Prof. Martin Weitzman who was among the most influential economists in the world passed away on 27 August 2019. His work on the uncertainty about how bad the impacts of a changed climate could be has made a huge difference to how economists think about climate change. In this post, Prof. E. Somanathan of the Indian Statistical Institute, Delhi Centre pays a tribute to him.
If you were to ask an environmental economist who the greatest of them all was, the name of Martin Weitzman, or Marty, as he was more commonly known, is certain to come up. Yet Weitzman began his career, not in the environmental field, but in comparative economic systems, a now defunct field that made a comparative study of capitalism and socialism. His most famous paper, “Prices vs. Quantities” published in the Review of Economic Studies in 1974, was a contribution to the decades-old debate on whether a central planner in a socialist economy such as that of the Soviet Union should set the prices of goods to be produced by each industry or set the quantities. The standard answer to this question was that it does not make any difference since the two are equivalent – for each set of quantities, there is an equivalent set of market-clearing prices, and vice - versa. Weitzman, however, realised that the two are not equivalent in the real world, because the central planner does not know the cost of production of any given good as well as the producer (the factory or farm manager) does. He showed that the aggregate surplus in any sector is maximised by setting quantities if the marginal benefit from producing output (the demand curve) is steeper than the marginal cost of producing that output, and by setting prices if the reverse was true. Some intuition for this result can be gained by considering an extreme case – when the marginal benefit curve is practically flat. In this case, the marginal social value of the good is constant and surplus is maximised when the producer is induced to equate his marginal cost to it. But it is not a good idea to “fool around” with prices when a certain quantity of the good is essential, as in a war situation – if the planner under- estimates the marginal cost of producing fighter planes and sets too low a price, too few will be made, and the war will be lost.
In his paper, Weitzman also wrote about the environmental application of this idea. In this interpretation, the social planner is an environmental regulator and the quantity to be regulated is pollution reduction. This insight has proved extremely important. In the case of climate change, it suggests that regulators should set a price for CO2 emission reduction (or require polluters to pay an emission fee) each year rather than setting a maximum allowable emission quantity in each year. The reason is that the damage from climate change comes from the aggregate stock of CO2 that is accumulated over many years. The emissions in each year change the stock very little, and so the marginal benefit of a change in any given year’s emissions can be taken as constant (since it is very small relative to the stock). This immediately implies that the emission fee should be used and be set equal to this marginal benefit.
The European Union’s politicians ignored this insight and set themselves up for failure with their Emission Trading System (ETS) that set a maximum allowable quantity of emissions in each year. Soon after the ETS was implemented, the world went into recession and emissions fell as economies contracted. The price of emission permits fell to zero and stayed near zero for many years. This was a time when it was extremely cheap to cut emissions, while at the same time the additional damage from the increasing CO2 concentration in the atmosphere was unchanged – Nature, after all, does not care about human economies – Arctic sea ice and Greenland’s glaciers continued to melt, coral reefs continued to die. Yet there was no incentive to make additional emission cuts in Europe because the emission price had collapsed to near zero.
Weitzman was a theorist who was deeply interested in how real economies worked. He made many more extremely original and insightful theoretical contributions to economics – including macroeconomics, as in his book, The Share Economy. Over the years he became increasingly interested in pollution and natural resource depletion problems and wrote many brilliantly original papers in the field on topics as diverse as biodiversity conservation, fisheries management, and green GDP (gross domestic product).
Perhaps his most important recent research that has made a huge difference to how economists think about climate change is his work on the uncertainty about how bad the impacts of a changed climate could be. Prior to this, the dominant strand of thinking in economics followed the approach of William Nordhaus who suggested that society should be willing to pay only a small amount to reduce the growth in atmospheric carbon concentrations. Weitzman showed in a series of papers starting with his 2007 commentary in the Journal of Economic Literature, on The Stern Review of the Economics of Climate Change, that uncertainty on how bad things could get is a structural feature of climate change. This implied that the standard cost-benefit analysis breaks down – the implication is that society should be willing to pay any amount to remove the possibility of catastrophic damages.
Weitzman was primarily interested in ideas and shied away from the limelight of the policy world. As his long-time colleague Rob Stavins at Harvard remarked – “you’d never see Marty on the 7 a.m. shuttle to Washington”. This did not mean he did not care about good policy. He wrote a book entitled Climate Shock, co-authored with Gernot Wagner, because he felt that the lack of action on climate change was extremely dangerous, and he wanted to explain this to the general public.
Weitzman was a true intellectual and scholar who cared above all about getting at a correct understanding of the world. We will miss him sorely, and perhaps especially so in today’s age of relentless self-promotion when almost every empirical paper in economics is touted for its 'unique’ dataset, and it has become almost obligatory for academic economists’ CVs to include an account of how much their work has been discussed in the press.