This study is about developing a unified cost-benefit framework of climate, nature conservation and land policies under risk and uncertainty. We derive modified Hotelling rules from a social planner’s welfare optimization.
Four forces jointly determine market design: First, discounted marginal climate damages enter the social cost of carbon (SCC), marginal ecosystem services the social value of nature (SVN) and the marginal product of land determines the social value of converted land (SVCL). Second, climate, nature and land are coupled, which raises all prices: degradation of ecosystems increases the SCC and the SVCL, while climate damages raise the SVN. Third, a climate-nature beta quantifies additional hedging components of policies against fat tails, when we consider a stochastic setting with exogenous random shocks. The climate-nature beta summarizes the option values for abatement, adaptation, ecosystem restoration and carbon dioxide removal. Fourth, Markov markups quantify tipping risks, which we capture by extending the model to a constrained Markov decision process with state-contingent transition probabilities.
Thereby, we endogenize tipping points: the likelihood of moving into a high-damage regime becomes a function of the atmospheric carbon stock and natural capital, which depend on policy choices. Thus, hazard risks are a policy-sensitive component of the system’s dynamics. The model yields state-contingent asset-pricing formulas for carbon prices, restoration subsidies, taxes on land use and land conversion and capacity payments.
