For climate economics, preferences can and should be treated as endogenous

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Take the example of a decision-maker aware of the fact that a growing proportion of young people in Western countries are choosing to be vegetarians. How should it integrate this information into its way of thinking about climate policy? A look at conventional economic analyzes might disconcert her. Economic agents are either modeled as updating beliefs about their consumption options, such as environmental consequences or their own health: they simply learn new facts. Or they change their habits, understood as making mindless choices. Economists rarely assume that people revise their preferences because their underlying values ​​change.

When it comes to climate change, economists have correctly pointed to the need for economic regulation (Klenert and Hepburn 2018, Klenert and Fleurbaey 2021). However, current economic policies are insufficient to achieve global climate goals. Environmentalists emphasize the need for voluntary action by consumers to reduce their carbon footprint. This suggests that the transition to net zero is more likely to succeed if values ​​change. However, this perspective is very different from how economists typically describe the transition to a net-zero carbon society.

Economic analysis assumes that people have fixed preferences for their current lifestyle. Avoiding certain consumer items and turning to more sustainable alternatives therefore has a cost in terms of well-being. A carbon tax would reduce welfare if environmental benefits are not taken into account. For example, policies aimed at reducing meat consumption could reduce well-being if people have a strong and consistent taste for meat.

Research in behavioral economics, however, has shown that choices cannot be fully explained by stable preferences and behavioral biases, but that the social environment affects agents’ decisions. Changes in values ​​and culture can lead to lasting changes in behavior. Smoking and recycling are just two examples of how attitudes have changed significantly in recent times (Nyborg et al. 2016).

A tax can change preferences through different channels. Bowles and Polania-Reyes (2012) show that taxes modify the social environment in which agents form their preferences. As part of environmental policy, large discounted charging schemes for low-carbon transport can increase their attractiveness through a social norm, while reducing the intrinsic motivation to adopt environmentally friendly behavior. environment (Hilton et al. 2014). In addition, the visible behavior of peers influences certain consumption decisions such as energy conservation or the adoption of renewable energy technologies.

Can formal economic analysis be performed when preferences are treated as endogenous?

In two recent publications, we examine climate mitigation policy assuming that policies can change preferences. In Mattauch et al. (2022), a study in collaboration with Nicolas Stern from the Stern-Report on the Economics of Climate Change 2006, we model a consumption decision between two goods: low carbon and high carbon. We assume that policy instruments such as taxes or infrastructure programs also alter preferences – whether intentional or not – and account for effects such as shifting utility curves, in addition to shifting relative prices ( figure 1). We prove that the level of taxation to achieve a climate goal should be adjusted when it induces consumers to like low-carbon goods more (or less). We also establish that the value of investing in low-carbon infrastructure is higher when that infrastructure leads to a shift towards low-carbon preferences. For example, citizens growing up in easily cycled cities might prefer low-carbon transportation options.

Figure 1 Simple microeconomics of a shift towards less polluting consumption

Remarks: Adapted from Mattauch et al. (2022). Higher consumption of the own good, C, can be obtained by changing its (relative) price p or by shifting the utility curve, or both.

In Konc et al. (2021), we model consumers as socially embedded agents, who form their preferences under the influence of their peers. Using a framework similar to Mattauch et al. (2022), we show that a carbon tax has two types of effects. A first-order or immediate effect is a reduction in carbon-intensive consumption, through the usual price effect. A second-order or later effect is a change in preferences due to consumption changes in the social network. Preferences in social networks being interdependent, the effects of taxation are reinforced by a social multiplier. Using calibrated simulations, we estimate that changes in preferences increase the effectiveness of a carbon tax by 38% (Figure 2). This means that a tax designed to achieve a certain emissions target can be reduced due to the social multiplier effect.

Figure 2 Reducing the consumption of carbon-intensive goods through the carbon tax under fixed and socially integrated preferences

Remarks: Adapted from Konc et al. (2021). We compare the effective tax between cases with (orange line) and without (blue line) social interactions. The marginal effect of the tax on carbon-intensive consumption is larger with socially rooted preferences. Therefore, the effective tax τ* is lower when considering social interactions.

Should formal economic policy analysis really treat preferences as malleable by policy?

So far, we have shown that it is possible to model the influence of policies on preferences. However, that doesn’t settle the question of whether it’s a good idea. After all, a long tradition in economic analysis has treated preferences as exogenous. This position is often defended on the grounds that policies would otherwise become “paternalistic”. After all, assessing policy-induced shifts in preferences often forces societies and their institutions to take a position on which preferences are more desirable – old or new. Our short general response to this objection is this: if society does not debate how preferences are formed and exercises explicit democratic control over the decisions that influence them, preferences are likely to develop without clarity as to what is at stake. This could result in preferences being shaped to benefit particular interest groups rather than society as a whole (Bowles 2016, Hoff and Stiglitz 2016). For most social scientists and public policy experts outside economics, the question of how values ​​should be changed is already of great concern. And even in welfare economics, recent contributions have paved the way for several precise ways to conduct welfare analysis with endogenous preferences, with different conclusions (Fleurbaey and Tadenuma 2014, Mattauch and Hepburn 2016, von Weizsäcker 2005).

For the future of climate policy advice, our work aligns with a chapter in the Intergovernmental Panel on Climate Change’s latest assessment: demand-side measures could cut carbon emissions by 40 70% (IPCC 2022: Chapter 5). A growing body of research examines how avoiding emissions-intensive behaviors or adopting low-impact behaviors (such as consumption of animal protein) could be encouraged by public policies (Creutzig et al. 2022). Implementing complementary instruments to pricing that alter the process of preference formation can ultimately increase welfare. Whether economists like it or not, social science research on how to create a net-zero carbon economy will continue to examine how preferences change. For us, the economy should be part of this program and contribute to it with its advanced tools for formal analysis and quantification of the effects on well-being.

References

Bowles, S and S Polania-Reyes (2012), “Economic incentives and social preferences: substitutes or complements? », Economic Literature Review 50(2): 368-425.

Bowles, S (2016), moral economy, Yale University Press.

Bloch, F (2016), “Targeting and pricing in social networks”, in Y Bramoullé, A Galeotti and BW Rogers (dir.), The Oxford Handbook of Network Economics.

Creutzig, F, L Niamir, X Bai, M Callaghan, J Cullen, J Díaz-José, M Figueroa, A Grubler, WF Lamb, A Leip, E Masanet, L Mattauch, J Minx, S Mirasgedis, Y Mulugetta, S Budi Nugroho, M Pathak, P Perkins, J Roy, S de la Rue du Can, Y Saheb, S Some, L Steg, J Steinberger and D Ürge-Vorsatz (2022), “Demand-side solutions to climate change mitigation compatible with high levels of well-being, Natural climate change 12(1): 36-46.

Fleurbaey, M and K Tadenuma (2014), “Universal Social Orders: An Integrated Theory of Policy Evaluation, Intersociety Comparisons, and Interpersonal Comparisons”, Review of economic studies 81(3): 1071-1101.

Hilton, D, L Charalambides, C Demarque, L Waroquier and C Raux (2014), “A tax can nudge: The impact of an environmental bonus/malus tax system on transport preferences”, Journal of Economic Psychology 42: 17-27.

Hoff, K and JE Stiglitz (2016), “Searching for Balance in Economics: Towards a Social Determination Theory of Behavior”, Journal of Economic Behavior and Organization 126: 25-57.

IPCC – Intergovernmental Panel on Climate Change (2022), Climate Change 2022: Climate Change Mitigation. Contribution of Working Group III to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change [P.R. Shukla, J. Skea, R. Slade, A. Al Khourdajie, R. van Diemen, D. McCollum, M. Pathak, S. Some, P. Vyas, R. Fradera, M. Belkacemi, A. Hasija, G. Lisboa, S. Luz, J. Malley, (eds.)]. Cambridge University Press

Klenert, D and M Fleurbaey (2021), “The social cost of carbon and inequalities”, VoxEU.org, 28 April.

Klenert, D and C Hepburn (2018), “Making carbon pricing work for citizen”, VoxEU.org, 31 July.

Konc, T, I Savin and JC van den Bergh (2021), “The social multiplier of environmental policy: application to carbon taxation”, Journal of Environmental Economics and Management 105:102396.

Mattauch, L and C Hepburn (2016), “Climate policy when preferences are endogenous – and sometimes they are”, Midwestern Studies in Philosophy 40: 76-95.

Mattauch, L, C Hepburn, F Spuler and N Stern (2022), “The Economics of Climate Change with Endogenous Preferences”, Saving resources and energyp.101312.

Nyborg, K, JM Anderies, A Dannenberg, T Lindahl, C Schill, M Schlüter, WN Adger, KJ Arrow, S Barrett, S Carpenter and FS Chapin III (2016), “Social norms as solutions”, Science 354(6308): 42-43.

von Weizsäcker, CC (2005), ‘The Welfare Economics of Adaptive Preferences’, MPI Collective Goods Preprint.

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