The ultimate market failure: Why classical economics struggles to price climate risk

“ That prima facie, the market price, that is to say, the price that is ever resulting from freedom in competition, is the right price; the one that will restrict over production and at the same time stimulate the needed production in times of scarcity. ”

“ I have already remarked that the market price of a commodity may exceed its natural or necessary price, as it may be produced in less abundance than the new demand for it requires. This however is but a temporary effect. The high profits on capital employed in producing that commodity will naturally attract capital to that trade; and as soon as the requisite funds are supplied, and the quantity of the commodity is duly increased, its price will fall, and the profits of the trade will conform to the general level. ”

“ It is then the desire, which every capitalist has, of diverting his funds from a less to a more profitable employment, that prevents the market price of commodities from continuing for any length of time either much above, or88 much below their natural price. ”

“ To popular apprehension it seems as if the profits of business depended upon prices. A producer or dealer seems to obtain his profits by selling his commodity for more than it cost him. Profit altogether, people are apt to think, is a consequence of purchase and sale. It is only (they suppose) because there are purchasers for a commodity, that the producer of it is able to make any profit. Demand—customers—a market for the commodity, are the cause of the gains of capitalists. It is by the sale of their goods, that they replace their capital, and add to its amount. ”

“ In economists’ jargon, emitting CO2 generates a negative externality and thus a market failure. Because the price of CO2 emissions does not reflect its true costs, market forces alone are not able to solve the problem of climate change. As a result, without policy action, there will be more emissions and less investment in emissions-reducing technology than there would be if the price of emissions reflected their true costs. ”

“ Many individuals cite selfish profit seekers for environmental degradation, rather than laying much of the blame - where it belongs - to misplaced incentives in the economic system. Progress in environmental problems is impossible without a clearer understanding of how the economic system works in the environment and what alternatives are available to take away the many roadblocks to environmental quality.
Our price system fails to take into account the environmental damage that the polluter inflicts on others. Economists call these damages - which are very real - "external social costs." ”

“ They reflect the ability of one entity, e.g., a company, to use water or air as a free resource for waste disposal, while others pay the cost in contaminated air or water. If there were a way to make the price structure shoulder these external costs - taxing the firm for the amount of discharge, for instance - then the price for the goods and services produced would reflect these costs. Failing this, goods whose production spawn pollution are greatly underpriced because the purchaser does not pay for pollution abatement that would prevent environment damage. ”

“ In abnormal times in particular, when the hypothesis of an indefinite continuance of the existing state of affairs is less plausible than usual even though there are no express grounds to anticipate a definite change, the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning and yet in a sense legitimate where no solid basis exists for a reasonable calculation. ”

“ It is of the nature of organised investment markets, under the influence of purchasers largely ignorant of what they are buying and of speculators who are more concerned with forecasting the next shift of market sentiment than with a reasonable estimate of the future yield of capital-assets, that, when disillusion falls upon an over-optimistic and over-bought market, it should fall with sudden and even catastrophic force. ”

“ Small trends in soil carbon releases have been already observed. Increasing release of methane from ocean methane hydrates: This is a particularly potent long-term risk due to hydrate deposits through changes in ocean water temperature; the likely timescale for the physical processes involved spans centuries, however, and there is low risk this century. 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. ”

“ The oceans are marked by a fundamental unity from which there is no escape. Interconnected cycles of energy, climate, marine living resources, and human activities move through coastal waters, regional seas, and the closed oceans. The effects of urban, industrial, and agricultural growth are contained within no nation's Exclusive Economic Zone; they pass through currents of water and air from nation to nation, and through complex food chains from species to species, distributing the burdens of development, if not the benefits, to both rich and poor. ”

“ In complementary work, Barro (2013) considers a simplified model in which the only benefits of reducing carbon emissions come from reducing the probability of potential climate catastrophes, and finds that this channel alone can justify investment in reducing GHG pollution of one percent of GDP or more, beyond what would normally occur in the market absent climate policy.
↑ 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. ”

“ We believe existing environmental regulations and other decisions, particularly those based on risk assessment, have failed to protect adequately human health and the environment - the larger system of which humans are but a part.
We believe there is compelling evidence that damage to humans and the worldwide environment is of such magnitude and seriousness that new principles for conducting human activities are necessary
While we realize that human activities may involve hazards, people must proceed more carefully than has been the case in recent history. ”

“ When the quantity brought to market exceeds the effectual demand, it cannot be all sold to those who are willing to pay the whole value of the rent, wages, and profit, which must be paid in order to bring it thither. Some part must be sold to those who are willing to pay less, and the low price which they give for it must reduce the price of the whole. ”

“ If the demand ceases unexpectedly, after the commodity to supply it is already produced, this introduces a different element into the question: the capital has actually been consumed in producing something which nobody wants or uses, and it has therefore perished, and the employment which it gave to labour is at an end, not because there is no longer a demand, but because there is no longer a capital. ”

“ Interest is the price paid simply for the use of capital. But what is capital, and in what does its use consist? What claim has it to be regarded as an independent factor of production? Our very familiarity with the term, our habit of employing it with the rich looseness of every-day life is an obstacle to the clearness of thought, which is again essential. We recognize, most of us, clearly enough that capital, although we reckon it in terms of money, consists, like income, of real things; factories, machinery, materials and the like. ”

“ The obstacle to a clear understanding is, in these examples, much the same as in many academic discussions of capital, namely, an inadequate appreciation of the fact that capital is not a self-subsistent entity existing apart from consumption. ”

“ The temptation to save from revenue to augment capital is always in proportion to the rate of profits, and, if from accumulation of capital profits [Pg 40] and interest should fall very low indeed, at that point accumulation would nearly stop, because it would be almost without an object. ”

“ The balancing of the cost of repairs against the future income is a never-ending task in practical business. One making repairs must purchase the needed materials and labor at a capitalization determined by their expected earning-power in other industries. If the repairs in question will not ensure an annual saving as great as this expected rent, they will not be made. When an industry is declining, it may, for the sake of putting the capital into a better business, be good policy to let the machinery fall into bad repair. ”

“ For the proper understanding of the climate of the southern hemisphere there is necessary a long-continued series of meteorological studies within the limits of perpetual ice.
In geology nearly everything remains to be done. Here are indications of some very interesting problems. Among them are the numerous open questions of the great ice age. In the period immediately preceding the ice age the polar regions were not, as they are now, submerged under a continental sea of ice, but had a somewhat profuse growth of plants, extending even to the base of the mountain glaciers. ”

“ So long as the boom was continuing, much of the new investment showed a not unsatisfactory current yield. The disillusion comes because doubts suddenly arise concerning the reliability of the prospective yield, perhaps because the current yield shows signs of falling off, as the stock of newly produced durable goods steadily increases. If current costs of production are thought to be higher than they will be later on, that will be a further reason for a fall in the marginal efficiency of capital. Once doubt begins it spreads rapidly. ”

“ The mistake lies in supposing that it is the rate of interest on which prospective changes in the value of money will directly react, instead of the marginal efficiency of a given stock of capital. The prices of existing assets will always adjust themselves to changes in expectation concerning the prospective value of money. The significance of such changes in expectation lies in their effect on the readiness to produce new assets through their reaction on the marginal efficiency of capital. ”

“ A period must elapse sufficient to establish the fact of this downward trend, and to enable the struggles of lenders and borrowers to overcome [Pg 552] habit in fixing a new rate that will correspond to the new earning power of monetary capital. These facts explain what at times looks like a failure of the loan market fully to take account of the fall of prices during a given interval. What that market really does is to base the interest paid in one interval on the business experience of another. ”

“ But the explanation which the broker and market writer offer is that people have awakened to the fact that mining stocks are stocks with wasting assets, that the incomes from copper stocks cannot, therefore, be capitalized on so high a basis as similar incomes from other securities; that people to-day realize this fact as they did not some years ago; that the earlier capital-prices of copper stocks were vastly exaggerated on the basis of a careful estimate of probable total future income, etc. ”

“ Investments in infrastructure and energy provide the greatest multiplier effect for growth and job creation. Pag maganda ang imprastraktura gaya ng kalsada, tulay, pantalan, telepono, koryente, maraming mamumuhunan. Maraming magkakaroon ng trabaho.
We must achieve sufficient, efficient, cheap energy in the near term. We must be sure to have the capacity to meet the demands of a growing economy, so as not to choke off growth when it comes, and thereby lose the opportunities that may not come again. ”

“ The National Academies of Sciences reported last week that a transition to a net-zero emissions economy could grow millions of jobs over the next decade.
And our plan — the President’s plan, which he’ll talk about today, will make historic investments in infrastructure — in the auto industry, in transit, in the power sector — creating millions of good union jobs, and in the process, also addressing the climate crisis head on. ”