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Economic Perspectives on Climate Change William D. Nordhaus Yale University Lecture for the Yale Climate Institute January 15, 2010 Slides are available nordhaus.econ.yale.edu . 1 Outline of lecture 1. Some historical background 2. What are economic integrated assessment models (IAM)? 3. What are some insights from IAM? 4. What are the issues in implementing international climate agreements? 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 CO2 emissions US (millions tC/yr) 2,000 1,600 1,200 800 400 1930 1940 1950 1960 1970 1980 1990 2000 2010 4 Trend in CO2 emissions relative to GDP, US .6 .5 .4 .3 .2 CO2-GDP ratio Trend (-1.7 percent per year) .1 1930 1940 1950 1960 1970 1980 1990 2000 2010 5 Instrumental record: global mean temperature index (°C) Temperature anomaly (1895-1905 = 0) 1.0 0.8 GISS Hadley US NCDC 0.6 0.4 0.2 0.0 -0.2 -0.4 1850 1875 1900 1925 1950 1975 2000 6 IPCC AR4 Model Results: History and Projections 7 Projections and the paleoclimatic record Temperature record and projections to 2200, Vostok core, Antarctica Temperature (2000 = 0) 8 4 0 -4 -8 -12 -400,000 -300,000 -200,000 -100,000 0 Years before present 8 The Contribution of Economics: 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 in consistent manner Assess costs and benefits of climate policies Estimate the carbon price and efficient emissions reductions for different goals 9 Fossil fuel use generates CO2 emissions The emissionsclimate-impactspolicy nexus: The RICE-2009 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, …) 10 Now focus for a moment on the details of: Fossil fuel use generates CO2 emissions Some detail on how output and emissions are generated Twelve regions (j = US, China, India, EU, Africa, ...) j t 1. Population exogenous : ΔL = L j j G t-1 t j 2. Total factor productivity exogenous : ΔA t = A j 3. Production is Cobb - Douglas in A, L, K : Yt j j Ht t-1 j j = A t K t α j L t 1-α 4. CO emissions are function of output, intensity, and carbon price (p) 2 j E t = j j j σ Y p t t t λ 5. Carbon price is determined by Hotelling rents and carbon - pricing policy 6. National investment rate is endogenous and optimized per the Ramsey model, over per capita consumption (c), and countries are combined using the "Negishi algorithm." 12 ∞ j j j max W = φ t U(c t ,L t )R(t) j c j=1 t=1 t 7. Current version is solved on Excel - Solver, with approximately 155 lines per country. The Impacts of Climate Change The Copenhagen Accord, which recognized “the scientific view that the increase in global temperature should be below 2 degrees Celsius.” Is this firmly based in “scientific” estimates of the impacts of climate change? Facts on the ground: – Estimating impacts has been the most difficult part of all climate science: house-to-house combat for analysts. – Very scant empirical support for the 2 degree target 13 What will be the impacts by sector? Impact of Industy Adaptation policies Climate-change impacts Energy-intensive Large near term Moderate medium term Moderate long term "Natureintensive" Small Moderate medium term Large long term Other Small Small Small Climate policies 14 Aggregate damage estimates from different studies Damages as percent of output 6 5 4 3 2 1 0 -1 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 -2 -3 Global mean temperature increase (°C) Source: Richard Tol, Jour. Econ. Persp., 2009 15 Policy Scenarios for Analysis 1. Baseline. No emissions controls. 2. Economic cost-benefit “optimum.” 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. Copenhagen, all countries. Uses US emissions targets joined by other rich countries, with developing countries entering after 1 -3 decades. 5. Copenhagen, rich only. Uses US emissions reductions joined by other rich countries, with developing countries staying out. 16 Rate of growth of CO2-GDP ratio: history and Congressional proposals Growth (percent per year) 0 -1 Congressional proposals -2 -3 -4 -5 -6 -7 50 60 70 80 90 00 10 20 30 40 50 Baseline projections: IPCC Scenarios and RICE-2009 RICE-2009 Model with no policy measures 18 Temperature profiles: RICE -2009 6.0 Temperature Global mean temperature (degrees C) Optimal Baseline 5.0 Lim T<2 Copen trade Copen rich 4.0 3.0 2.0 1.0 0.0 2005 2025 2045 2065 2085 2105 2125 2145 2165 2185 2205 Available at http://www.econ.yale.edu/~nordhaus/homepage/RICEModelDiscussionasofSeptember30.htm 19 What do carbon prices mean in practice? Carbon tax, 2010 Minimal “Optimal” Climate constrained (ΔT < 2 °C) Increase, price of energy, US [$/tC] Gasoline All energy expenditures $10 35 50 1.0% 3.3% 4.8% 1.5% 5.4% 7.7% 20 Carbon prices for major scenarios 500 450 Global carbon price Optimal Carbon price (2005 $ per ton C) 400 Lim T<2 350 Copen All Trade Copen rich only 300 250 200 150 100 50 0 2005 2025 2045 2065 2085 2105 21 Carbon prices for major scenarios 100 Optimal Carbon price (2005 $ per ton C) 90 Lim T<2 80 Copen all 70 Actual equivalent global carbon price = $4 / tC Copen rich only 60 50 40 30 20 10 0 2005 2015 2025 2035 22 Carbon price (2 40 Carbon prices for major scenarios 30 20 Actual equivalent global carbon price = $4/tC 10 0 2005 201 23 Net benefit through 2050 (billions) -50 Russia Japan EU Africa Middle East India China Other OHI Latin America -150 Eurasia -100 US Net impacts by region to 2050 of Copenhagen proposal 100 50 0 -200 -250 -300 -350 24 Final Question: How Should Policies Be Implemented 25 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. 26 Harmonized Carbon Taxes What are “harmonized carbon taxes”? • Raise prices of GHGs proportional to carbon content • All countries would levy a comparable tax • Countries would retain all revenues (this is not an international transfer program) Hybrid plans: • Auction permits • Floor and cap on auction prices 27 Cap and trade v. Carbon taxes The problems with cap-and-trade systems for climate change, particularly in the international arena, are insufficiently appreciated. Some concerns: Quantity limits are troublesome in a world of differential economic growth and uncertain technological change because of the difficulty of resetting country limits. 28 Quantity-type regimes show extremely volatile prices 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 Source: Nordhaus, Various. 29 Financial volatility under quantityand price-type monetary regimes 20 Federal funds rate Three-month Treasury bill rate 16 12 Period of price-type monetary policy 8 4 0 Period of quantitative monetary policy 80 81 82 00 01 02 03 04 05 06 07 08 30 Volatility in EU CO2 trading system: This volatility is inherent in such a system because of priceinelasticity of supply and demand Source: Metcalf, Carbon Taxes, Hamilton Project. 31 It is important for governments to capture the revenues (either through 100% auctions or taxes): – raise revenues for distributional policies – reduce the efficiency losses from taxation. 32 Cap and trade systems are not attractive regimes for countries to join. Fraction of Global Emissions Covered by KP With US Without US Enthusiasts 100% 80% 60% 40% 20% 0% 1990 2002 33 Corruption Quantity-type systems with international trading are much more susceptible to corruption than price-type regimes. International cap-and-trade plans are a three-sided game. There are strong incentives for a corrupt domestic government to collude with corrupt polluting firms to underestimate domestic emissions and hide from international monitors. 34 The problem of offsets Offsets have been part of all plans. Clean Development Mechanism (CDM) in the Kyoto Protocol has been major source of “accounting emissions” and has very questionable additionality. For example, in EU-ETS, there have been virtually no internal emissions reductions. The Clean Development Mechanism in EU has 280 million tons of offsets compared to 130 million tons of emissions reductions for current phase. Another set of defective financial instruments like credit default swaps? 35 The Perils of the Current Regime • The international cap-and-trade program is a radical and unproven approach, whereas taxes are well understood and have been used in every country of the world. • To bet the world’s climate system and global environment on this untested approach which such clear structural flaws would appear a reckless gamble. 36 Final thoughts “Mankind in spite of itself is conducting a great geophysical experiment, unprecedented in human history.” Roger Ravelle (1957) 37