Download Cap and trade v. carbon taxes - Yale Economics

The Challenge of Global Warming
for the Global Economy
William D. Nordhaus
Yale University
September 11, 2008
World Bank Seminar
Slides are available at http://nordhaus.econ.yale.edu/. Full study is William
Nordhaus, A Question of Balance: Weighing the Options on Climate Change, Yale
University Press, 2008, available in full at author’s web page.
1
Outline of lecture
1. The science of global warming
2. What is the underlying economic problem?
3. What are the insights of economic integrated
assessment (IA) models?
4. Major Issues for the Next Round of the International
Accords (post-Kyoto Protocol)
-
Impacts
Participation
Taxes v. caps
2
CO2 concentrations at Mauna Loa
390
380
370
360
350
340
330
320
310
60
65
70
75
80
85
90
95
00
05
3
Instrumental record: global mean temperature index(°C)
Global Mean Temperature Anomaly
(Relative to 1900)
1.2
GISS
Hadley
1.0
Degrees C
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
1860
1880
1900
1920
1940
1960
1980
2000
4
IPCC AR4 Model Results: History and Projections
DICE-2007
model
5
What is the economist’s bottom on global warming?
The fundamental problem is the climate-change externality – a
“global public good”
Economic participants (millions of firms, billions of people, trillions
of decisions) need to face realistic carbon prices if their decisions
about consumption, investment, and innovation are to be correct.
1. To be effective, we need a market price of carbon
emissions that reflects the social costs.
2. Moreover, to be efficient, the price must be universal
and harmonized in every sector and country.
But a major economic question remains: what is the appropriate
price of carbon? This question is addressed by integrated
assessment models.
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Integrated Assessment (IA) Models
What are IA models?
- These are models that include the full range of cause
and effect in climate change (“end to end” modeling).
Major goals of IA models:
Project trends
Assess costs and benefits of climate policies
Assess uncertainties and research priorities
Estimate the carbon price and efficient emissions reductions
for different goals
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Fossil fuel use
generates CO2
emissions
The emissionsclimate-impactspolicy nexus:
The DICE-2007
model
Carbon cycle:
redistributes around
atmosphere, oceans, etc.
Climate system: change
in radiative warming, precip,
ocean currents, sea level rise,…
Impacts on ecosystems,
agriculture, diseases,
skiing, golfing, …
Measures to control
emissions (limits, taxes,
subsidies, …)
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Policy Scenarios for Analysis
1. Baseline. No emissions controls.
2. Optimal policy. 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
4. Strengthened Kyoto Protocol. Modeled on US proposal
with rich countries at same time and developing
countries join after 1 -3 decades.
5. “Ambitious”: Gore/Stern early emissions reductions
9
Temperature profiles: DICE 2008
Temperature increase from 1900 (deg C)
6.0
5.0
4.0
Base 2007
Strong Kyoto
Optimum
2 degree C limit
Base 2008
3.0
2.0
1.0
0.0
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Concentrations profiles: DICE 2008
1300
Carbon concentrations (ppm)
1200
1100
1000
Optimal
Baseline
< 2 deg C
Strong Kyoto
900
800
700
600
500
Double of
Pre-industrial
level
400
300
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Carbon prices for major scenarios
1000
Carbon price (2005 US$ per ton C)
900
800
700
Optimal
Baseline
< 2 degrees C
Strong Kyoto
600
500
400
300
200
100
0
2005 2015 2025 2035 2045 2055 2065 2075 2085 2095 2105
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What do carbon prices mean in practice?
Carbon tax,
2010
Kyoto: global average
"Optimal"
Climate constrained
Gore/Stern
Increase, price of energy, US
[$/tC]
Gasoline
All energy
expenditures
$2
35
50
200
0.2%
3.3%
4.8%
19.0%
0.3%
5.4%
7.7%
30.7%
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Limitations of DICE Model
•
•
•
•
Version discussed today is global aggregate
(however, regional model has been developed and is
being updated).
Major uncertainties about many modules
(particularly future technological change and
impacts)
Many modules are “reduced form” rather than
structural
Enduring controversy and confusion about
“discounting”
14
Major issues for a revised international regime
1. What are the likely impacts of climate change?
2. The economics of participation
3. Cap and trade v. carbon taxes?
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1. The Question of Climate Impacts
Estimating the impact of climate change on society
is the most treacherous of all areas.
First approximation of climate damages:
- Relatively minor impacts on market economies of
“North” for a century (+ 1 percent of output)
- Likely to have very large impacts on unmanaged
ecosystems a century out and more
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The Economics of Hurricanes
Source: NOAA, Hurricane Katrina shortly before landfall
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Global
intensity
P. J. Webster, G. J. Holland, J. A. Curry, H.-R. Chang, “Changes in Tropical Cyclone Number,
Duration, and Intensity in a Warming Environment,” Science, Sept. 2005
18
Normalized costs of hurricanes, 1950-2008:08
.9
.8
Hurricane cost
(% of GDP/year)
.7
.6
.5
.4
.3
.2
.1
.0
1950
1960
1970
1980
1990
2000
2010
Year
Source: author’s estimates.
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Damage and power for individual hurricanes, 1950-2005
4
ln (damage/GDP)
0
-4
-8
-12
-16
3.6
4.0
4.4
4.8
ln (maximum wind)
5.2
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Econometrics of hurricane damages (updated to 2008)
“[The] amount of damage increases roughly as the cube of the maximum
wind speed in storms…” (Kerry Emanuel, Nature, 2005)
“While this may appear to be a relatively insignificant increase, nonlinear
effects can make even a small increase important in causing damage,
because damage is proportional to the cube of the wind speed.”
(Anthes et al, BATIS, 2006)
MAJOR SURPRISE: Super-high elasticity.
(1)
ln(cost/GDP)    8.09 ln (maxwind)  0.023 year
(0.66)
(0.0071)
R 2  0.503; N  154; standard errors of coefficients in parentheses
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Estimated mean damages from global warming, central
case and alternative estimates
(1)
Case
Elasticity of
damages
w.r.t.
windspeed
(2)
(3)
(4)
SemiChange in Estimated
elasticity of tropical sea- increase in
maximum
surface
mean
wind speed temperature damages
w.r.t. T
(SST , oC) (% increase)
Central case
8.0
0.035
2.5
96%
OLS elasticity
Emanuel semi-elasticity
Conventional damage impact
SST warming since 1950
Higher storm elasticities
7.2
8.5
3.0
8.0
8.5
0.035
0.055
0.035
0.035
0.125
2.5
2.5
2.5
0.4
2.5
83%
199%
29%
12%
2018%
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2. The economics of participation
One of the important issues in a climate policy regime is the
extent of participation :
- “Free riding” reduces the effectiveness of a policy
- Free riding makes other countries angry and gives them an
excuse not to participate.
The excess costs of participation can be estimated as:
(2)
E() ≈ 1-
where  is the participation rate and  the convexity of the cost
function.
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Normalized cost as function of participation rate
Cost (as fraction of 100% participation)
10
9
8
7
6
5
4
3
Top down studies
2
Bottom up studies
1
0
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
Participation rate
Source: IPCC, Fourth Assessment Report, Summary of Mitigation Cost
Models.
Attrition of Kyoto Protocol: share of global emissions
25
Penalty of non-participation in Kyoto Protocol
Cost (as fraction of 100% participation)
10
9
8
7
6
5
4
3
2
1
0
Original design
Source: Question of Balance
Current participation
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3. Major Policy Approaches for Global Warming
• 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) are difficult to
calculate and verify and probably a useless diversion.
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Harmonized Carbon Taxes
What are “harmonized carbon taxes”?
• Raise fossil fuel prices proportional to carbon content
• All countries would target a comparable tax
• Level of tax set to meet environmental target
• Use consumption basis for tax
Many advantages over cap and trade (see slide below)
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Cap and trade v. carbon taxes
1.
The fundamental defect of most quantity regimes is the LACK OF
CONNECTION between targets (emissions) and objective (climate or
damages).
2.
QUANTITY LIMITS TROUBLESOME in a world of differential
economic growth and uncertain technological change.
3.
Because of structure of uncertainty for stock pollutant, emissions taxes
are MORE EFFICIENT than quantitative standards or auctionable
quotas. (Weitzman)
4. Quantity-type regulations show EXTREMELY VOLATILE PRICES for
the trading prices of carbon emissions (see slide).
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Price volatility of emissions permits
12.0
Price (May 1994=1)
8.0
Price oil
Price SO2 allowances
S&P 500
4.0
2.8
2.0
1.6
1.2
0.8
0.4
94 95 96 97 98 99 00 01 02 03 04 05
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Cap and trade v. carbon taxes
5. Tax-type mechanisms or auctions have advantage because they raise
revenues and have potential for REDUCING DEAD-WEIGHT LOSS OF
TAXATION.
6. Quantity-type systems with international trading are much more
SUSCEPTIBLE TO CORRUPTION than price-type regimes.
7. The international cap and trade is a RADICAL AND UNPROVEN
APPROACH, whereas taxes have been used in every country of the
world.
All these emphasize the difficulty of reaching an effective and efficient
mechanism for global public goods.
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Final thoughts
ankind in spite of itself is
nducting a great geophysical
periment, unprecedented in
man history.”
Roger Ravelle (1957)
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