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Climate Change Adaptation as the Ultimate Test of Neo-Classical vs. Behavioral Economics

By Matthew Kahn, guest-blogging

(Matthew Kahn, guest-blogging)

Climatopolis is an optimistic book that previews how we will individually and collectively adapt to climate change. If the world could cap global greenhouse gas production, then adaptation would be much easier. But, the world?s population and per-capita income continue to grow. Without being overly dramatic, climate change is coming. It would certainly be easier to adapt to climate change if we could stabilize global carbon dioxide levels, but I believe that the fundamental global free rider problem means that it will continue to rise. How will we respond to this anticipated but uncertain threat?

The neo-classical economics perspective views people as if they are Mr. Spock from Star Trek. This vision treats people as forward looking decision makers with rational expectations. Rational expectations does not equal perfect foresight. Instead it means that people use all currently available information in forming their best predictions of the future. Such aware individuals know ?that they do not know? and invest in learning to update their priors through Bayesian updating. As climate scientists learn more and this information becomes public knowledge this information influences our investment decisions along a variety of margins including migration patterns, and the products we purchase. 

In contrast, the upstart group of behavioral economists would say that most of us are Homer Simpsons who represent a set of climate change deniers or technological optimists who figure that some nerd will come up with a magical fix if and when climate change really unfolds. This view of men and women fosters a pessimistic view of our ability to adapt to climate change because it hints that a global ?Titanic? day of reckoning awaits us. 

But, imagine a diverse world in which for every 100 citizens; there are 97 Homer Simpsons and 3 Spocks. The self interested second group can and will smell an economic opportunity. The sheer desperation and suffering that the Homers will suffer from as climate change unfolds means that a huge market is available for those entrepreneurs who seize the day. The irony here is that while the Homers smugly believe in technological optimism, their collective willingness to pay for a ?bailout? actually helps to make this happen. Part of my optimism about our future in the face of climate change is my belief in induced innovation as self interested entrepreneurs seek out the potential opportunities caused by climate change. Thomas Friedman celebrates the wise prescient investments being made by the Chinese government to develop their green export sector. These investments are likely to offer a high rate of return to China?s investors and to create ?green jobs?. Economic growth theorists have long argued that ideas are public goods. Once we figure out a good idea, it is easy for it to diffuse around the world. For decades China imported U.S intellectual property at low price (i.e Hollywood movies and Microsoft Software). In an ironic twist, China?s investments today may help the U.S adapt to climate change if they develop renewable power generation such as wind and solar that allow us to generate electricity with minimal air pollution and greenhouse gas impacts.

Full post as published by The Volokh Conspiracy on September 24, 2010 (boomark / email).