Climate-change policy: the challenge to economics 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….

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?

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

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.

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

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.

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

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

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

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)

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

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

Climate Change – Background

CO2 emissions from fossil fuels (2004)

Climate Change – Background

per-capita CO2 emissions from fossil fuels (2004)

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%).

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

Kyoto Protocol (1997)

127 countries have ratified agreement. Participating countries account for 62% of

ghg emissions. Russia was last country to ratify.

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

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?

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.

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.

Have a good summer!