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 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 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 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!