Abstract
We study a highly aggregated fossil-based world economy with two competing stochastic thresholds or tipping points. Current production generates emissions that add to a stock of GHGs that affect the probability distribution of hitting a climate threshold with severe consequences (the “ugly” scenario). The fossil-intensive output is used either for current consumption or as R&D-investment in knowledge production, with the stock of knowledge affecting the probability distribution for hitting a “good” threshold or having a technological breakthrough (the “good” scenario) providing a clean emission-free substitute to fossil energy. We characterize an optimal strategy for allocating resources over time, given that no threshold has been hit, with the strategy or decision rules being continuously revised due to the induced changes in the derived probability distribution. To avoid the ugly scenario, while pushing for the good one, we find that the conditional expected marginal benefit or willingness-to-pay for knowledge will be increasing over time, with a non-decreasing rate of R&D investment and a non-increasing rate of consumption. Implementation of this strategy requires a global organization with coercive power, equipped with instruments so as to tax the negative stock externality and to subsidize the provision of the public good or stock of knowledge. An important task for the global planner is continuously to update the hazard rates for hitting the two thresholds.
JEL Classification C02, H23, H41, Q54, Q55