Page:The Cost of Delaying Action to Stem Climate Change.pdf/24

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  • Rapid state changes in ecosystems, species range shifts, and species boundary changes: Research shows that climate change is an important component of abrupt ecosystem state-changes, with a prominent example being the Sahel region of Africa. Such state-changes from forests to savanna, from savanna to grassland, et cetera, will cause extensive habitat loss to animal species and threaten food and water supplies. The NRC study assesses moderate risk during this century and high risk afterwards.
  • Increases in extinctions of marine and terrestrial species: Abrupt climate impacts include extensive extinctions of marine and terrestrial species; examples such as the destruction of coral reef ecosystems are already underway. Numerous land mammal, bird, and amphibian species are expected to become extinct with a high probability within the next one or two centuries.

Implications of Tail Risk

An implication of the theory of decision-making under uncertainty is that the risks posed by irreversible catastrophic events can be substantial enough to influence or even dominate decisions.

Weitzman’s Dismal Theorem

Over the past few years, economists have examined the implications of decision-making under uncertainty for climate change policy. In a particularly influential treatment, Weitzman (2009) proposes his so-called “Dismal Theorem,” which provides a set of assumptions under which the current generation would be willing to bear very large (in fact, arbitrarily large) costs to avoid a future event with widespread, large-scale costs. The intuition behind Weitzman’s mathematical result rests with the basic insight that because individuals are risk-averse, they prefer to buy health, home, and auto insurance than to take their chances of a major financial loss. Similarly, if major climate events have the potential to reduce aggregate consumption by a large amount, society will be better off if it can take out “climate insurance” by paying mitigation costs now that will reduce the odds of a large-scale—in Weitzman’s (2009) word, catastrophic—drop in consumption later.[1]

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  1. This logic has its basis in expected utility theory. Because individuals are risk averse, each additional dollar of consumption provides less value, or utility, to individuals than the previous dollar. To avoid this major loss, an individual will buy home insurance. That insurance is provided by the market because an insurance company can offer home insurance to many homeowners in different regions of the country, and through diversification the company will on average have many homeowners paying premiums and a few collecting insurance, so diversification allows the company to run a relatively low-risk business. But risks from severe climate change are not diversifiable because their enormous costs would impact the global economy. Consequently, as long as there is a non-negligible probability of a large drop in consumption, and therefore a very large drop in utility, arising from a large-scale loss in consumption, society today should be willing to pay a substantial amount if doing so would avoid that loss.