Download Climate and economics

Climate and economics
John Hassler
Professor of Economics
Introduction
 Starting point:
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A ton of emitted fossil carbon mixes quickly in the atmosphere.
Higher carbon dioxide (CO2) concentration affects global climate.
Changed climate affects economy in many ways.
Fossil fuel has benefits for the user but affects other people all over the world.
Markets cannot deal with such a situation. Government policy and international
coordination required.
 Purpose:
 present a transparent calculation of the external effects of fossil fuel use.
 Can be used to judge the value of reducing fossil fuel use and determine
optimal carbon tax.
Natural science background
 Carbon dioxide (CO2) affects the global energy balance
(difference between inflow to and outflow from earth)
 CO2 passes easily high frequency electromagnetic energy (sun light)
but less easily low frequency heat radiation. More CO2 acts like the
roof of a greenhouse, reducing outflow and leads to warming.
 Can easily be verified experimentally
 1903 Nobel laureate in chemistry Svante Arrhenius described this already
(1896) and postulated an approximate relationship between the global
mean temperature and the percentage increase in CO2 concentration.
One per cent increase leads to 0.06 degrees warming. A doubling leads
to an increase of 4 degrees. (Worlds in the making: the evolution of the
universe, Arrhenius, 1908).
Natural science background:2
 In reality, a large number of more or less known feedback
mechanisms. Some reinforce and some weaken the direct effect.
 Positive: Less arctic ice reduces sunlight reflection, more water vapor (another
greenhouse gas).
 Negative: Cloud formation, airborne particles.
 Total effect unclear, best guess that Global Average Temperature
increases by 3° C for (each) doubling of CO2-concetration
 Arrhenius’ result still valid!
 Effects are unevenly spread and include effects on precipitation and
other characteristics of climate.
 Thresholds and tipping points possible but no general consensus.
Fossil fuel externality
three questions
 In order to determine the (approximate) value today of the
damages caused by one ton of fossil carbon emissions, we need to
answer:
1. How much damages (per year) are caused by an extra ton fossil
carbon in the atmosphere?
2. How long time does an extra ton emitted carbon stay in the
atmosphere?
3. How should we value future losses of consumption?
Question 1
Climate damages
 We know less (and have researched less) on the economic
consequences of climate change.
 Effects are global, comes in many difference ways and are long-run.
 Existing research has used two complementary approaches:
1.
Study different sectors (agriculture, forestry, health, coastal erosion, storm
damages …) separately. Then sum all effects.
2.
Statistical analysis on how natural variation in climate has affected the
economy (GDP, growth).
 Both leads to a climate damage function -- size of damage to GDP
for different increases in temperature.
 Limited knowledge, in particular about extreme climate change.
Climate damage:2
 Large differences between effects in different regions, including very
large and moderate negative effects as well as some areas with
positive effects (Northern Europe).
 In larger regions/countries – perhaps less diversity. Example from
Nordhaus RICE and DICE models.
 Also substantial local externalities from fossil fuel extraction and
use.
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Air quality and damages to land.
Congestion and accidents (also for other fuels).
Requires national policies but arguably not international policy coordination.
These are abstracted from here but can be very substantial.
Should be added to the global externality.
Climate Damage Functions
Nordhaus RICE 2007-10
Per cent loss of GDP
12%
10%
US
8%
EU
6%
China
4%
Africa
2%
Global
0%
0
1
2
3
4
Increase Global Average Temperature
5
6
Damage per ton fossil carbon
 How large is the externality – how much damages are caused by an
extra ton carbon in the atmosphere?
 More carbon in atmosphere -> higher temperature -> larger
damages.
 First step has decreasing marginal effects. Temperature increase less than
proportionally with carbon emission.
 Second step has increasing marginal effects. Damages increase more than
proportionally.
 The combined effect is approximately linear.
 1 billion ton carbon (1 GtC) extra in the atmosphere reduces global
GDP by around 1/400 per cent.
 Today, we have around 200 GtC over preindustrial levels. Reduces global GDP
by ½ %.
Question 2
How long does carbon stay in atmosphere?
 One extra ton of carbon causes yearly damages at around US $2.
 BUT– an emitted ton of carbon stays in atmosphere and causes
damages over a very long time.
 A good approximation:
 One share 1-φ0 (50%) disappears quickly to plants and surface ocean.
 Another share (20%) stays very long (thousands of years).
 Rest trickles down to deep oceans quite slowly (a few per cent per decade φ).
 Remaining question – how to evaluate future losses of
consumption?
Question 3
How to evaluate future consumption losses?
 Three aspects:
1. Under the (arguably reasonable) assumption that losses are proportional to
GDP, a larger future economy is hit by larger damages.
2. If we (future generations) are richer the welfare loss of a lost consumption unit
is smaller.
3. How to evaluate future welfare relative to today’s, all else equal (e.g., with
same consumption). A subjective and moral issue.
• Larger income in future leads to more consumption loss (aspect 1)
but with less value per unit of consumption (aspect 2). Under
standard assumptions in macroeconomics, these two aspects
cancel each other and the current value of future proportional
damages is independent of future income.
A formula for the carbon externality
Flow damage per ton carbon
Share of ton carbon that stays ”for ever”.
Share of carbon trickling down to deep ocean.
Current global GDP
Subjective discount rate for future welfare
Rate of trickling down
Carbon externality
Externality cost
RMB/Liter gasoline
US$/ton carbon
2.00
500
1.75
400
1.50
1.25
300
1.00
200
0.75
0.50
100
0.25
0.00
0
0.1
0.3
0.5
0.7
0.9
1.1
1.3
1.5
Yearly discount rate per cent
1.7
1.9
Are optimal taxes high?
 The optimal tax is fairly low relative to gasoline price and to other
externalities.
 Estimates of externalities from driving cars on fossil fuel point to
other externalities being larger. Around RMB 1.50 /ltr in US and
2RMB/ltr in UK. China?
 The world market price of coal is around 5 times lower per unit of
energy. The optimal tax relative to this is higher, making coal mining
less attractive.
Global Carbon Debt
 Our approximate formula can also be used to calculate the ”Global
Carbon Debt”, i.e., the discounted value of future damages that will
come in the future from the carbon that has already been emitted
(largely by the rich Western world).
 We have an excessive amount of carbon in the atmosphere at 200
GtC. Of this half will stay for a very long time according to our
approximation.
 Using the formula and a yearly discount rate of 1%, the carbon debt
is US $30 trillion, or around 40% of current world yearly GDP or
equal to the sum of EU and US yearly GDP.
 Who should pay this debt?
Tax vs. quantity restrictions
 The tax gives incentives for agents to make the right tradeoff
between private benefits and collective damages.
 Our formula requires much less knowledge than quantity
restrictions. For the optimal quotas, we also need to predict
technology, alternative energy, population growth….
 EU emission trading severely overestimated cost of reducing
emissions.
 But, markets needs to work well for tax to be sufficient. Some heavy
polluters might be less constrained by market forces.
Qualifiers
 We generally, and in particular regarding economic effects, face
large degrees of uncertainty and our knowledge is continuously
changing.
 If we find threshold effects or tipping points in climate system,
carbon circulation or the economy (yet to be found). Quantity
restrictions may become preferable.
 In general, market does not make the right incentives for research
and development. Government involvement important but poses
many difficult problems. Who is best at picking the winners?
Is a carbon tax a threat to growth?
 In the short run, energy use almost proportional to production.
 In the longer run, substantial possibilities to increase energy
efficiency. Swedish energy consumption constant since 1973 while
real GDP is up by 75%.
 Last 20 years, 1.5% yearly growth in energy efficiency in west.
 Large differences in energy efficiency also among countries at
similar level of development. Example from my part of the world.
GDP/kg oil equivalent:
 Iceland $2, Sweden $6, Denmark $10, Switzerland $12.
 In the (little) longer run, energy can be disconnected.
8 propositions
1. Burning fossil fuel leads to climate change, unclear how much.
2. Substantial, but likely not catastrophic, costs.
3. Catastrophic effects possible but currently impossible to evaluate.
4. Uneven distribution of costs, poor countries likely most effected.
5. Market failure, global policy coordination needed, global tax likely to
be best. R&D policy likely to be needed too.
6. Optimal tax is modest, no threat to growth.
7. Conventional oil is not the problem, coal and unconventional is.
8. Very substantial additional local costs of fossil fuel use. Requires
policy, but not (much less) international coordination.