With its fixation on equilibrium thinking and an exclusive focus on market factors that can be accurately measured, neoclassical orthodoxy in economics is fundamentally ill-equipped to deal with today’s biggest problems. The change within the discipline is underway, but it cannot come quickly enough
Nowhere are the limits of neoclassical economic thought – the DNA of economics as it is currently taught and practiced – more apparent than in the face of the climate crisis. As new ideas and models emerge, the old orthodoxy remains deeply rooted. Change cannot come quickly enough.
The discipline of economics has failed to understand the climate crisis – let alone provide it with effective policy solutions – because most economists tend to break problems down into manageable little chunks. Rational people, they tend to say, think on the margins. What matters is not the average or all of its actions but rather the next step, weighed against the immediate alternatives.
Such thinking is indeed rational for small discrete problems. Compartmentalization is necessary to manage competing demands for time and attention. But marginal thinking is inadequate for a consuming problem affecting all aspects of society.
Economists also tend to equate rationality with precision. The power of discipline over public discourse and policymaking lies in its implicit assertion that those who cannot accurately calculate benefits and costs are somehow irrational. This allows economists – and their models – to ignore pervasive climate risks and uncertainties, including the possibility of climate tipping points and societal responses to them. And when we consider the fixation of economists on equilibrium models, the mismatch between the climate challenge and the current tools of the discipline becomes too glaring to be ignored.
Yes, returning to balance – “returning to normal” – is far too human a preference. But it is precisely the opposite of what is needed – the rapid phase-out of fossil fuels – to stabilize the global climate.
These limits are reflected in the cost-benefit analyzes of reducing emissions of carbon dioxide (CO2) and other greenhouse gases. Traditional thinking suggests a slow way to reduce CO2. The logic seems compelling: The cost of damage from climate change, after all, is incurred in the future, while the costs of climate action occur today. The Nobel Prize’s verdict is that we should delay the necessary investments in a low-carbon economy to avoid harming the current high-carbon economy.
To be clear, much thought has been given to showing that even this conventional logic would now require much more climate action, as the costs are often overestimated while the potential benefits (even if they are uncertain) are underestimated. The young researchers who are pushing this work forward have to walk an almost impossible tightrope, as they cannot publish what they believe to be their best work (based on the most defensible assumptions) without invoking the outdated neoclassical model to demonstrate the validity of new ideas.
The very structure of university economics almost guarantees that marginal thinking continues to dominate. The most effective way to introduce new ideas into peer-reviewed academic literature is to follow something akin to an 80/20 rule: stick to the established scenario for the most part; but try to push the boundaries by probing one questionable hypothesis at a time. Needless to say, this makes it extremely difficult to change the overall frame of reference, even when those who helped set the standard view themselves are looking far beyond.
Take the case of Kenneth J. Arrow, who shared a Nobel Prize in economics in 1972 for showing how marginal actions taken by interested individuals can improve the well-being of society. This pioneering work cemented the equilibrium thinking of economists. But Arrow lived another 45 years, and he spent that time moving beyond his previous job. In the 1980s, for example, he was instrumental in founding the Santa Fe Institute, which devoted itself to what has since come to be known as the science of complexity – an attempt to move beyond the state of mind. balance he had helped to establish.
Because equilibrium thinking underlies the traditional climate-economic models that were developed in the 1990s, these models assume that there are trade-offs between climate action and economic growth. They imagine a world where the economy simply slides down a Panglossian path of progress. Climate policy may still be worthwhile, but only if we are prepared to accept costs that will divert the economy from the path it has chosen.
In the context of this traditional view, recent statements by the International Monetary Fund and the International Energy Agency are simply revolutionary. The two institutions have now concluded that ambitious climate action leads to higher growth and more jobs, even in the short term.
The logic is simple: Climate policies create far more jobs in clean energy sectors than they lose in fossil fuel sectors, reminding us that investing is the flip side of the cost. That is why the proposed US $ 2 trillion infrastructure package in the United States is expected to boost net economic activity and employment. Perhaps more surprising is the finding that carbon pricing alone appears to reduce emissions without harming jobs or overall economic growth. The problem with carbon taxes or emissions trading is that real-world policies don’t reduce emissions fast enough and will therefore need to be backed up by regulation.
There is no excuse for continuing to adhere to an intellectual paradigm that has served us so badly for so long. Standard models have been used to reject policies that would have helped turn the tide many years ago, when the climate crisis could still have been resolved with marginal changes to the existing economic system. Now we no longer have the luxury of being able to settle for gradual change.
The good news is that rapid changes are occurring on the political front, not least due to the falling cost of climate action. The bad news is that the neoclassical framework of economics still blocks progress. The discipline is long overdue for its own tipping point towards new ways of thinking commensurate with the climate challenge.
Tom Brookes is Executive Director of Strategic Communications at the European Climate Foundation and Gernot Wagner is Clinical Associate Professor of Environmental Studies at New York University.
Copyright: Project Syndicate