1. 1 Economics 331b Spring 2009 Integrated Assessment Models of Economics of Climate Change

2. Note on final problem set This will be ready later this week. You should fine-tune your little model to make sure that it is working reasonably well. Basic problem will be to find the “optimal” mitigation policy. This will involve: - Setting up an objective function - Finding the μ(t) that optimizes the objective function - Then doing some alternatives (different discount rates, climate models, GDP growth rates) 2

3. 3 CO 2 concentrations at Mauna Loa

4. 4 2,000 1,600 1,200 800 400 193019401950196019701980199020002010 CO2 emissions US (millions tC/yr)

5. 5 Trend in CO2 emissions relative to GDP, US

6. 6 Instrumental record: global mean temperature index (°C)

7. 7 Projections and the paleoclimatic record

8. Some detail on how output and emissions are generated

9. What will be the impacts by sector? 9

10. Aggregate damage estimates from different studies Source: Richard Tol, Jour. Econ. Persp., 2009 10

11. 11 Estimated Damages from Yale Model and IPCC Estimate

12. 12 Monday 1. Baseline. No emissions controls. 2. Economic cost-benefit “optimum.” Emissions and carbon prices to maximize discounted economic welfare. 3. Limit to 2 °C. Climatic constraints with global temperature increase limited to 2 °C above 1900 On Wednesday 4. Copenhagen, all countries. Uses US emissions targets joined by other rich countries, with developing countries entering after 1 -3 decades. 5. Copenhagen, rich only. Uses US emissions reductions joined by other rich countries, with developing countries staying out. Scenarios for Analysis

13. Solution details 1. In most general case, have W = W[U US (c 1, c 2, …), U China (c 1, c 2, …),…] 2. Simplify for 1 country (see MU and MC diagram), which yields: 3. Further simplify by assuming fixed output and simple cost and abatement functions: 13

14. 14 MU, MC MU Utility (to be maximize) Abatement MC 0 μ*μ*

15. Baseline projections: IPCC Scenarios and RICE-2010 15 RICE-2010 Model with no policy measures

16. Emissions trajectories alternative policies 16 RICE-2010 Model with no policy measures

17. Carbon prices alternative policies 17 RICE-2010 Model with no policy measures

18. What do carbon prices mean in practice? 18 Carbon tax, 2010 Increase, price of energy, US [$/tC]Gasoline All energy expenditures Minimal $10 1.0%1.5% “Optimal”353.3%5.4% Climate constrained (ΔT < 2 °C) 504.8%7.7%

19. Carbon prices alternative policies 19 RICE-2010 Model with no policy measures Current global policy

20. Temperature profiles: RICE -2010 20

21. Agenda Monday - Integrated assessment models - The Yale DICE/RICE model Wednesday - Presentations on Kyoto and Copenhagen - Assessment of policies Next week: - Cap and trade v. carbon prices - Wrap up - Final problem set due 21

22. Implementation of Policies -Move from science to policy -Disappointment of scientists -Three level decisions: -Global -National -Individual -Virtually unique set of policy issues in historical context because of global public good, long-time lags, asymmetric impacts and costs, uncertainties, catastrophic potential -Presentations on cap and trade theory and Kyoto/Copenhagen Accords on climate change 22

23. 23 Monday 1. Baseline. No emissions controls. 2. Economic cost-benefit “optimum.” Emissions and carbon prices to maximize discounted economic welfare. 3. Limit to 2 °C. Climatic constraints with global temperature increase limited to 2 °C above 1900 On Wednesday 4. Copenhagen, all countries. Uses US emissions targets joined by other rich countries, with developing countries entering after 1 -3 decades. 5. Copenhagen, rich only. Uses US emissions reductions joined by other rich countries, with developing countries staying out. Scenarios for Analysis

24. Structure of policies Kyoto Protocol: Rich countries only, 7 percent average cuts, only for first “budget period”: 2008 – 2012. Minimal global cuts. Copenhagen Accord: Deep cuts for rich countries (see next slide for US). In principle, developing countries follow soon. Copenhagen, rich countries only: Same as Accord, with developing countries not participating till 2200. Key issue of whether have the “trade” in “cap-and-trade” 24

25. From Science to Implementation 1.Understand the basic science 2.Weigh costs and benefits to determine a “reasonable policy ” for emissions, economic, and climate trajectory 3.Design an approach for translating the policy into actual steps (taxes, regulations, subsidies, …) 4.Negotiate both among nations (e.g., Copenhagen) and in national decision-making bodies (Congress, CCP, EU bodies,…) 25

26. Four Approaches Internationally harmonized carbon tax – economist’s ideal. Universal cap and trade – close second if well designed, but Kyoto Protocol is not doing well. ____________________________________________ Regulatory substitutes (CAFE standards, ban on light bulbs, …) – very inefficient approaches Voluntary measures (carbon offsets) have little effectiveness and penalize the virtuous. 26

27. 27 Major Approaches Cap and trade (see earlier presentations and readings) Harmonized carbon taxes Raise prices of GHGs proportional to carbon content All countries would levy a comparable tax Countries would retain all revenues (this is not an international transfer program) Hybrid plans: Auction permits Floor and cap on auction prices

28. Pros and Cons Pros of cap and trade: - Familiar to political participants - Part of Kyoto Protocol - Does not involve “T” word - Allows transfer of resources to developing countries Pros of carbon taxes: - Lower volatility - Can capture revenues (public finance “double dividend”) - Less prone to corruption - Friendlier for small countries to join - A proven fiscal regime 28

29. Quantity-type regimes show extremely volatile prices 29 Source: Nordhaus, Various.

30. 30

31. 31 Volatility in EU CO 2 trading system: This volatility is inherent in such a system because of price- inelasticity of supply and demand Source: Metcalf, Carbon Taxes, Hamilton Project.

32. It is important for governments to capture the revenues (either through 100% auctions or taxes): –raise revenues for distributional policies –reduce the efficiency losses from taxation. 32

33. Corruption Quantity-type systems with international trading are much more susceptible to corruption than price-type regimes. International cap-and-trade plans are a three-sided game. There are strong incentives for a corrupt domestic government to collude with corrupt polluting firms to underestimate domestic emissions and hide from international monitors. 33

34. The problem of offsets Offsets have been part of all plans. Clean Development Mechanism (CDM) in the Kyoto Protocol has been major source of “accounting emissions” and has very questionable additionality. For example, in EU-ETS, there have been virtually no internal emissions reductions. The Clean Development Mechanism in EU has 280 million tons of offsets compared to 130 million tons of emissions reductions for current phase. Another set of defective financial instruments like credit default swaps? 34

35. Regime Uncertainty The international cap-and-trade program is a radical and unproven approach, whereas taxes are well understood and have been used in every country of the world. 35