The Economics and Policy of Climate Change

1. The Economics and Policy of Climate Change API-35/Econ1661 Section Notes Jisung Park April 2013 These slides incorporate material originally produced by Geoffrey Heal, Rich Sweeney, Liz Walker, and Gabe Chan

2. Outline of next three sections • Science • Climate Science • Physical impacts • Economics I: Cost-Benefit Analysis of Climate Change • Benefits • Uncertainty • Aggregation – Ethics, Discounting, Inequality • Debate on ethical positions and Uncertainty • Economics II: Policy Design / Instrument Choice • Overlapping instruments and other temptations • REDD • Geoengineering and the “Free-Driver” Problem • Debate on policy alternatives

3. Climate Change is sort of a big problem • “Climate change is the mother of all environmental externality problems.” - Martin Weitzman (2012) • “Climate change is the result of the biggest market failure the world has ever seen.”- Nicholas Stern (2007)

4. What Role can Economics Play? • Where to go (How much mitigation?) • Cost-Benefit Analysis • Find the “optimal” emissions trajectory? • Target level: 350ppm? 450ppm? • How to get there (Which policy tools?) • Instrument Choice: • Carbon Taxes? Cap-&-Trade? • Top-down, Bottom-up? Hepburn and Park, 2011

5. Looking Ahead: The Economist’s challenge • How to quantify the social welfare losses arising from these physical impacts, given multiple layers of uncertainty and interdisciplinary contingencies? SOCIAL COST OF CARBON ($)

6. Why do we need to learn Econometrics? • The Bigger Picture SOCIAL COST OF CARBON ($) POLICY RECOMMENDATIONS

7. Outline of next three sections • Science • Climate Science • Physical impacts • Economics I: Cost-Benefit Analysis of Climate Change • Benefits • Uncertainty • Aggregation – Ethics, Discounting, Inequality • Debate on ethical positions and Uncertainty • Economics II: Policy Design / Instrument Choice • Overlapping instruments and other temptations • REDD • Geoengineering and the “Free-Driver” Problem • The way forward? • Debate on policy alternatives

8. Radiative Forcing and the Greenhouse Effect The mean annual radiation and heatbalance of the Earth. From Houghton et al., (1996: 58), which used data from Kiehl and Trenberth (1996). Figure from Withgott and Brennan (2007)

9. Uncharted Territory 10000 5000 (yrs before 2005)

10. Useful rules of thumb: GHG Concentrations/Emissions • Annual increase between 2 and 3 ppm • Over a decade concentration increases by roughly 20-30 ppm • Currently at 390 ppm: • (390 is CO2-only: including all GHGs concentration is nearer 440) • Will reach 410-420ppm by 2020 • Current annual emissions: 40 billion tons CO2 equiv • Check out: http://cdiac.ornl.gov/pns/current_ghg.html

11. Stocks vs Flows For Climate Change, what matters is the STOCK of GHG’s Flow Stock

12. Where is it coming from? This is CO2-e not C, from all sources, not just fossil fuels 12 12

13. Where is it coming from? • Despite popular misconceptions… • Transport is relatively small (13%) • Forestry is over 1/6th (17.4%) • Building efficiency improvements are somewhat trivial (7.9%)

14. Who is responsible? • Historically

15. Who is responsible? • Relative contributions by major countries to a) cumulative CO2 emissions, b) current annual CO2 emissions, c) the growth in CO2 emissions, and d) population (Raupach, et al., 2007)

16. Who is responsible? • Relative contributions by developing and developed countries to a) cumulative CO2 emissions, b) current annual CO2 emissions, c) the growth in CO2 emissions, and d) population (Raupach, et al., 2007)

17. Distributional Inequality in GHG per person Annex 1: 16.1 tCO2eq / capita Non-Annex 1: 4.2 tCO2eq / capita But how much of your carbon footprint is actually within your individual control?

18. Attribution – Anthropogenic? out of Africa first humans Historical Atmospheric CO2 Concentration

19. Outline of next three sections • Science • Climate Science • Physical impacts • Economics I: Cost-Benefit Analysis of Climate Change • Benefits • Uncertainty • Aggregation – Ethics, Discounting, Inequality • Debate on ethical positions and Uncertainty • Economics II: Policy Design / Instrument Choice • Overlapping instruments and other temptations • REDD • Geoengineering and the “Free-Driver” Problem • The way forward? • Debate on policy alternatives

20. Weather vs Climate • Weather is a short-term realization from a long-term Climate distribution

21. Temperatures are Rising Variations in the Earth’s surface temperature in the Northern Hemisphere (IPCC, 2001)

22. Sea-Level is Rising Sea level movement 22 22

23. Potential Future Sea Level Rise

24. For those interested in the details…

27. Epidemiological studies suggest warm nights are more important in determining mortality and morbidity responses from heat waves

31. Projected Warming Scenarios Forecast warming greatest in Arctic Research question: should we care about absolute degree changes or stdev from normal variability? Temperature forecasts 31 31

32. Ecosystem Services • Among the natural processes that will be affected, which are the ones that will have significant human welfare implications? • Temperature and Precipitation changes will impact.. • Water availability and quality • Crop Yields and growing seasons • Coastline Habitability • Soil availability and quality

33. Biodiversity Loss • What about the processes (and entities) that are not human? • Where does biodiversity loss fit in? • Up to 30% of species gone by 2100. • Only through the social welfare function? • Where UV = use-value, EV = existence value • Norton (2010): Economics as a discipline commits the sin of assumed “value monism”

34. Physical Impacts: Summary • Average temperature increases worldwide • (tremendous regional heterogeneity) • Increased temperature variability in some areas • Shifts in rainfall patterns • (even more tremendous regional heterogeneity) • Sea-level rise • Biodiversity loss (up to 30% of all species by 2100) • Ocean acidification -> Coral bleaching • Increased storm intensity and frequency in most regions

35. Some Figures worth Remembering • World GDP ~ $70 trillion • US GDP ~ $15 trillion • Social cost of carbon estimates: $23-$38/ton (Greenstone et al, 2013); (-10$ to $200+ with a wider net) • Implied size of potential carbon market: >$800 billion annually

36. Questions and Comments? (Won’t spend any more time debating the science)

37. Outline of next three sections • Science • Climate Science • Physical impacts • Economics I: Cost-Benefit Analysis of Climate Change • Benefits • Uncertainty • Aggregation – Ethics, Discounting, Inequality • Debate on ethical positions and Uncertainty • Economics II: Policy Design / Instrument Choice • Overlapping instruments and other temptations • REDD • Geoengineering and the “Free-Driver” Problem • The way forward? • Debate on policy alternatives

38. The Economist’s challenge • How to quantify the social welfare losses arising from these physical impacts? SOCIAL COST OF CARBON ($)

39. (Refresher)Where to go and how to get there • Where to go (How much mitigation?): • Cost-Benefit Analysis • Find the “optimal” emissions trajectory? • Target level: 350ppm? 450ppm? +2C? +3C? • How to get there (Which policy tools?): • Instrument Choice: • Carbon Taxes? Cap-&-Trade? • Top-down, Bottom-up?

40. Disconcerting Issues • “Climate change pushes economists beyond their methodological comfort zone.” (Weitzman) • Key Issues • Uncertainty • Missing Damages • Long-Time Horizons (Discounting) • Ethics and Inequality

41. Uncertainty: Vast and Multiplicative ALL OF THIS NEEDS TO SPIT OUT ONE POLICY-RELEVANT NUMBER?

42. Uncertainty: Vast and Multiplicative • Social Cost of Carbon Estimates: • Vary by two orders of magnitude (Tol, 2008) • Most recent “synthesis estimate” by Greenstone et al (2013):

43. Missing Damages? • Most IAM’s to date are highly incomplete (Heal, Weitzman, Hanneman) • For example, DICE Model (Nordhaus): Damages driven primarily by… • 1) Agriculture • 2) Sea-level rise • Even within agriculture, substantial controversy over underestimates due to leaving out effect of rainfall: • E.g. (MendelsohnvsSchlenker)

44. Missing Damages? • Recent research documents significant Missing Damages: • Storm Intensity and Frequency (Hsiang & Jina, 2013) • Large, persistent effects on economic growth: up to 70% of present GDP in NPV terms (Japan, South Korea, Phillipines) • Over $4 trillion • Highly heterogeneous (Australia and India benefit slightly) • Still inexact – what was the “damage” from Sandy?

45. Missing Damages? • Labor Productivity (Park & Heal, forthcoming; Dell et al, 2011) • +1 deg C => -1.2% GDP growth per year in poorer countries • Adaptation implication: AC in poor and hot countries?

46. Missing Damages? • Violent Conflict (Miguel et al, 2013; Hsiang et al, 2011) • Large and significant increases in civil conflict Also some suggestive Evidence of Climate Change affecting… • Health and Human Capital Accumulation (Greenstone et al, 2012; Graff-Zivin et al, 2013) • Effects on mortality, morbidity, even test scores

47. Long Time Horizons: Discounting “Climate policy involves time scales hitherto unprecedented in policymaking, periods of at least100 years.” (Heal, 2008) • At these time scales, the choice of discount rate can DOMINATE the cost-benefit analysis • E.g. $1,000,000 in damages occurring 200 years from now, discounted at 7% has an NPV of $1.32

48. Discounting What happens to NPV of SCC at “benchmark” discount rate of 7%?

49. Discounting and Ethics • Becomes a matter, in part, of Intergenerational Ethics “The problem of discounting for projects with payoffs in the far future is largely ethical.” - Kenneth Arrow “Discounting later enjoyments versus earlier ones is simply a practice that is ethically indefensible.” - Frank P. Ramsey

50. Discounting and Ethics r = ρ + ηg • r : discount rate • ρ: pure rate of time preference (arguably an ethical parameter) • η: elasticity of marginal utility (also ethical in the context of global social planner) • g: future consumption growth rate