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Can we afford the future?
The economics of a warming world
Frank Ackerman
SEI-US and Tufts/GDAE
November 30, 2007
The latest evidence (IPCC, 2007)
The world is
getting hotter
Sea levels are
rising
Snow cover is
decreasing
(Northern Hemisphere,
March-April)
Temperature change (relative to 1980-99)
2020-2029
B1
A1B
A2
2090-2099
Climate policy: two excuses for inaction
• Fake science
 Temperature extremes have softened … the frequency of
hurricanes has been diminishing ... since 1940, weather
satellites, tree ring data, and corrected thermometer
readings all agree that climate has not warmed -- even
though CO2 levels rose. (Fred Singer)
• Conventional economics
 …efficient or “optimal” economic policies to slow climate
change involve modest rates of emission reduction in the
near term… The optimal rate of emissions reduction is 14
percent in 2015, 25 percent in 2050, and 43 percent in
2100.
(William Nordhaus, 2007)
 We should tax CO2 at the economically correct level of
about two dollars per ton (Bjorn Lomborg, 2007)
Many styles of denial
What will you wear to the apocalypse?
Three ideas about climate economics
1. Our descendents are important
2. Uncertainty is inescapable
3. Some costs are better than others
Discounting the future
(at 3% interest or discount rate)
years
from now
compound
interest
0
$100
1
$103
2
$106
10
$134
50
$438
100
$1,922
200
$36,936
XT = (1+r)T X0
present value
$5.20
$0.27
$100
$100
X0 = XT
/ (1+r)T
Bigger r means compound interest grows faster
– and present value shrinks faster!
Why do discount rates matter?
• A higher discount rate makes it harder to “see”
future costs
 How much should we do to prevent $1000 of damages
100 or 200 years from now?
• Present value of $1000 in 2107
 At 1.5%: $226
 At 3%:
$52
 At 6%:
$3
• Present value of $1000 in 2207
 At 1.5%:
 At 3%:
 At 6%:
$51
$3
$0.01
• Economic analysis supports active climate policy
with 1.5% discount rate – but not with 6% !
A future we’ll never know
Choosing a discount rate
• Market interest rates?
 Appropriate for short/medium-term private investments
 Need not apply to long-term public policy
• Will future generations be richer and need less help?
 If they are poorer, will they need more help?
• Pure impatience: if all generations are equally
wealthy, should we discount the future?
 Is your granddaughter less valuable than your daughter,
because she will be born a generation later?
 If both are equally valuable, the “pure impatience”
component of discounting should be zero
Three ideas about climate economics
1. Our descendents are important
2. Uncertainty is inescapable
3. Some costs are better than others
Things that won’t happen (soon)
Worst case or average?
• Economic analysis is based on average forecasts
 Sea level rise: without catastrophic loss of ice sheets, less
than 1 meter forecast for this century (IPCC 2007)
 Poses problems for low-lying areas (Bangladesh, Miami, …)
• The greatest fears about climate change are often
based on worst-case possibilities
 Complete loss of the Greenland (or West Antarctic) ice
sheet would cause 7 meters of sea level rise
 Catastrophic impacts on most coastal cities, communities
• Will the Greenland ice sheet melt?




Complete melting is unlikely in this century
But it becomes less unlikely as temperatures rise
Average: no problem this century
Worst case: increasing cause for worry
Why buy insurance?
• People care a lot about unlikely “worst cases”
 How much time do you leave to get to the airport?
 Airport security is all about worst case possibilities
• Insurance is not based on average outcomes
 Probability that you will have a residential fire next year is
much less than 1%
 Probability that healthy young parents will die next year is
much less than 1%
 But we buy fire insurance and life insurance!
• Probability of enough warming to guarantee loss of
Greenland ice sheet is much greater than 1%
 Should we buy life insurance for the planet?
“Fat tail” uncertainty
•What is the likely effect of a doubling of
CO2?
• Blue curve: normal distribution
probability
Normal
Applies when uncertainty is well
understood from extensive evidence
• Red curve: “Student’s t”
Applies when uncertainty is inferred
from limited data, as with climate change
• “Fat tail” uncertainty
Student’s t
Extreme values are much more likely
with red curve than with blue
• New economic theory (Martin
Weitzman, Harvard):
“Fat tail” uncertainty dominates climate
analysis
 Average effect (peak of curve) is less
important
Expected temperature change
(or climate sensitivity parameter)
Three ideas about climate economics
1. Our descendents are important
2. Uncertainty is inescapable
3. Some costs are better than others
Two meanings of “costs”
• Economic models of climate change are based on
cost-benefit analysis
 Benefits must exceed costs in order to endorse a policy
• Numerous problems with methodology
 Benefits not meaningfully measured in dollars (value of a
human life, extinction of a species, etc.)
• See Ackerman and Heinzerling, Priceless
• One more problem: what do we mean by “costs”?
 Pure physical losses (storm damages)
 Investment in different industries than we had planned on
Which costs are larger?
• Hurricane Katrina: $135 billion property damage
(more than half uninsured)
• Cost of prevention
 Dutch seawalls are twice as high as New Orleans levees
 Cost is a small fraction (10% ?) of the Katrina damages
• Difference in kinds of costs
 Building higher levees creates jobs
 Letting storms destroy property does not
• Renewable energy, efficiency, conservation will
create new industries, technologies, jobs
 Not the same industries we would otherwise have chosen to
create
 Is this a “cost”?
Costs
exceed
benefits
Benefits
exceed
costs
Conclusion: a new climate economics
• The future matters
 Your granddaughter’s life is an important one
 The discount rate should be low (1.5% or less)
 Future benefits are worth spending money on today
• Uncertainty is decisive
 Climate policy is insurance against low-probability (but not
impossible) catastrophic events
 Certainty will not be achieved until it is too late
• Some costs are well worth paying
 We are “forced” to invent new industries, technologies, and
job opportunities in energy efficiency, renewable energy,
and related technologies
• Get it right, and your grandchildren will thank you for
leaving them a liveable world
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