Economic theory and climate change policy

Our willingness to embrace climate change policies depends on our perceptio n of their benefits and costs. Evaluation of these costs and benefits requi res cartful economic analysis. Yet the standard tools for such assessment - computable general equilibrium (CGE) models - are inadequate on several gr ounds. Their underlying theory suffers from well-known logical difficulties ; in general, their equilibria may be neither unique, stable, nor efficient . Moreover, real-world phenomena such as increasing returns to scale, learn ing, and technological innovation are neglected in CGE models. These phenom ena make the resulting equilibria in the models inefficient; in the real wo rld they can lock society into sub-optimal technology choices. They introdu ce uncertainty and path-dependence, annihilating the concept of a single ef ficient allocation produced by the unfettered market. Yet conventional econ omics assesses the cost of policies solely on the basis of their departure from a purportedly efficient equilibrium - ignoring deeper structural chang es that are often decisive in practice. New socio-economic theories and mod els are emerging that allow for bounded rationality, the limiting and enabl ing character of institutions, technological change, and the complexities a nd uncertainties in economic evolution. Meanwhile, existing models should b e modified to better reflect real-world phenomena and to abandon unfounded assumptions about the inherent "inefficiencies" of government intervention in the market. (C) 1999 Elsevier Science Ltd. All rights reserved.