Climate change policy the challenge to economics
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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. What to do about it. Nothing--rely on adaptation

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Climate-change policy: the challenge to economics

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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

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!

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