What to Do? Does Science have a Role?

1. What to Do? Does Science have a Role? Klaus Hasselmann Max-Planck-Institut for Meteorology, Hamburg, European Climate Forum Heraeus Seminar Energy and Climate A Physics Perspective on Energy Supply and Climate Change Prediction, Mitigation and Adaptation 26 - 29 May 2008, Physikzentrum Bad Honnef,

2. Discussion topics Interconnections: Climate change adaptation mitigation What to Do? Does Science have a Role? policy

3. Hasselmann and Barker, Climatic Change, in press: • IPCC Working Group 3 (in contrast to WG1) has had very little political influence • The influential Stern Report, for example, developed its political recommendations independently • Needed is a new UN “Climate Policy Panel” that interacts continuously with policymakers • But to be effective a Climate Policy Panel will need to develop a new suite of Integrated Assessment (coupled climate-socio- economic) models

4. No longer disputed: • Climate change is real • The costs of unregulated climate change greatly exceed the costs of mitigation • There exist various technologies that, in combination, could limit global warming to acceptable levels (< 20C above pre-industrial) • The estimated costs (-1% to 4% of GDP), although appearing high today (a few trillion $), are quite affordable in the long term (a delay in long-term global growth, if at all, of a few months to a year)

5. Strongly disputed: • How best transform our present unsustainable global economic system based on fossil fuels into a sustainable carbon-free system? • Do scientists have the right tools to provide useful signals that will be heard in the noisy debate over conflicting stakeholder interests, divergent national goals and the stresses of globalization?

6. Answers: Traditional (main stream) economists: Yes, the available standard general- equilibrium macro-economic models are fine. Physics-based economists: No, we need a new generation of dynamic multi-agent dynamic models.

7. Overview • Available technologies for closing the wedge between the BAU (Business as Usual) emissions trajectory and the sustainable emissions goal • Proposed strategies for closing the wedge • Traditional versus multi-agent economic models - with three examples of the latter: • 1) Ginti’s model of the “invisible hand” • 2) A Multi-Actor Dynamic Integrated Assessment Model (MADIAM) of climate policies • 3) A climate-policy evolution model • Conclusions

8. Overview • Available technologies for closing the wedge between the BAU (Business as Usual) emissions trajectory and the sustainable emissions goal • Proposed strategies for closing the wedge • Traditional versus multi-agent economic models - with three examples of the latter: • 1) Ginti’s model of the “invisible hand” • 2) A Multi-Actor Dynamic Integrated Assessment Model (MADIAM) of climate policies • 3) A climate-policy evolution model • Conclusions

9. Filling the wedge between projected BAU emissions and a sustainable emissions path (T< 20C) Business as Usual Energy efficiency: zero mean cost Low fruits renewables High fruits (solar, and unproven or controversial options: CCS, nuclear, fusion, … ) sustainability path

10. Overview • Available technologies for closing the wedge between the BAU (Business as Usual) emissions trajectory and the sustainable emissions goal • Proposed strategies for closing the wedge • Traditional versus multi-agent economic models - with three examples of the latter: • 1) Ginti’s model of the “invisible hand” • 2) A Multi-Actor Dynamic Integrated Assessment Model (MADIAM) of climate policies • 3) A climate-policy evolution model • Conclusions

11. Basic climate policy instruments: • Whip: internalization of external costs (carbon price) • Carrot: subsidies (societal investments that are unprofitable for individual investors – bridging the difference between low discount rates appropriate for public investments and high discount rates demanded by private investors) • Regulatory framework: for sectors that are not amenable or sufficiently responsive to market-based instruments (automobile emissions, building insulation, etc.) • Technical and financial transfer from rich to poor countries

12. high-fruits renewables (solar energy) low-fuits renewables fossil energy energy costs climate damage costs

13. high-fruits renewables (solar energy) low-fruits renewables fossil energy 1. whip (Kyoto, carbon price: internalize external costs) energy costs climate damage costs

14. high-fuits renewables (solar energy) low-fruits renewables fossil energy 1. whip (Kyoto, carbon price: internalize external costs) low-cost renewables become competetive remain non-competitive energy costs climate damage costs

15. high-fruits renewables (solar energy) low-fruits renewables fossil energy 1. whip (Kyoto, carbon price: internalize external costs) low-cost renewables become competetive remain non-competitive energy costs problem: limited abatement capacity! climate damage costs

16. high-fruits renewables (solar energy) low-fruits renewables fossil energy 1. whip 2. carrot (Kyoto, carbon price: internalize external costs) (Post-Kyoto: subsidies) price reduction low-cost renewables become competetive energy costs both become competitive! climate damage costs

17. Basic climate policy instruments: • Whip: internalization of external costs (carbon price) • Carrot: subsidies (societal investments that are unprofitable for individual investors – bridging the difference between low discount rates appropriate for public investments and high discount rates demanded by private investors) • Regulatory framework: for sectors that are not amenable or responsive to market-based instruments (automobile emissions, building insulation, etc.) • Technical and financial transfer from rich to poor countries

18. 8 BAU per capita emissions (speculative) TC/yr USA 6 USA EU+Japan 4 EU+ Japan China World 2 India World Sustainability GOAL China India 2000 2050 2100

19. 8 Convergence and contraction paths TC/yr Achievable only with significant N-S transfer of investments and technology USA 6 USA EU+Japan USA 4 EU+ Japan China World EU+Japan 2 India World Sustainability GOAL China India China Indien 2000 2050 2100

20. Challenge for global climate policy: arrive at an equitable international agreement structured on a combination on the four basic instruments: • carbon price • subsidies • regulatory framework • technical and financial transfer from developed to emerging and developing countries • Task for science: Which type of coupled climate-socio-economic (IA) models should one apply to assess the impact of alternative climate policies?

21. Overview • Available technologies for closing the wedge between the BAU (Business as Usual) emissions trajectory and the sustainable emissions goal • Proposed strategies for closing the wedge • Traditional versus multi-agent economic models - with three examples of the latter: • 1) Ginti’s model of the “invisible hand” • 2) A Multi-Actor Dynamic Integrated Assessment Model (MADIAM) of climate policies • 3) A climate-policy evolution model • Conclusions

22. Traditional coupled climate-economic (integrated assessment-IA) model climate policy regulatory instruments scenario predictions ghg emissions climate system economic system impacts on production,welfare,… Single-actor “invisible hand“ establishes market equilibrium

23. Shortcomings of economic equilibrium models: • exclusion of important dynamical processes (technological change, structural unemployment, rich-poor inequalities, business cycles, financial instabilities, globalization adjustments, ……) • inadequate representation of divergent interests between different actors (“tragedy of the commons” conflict between individual goals and societal responsibilities – in particular: climate , actor- dependent discount factors, business-labor relations, trade agreements,,....) • inadequate treatment of equity issues (burden sharing, rich-poor inequalities, conflict potential, terrorism, …)

24. Multi-actor integrated assessment model climate policy regulatory instruments Actors: governments, voting public, media, CEOs, consumers, firms, workers, … scenario predictions ghg emissions climate system economic system impacts on production,welfare,… Multi-actor dynamic evolution, market response actor dependent

25. Historical interjection: Four stages in the development of economic theory (a physicist’s view). • Verbalisation (story telling)_ Adam Smith (1723-1790), David Ricardo (1772-1823) Karl Marx (1818-1883), John Maynard Keynes (1883-1946) Joseph Schumpeter (1883-1950), Milton Friedman (1912-2006),... • Optimization (marginalization) Leon Walras(1834-1910), Kenneth Arrow (1921- ) , Gerard Debreu (1921-2004), Lionell McKenzie (1919-),... • Game theory (interactions between a few players) John von Neumann (1903-1958), John F. Nash (1928-),... • Simulation (continuous dynamics, multi-agent) Meadows et al, Limits to Growth (1972); Epstein and Axtell, Growing Artifical Societies (1996) (Sugarscape); John Sterman, Business Dynamics (2000); Eric Beinhocker, The Origin of Wealth (2006)....

26. Historical interjection: Four stages in the development of economic theory (a physicist’s view). • Verbalisation (story telling)_ Adam Smith (1723-1790), David Ricardo (1772-1823) Karl Marx (1818-1883), John Maynard Keynes (1883-1946) Joseph Schumpeter (1883-1950), Milton Friedman (1912-2006),... • Optimization (marginalization) Leon Walras(1834-1910), Kenneth Arrow (1921- ) , Gerard Debreu (1921-2004), Lionell McKenzie (1919-),... • Game theory (interactions between a few players) John von Neumann (1903-1958), John F. Nash (1928-),... • Simulation (continuous dynamics, multi-agent) Meadows et al, Limits to Growth (1972); Epstein and Axtell, Growing Artifical Societies (1996) (Sugarscape); John Sterman, Business Dynamics (2000); Eric Beinhocker, The Origin of Wealth (2006).... quantification

27. Economic theory is in the process of a radical paradigm shift from “traditional economics” based on a combination of verbalized descriptive concepts, economic equilibrium analyses and basic game theoretical elements to “complexity economics” based on computer simulations of multi-agent interactions in a dynamically evolving system.

28. This raises two questions: • The emergence problem; How do macro-economic structures emerge from the complex micro-economic interactions of many agents pursuing different goals? • The parametrization problem: How can one represent the dynamics of macro-economic systems in terms of the interactions between a small set of aggregated agents? • And in the present context: can one apply such models to assess the impacts of climate policies on the global socio-economic system?

29. This raises two questions: • The emergence problem; How do macro-economic structures emerge from the complex micro-economic interactions of a multitude of agents pursuing different goals? • The parametrization problem: How can one represent the dynamics of macro-economic systems in terms of the interactions between a small set of aggregated agents? • And in the present context: can one apply such models to assess the impacts of climate policies on the global socio-economic system?

30. Overview • Available technologies for closing the wedge between the BAU (Business as Usual) emissions trajectory and the sustainable emissions goal • Proposed strategies for closing the wedge • Traditional versus multi-agent economic models - with three examples of the latter: • 1) Ginti’s model of the “invisible hand” • 2) A Multi-Actor Dynamic Integrated Assessment Model (MADIAM) of climate policies • 3) A climate-policy evolution model • Conclusions

31. Herbert Gintis, The dynamics of general equilibrium, The Economics Journal, 117, 1280-1309 (Oct. 2007) (Simulations kindly provided by Steffen Fuerst, PIK) Question: How does the “invisible hand” of Adam Smith lead to an equilibrium price of goods in which supply and demand are exactly balanced? (The basic credo of economic equilibrium theory) Embarrassing counter-example, Scarf (1960): three agents offering and demanding three different goods result in a periodic non-equilibrium price attractor. Gintis’ approach: a large number of producers and consumers interacting individually with each other.

32. Agent type 1: 140 Firms (on average): - produce 10 different goods, - set (individual) prices, - take up credit (from a “central authority“), - pay taxes, - imitate successful competitors, - can go bankrupt (to be replaced by newcomers) Agent type 2: 5250 workers/consumers/shareholders: - work or become unemployed (receiving wages or unemployment benefits) - consume goods - buy shares Agent type 3: one “central authority“: - imposes and distributes taxes - creates and lends money/ accepts savings

37. Results: • Establishment of a statistical equilibrium, with random fluctuations about the mean state - although all trades were based on local information only: a nice confirmation of the “invisible hand“ • But: Are the actor strategies realistic? No business cycles, recessions, financial instabilities, technological change, structural unemployment, social inequalities,.... • Clearly, we have some way to go to construct reasonably realistic multi-actor economic models! • Nevertheless: a historical aside on the rate of progress: - Adam Smith: “The Wealth of Nations“: 1776 ; - Herbert Gintis: The Economic Journal, October, 2007

38. This raises two questions: • The emergence problem; How do macro-economic structures emerge from the complex micro-economic interactions of a multitude of agents pursuing different goals? • The parametrization problem: How can one represent the dynamics of macro-economic systems in terms of the interactions between a small set of aggregated agents? • And in the present context: can one apply such models to assess the impacts of climate policies on the global socio-economic system?

39. Overview • Available technologies for closing the wedge between the BAU (Business as Usual) emissions trajectory and the sustainable emissions goal • Proposed strategies for closing the wedge • Traditional versus multi-agent economic models - with three examples of the latter: • 1) Ginti’s model of the “invisible hand” • 2) A Multi-Actor Dynamic Integrated Assessment Model (MADIAM) of climate policies • 3) A climate-policy evolution model • Conclusions

40. Example 2: A Multi-Actor Dynamic Integrated Assessment Model (MADIAM) Hoos, G, V. Barth and K. Hasselmann, Ecological Journal , 54, 306-327, 2005 Attempt to capture the emergent structures of a macro-economic system in terms of the interactions of a few aggregated actors (firms, households, governments, banks) pursuing different goals – and to apply this to climate policy assessment.

41. MADIAM:Multi-Actor Dynamic Integrated Assessment Model Policy + Economics Climate CO2 emissions NICCS:Non-linear Impulse response coupled Carbon cycle-Climate System MADEM:Multi-Actor Dynamic Economic Model Climate change : space-time fields of temperature, precipitation, cloud cover, sea level, etc

42. MADEM (Multi-Actor Dynamic Economic Model) Actors Goals Firms Maximize profits Workers Maximize wages Governments Maximize GDP Banks Stabilize money supply All actors strive to achieve individual goals while jointly committed to avoiding dangerous climate change (classical “tragedy of the commons” conflict)

43. MADEM mathematical structure: state variables x = (xi) control variables z = (zi) = Ci(x) (Ci(x) define the actors’control strategies) Prognostic equations: dxi/dt = Fi (x,z) = Gi (x) 10 state variablesxi: physical capital, productivity, employed workers, wages, household and firm savings, government budget deficit, energy intensity, carbon intensity, fossil resources

44. Control parameters: Firms: Investments in physical capital Investments in productivity Investments in emissions reduction Credit uptake/Savings Consumers/Wage earners: Wage negotiations Credit uptake/Savings Consumer preferences (climate friendly or climate adverse goods) Governments: Emissions tax Recycled taxes (in consumption or subsidies in renewables)

45. Principal driver of economic growth: Investments in technological change Firms strive to escape the erosion of profits through the pressures of competition (increasing wage levels, diffusion of technological advantages) by continually investing in technology and know how (human capital). Structural unemploymentarises when it is more profitable for firms to invest in productivity (technology - with associated reduction in employment) than in physical capital (Basic idea expressed by classical economists of all persuasions - Adam Smith, Karl Marx, Joseph Schumpeter, ... – but ignored in traditional economic equlibrium models)

46. BAU / MM (Moderate Mitigation)

47. ITC (Induced Technological Change)

48. Relative demand Good1(climate-friendly)/Good2(climate-hostile)

49. mitigation measures: w: weak, m: moderate, s: strong (a) (b)

50. Estimates of the costs of climate change mitigation: 1 % of GDP Consistent with: IPCC 4th Assessment Report; macro-economic model intercomparison, The Energy Journal, Special Issue, 2006; the Stern Review, 2006). Range of other estimates: -1 % to + 4% of GDP