Download The Economics of Climate Change

The Economics of
Climate Change
Thomas C. Kinnaman, Ph. D.
Department of Economics
Bucknell University
The Economics Perspective
“… it will do us little good to solve our
common global economic problems if we
do not do something about the most
pressing common environmental problem:
global warming.”
– Joseph E. Stiglitz, 2001 Nobel Memorial Prize
in Economics
The Economics Perspective
“we are much better off to act to reduce CO2
emissions substantially than to suffer and
risk the consequences of failing to meet
this challenge.”
– Kenneth J. Arrow, 1972 Nobel Memorial Prize
in Economics
The Economics Perspective
“The basics of global warming are not in
scientific dispute …the theory is not in
doubt. … We need, urgently, to better
understand what alternatives to fossil fuels
there will be.”
– Thomas C. Schelling, 2005 Nobel Memorial
Prize in Economics
The Economics Perspective
“In light of the near-consensus on the need
to slow global warming, the question is not
whether the United States will join other
industrial countries in working to contain
greenhouse gas emissions, but how and
when.”
– The Milkin Institute (a nonpartisan economic
policy think tank)
Benefits and Costs
• The UK issued a major government report
directed by economist Nicholas Stern
• Costs and benefits of reducing CO2 are
estimated
• Stern Report criticized for lack of discount
rates (a considerable tradition among
British economists and many
philosophers)
Benefits and Costs
• Economic benefits of reducing CO2
suggest growth of rate of GDP between
now and 2200 will be 1.3% rather than
1.2%.
• By 2200 GNP will be 20% higher (3%-34%
confidence interval) if CO2 is reduced
Benefits and Costs
• Costs: Stern estimate economic costs of
3.4% to -3.9% of GNP (as energy savings
reduces energy costs)
• Using a conservative mid-point estimate of
1% of GNP forever, benefits of reducing
CO2 exceed costs for all discount rates
less than 8.5% (Arrow, 2007).
Specific Policy Options
1. Technology-Push Subsidies
2. Direct Regulations (Tech-Based
Standards)
3. Cap and Trade Scheme
4. Carbon Tax on all Fossil Fuels
More than one approach is likely necessary
1. Technology Pushing
• Subsidize R&D in carbon-reducing energy
sources
• Justified by external benefits of such
energy sources
• Can work within other policy environments
2. Direct Regulation
• Examples include Clean Air Act and Clean
Water Act in the US
• Government determines best methods to
reduce CO2, requires use of those
methods, and punishes non-compliers.
• Very costly
• Only policy option in situations where
emissions or inputs cannot be measured
3. Cap and Trade
Examples include
• Phase out of leaded gasoline in 1980’s
saved $250 million per year over
traditional regulatory approach
• Reduction SO2 emissions in 1990’s saved
$1 billion, or 45-55% of cost of traditional
regulations (Carlson et al., 2000, Ellerman,
2003)
3. Cap and Trade Scheme
Role for Government
1. Determine the desired reduction in CO2
emissions (30%, 60%?)
2. Identify all major sources of CO2 (power
plants, heavy industries, autos, etc.)
3. Issue each source a permit for each unit
of allowed CO2 emissions
4. Monitor CO2 emissions from each
identified source
3. Cap and Trade Scheme
Role for CO2 Emitters
1. Generate allowable quantity of CO2
2. Generate more CO2 than allowed – must
purchase permits (to avoid fines)
3. Generate less CO2 than allowed – sell
permits
3. Cap and Trade
Expected Savings:
• Reduce compliance costs by 50% across
the economy if implemented only in
industrialized countries
• Reduce costs by 75% if also implemented
in developing countries (Edmonds, et al.)
3. Cap and Trade
Other Advantages
• Unregulated low-cost CO2 abaters will
voluntarily join program to sell permits
• Unregulated high-cost abaters will not join
– this is OK too.
• Anyone can purchase permits
Prices for CO2 Allowances
ECX CER Futures Contracts: Price and Volume
Total Volume
Dec08 Sett
2,500,000
€ 16.80
2,000,000
€ 16.40
€ 16.20
1,500,000
€ 16.00
€ 15.80
€ 15.60
1,000,000
€ 15.40
€ 15.20
500,000
€ 15.00
€ 14.80
0
8 8
8 8
8 8 8
8 8
8 8
8 8
8 8
8 8
8 8 8
8 8
8
00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00 /2 00
2
/
/03 /03 /03 /03 /03 /03 /03 /03 /03 /03 /04 /04 /04 /04 /04 /04 /04 /04 /04 /04 /04 /04 /04
14 17 18 19 20 25 26 27 28 31 01 02 03 04 07 08 09 10 11 14 15 16 17
€ 14.60
Price per tonne
VOLUME (tonnes CO2)
€ 16.60
4. Carbon Tax
All fossil fuels would be taxed to reflect the
carbon content of the fuel
– Those sources that can abate substantial CO2
levels pay less taxes – encourages
abatement
– Easy to administer as the bulk of fossil fuels
are sold on international commodities
markets.
– Same level of economic savings
Cap and Trade or Carbon Tax?
Economists have not reached a consensus
• Advantages to Cap and Trade
– Quantities are determined by regulators
– Less of a financial burden on sources (if
permits are given away)
– Disadvantages:
– Initial distribution will be difficult
– Prices of permits may fluctuate
Cap and Trade or Carbon Tax
• Advantages of Carbon Tax
– Revenues are earned
• Used to reduce income taxes
• Used to finance R&D in clean energy technologies
CO2 Emission Reduction Paths
• Begin at business-as-usual level and depart
gradually (targets will rise at first).
– avoid rendering large parts of the capital stock,
constructed in era of free carbon emissions,
prematurely obsolete
• Depart widely from business-as-usual path
• Politically pragmatic
• Will alters future investment decisions
• Will spur technological change
• Kyoto protocol would require USA to reduce 2530% of emissions at once, Canada 35%.
Policy Dilemma
1. Issue a unique CO2 reduction path to
each country and allow that country to
choose how to follow its own path (Kyoto
Protocol).
2. Create a global CO2 reduction path and
follow the global path at lowest cost
Country Specific Path
Examples:
• Each country must reduce CO2 by X%
• Each country must reduce CO2 to year X levels
(Kyoto)
Problems:
• Cost of CO2 abatement vary across countries
• Penalizes those countries with economies that
are not CO2 intensive
Global Path
• Much less costly
• Requires extraordinary international
organization and cooperation
• Can be achieved by either a carbon cap
and trade program or a carbon tax
Developing Countries
• Many argue industrial countries should take first
step to combat climate change
– responsible for the bulk of the problem
• But,
– Developing countries currently provide the greatest
opportunity for low-cost emission reductions.
– Production of carbon-intensive goods could “leak”
outside coalition of participating countries
• Could promote carbon-intensive growth paths in developing
countries
Developing Countries
Future economic aid could be reconfigured
to take the form of large scale financing of
the purchases of cleaner technologies
– Could be justified by facts such as rich
countries have caused the problem and poor
countries are most vulnerable to
consequences of climate change
International Compliance
Allowing open market CO2 emission levels
can be considered government subsidy to
carbon intensive industries
– Existing trade laws discourage such
subsidies, and most nations have successfully
eliminated subsidies on all forms of
production except agriculture
– Otherwise, costly trade sanctions must be
imposed
Political Successes
The “Emergency Economic Stabilization Act of 2008”
included fiscal stimulus for alternative energy
• Tax advantages to wind, refined coal, biomass, marine
renewables (wave and tide), solar fuel cell, and
geothermal
• Tax credits for carbon abatement projects of 65% or
more
• Tax rebate on plug-in electric cars ($2,500-$7,500)
• Firms can provide tax-free fringe benefit of bicycle
storage
Summary
• Economists take the threat to the climate
seriously
• Initial benefit-cost analyses justify CO2
reductions paths
• A policy framework can be developed