This is an extract from the 2010 Sir Leslie Melville lecture, delivered last night by Dr Martin Parkinson at ANU:

… there has not been a broad consensus within the economics profession on the merits of action to reduce Australia’s greenhouse gas emissions, nor the general approach to how it should be implemented.

In fact, with a few notable exceptions like Ross Garnaut and Warwick McKibbin, it has been somewhat surprising how little serious engagement we have seen from economists in the CPRS debate.

Despite 15 years of thinking on this issue in the public sector, there are few Australian economists who could discuss any of the emissions trading scheme’s design concepts, choices, and trade-offs in detail.

This is unfortunate, as economists have much to offer in this field, and I strongly believe the policy debate would be enriched by greater serious engagement by the profession.

When the question of climate change action is considered in broad terms — abstracting from debates over whether action is needed, or specific details of how to act — economists as a group seem fairly uniform in supporting carbon pricing — certainly in preference to responses based on regulations, standards, or subsidies.

However, preference for a carbon price signal in the abstract is where the agreement among economists ends. There is disagreement on the detail required for practical implementation, such as the timing, level and nature of the mechanisms that should be used to provide a carbon price signal, and in some cases disagreement on whether action should be taken at all.

The fact that economists collectively view a price signal as a first best approach is significant if the desired goal is to reduce emissions at least cost to the economy as a whole.

Yet the lack of agreement on key implementation questions – or even on whether action is needed at all — renders this preference for a price signal largely meaningless in practice and, in fact, undermines public support for least cost approaches.

This contrasts to previous reforms where the case for action and key policy choices have been largely internal to economics as a discipline.

I would like to consider some of the possible reasons for this lack of broad consensus and, perhaps, lack of full engagement, among economists.

1. Some economists perceive climate change as an environmental problem rather than a multidisciplinary problem.

One possible cause may stem from some economists viewing climate change as an environmental problem rather than a multidisciplinary problem.

When seen as an environmental issue, economists may also associate it with historical perceptions that environmentalists are interventionist and anti-growth.

The consequence of this is that some economists have remained sceptical of the debate, and in particular appear to have remained highly suspicious of claims in relation to the science.

In respect of the science, the reality is that the most compelling claims about human-induced climate change are based upon work coming out of the scientific community, not the environmental community.

Of course there remains genuine debate over elements of the science, particularly on specific impacts, and it is important to recognise that.

However, the vast bulk of evidence from the scientific community seems to support the arguments that warming is occurring and that the oceans are acidifying, and that these phenomena are most likely a result of human activity. The elements of genuine, mainstream scientific debate are about issues at the margins, not around the central questions of whether the climate is warming or whether humans are largely responsible for this.

As an economist, how should one treat the scientific evidence? I suspect economists in any field would be less than impressed if scientists without background or training in economics began making sceptical comments on broadly accepted economic principles that had been well-tested in the mainstream economics literature — or worse, began questioning empirically observed economic outcomes.

When it comes to climate change science and projections, it is probably reasonable that economists without expertise in the relevant scientific disciplines should let scientists be the professional experts in this area. And vice versa! Scientists without a professional understanding of economics should recognise the advantages economists have in developing economically efficient policy responses.

Despite this, economists are only human and some may well remain sceptical. In such cases, assuming it is genuine scepticism rather than outright rejection of the scientific evidence, it has been surprising that some economists have resisted serious consideration of the professional application of the precautionary principle — that is, that taking action on climate change today is a form of insurance.

2. Economists have significant experience dealing with marginal issues, and relatively little experience dealing with issues that have potentially catastrophic outcomes.

This raises another possible reason for the lack of broad consensus. Economists as a profession tend to approach the analysis of issues by considering what happens at the margin i.e. in response to incremental changes. However, climate change potentially represents a complete change in the state of the world, including the potential for catastrophic outcomes. Economists have little experience in dealing with non-trivial probabilities of such outcomes occurring, or the related application of the precautionary principle and of risk management.

The Nobel prize-winning economist Paul Krugman has written several times on the potential costs of inaction on climate change, and has highlighted the issue of uncertainty over future climate impacts in trying to assess those costs. Somewhat counter-intuitively for many people, he suggests that the uncertainty over future impacts strengthens the case for action rather than detracting from it. In his arguments he particularly cites the work of Martin Weitzman of Harvard University.

Weitzman has written at length on the risk of a catastrophic outcome arising from a low but non-trivial probability of extreme increases in global average temperatures — a characteristic of human induced climate change that makes it very difficult to assess using conventional expected-value risk analysis.

Weitzman focuses on what he calls “fat-tailed cost benefit analysis” of greenhouse gas mitigation. The fat tail refers to the risk of catastrophic outcomes arising from global greenhouse gas emissions, and contrasts to the “thin-tailed” analysis that leads to conclusions that there should be an incremental tightening of emissions reduction targets over time.

Weitzman’s analysis suggests there is a low but non-zero risk associated with global temperature increases that could lead to:

mass species extinctions and biosphere ecosystem disintegration matching or exceeding the immense planetary die-offs associated in Earth’s history with a handful of previous geo-environmental mega-catastrophes.

This type of analysis, based on the non-zero risk of catastrophic outcomes including possible mass failure of civilisations, or even human extinction, creates a particular challenge for the economics profession. There are few, if any, other public policy issues in which the potential for a catastrophic outcome must be assessed in economic terms. The only other recent example of potential human-driven catastrophic outcomes that springs to mind was the risk of a global nuclear war.

3. While economists understand externalities in principle, they have a strong preference for leaving things to the market.

Returning to the question of the lack of broad consensus across the profession, another potential reason may be that while economists understand externalities in principle, they have a strong preference – in practice – for leaving things to the market.

The implication of this is that even if economists accept the scientific evidence and the conclusion that unmitigated greenhouse gas emissions will lead to externalities, some economists will still find it hard to accept that governments should intervene to address the externality.

And it is certainly not the case that the existence of a market failure automatically justifies government intervention. Intervention brings with it the risk of “government failure”, where the intervention fails to address the market failure, or does so at a higher efficiency cost than simply leaving the market failure in place.

The analysis required to support intervention in such cases is to show that addressing the market failure is cost effective. This requires examination of the consequences of leaving the market failure unaddressed, and the costs of intervention, including consideration of the likely outcomes of intervening.

In the climate change area, this therefore requires consideration of the cost of inaction, which comes back to a consideration of the science, as I mentioned before.

Consideration of the cost of inaction must be carried out within an economic framework that accounts for the long timeframes involved as well as the risks and uncertainties arising from imperfect knowledge of the climate system, its potential responses and possible tipping points.

This is a non-trivial exercise, as has been shown in recent years by both Sir Nicholas Stern and Ross Garnaut in preparing their landmark assessments of the costs and benefits of action to avoid dangerous climate change.

If the assessment from the science is that “something should be done”, an important role for economists is to ensure that the market failure is addressed most effectively and efficiently.

This suggests that measures taken should be able to incentivise emissions reductions across a wide range of possible sources, and that any response is flexible, scalable, and amenable to changing levels of international ambition.

In these circumstances, therefore, one would expect that economists would support a flexible, market-based solution, ahead of regulatory approaches.

4. Economists prefer pure solutions to negotiated outcomes and transitional assistance

Another possible reason for the lack of broad consensus among economists on climate change may be that economists prefer to be pure in their proposed solutions to problems, and are suspicious of politically negotiated outcomes and transitional assistance.

This may lead to resistance within the profession to accept that some elements of the policy problem may need to be taken as given, and to work within those to find the best practically available solution to the given problem. This may reflect a view from the profession that the policy slate should be wiped clean to enable development of an economically elegant solution to a complex problem.

However, in a policy studies sense, this purity can also reflect a failure to recognise that there is only limited agenda-setting capacity available, that past policy debate matters and carries momentum in terms of public recognition and potential political action, and that policy action occurs through building of coalitions around concrete policy proposals.

A possible consequence of the idea of a clean policy slate is a tendency of some in the profession to strongly argue the benefits of alternative carbon pricing models in preference to a cap-and-trade emissions trading scheme.

These alternative carbon pricing proposals may include hybrid models; baseline-and-credit schemes; consumption based obligations; or general support for a carbon tax.

These proposals are generally put forward at a conceptual level, where they may be models of elegance and simplicity, untrammelled by questions of practical implementation or political reality.

However, the profession’s discussion of alternative carbon pricing models generally fails to recognise that these alternatives have significant implementation issues themselves.

In addition, none of the alternative carbon pricing models contain any special feature that can overcome the fundamental issue — that introducing a carbon price will always be politically challenging due to its actual or perceived impacts on the distribution of wealth and income.

Another outcome of a more purist approach is that economists culturally resist the idea that transitional arrangements are a necessary component of any major reform — despite most of Australia’s major reforms having had transitional arrangements of some type. They may also resist the idea that transparency combined with the political process can ensure that transitional arrangements are removed over time, whereas hidden subsidies are much more difficult to deal with.

Furthermore, the idea that transitional assistance is contrary to efficiency should be tested in respect of a proposed economic reform, rather than assumed as a given from the outset.

In this light, it seems to me that few economists have analysed the details of the transitional arrangements for the proposed Carbon Pollution Reduction Scheme.

These have been designed with careful attention to ensure that the transitional assistance arrangements for households and businesses do, by and large, preserve the carbon price signal and marginal incentives to reduce emissions, and that they will be highly transparent and subject to regular reviews.

It is interesting to contrast reactions to tariff reform and carbon pricing reform. No one ever suggested that tariff reform wasn’t worth doing because it was implemented gradually and with generous transitional assistance packages — yet despite the careful attention paid to preserving the abatement incentives and ensuring that assistance is provided for a transitional period only, this is exactly what many are saying about the CPRS.

Had such an approach been applied to previous reforms, it is hard to believe that Australia would have the prosperous, flexible and resilient economy we enjoy today.

Today I have described the absence of a broad consensus among Australian economists about the merits of proceeding with an emissions trading scheme and noted that this sits in marked contrast to the profession’s view of the desirability of Australia’s major economic reforms of the late 20th century.

I have also reflected upon some of the possible reasons why such a consensus does not exist.

No doubt some of this will be confronting to some and may be strongly contested.

As such, I should offer my own views as an economist on the challenge of addressing climate change.

I believe that economists as a profession should take the best possible advice from experts in the scientific community and act upon that advice.

My own assessment is that the scientific advice, when combined with risk analyses that reflect the asymmetric impacts and uncertain probabilities of climate change outcomes, strongly suggests an approach based on risk management and the application of the precautionary principle to both reduce our own emissions and to give the strongest encouragement to other countries to do likewise.

Combined with the need to have a flexible and scalable approach to reducing emissions — one that can accommodate changing scientific understanding and uncertainty over the precise timing and scale of international action — this suggests that the most efficient policy response is to place a market price on those emissions.

Australia’s experience of economic reform over the late 20th Century indicates that a well-designed, market-based approach is better at the efficient allocation of resources than approaches based on regulation or public purchaser or provider models.

Moreover, our experience of reform should give us confidence that we can deliver significant reductions in emissions while maintaining strong and sustained growth.

Establishing quickly that this is true in practice will be important if there is even a small probability that the climate science is correct — or turns out to be worse than we thought — and we are required to make considerably greater reductions in emissions in subsequent decades.

While the temptation is to talk only in terms of purist carbon pricing systems, as economists we need to accept that transitional measures have a legitimate role in democratic systems. Our job is to ensure that transitional measures are designed to maximise efficiency by delivering broad based incentives for reducing emissions, to ensure they are transparent, and that they provide the information required to support long run reforms, while addressing the political economy of concentrated interests and asymmetric information.

Finally, as I have said many times before, it is my assessment that Australia simply cannot meet any significant emissions reduction target without the implementation of a carbon price. Regulation and government purchases or subsidy arrangements cannot deliver sufficient abatement to meet Australia’s emission reduction targets at a reasonable cost.

In this I believe that economists have a key contribution to make in ensuring that policies in the area of climate change, as in other areas, contribute to Australia’s national interest.

Like it or not, the broader community wants action on climate change.

It is therefore incumbent on economists to play a greater role in this debate — economists are unique as a profession in their understanding of the role of prices in the economy, and in their understanding the power of the market and what it can deliver.

With the implementation of an overarching carbon price signal, and with linkages to the international carbon market, Australia will be able to meet its targets at the lowest overall cost to the economy. And when that occurs, another chapter will have been completed in the application of economics to Australian policy reform in the spirit of Sir Leslie Melville and his generation of reformers.