"Adaptation and the envelope theorem"

Here's a simple, elegant and important point about the economics of climate change, but it applies to other environmental changes equally well. (I was recently at an entire conference dedicated to the economics of adaptation, and nobody mentioned this idea.)

William Nordhaus writes in a 2010 paper published in the journal Climate Change Economics (emphasis added):

Adaptation and the envelope theorem 

Including potential adaptation is beyond the scope of the current study. However, if changes in the means and higher moments of environmental parameters are small or gradual, and if agents make decisions on the basis of appropriate expectations, then omitting adaptation will have, to a first approximation, no effect on correctly measured damages. The reason is due to the “envelope theorem” of decision making. Under this result, the first-order cost of changing environmental conditions is equal to the first-order cost of adapting to those conditions. Of course, if environmental conditions change very rapidly, expectations are wildly inaccurate, or the cost of adapting is very non-linear, then second-order effects come into play. We would then need to consider adaptation costs explicitly.

What he's saying is that in the current equilibrium, individual's investment in adaptation to the current climate should be optimal (or close, given constraints/distortions).  And if it's optimal, this means the marginal benefits of additional adaptation are equal to the marginal costs.  So if we introduce a small change to the current climate such that it becomes optimal to adapt a little more, we will adapt slightly more at the current marginal cost and only reap exactly the same amount in marginal benefits (since the two are equal).  This means, we don't "win" by adapting. Instead, we just adapt slightly more at zero net benefit, so the overall social cost of the climatic shift remains unchanged.

Now, if only I could remember where I left my copy of MWG...