Simon Dietz

"Losing the environment: the endowment effect and environmental discounting" (with Frank Venmans), Centre for Climate Change Economics and Policy Working Paper 264 and Grantham Research Institute on Climate Change and the Environment Working Paper 233, 2016 (download)

It has recently been shown that, when discounting future improvements in the environment, relative prices matter. However, we argue relative prices are not the whole story. Not only is the environment a consumption good in its own right, with a corresponding environmental discount rate that depends on relative scarcity, it also matters that we tend to be losing it. That is, there is a considerable body of evidence from behavioural economics and stated-preference valuation showing that we are loss-averse, even in riskless choice settings. Therefore in this paper we introduce reference dependence and loss aversion – the endowment effect – to a model where welfare depends on consumption of a produced good and of environmental quality. We show that the endowment effect modifies the discount rate by introducing (i) an instantaneous endowment effect and (ii) a reference-level effect. Moreover we show that, when environmental quality is strictly decreasing, these two effects mostly combine to dampen our usual preference to smooth consumption over time – perhaps surprisingly, the endowment effect increases the environmental discount rate on these paths. In addition, on non-monotonic paths the endowment effect can give rise to substantial discontinuities in the discount rate.

"'Climate Value at Risk' of global financial assets" (with Alex Bowen, Philip Gradwell and Charlie Dixon), Nature Climate Change, 2016 (link to journal)

Investors and financial regulators are increasingly aware of climate-change risks. So far, most of the attention has fallen on whether controls on carbon emissions will strand the assets of fossil-fuel companies. However, it is no less important to ask, what might be the impact of climate change itself on asset values? Here we show how a leading integrated assessment model can be used to estimate the impact of twenty-first-century climate change on the present market value of global financial assets. We find that the expected ‘climate value at risk’ (climate VaR) of global financial assets today is 1.8% along a business-as-usual emissions path. Taking a representative estimate of global financial assets, this amounts to US$2.5 trillion. However, much of the risk is in the tail. For example, the 99th percentile climate VaR is 16.9%, or US$24.2 trillion. These estimates would constitute a substantial write-down in the fundamental value of financial assets. Cutting emissions to limit warming to no more than 2°C reduces the climate VaR by an expected 0.6 percentage points, and the 99th percentile reduction is 7.7 percentage points. Including mitigation costs, the present value of global financial assets is an expected 0.2% higher when warming is limited to no more than 2°C, compared with business as usual. The 99th percentile is 9.1% higher. Limiting warming to no more than 2°C makes financial sense to risk-neutral investors—and even more so to the risk averse.

"The risk of climate ruin" (with Nick Silver and Oliver Bettis), Centre for Climate Change Economics and Policy Working Paper 243 and Grantham Research Institute on Climate Change and the Environment Working Paper 217, 2015 (download)

How large a risk is society prepared to run with the climate system? One perspective on this is to compare the risk that the world is running with the climate system, defined in terms of the risk of ‘climate ruin’, with the comparable risk that financial institutions, in particular insurance companies, are prepared or allowed to run with their own financial ruin. We conclude that, in terms of greenhouse gas emissions today and in the future, the world is running a higher risk with the climate system than financial institutions, in particular insurance companies, would usually run with their own solvency.

"The climate beta" (with Christian Gollier and Louise Kessler), Centre for Climate Change Economics and Policy Working Paper 215 and Grantham Research Institute on Climate Change and the Environment Working Paper 190, 2015 (download)

Reducing emissions of CO2 today is expected to reduce climate damages in the future. In this paper, we examine the question of whether fighting climate change has the additional advantage of reducing the aggregate risk borne by future generations. This raises the question of the ‘climate beta’, i.e. the elasticity of climate damages with respect to a change in aggregate consumption. Using the DICE integrated assessment model, we show that the climate beta is positive and close to unity, due above all to the effect of uncertainty about technological progress. In estimating the social cost of carbon, this justifies using a relatively larger rate to discount expected climate damages. On the other hand, expected climate damages are themselves made larger by this effect and overall the NPV of emissions reductions today is increased by the climate beta.

"Running with the red queen: an integrated assessment of land expansion and global biodiversity decline (with Bruno Lanz and Tim Swanson), Grantham Research Institute on Climate Change and the Environment Working Paper 167, 2014 (download)

Modern agriculture relies on a small number of highly productive crops and the continued expansion of agricultural land area has led to a significant loss of biodiversity. In this paper we consider the macroeconomic consequences of a continued expansion of modern agriculture from the perspective of agricultural productivity and food production: as the genetic material supporting agriculture declines, pests and pathogens become more likely to adapt to crops and proliferate, increasing crop losses due to biological hazards. To evaluate the macroeconomic consequences of a reduction in agricultural productivity associated with the expansion of agriculture, we employ a quantitative, structurally estimated model of the global economy in which economic growth, population and food demand, agricultural innovations, and the process of land conversion are jointly determined. We show that even a small impact of global biodiversity on agricultural productivity calls for both a halt in agricultural land conversion and increased agricultural R&D in order to maintain food production associated with population and income growth.

"Global population growth, technology and Malthusian constraints: A quantitative growth theoretic perspective" (with Bruno Lanz and Tim Swanson), International Economic Review, accepted (download the working paper)

We study the interactions between global population, technological progress, per capita income, the demand for food, and agricultural land expansion over the period 1960 to 2100. We formulate a two-sector Schumpeterian growth model with a Barro-Becker representation of endogenous fertility. A manufacturing sector provides a consumption good and an agricultural sector provides food to sustain contemporaneous population. Total land area available for agricultural production is finite, and the marginal cost of agricultural land conversion is increasing with the amount of land already converted, creating a potential constraint to population growth. Using 1960 to 2010 data on world population, GDP, total factor productivity growth and crop land area, we structurally estimate the parameters determining the cost of fertility, technological progress and land conversion. The model closely fits observed trajectories, and we employ the model to make projections from 2010 to 2100. Our results suggest a population slightly below 10 billion by 2050, further growing to 12 billion by 2100. As population and per capita income grow, the demand for agricultural output increases by almost 70% in 2050 relative to 2010. However, agricultural land area stabilizes by 2050 at roughly 10 percent above the 2010 level: growth in agricultural output mainly relies on technological progress and capital accumulation.

"Spaces for agreement: a theory of Time-Stochastic Dominance and an application to climate change" (with Nicoleta Anca Matei), Journal of the Association of Environmental and Resource Economists 3(1), 85-130, 2016 (link to journal) (download the working paper)

Many investments involve both a long time horizon and risky returns. Making investment decisions thus requires assumptions about time and risk preferences. Such assumptions are frequently contested, particularly in the public sector, and there is no immediate prospect of universal agreement. Motivated by these observations, we develop a theory and method of finding “spaces for agreement.” These are combinations of classes of discount and utility function, for which one investment dominates another (or “almost” does so), so that all those whose preferences can be represented by such combinations would agree on the option to choose. The theory combines the insights of stochastic dominance and time dominance and offers a nonparametric approach to intertemporal, risky choice. We then apply the theory to climate change and show using a popular simulation model that even tough carbon emissions targets would be chosen by almost everyone, barring those with arguably “extreme” preferences.

"Tall tales and fat tails: the science and economics of extreme warming" (with Raphael Calel and David Stainforth), Climatic Change, 132(1), 127-141, 2015 (link to journal) (download paper) (download SI)

It has recently been highlighted that the economic value of climate mitigation depends sensitively on the slim possibility of extreme warming. This insight has been obtained through a focus on the fat upper tail of the climate sensitivity probability distribution. However, while climate sensitivity is undoubtedly important, what ultimately matters is transient temperature change. A focus on transient temperature change stresses the interplay of climate sensitivity with other physical uncertainties, notably effective heat capacity. In this paper we present a conceptual analysis of the physical uncertainties in economic models of climate mitigation, leading to an empirical application of the DICE model, which investigates the interaction of uncertainty in climate sensitivity and the effective heat capacity. We expand on previous results exploring the sensitivity of economic evaluations to the tail of the climate sensitivity distribution alone, and demonstrate that uncertainty about the system's effective heat capacity also plays a very important role. We go on to discuss complementary avenues of economic and scientific research that may help provide a better combined understanding of the physical and economic processes associated with a rapidly warming world.