ....................................................................................................... 21 GENUINE INTERDISCIPLINARY INFLUENCES ........................................................................... 21 Complexity theory and complexity economics ................................................................. 21 The role of a genuine interdisciplinary philosophy ....................................................... 21 Inspiration from polymaths ........................................................................................... 25 Parallels in traditional science and traditional economics ............................................ 26 The Santa Fe Institute ................................................................................................... 27 Expanding econophysics? ............................................................................................. 28 Traditional versus complexity economics ..................................................................... 31 Constructively dissident economic voices are not a new phenomenon ....................... 31 Behavioral economics and the potential contribution from psychology .......................... 33 WHAT MIGHT THIS MEAN FOR ECONOMICS IN THE FUTURE? .................................................... 35 Animal spirits and market failures ................................................................................... 35 Complexity and the role of other disciplines .................................................................... 36 LESSONS FOR CLIMATE CHANGE POLICY FROM RECENT EVENTS ................................................. 37 The Copenhagen Accord ................................................................................................... 38 A “price collar” to reduce risk ........................................................................................... 40 Should climate policy change radically? ........................................................................... 41 Implications ...................................................................................................................... 44 The key issues remain large‐scale .................................................................................... 46 THE ECONOMIC PARADIGM UNDER ALTERNATIVE SCENARIOS ................................................... 47 2 ADDENDUM 1: ANIMAL SPIRITS IN THE GENERAL THEORY ...................................................... 49 ADDENDUM 2: SCHUMPETER ON ECONOMIC DEVELOPMENT .................................................. 53 REFERENCES .................................................................................................................. 54 3 THE CHANGING ECONOMIC PARADIGM INTRODUCTION Greenhouse gas emissions constitute the greatest market failure the world has seen (Stern 2006, p 1; Stern 2009, pp 11‐13). This is an important reason why the macroeconomic policy model that guided the United States, Great Britain and other economies over thirty years is being reappraised. The neoclassical economic policy philosophy that became prominent in the 1970s asserted that free markets are self‐regulating and governments need not interfere with businesses pursuing their own self‐interest. This philosophy is being critically questioned as climate change starts to bite, because it allows major polluting industries to operate without proper environmental control. Dealing with climate change became progressively more urgent with the mounting evidence that previous climate projections which showed regular and steady rises in emissions did not tell the full story. From 2000 onwards (Cox et al. 2000)1 climate models have contained positive feedback loops incorporating events that can trigger potentially catastrophic change in the global climate – events that have already become visible such as the melting sea‐ice, ice caps and thawing permafrost in the Arctic. There are many references in the recent literature to worst‐case scenarios of only a few years ago being exceeded, none more authoritative than NASA’s James Hansen and his colleagues (Hansen et al. 2008 is a good example). Hansen only fairly recently criticized his fellow scientists for being reticent when evidence still had a tiny element of uncertainty (Hansen 2007); however, there was no reticence in the synthesis report from the climate change conference of scientists in Copenhagen, Denmark, in March 2009 (Richardson et al. 2009). Its six key messages are stark, uncompromising, and call for urgent action. The book Six Degrees by Mark Lynas (2008) provides a well‐researched, readable, and frightening overview of what a warming world might mean to humankind. A recent Australian book (Spratt and Sutton, Climate Code Red, 2008) makes a powerful call for emergency action, publicly endorsed by Jim Hansen and other prominent experts.2 1 This work was pioneered by climate scientists at the Met Office Hadley Centre in Exeter, United Kingdom. The timeline can be further traced back to a previous paper by Met Office’s Richard Betts and Peter Cox and two plant scientists from the University of Sheffield which studied climate model feedbacks from changes in vegetation structure (Betts et al. 1997). Unlike Cox et al. (2000), the previous paper only compared the impact on the global mean temperature increase in a limited sense. It found that changes in vegetation structure largely offset physiological vegetation‐climate feedbacks in the long term (with some significant regional‐scale effects). 2 The book was followed up by the launch of Safe Climate Australia in Melbourne, Australia, in July 2009, by former Vice President Al Gore (http://www.safeclimateaustralia.org/). The new organization is seen as a model for similar groups in other countries to develop whole‐of‐society plans to restructure economies from fossil fuels to reach “net‐zero carbon” at emergency speed. Al Gore had already launched similar ventures in the US, including Repower America in 2008, which aims at converting all electricity supplies to clean power (http://www.repoweramerica.org/). The venture is one of several under the auspices of The Alliance for Climate Protection, founded by Al Gore in 2006 to alert the global community to the urgent need for comprehensive solutions to the climate crisis. The non‐profit, non‐partisan Alliance was reported in late 2009 to have more than two million members worldwide (http://www.climateprotect.org/ ). The prevalent macroeconomic policy model has also been dealt a blow by the global economic crisis. George Akerlof, joint winner of the 2001 Nobel Prize in economics, and Yale economics professor Robert Shiller, find that the conventional theory is not providing anything like an adequate explanation. Their book is Animal Spirits: How human psychology drives the economy,