Climate-change policy: the challenge to economics

1. Tom Hickson: scientists > 99% in agreement about anthropogenic global warming (AWG) Economists and policy-makers in less agreement, but here is where things get really divergent…. Climate-change policy: the challenge to economics

2. What to do about it • Nothing--rely on adaptation • Do something, but how and what? • GHG abatement • Technology research • Sequestration: natural and technological • Cap and trade • GHG (carbon) taxes • Preparation for catastrophic events • Do something, but how much?

3. Most favor doing something • Benefit Cost Analysis is VERY difficult • Stern Review • British study • Used very low discount rate—puts heavier weight on potential future • “Mainline” economists • More gradual policy “ramp” • Argument: early resources better spent on technology and human capital

4. Some difficulties with BCA/CBA • Big uncertainties about the discount rate (r) • Big uncertainties about the probability and magnitude of a catastrophic event: outgassing of methane, loss of Greenland or Antarctic ice sheets, etc.

5. Let’s consider some issues with r • Many philosophers and ethicists argue for r = 0, or at least very low • They argue that it is wrong to place less weight on the well-being of future generations • The Stern Review comes close to this

6. An experiment with economic growth and low r • Economic growth of 1.3% annually (from Stern) • r = 1% = 0.01 • Now suppose our actions today reduce future consumption by 0.1% (1/10 %) starting in 200 years and continuing forever.

7. Approximate current per capita consumption is 10,000 (with very unequal distribution) • In 200 years it would be approximately 130,000 • A 0.1% (.001) decline would be 130, the present value of which 200 years out would be 130/0.01 = 13,000 • Discounting 200 years back to the present at r = 0.01 gives us a PV of approximately 1777 of damages

8. Where does CBA get us? • Would it make sense to ask the current generation to go 10,000 – 1777 = 8223…. • ….to prevent folks 200 years and beyond from going 130,000 – 130 = 129,870? • This is a simple thought experiment, but it alerts us to the implications of low r

9. Big uncertainty #1 • What discount rate to use • The great economist Tjalling Koopmans (1975 Nobel Prize in Economics) cautioned that we should never get wedded to a particular idea for the discount rate until its implications are understood

10. What about catastrophes? • This is another HUGE wildcard in the CBA debate • What and how much to do are very sensitive to assumptions about probabilities and magnitudes • CBA works pretty well when dealing with E(X) and known probabilities from estimable probability density functions (PDF)

11. Ordinary risk analysis under conventional uncertainty • Works well when we have a good idea of PDFs and probabilities • Insurance companies • Risks of morbidity and mortality due to exposure to pollutants • This type of risk analysis is backed up by loads of data

12. Profound uncertainty • The analysis of probabilities associated with climate catastrophes has an extra layer of uncertainty • We are uncertain about the probabilities and PDFs • It is less about risk analysis and more about trying to resolve how uncertain we are about the uncertainty we face

13. Climate Change – Background CO2 emissions from fossil fuels (2004)

14. Climate Change – Background per-capita CO2 emissions from fossil fuels (2004)

15. Kyoto Protocol (1997) • 150 nations • Task was to create a legally-binding international agreement on climate change. • Targets and timetables • Reduce ghgs in aggregate by 5.2% from a 1990 baseline for the 2008-12 time period. • Targets are differentiated by nation (U.S. is 7%).

16. Kyoto Protocol (1997) • Allowable policies • Emissions trading. • Joint implementation – one country gets credit for implementing a project to reduce carbon emissions from another country. • Carbon sinks – land and forestry practices that remove carbon emissions

17. Kyoto Protocol (1997) • 127 countries have ratified agreement. • Participating countries account for 62% of ghg emissions. • Russia was last country to ratify.

18. U.S. Developments • Signed Kyoto Protocol in 1997. • Byrd-Hagel Resolution in U.S. Senate (1997) • The U.S. should accept no climate agreement that did not demand comparable sacrifices of all participants. • Passed 95 to 0. • U.S. pulled out of Kyoto in spring 2001. • Regional Greenhouse Gas Initiative (RGGI underway in 2009) • Regional cap-and-trade program. • Northeastern states. • Pacific states considering their own cap-and-trade program. • Regional trading program being planned for this region

19. Economics of Climate Change • Issues underlying costs of controlling ghgs: • How quickly can society change its energy systems? • Can technology change fast? • How willing and able are consumers to substitute? • How flexible will climate change policies be? • Will marginal cost of controlling ghgs be lower in future? • If green (corrective)taxes are used, will distortionary taxes (e.g., income) be lowered?

20. The “Broad-then-Deep” Strategy • A broad set of countries should make small cuts today and progressively deeper cuts in the future. • Damages occur gradually and catastrophes are highly uncertain and in the future. • Mitigation costs are likely to fall over time with increasingly cleaner technology. • Strategy ensures that payoffs to countries for joining a coalition will be higher.

21. Debate on Kyoto Protocol • Critique of Kyoto Protocol: a “deep then broad” strategy. • Only developed countries make deep cuts today. • No provisions for bringing in developing countries. • Support for Kyoto Protocol: • Developed countries are most responsible for current levels of ghgs. • An agreement is better than no agreement.

22. Have a good summer!