THE MOST IMPORTANT AND MISLEADING ASSUMPTION IN THE WORLD
Part one of this blog post explained how macroeconomic models are flawed in a fundamental way.
These models are coupled to models of the Earth’s natural systems as Integrated Assessment Models (IAMs) that are used to inform climate change policy. Most IAM results presented in the Intergovernmental Panel on Climate Change (IPCC) reports show climate mitigation costs as trivial compared to gains in economic growth.
The referred to “elephant in the room” (from part one of this series) is the fact that economic growth is usually simply assumed to occur. No matter what the quantity or rate of investment in the energy system or the level of climate damages, the results indicate that economy will always grow. This defies intuition, and begs the question: If the costs of climate mitigation really are so small, then why is there so much disagreement over a low-carbon transition?
One way to explain the problem is via a term called “total factor productivity,” or TFP. TFP is the Achilles Heel of macroeconomics, and why no one talks about the aforementioned elephant with the exposed heel in the macroeconomics classroom.
Essentially economic output, or GDP, is usually modeled as being dependent upon the amount of labor in the workforce, the amount of capital (e.g., factories, machines, computers, buildings), and TFP.
TFP can be understood as all of the reasons why the economy grows that are not already characterized by the quantity of labor and capital. In statistical terms it’s called a “residual,” or the amount unexplained by an assumed underlying equation of economic growth.
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