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Risk, Uncertainty and the Economics of Climate Change: Research Frontiers and Opportunities. Prof. Charles D. Kolstad University of California, Santa Barbara and Resources for the Future WSWC/CDWR Climate Change Research Needs Workshop, Irvine, May 17, 2007. Structure of Presentation. Part I

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risk uncertainty and the economics of climate change research frontiers and opportunities

Risk, Uncertainty and the Economics of Climate Change: Research Frontiers and Opportunities

Prof. Charles D. Kolstad

University of California, Santa Barbara

and Resources for the Future

WSWC/CDWR Climate Change Research Needs Workshop, Irvine, May 17, 2007

structure of presentation
Structure of Presentation
  • Part I
    • Remarks on Risk and Uncertainty in Climate
  • Part II
    • Remarks on research frontiers in economics of climate change

UCSB Bren School of Environmental Management

slide3

Risk, etc

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just what are we talking about
Just what are we talking about?
  • Uncertainty vs. Risk
    • Risk – we sort of understand the probabilities (eg, hurricanes in the Gulf)
    • Uncertainty – we don’t really even understand how likely or unlikely things are (eg, shut down of Gulf Stream). Most climate consequences.
  • Abrupt change: regime shift, something new happens quickly, gets out of hand, snowballs – chaotic
  • Catastrophe: something really big happens, though perhaps slowly, perhaps quickly (eg, sea level creeps up at 1 meter a decade, steadily)

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slide5

Size of

Consequences

Snowballiness

Real

Uncertainty

(not risk)

Good: close to origin

Bad: far from origin

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just what are we talking about ii
Just what are we talking about II?
  • Physical changes
    • Gulf stream shutdown
    • Ice Sheet collapse
  • Economic disruptions from small physical changes
    • Infrastructure overload
    • Financial markets collapse
    • Mass migration
  • Social and Political Crises from small physical changes
    • Wars over resources (eg, Pakistan-India)

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rumsfeld on uncertainty
“There are known knowns: there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns — the ones we don't know we don't know."

-Donald Rumsfeld, Feb 2003

Rumsfeld on Uncertainty

UCSB Bren School of Environmental Management

frank knight s typology risk and uncertainty in economics
Frank Knight’s TypologyRisk and Uncertainty in Economics
  • Three kinds of probabilities (Knight, 1921)
    • Clear objective ones like the flip of a coin
    • Statistical ones like the probability of rain in September in Santa Barbara
    • Estimated ones like the probability of THC shutdown from a 3o global temperature rise (where there is no basis for statistical estimates)
  • We can get a handle on the first two
  • BUT, some things are just not knowable from direct statistical observation (“non-ergodic theorem”)

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climate change what can be done
Climate Change: What can be done?
  • Mitigation
    • Slow additions to atmosphere of GHG
    • Take action to sequester carbon
  • Adaptation
    • Private – individuals and firms take action to reduce vulnerability and impact from change
    • Public – infrastructure change in anticipation
  • Learning
    • Invest in better understanding the problem
    • Encourage R&D into carbon saving technologies

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climate risk and uncertainty what can be done
Climate Risk and Uncertainty:What can be done?
  • Insurance markets (good for risk, not uncertainty)
    • Some risks insurable (require risk pooling)
      • Flood risk
    • Problems
      • Risks not always well known or well defined with changing climate
      • Reinsurers vulnerable
      • Market distortions an obstacle (Federal Flood Insurance, state regulation)
  • Derivative markets (better for uncertainty)
    • Catastrophe bonds
      • Pay off in certain well defined states of the world
        • Eg, Pay if Category 5 hurricane hits downtown New Orleans in 2006 pays $1
        • Market price of 20¢ with people on both sides  20% market probability
      • Both sides of market involved
    • Risk pooling not necessary
    • Allows hedging of risk but doesn’t eliminate damage from change
  • Insurance and derivatives do not undo damage, only hedge risk
    • Mitigation and adaptation reduce damage

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economics of climate change why do research in this area
Economics of Climate ChangeWhy do research in this area?
  • Pluses
    • Problem of immense import in the world (regardless of views on the seriousness of the issue)
    • Economics is at the center of the debate on what to do about climate change (essentially costs vs. benefits).
    • Comparatively few people work on the economics of climate change
  • Minuses
    • Many of the “economic issues” have little economics research content – mostly routine application of economic methods to develop estimates of damages or costs

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economics of climate change research needs
Economics of Climate ChangeResearch Needs
  • Need for long-term basic research to improve our set of tools
    • NSF-type support
  • Need for support for applications of economics to real-world decision problems
    • Work with BuRec, CDWR, others to develop tools to help with management decisions
  • Most of all: need to support capacity building so that there are more talented people working in these areas
    • More researchers
    • Encourage smart young people to go into the field

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subcategories of climate economics
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
  • Cost estimation
  • Regulation
  • International agreements
  • Integrated assessment and policy models
  • Technical change
  • Discounting and intertemporal issues
  • Uncertainty and knowledge acquisition
  • Others???

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subcategories of climate economics14
Subcategories of Climate Economics
  • Damage estimation
    • For Example: what are the losses from drought in California?
    • Clear need for better and more comprehensive estimates of damage, both at aggregate and regional levels.
    • Desirable to develop methods based on historic data and econometrics (as opposed to speculative modeling about the future)

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subcategories of climate economics15
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
    • For example: How will agriculture in the central valley be able to adapt to reduced water flow from Sierra? How will cropping respond to reduced water availability?
    • Adaptation is emerging as a major issue
    • Problem of how to measure costs and extent of adaptation
    • Primarily an economic response to changed circumstances
    • Theoretical and empirical work needed to characterize adaptation process and investment in defensive expenditures

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subcategories of climate economics16
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
  • Cost estimation
    • For example: what are the costs to the state of reducing emissions from the transport sector?
    • Cost of mitigation important though not too exciting
    • Methods for estimating mitigation costs from historic data most useful

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subcategories of climate economics17
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
  • Cost estimation
  • Regulation
    • For example: What options are available to CARB? What can be done to manage a long-term reduction in water available to State?
    • Opportunity to develop innovative regulatory tools based on advances in economics of regulation – decentralized methods of promoting public good
    • Improved understanding of existing regulatory experiments (eg, ETS)

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subcategories of climate economics18
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
  • Cost estimation
  • Regulation
  • International agreements
    • For example: forging the post-Kyoto framework
    • Theory hampered by computational complexity
    • More realistic models of agreements desired
    • Truth testing with empirical analysis highly desirable

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subcategories of climate economics19
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
  • Cost estimation
  • Regulation
  • International agreements
  • Integrated assessment and policy models
    • For example: develop a model of California that can assess the distributional impacts of regulatory proposals.
    • Big demand for policy assessment models for evaluating the likely impact of proposed regulatory regimes
    • Continues to be demand for high level integrated assessment models for gaining insight into overall problem – simplicity and some realism

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subcategories of climate economics20
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
  • Cost estimation
  • Regulation
  • International agreements
  • Integrated assessment and policy models
  • Technical change
    • For example: can we expect LED’s to replace CFL’s in home lighting?
    • Remains a very important but poorly understood dimension of climate policy
    • Induced technical change particularly poorly understood.
    • Requires theoretical and empirical advances

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subcategories of climate economics21
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
  • Cost estimation
  • Regulation
  • International agreements
  • Integrated assessment and policy models
  • Technical change
  • Discounting and intertemporal issues
    • Issue of slow or hyperbolic discounting remains important for cost-benefit analysis of climate policy
    • This is a long term issue that is unlikely to go away

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subcategories of climate economics22
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
  • Cost estimation
  • Regulation
  • International agreements
  • Integrated assessment and policy models
  • Technical change
  • Discounting and intertemporal issues
  • Uncertainty and knowledge acquisition
    • Example: BuRec water management in Colorado
    • Uncertainty plagues climate problem
    • Are there institutional mechanisms for dealing with uncertainty (eg, derivative or insurance markets)?
    • Theoretical advances?

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subcategories of climate economics23
Subcategories of Climate Economics
  • Damage estimation
  • Adaptation characterization
  • Cost estimation
  • Regulation
  • International agreements
  • Integrated assessment and policy models
  • Technical change
  • Discounting and intertemporal issues
  • Uncertainty and knowledge acquisition
  • Others???

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conclusions
Conclusions
  • There are needs for applied tools to help decision-makers deal with climate
  • There are also long-term needs for basic social science research (particularly economics) to help provide the methods and tools for decision-support
  • There is also a need for capacity building. Current incentives in economics are NOT to go into environmental economics and climate.

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