Abstract
Understanding how the economy affects natural systems, and how changes in these systems feed back to the economy, is at the core of sustainable development strategies. Traditionally, the economics of climate change builds on a weak notion of sustainability, which assumes high substitutability between natural capital and other kinds of capital and goods. This paper looks at what an intermediate notion of sustainability in a climate-economy system entails. The basic premise of this paper is that human society and natural systems are deeply interconnected. As human economic activity is becoming the main determinant of the state and quality of natural systems in the future, fundamental geophysical limits must be considered in the analysis of optimal economic growth. I augment the standard Dynamic integrated climate-economy (DICE) model to include natural amenities that are subject to limited substitutability both in preferences and in production. Additionally, I let the availability of natural amenities follow an endogenous path, depending on economic growth and climate change. The stock of natural capital, from which these natural amenities flow, also has a capacity for resilience if it is relieved from anthropogenic pressures. The resulting Natural amenities in a climate-economy (NAICE) model highlights two effects that are important to the economic analysis of climate change. The first follows from nature’s endogeneity, which causes the social cost of carbon (SCC) to be higher than in the standard DICE model. The second effect relates to the growth rate of the economy. Since economic output grows at a lower rate in the NAICE model, the SCC also grows at a lower rate over time compared to the DICE model. The analysis also shows that substitutability in preferences has a larger effect on the optimal climate policy than the degree of substitutability in production. I have built both the DICE and NAICE models using Microsoft Excel. The resulting Excel file is available upon request.