The Challenge of Global Warming for the Global Economy

1. 1 William D. Nordhaus Yale University September 11, 2008 World Bank Seminar Slides are available at http://nordhaus.econ.yale.edu/. Full study is William Nordhaus, A Question of Balance: Weighing the Options on Climate Change, Yale University Press, 2008, available in full at author’s web page. The Challenge of Global Warmingfor the Global Economy

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4. 4 Instrumental record: global mean temperature index(°C)

5. IPCC AR4 Model Results: History and Projections 5

6. What is the economist’s bottom on global warming? 6

7. 7 Integrated Assessment (IA) Models What are IA models? - These are models that include the full range of cause and effect in climate change (“end to end” modeling). Major goals of IA models: Project trends Assess costs and benefits of climate policies Assess uncertainties and research priorities Estimate the carbon price and efficient emissions reductions for different goals

8. 8 The emissions-climate-impacts-policy nexus:  The DICE-2007 model

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10. Temperature profiles: DICE 2008 10

11. Concentrations profiles: DICE 2008 11

12. Carbon prices for major scenarios 12

13. What do carbon prices mean in practice? 13

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15. Major issues for a revised international regime What are the likely impacts of climate change? The economics of participation Cap and trade v. carbon taxes? 15

16. 1. The Question of Climate Impacts Estimating the impact of climate change on society is the most treacherous of all areas. First approximation of climate damages: - Relatively minor impacts on market economies of “North” for a century (+ 1 percent of output) - Likely to have very large impacts on unmanaged ecosystems a century out and more 16

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18. 18 P. J. Webster, G. J. Holland, J. A. Curry, H.-R. Chang, “Changes in Tropical Cyclone Number, Duration, and Intensity in a Warming Environment,” Science, Sept. 2005

19. 19 Normalized costs of hurricanes, 1950-2008:08

20. 20 Damage and power for individual hurricanes, 1950-2005

21. 21 Econometrics of hurricane damages (updated to 2008) “[The] amount of damage increases roughly as the cube of the maximum wind speed in storms…” (Kerry Emanuel, Nature, 2005) “While this may appear to be a relatively insignificant increase, nonlinear effects can make even a small increase important in causing damage, because damage is proportional to the cube of the wind speed.” (Anthes et al, BATIS, 2006) MAJOR SURPRISE: Super-high elasticity.

22. 22 Estimated mean damages from global warming, central case and alternative estimates

23. 2. The economics of participation One of the important issues in a climate policy regime is the extent of participation : “Free riding” reduces the effectiveness of a policy Free riding makes other countries angry and gives them an excuse not to participate. The excess costs of participation can be estimated as: (2) E(?) ˜ ?1-? where ? is the participation rate and ? the convexity of the cost function. 23

25. 25 Attrition of Kyoto Protocol: share of global emissions

26. Source: Question of Balance 26

27. 3. Major Policy Approaches for Global Warming Internationally harmonized carbon tax – economist’s ideal. Universal cap and trade – close second if well designed, but Kyoto Protocol is not doing well. ____________________________________________ Regulatory substitutes (CAFE standards, ban on light bulbs, …) – very inefficient approaches Voluntary measures (carbon offsets) are difficult to calculate and verify and probably a useless diversion. 27

28. 28 Harmonized Carbon Taxes What are “harmonized carbon taxes”? Raise fossil fuel prices proportional to carbon content All countries would target a comparable tax Level of tax set to meet environmental target Use consumption basis for tax Many advantages over cap and trade (see slide below)

29. Cap and trade v. carbon taxes The fundamental defect of most quantity regimes is the LACK OF CONNECTION between targets (emissions) and objective (climate or damages). 2. QUANTITY LIMITS TROUBLESOME in a world of differential economic growth and uncertain technological change. Because of structure of uncertainty for stock pollutant, emissions taxes are MORE EFFICIENT than quantitative standards or auctionable quotas. (Weitzman) 4. Quantity-type regulations show EXTREMELY VOLATILE PRICES for the trading prices of carbon emissions (see slide). 29

30. Price volatility of emissions permits 30

31. Cap and trade v. carbon taxes 5. Tax-type mechanisms or auctions have advantage because they raise revenues and have potential for REDUCING DEAD-WEIGHT LOSS OF TAXATION. 6. Quantity-type systems with international trading are much more SUSCEPTIBLE TO CORRUPTION than price-type regimes. 7. The international cap and trade is a RADICAL AND UNPROVEN APPROACH, whereas taxes have been used in every country of the world. All these emphasize the difficulty of reaching an effective and efficient mechanism for global public goods. 31

32. 32 Final thoughts