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Climate-change policy: the challenge
to economics
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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
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Nothing--rely on adaptation
Do something, but how and what?
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GHG abatement
Technology research
Sequestration: natural and technological (CCS)
Cap and trade
GHG (carbon) taxes
Preparation for catastrophic events
Do something, but how much?
Most favor doing something
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Benefit Cost Analysis is VERY difficult
Stern Review
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British study
Used very low discount rate—puts heavier weight
on potential future
“Mainline” economists
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More gradual policy “ramp”
Argument: early resources better spent on
technology and human capital
Some difficulties with BCA/CBA
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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.
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Recent news about the West Antarctic ice sheet
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Possible sea level rise 5-10 feet
Let’s consider some issues with r
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Many philosophers and ethicists argue for r =
0, or at least very low
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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
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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.
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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?
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Would it make sense to ask the current
generation to go 10,000 – 1777 = 8223….
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….to prevent folks 200 years and beyond
from going 130,000 – 130 = 129,870?
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This is a simple thought experiment, but it
alerts us to the implications of low r
Big uncertainty #1
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What discount rate to use
Ramsey formula for intergenerational
discounting
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DDR gains favor—Martin Weitzman
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?
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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
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Works well when we have a good idea of
PDFs and probabilities
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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
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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)
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150 nations
Task was to create a legally-binding
international agreement on climate change.
Targets and timetables
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Reduce ghgs in aggregate by 5.2% from a 1990
baseline for the 2008-12 time period.
Targets are differentiated by nation (U.S. is 7%).
Kyoto Protocol (1997)
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Allowable policies
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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)
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127 countries have ratified agreement.
Participating countries account for 62% of
GHG emissions.
Russia was last country to ratify.
U.S. Developments
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Signed Kyoto Protocol in 1997.
Byrd-Hagel Resolution in U.S. Senate (1997)
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U.S. pulled out of Kyoto in spring 2001.
Regional Greenhouse Gas Initiative (RGGI underway in
2009)
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The U.S. should accept no climate agreement that did not
demand comparable sacrifices of all participants.
Passed 95 to 0.
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
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Issues underlying costs of controlling GHGs:
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How quickly can society change its energy
systems?
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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
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A broad set of countries should make small
cuts today and progressively deeper cuts in
the future.
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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
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Critique of Kyoto Protocol: a “deep then
broad” strategy.
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Only developed countries make deep cuts today.
No provisions for bringing in developing countries.
Support for Kyoto Protocol:
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Developed countries are most responsible for
current levels of GHGs.
An agreement is better than no agreement.