Climate risk is, at its core, a risk management problem. That should come as no surprise. What is surprising is how interesting, complex, and generally poorly understood the economic analysis of climate risk is. Two issues make determining the appropriate price of carbon emissions difficult to determine. The first issue is that the unusually long time before the damages are expected to be realized makes them difficult to value. The second issue, even more difficult than the first, is that the potential for an unknown low-probability/ high-damage scenario to occur is fundamentally uncertain, and only recently has been taken seriously in the academic debate. This latter issue is so hard to analyze that it has only recently been taken seriously in the academic debate. There is no disagreement among economists on the benefits of pricing carbon emissions. Prices create the appropriate incentives for producers and consumers by internalizing the externality of future damages created by economic activities that produce emissions. Given that globally the production and consumption of fossil fuels today on average receives a subsidy of around $16 per ton of carbon dioxide emissions, incentives are misaligned, society fails to make appropriate investments in mitigation, and the capacity of the atmosphere to safely absorb emissions is wasted. The only interesting issue is what the right level for a tax on emissions is. Because of the long time horizon until damages are expected to occur, the present value of the expected damages is distressingly sensitive to alternative discount rates that are not observable in the market, and thus difficult to justify. Interestingly, however, the valuation of these expected damages is the less controversial part of the debate. There is a general consensus among economists that future generations will be able to deal with the expected impacts of climate change relatively uneventfully.
