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Cameron Hepburn and Alex Bowen

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Penny Mealy and Cameron Hepburn

Climate change and poverty alleviation are, as Stern (2016) has coined, ‘the twin defining challenges of our century’. Historically, efforts to address these two challenges have been conflicted. However, two important developments suggest a new global readiness to move beyond historical conflicts and instead take advantage of key commonalities and collective interests. The 2015 adoption of the Sustainable Development Goals (SDGs) demonstrated an acute awareness that any plan to advance living standards of present and future generations must address the inseparable links between people, the planet and prosperity, while the Paris Agreement provides a promising new international platform to progress a unique collective framework for global climate cooperation. Against this encouraging backdrop, this chapter draws attention to a somewhat under-appreciated, but profoundly important commonality in the twin climate and development challenges: both require societies to navigate and manage system-wide transformative change. As a better understanding of the process of transformational change could catalyse progress on both climate and development fronts, this chapter explores parallel efforts in respective fields.

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Cameron Hepburn and J. Doyne Farmer

The climate and financial system share various features—they are both “complex systems”—but they also have important differences. This chapter explores what lessons might be learned from climate system modelling for financial system modelling and macroprudential policy. First, we argue that the primary lesson from climate science is that systematic data collection at a number of scales is a vital ingredient for properly understanding and modelling systemic risk. Yet, there is no equivalent for the financial system to the comprehensive data collection used by humanity to monitor Earth’s climate. Second, we consider models for the economic consequences of climate change, which we refer to as climate economics. We argue that, unfortunately, the main lessons from climate economics concern how not to model complex systems. As with estimates of physical parameters throughout history, the treatment of uncertainty in climate economic models remains inadequate, and outputs are expressed with far too much confidence. Climate economic models often omit significant variables, inadequately account for feedbacks, non-linearities, heterogeneity and non-rational behaviour. Suggested cures to these problems include: stating conclusions that are less precise but more truthful; employing scenarios to explore the ranges of possible system behaviours; placing greater focus on resilience and not just efficiency; and making policy with an eye on precautionary principles.

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Ben Groom, Cameron Hepburn and Phoebe Koundouri

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Philippe Aghion, Cameron Hepburn, Alexander Teytelboym and Dimitri Zenghelis

Shifting our fossil-fuelled civilisation to clean modes of production and consumption requires deep transformations in our energy and economic systems. Innovation in physical technologies and social behaviours is key to this transformation. But innovation has not been at the heart of economic models of climate change. This chapter reviews the state of the art on the economics of innovation, applying recent insights to climate change. The core insight is that technological innovation is a path-dependent process in which history and expectations matter greatly in determining eventual outcomes. This insight has six important implications for climate policy design. First, efficient climate policy requires direct research subsidies for inducing and/or diffusing clean innovations, combined with carbon pricing (whether by taxes or trading). Second, both public and private sector involvement is required. Third, path dependence and system inertia imply that delaying policies that redirect innovation towards clean technologies significantly increases costs in the future. Fourth, more developed countries should act as leaders in clean technology and should subsidise access to such technologies for less developed countries. Fifth, if a transition from coal to clean energy is to be made via intermediates (for example, gas), the use of gas (without carbon capture) should be agreed to be on a time-limited basis. Finally, investment in coal should not be encouraged, as its continued use is only safe if we assume the cost-effectiveness of carbon capture and storage (CCS) technologies. While much greater efforts should be taken to reduce the costs of CCS, the speed that these technologies can be developed and deployed is uncertain.