Leveraging markets to slow climate change, from carbon taxes to climate clubs
William D. Nordhaus is an American economist and Sterling Professor of Economics at Yale University. Sometimes called the “father of climate-change economics,” he is best known for his work on the economics of climate change and climate policy, which he has written about in books such as Managing the Global Commons: The Economics of Climate Change (1994) and The Climate Casino: Risk, Uncertainty, and Economics for a Warming World. His work in this area won him the Nobel Memorial Prize in Economic Sciences in 2018.1
Nordhaus has been a long-time advocate for taxing carbon emissions and his stance on climate policy has earned him praise and criticism. There are those who agree that taxation is an obvious solution to climate change;2 however, there are also many who argue that Nordhaus’ early work in the mid-1990s greatly underestimated the costs of inaction, and that his research has enabled climate denial and delayed responses to the crisis.3 However you might feel about Nordhaus’ conclusions, he pioneered an approach to climate change that integrates knowledge and insights from a number of different disciplines. Nordhaus also recognizes that there are human costs to trying to reduce emissions and a balance needs to be struck between extreme solutions.
On their shoulders
For millennia, great thinkers and scholars have been working to understand the quirks of the human mind. Today, we’re privileged to put their insights to work, helping organizations to reduce bias and create better outcomes.
The DICE Model – An interdisciplinary look at climate change
In order to make predictions about a phenomenon as complex as climate change, scientists and economists rely on computer-based models. Nordhaus has developed one highly influential model, the DICE model, that allows researchers to simulate how various factors will interact with one another in response to various approaches to slowing climate change. It was first introduced in a paper for Yale University’s Cowles Foundation in 1992, but Nordhaus has revised it many times since then.
“An economist is a scoundrel who tells you the way things really are rather than the way you’d like them to be.”
— William D. Nordhaus (interviewed for PBS News)
The Dynamic Integrated model of Climate and the Economy (DICE model) is an integrated assessment model (IAM)—a type of model that integrates economics, policy, and scientific aspects of climate change all into one framework.4 Estimating the damage that will be done by climate change is more different than people might realize: because we have no precedent and because climate change involves interactions between many complex systems, we don’t really know exactly how things will unfold.5 And when it comes to slowing climate change, any potential solutions will have effects in numerous spheres of life: for example, policies that sharply reduce greenhouse gas emissions will also likely come with economic costs. The DICE model weighs all of these variables against each other to evaluate or optimize policy for combating climate change.
The DICE model was the first integrated assessment model ever developed, and has now become widespread.5 It is used by the United States Environmental Protection Agency (EPA) to weigh different potential policies.6
Carbon taxes – Recouping the social cost of carbon
While the idea of a carbon tax has become a highly politicized and, in some circles, unpopular option, this has not dissuaded Nordhaus from arguing in their favor. Over four decades, his research has been gathering empirical support for price-based solutions, including carbon taxes, as more effective strategies than alternatives such as cap-and-trade systems.7,8 While Nordhaus did not invent the idea of a carbon tax himself, he has become known as one of its most high-profile advocates.
A carbon tax is exactly what it sounds like: charging individuals and corporations for the CO2 they emit. According to Nordhaus, the global price of carbon is currently far below the “social cost of carbon”—the additional economic damages, in the present and in the future, caused by each additional ton of CO2 released into the atmosphere.5,9 In economics, this is known as an “externality”: the agent who is emitting this carbon isn’t paying the full price for it, but is instead passing on those costs to the rest of the world.
“One of the insights of economics I feel very strongly about is, if you’re going to be effective, you have to raise the price [of carbon]. … We have to get billions of people … millions of firms, thousands of governments to take steps, if we’re going to move in the direction we want. And the only way that you’re going to do that effectively is to increase the price of carbon.”
— William D. Nordhaus, Nobel lecture (2018)
A handful of countries and states have already passed carbon tax legislation: for example, in Britain, Parliament enacted a carbon price floor system in 2013, which effectively amounts to a carbon tax of around $25 per ton. After the tax came into effect, electric utility generators began to switch from coal to more renewable sources of energy.10
Britain’s example is in line with predictions made by Nordhaus and other economists: that a carbon tax will provide market incentives to invent and innovate new, more renewable methods of doing things.9 Paul Romer, who shared Nordhaus’ Nobel Prize in 2018, has also found in his research that enacting policies like carbon taxes can encourage governments to back innovation. Despite how dire the situation is, Romer says he believes that “humans are capable of amazing accomplishments when we set about trying to do something.”
The Climate Club – A solution to the free rider problem
Nordhaus has also proposed a possible solution to what is known in economics as the “free rider problem,” the main reason that past efforts to tackle climate change have failed.5 The free rider problem occurs when some members of a group don’t pull their weight or pay their fair share, absorbing the benefits of collective action while pushing the costs onto others. Past treaties to reduce carbon emissions were stymied by some countries who did not their own carbon emissions, while benefiting from efforts by everybody else.
Nordhaus’ solution to this is to set up an international “Climate Club,” where member countries would pay their club “dues” by mitigating CO2 emissions (probably with a carbon tax), and non-members would be penalized through tariffs. As tariffs get higher and higher, more and more regions are likely to participate.
“The problem is that those who produce the emissions do not pay for that privilege, and those who are harmed are not compensated.”
― William D. Nordhaus, The Climate Casino: Risk, Uncertainty, and Economics for a Warming World
Nordhaus has acknowledged that, the way things currently stand, the Climate Club is not a solution that we can implement anytime soon.5 However, as a possible strategy for the future, it rests on a basic concept in behavioral science: that incentives are powerful tools to change behavior. As Nordhaus has argued, the international climate change agreements of the past did not fail just because the effort is futile and humans are doomed; they failed because they were not designed with proper incentives in mind.12
William D. Nordhaus was born in 1941 in Albuquerque, New Mexico.13 Growing up, Nordhaus spent a lot of time outdoors, in nature, which he feels is an important part of his background.14 He didn’t get “seriously” interested in economics until he was a graduate student, where he started out researching economic growth and technology. Nordhaus received his Ph.D. in economics from MIT in 1967, and has been at Yale University ever since.
“We have to be grown-ups, I think [when discussing the payment of funds today to prevent climate harm which may be decades in the future]. There are lots of things we do where the investments come way, way in the future. Educating 4-year-olds . . . that’s an investment that goes way into the future as well.”
— William D. Nordhaus (interviewed for National Public Radio)
Nordhaus’ passion for economics stems from his desire to solve the problems plaguing humanity: he saw the field as a promising tool to make the world a better place.14 When he first began his academic career, Nordhaus was most interested in poverty and macroeconomics, but started to get interested in climate change around 1974, when he went to the International Institute for Applied Systems Analysis in Vienna. Some of his colleagues there were climatologists, which got Nordhaus to start thinking about climate change. This is when he invented integrated assessments models, to combine insights across multiple fields to make better predictions of climate change and how policies would work.
When it comes to his work on climate change, Nordhaus credits the Dutch economist Tjalling Koopmans as a major influence on him. Koopman was one of Nordhaus’ colleagues at Yale, and many of Nordhaus’ methods and techniques came out of his work.14
“Putting a low price on valuable environmental resources is a phenomenon that pervades modern society. Agricultural water is not scarce in California; it is underpriced. Flights are stacked up on runways because takeoffs and landings are underpriced. People wait for hours in traffic jams because road use is unpriced. People die premature deaths from small sulfur particles in the air because air pollution is underpriced. And the most perilous of all environmental problems, climate change, is taking place because virtually every country puts a price of zero on carbon dioxide emissions.”
— William D. Nordhaus, “The Pope & the Market” (The New York Review of Books)
Nobel Lecture (2018)
In the talk he gave after receiving the Nobel Memorial Prize in Economic Sciences, Nordhaus explains the broad strokes of his work on the economics of climate change, including why he believes carbon taxes and a “climate club” are good solutions.
This paper is mostly a technical look at a revised version of the DICE model and analyses of policy proposals, but it also contains a “Summary for the Concerned Citizen,” which is written to be much more accessible and provides a useful rundown of the issues and concepts at hand.
Nobel Interview (2018)
On this page you’ll find three separate interviews with Nordhaus, where he talks about his upbringing, how his career got started, what it was like to win the Nobel prize, and what he thinks are the biggest challenges in addressing climate change.
This book brings together science, economics, and politics to talk about climate change, and policies we should take up to address it.
This paper introduces Nordhaus’ famous DICE model.
In this paper, Nordhaus uses the DICE model to get an estimate of the social cost of carbon in the US.
- The Royal Swedish Academy of Science. (2018, October 8). The Prize in Economic Sciences 2018 [Press release]. Retrieved from https://www.nobelprize.org/uploads/2018/10/press-economicsciences2018.pdf
- Vaughan, S. (2018, October 15). Nordhaus Nobel recognizes what we’ve long known: Carbon pricing works. International Institute for Sustainable Development. https://www.iisd.org/articles/nordhaus-nobel
- Linden, E. (2018, October 25). Op-Ed: The economics Nobel went to a guy who enabled climate change denial and delay. The Los Angeles Times. https://www.latimes.com/opinion/op-ed/la-oe-linden-nobel-economics-mistake-20181025-story.html
- Nordhaus, W., & Sztorc, P. (2013). DICE 2013R: Introduction and User’s Manual (2nd ed.). http://www.econ.yale.edu/~nordhaus/homepage/homepage/documents/DICE_Manual_100413r1.pdf
- Nobel Prize. (2018, December 9). William D. Nordhaus: Lecture in Economic Sciences 2018 [Video]. YouTube. https://www.youtube.com/watch?v=h1RkSuAs03Q
- Dynamic integrated climate economy model (DICE). (2012, June 1). United States Environmental Protection Agency. https://cfpub.epa.gov/si/si_public_record_report.cfm?Lab=OAP&dirEntryId=240426
- Nordhaus, W. (2005). Life After Kyoto: Alternative Approaches to Global Warming (No. w11889). National Bureau of Economic Research.
- Gleckman, H. (2018, October 10). Bill Nordhaus, the Nobel prize, climate change and carbon taxes. Forbes. https://www.forbes.com/sites/howardgleckman/2018/10/10/bill-nordhaus-the-nobel-prize-climate-change-and-carbon-taxes/#5234cb6d6a03
- Nordhaus, W. (2007). The Challenge of Global Warming: Economic Models and Environmental Policy. Yale University. http://www.econ.yale.edu/~nordhaus/homepage/OldWebFiles/DICEGAMS/dice_mss_072407_all.pdf
- Plumer, B., & Popovich, N. (2019, April 2). These countries have prices on carbon. Are they working? The New York Times. https://www.nytimes.com/interactive/2019/04/02/climate/pricing-carbon-emissions.html
- Keyton, D., & Wiseman, P. (2018, October 8). Americans William Nordhaus and Paul Romer win Nobel prize in economics for work on climate change and growth. The National Post. https://nationalpost.com/news/world/nobels-outlier-the-economics-prize-to-be-announced-monday
- Nordhaus, W. (2020, May 29). The climate club. Foreign Affairs. https://www.foreignaffairs.com/articles/united-states/2020-04-10/climate-club
- Duignan, B. (2018, October 11). William Nordhaus. Encyclopedia Britannica. https://www.britannica.com/biography/William-Nordhaus
- Interview with William D. Nordhaus. (2018, December). The Nobel Prize. https://www.nobelprize.org/prizes/economic-sciences/2018/nordhaus/interview/