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The Economics of Steering the Transition to a Low Carbon Economy Monday 20th October: Understanding Climate Risk A framework for the economics of low-carbon 10.30 – 11.30 Session 1: change 11.30 – 12.00 12.00 – 13.00 Session 2: 13.00 – 15.00 Lunch 15.00 – 16.00 Session 3: 16.30 – 17.00 Break Exploring the Apparent Trade-Offs Between Reducing Climate Risk and Fostering Growth The Dynamic Net Economic Costs of Transition Session 4: Wrap-up and Open Discussion Copyright © LSE 2014 A framework for the economics of low-carbon change Dimitri Zenghelis Monday 20th October Session One Copyright © LSE 2014 A framework for the economics of low-carbon change Part I: Understanding climate risk Part II: Working with Uncertainty Part III: Endogenous growth Copyright © LSE 2014 Part I: Understanding climate risk • The next 15 years of investment will also determine the future of the world’s climate system • Climate change caused by past greenhouse gas emissions is already having serious economic consequences, especially in more exposed areas of the world • Without stronger action in the next 10-15 years, which leads global emissions to peak and then fall, it is near certain that global average warming will exceed 2°C, the level the international community has agreed not to cross • On current trends, warming could exceed 4°C by the end of the century, with extreme and potentially irreversible impacts Copyright © LSE 2014 Part I: Understanding climate risk • Stocks not flows of greenhouse gases affect climate • The Intergovernmental Panel on Climate Change (IPCC)’s review of recent emission projections suggests that if current trends continue, global emissions in 2030 will be around 68 Gt CO2e, compared with around 50 Gt CO2e today • To have a likely (more than two-thirds) chance of holding the average global temperature rise to 2°C, the IPCC suggests that by 2030, global emissions should be no more than 42 Gt CO2e per year • Would need to fall thereafter to near 25 Gt CO2e by 2050 and below 10 CO2e by end-century (stabilise) Need to understand uncertainty – how would a business react? Estimates based on analysis of the IPCC’s review of emission scenarios, as shown in Figure SPM.4 and Table SPM.1 in IPCC, 2014. Summary for Policymakers (IPCC AR5, Working Group III). Copyright © LSE 2014 Part I: Global temperature change (relative to pre-industrial) 1°C 2°C 3°C 4°C 0°C Food Water Understanding climate risk 5°C Falling crop yields in many areas, particularly developing regions Falling yields in many Possible rising yields in developed regions some high latitude regions Small mountain glaciers disappear – water supplies threatened in several areas Significant decreases in water availability in many areas, including Mediterranean and Southern Africa Sea level rise threatens major cities Ecosystems Extensive Damage to Coral Reefs Rising number of species face extinction Extreme Weather EventsRising intensity of storms, forest fires, droughts, flooding and heat waves Risk of Abrupt and Major Irreversible Changes Increasing risk of dangerous feedbacks and abrupt, large-scale shifts in the climate system Copyright © LSE 2014 Total Emissions (CO2 Equivalent) 160.0 140.0 120.0 100.0 80.0 Cascade of Uncertainty Population, technology, production, consumption IS92a A1T A1FI B2 B1 A2 A1B Emissions 60.0 40.0 Atmospheric concentrations 20.0 0.0 1990 2010 2030 2050 2070 Cumulative CO2 Emissions Part II: 2090 Radiative forcing Temperature rise and global climate change Temperature Increase % Change in Cerea Production 0 -2 0 1 2 3 4 -4 Direct impacts (e.g. crops, forests, ecosystems) -6 -8 -10 -12 Without Carbon Fertilisation With Carbon Fertilisation Socio-economic impacts Copyright © LSE 2014 Probability % Change in Global Cereal Production ‘Non - Market’ Market Projection Limit of coverage of some studies, including Mendelsohn Socially contingent None Some studies, e.g. Tol Bounded risks None System change/ surprise Limited to Nordhaus and Boyer/Hope Stern None Models only have partial coverage of impacts Values in the literature are a sub-total of impacts Source: Watkiss, Downing et al. (2005) Copyright © LSE 2014 Part III: • • • • • • • Endogenous growth (i) Thomas Malthus posited that finite resources would constrain humans’ ability to supply rising demand But every mouth is born with a brain and knowledge and innovation weightless; helped us do more with resources we have Recent endogenous-growth theory has focused on the factors that drive technology in an attempt to understand its role in economic growth Knowledge has the potential to positively impact capital productivity The concept of “knowledge capital” ~ similar to physical capital, but is dependent on a number of factors such as cumulative R&D expenditures and physical and human capital investment Even in a materially stationary state, indefinite growth in well-being is possible because of progress in the intellectual economy Not new: Adam Smith argued that the division of labour is limited by the extent of the market (Smith, 1776), and economic growth enlarges markets and permits greater specialisation and variety; increasing returns to scale stimulate economic growth (Young, 1928) Copyright © LSE 2014 Part III: • • • • • Endogenous growth (ii) New equipment enables new ideas and innovation in technologies. E.g. investing in computers induces bright ideas on how to use them. Investment in physical and knowledge capital drives increasing returns to scale in production, where more knowledge begets increased output and liberates resources for further investment (Romer 1990/1994 Solow 1999*) A virtuous growth spiral in which future output becomes “pathdependent.” It’s what Malthus (and many others) missed This lecture examines the impact of endogenous growth on assessing the transition to a low carbon economy *Romer P.M. (1990), “Endogenous Technical Change,”Journal of Political Economy, 98:S71-S102. Romer P.M. (1994), “The Origins of Endogenous Growth,” Journal of Economic Perspectives, 8:3-22. Solow, R.M. (1999), “Neoclassical Growth Theory,” Taylor J.B. and Woodard M., eds., “Handbook of Macroeconomics,” vol. 1A (North-Holland, Amsterdam). Copyright © LSE 2014 Part III: Endogenous Growth and Climate Dietz and Stern (2014) use Nordhaus‘ static 'DICE' models. Take more strongly into account three essential elements of the climate problem • the endogeneity of growth, relaxed underlying drivers of economic growth are exogenous and unaffected by climate change • the convexity of damages, • and climate risk To facilitate comparison with Nordhaus' work, all of the analysis is conducted with a high pure-time discount rate Main innovation: the damages from climate change affect the drivers of long-run growth, not just current output. Cant just add/subtracts levels impacts off a pre-determined trend*. They find business-as-usual trajectories of greenhouse gas emissions give rise to potentially large impacts on growth and prosperity in the future, especially after 2100. *See also Daniel et al, ‘Applying Asset Pricing Theory to Calibrate the Price of Climate Risk: A Declining Optimal Price for Carbon Emissions’ American Economic Association Meetings, January 2015. Copyright © LSE 2014 Key reading Ackerman, F. and Daniel, J., 2014. (Mis)understanding Climate Policy: The role of economic modelling. Synapse Energy Economics, Cambridge MA. Prepared for Friends of the Earth and WWF-UK. Available at: https://www.foe.co.uk/sites/default/files/downloads/synapsemisunderstanding-climate-policy-low-res-46332.pdf. Aghion, P.; Howitt, P.; (2009) The economics of growth. Massachusetts Institute of Technology (MIT) Press: Cambridge, US. http://discovery.ucl.ac.uk/17829/ Aghion, P., Hepburn, C., Teytelboym, A., and Zenghelis, D., (2014). Path-dependency, innovation and the economics of climate change. Simon Dietz & Nicholas Stern, (2014). Endogenous growth, convexity of damages and climate risk: how Nordhaus’ framework supports deep cuts in carbon emissions, GRI Working Papers 180, Grantham Research Institute on Climate Change and the Environment. http://www.lse.ac.uk/GranthamInstitute/wp-content/uploads/2014/06/WorkingPaper-159-Dietz-and-Stern-2014.pdf Global Commission on the Economy and Climate, 2014. Better Growth, Better Climate: The New Climate Economy Report, Chapter 5, Available at http://newclimateeconomy.report Mazzucato, M. (2011), The Entrepreneurial State, London: Demos. Stern, N (2007): The economics of climate change, Cambridge University Press, Cambridge Copyright © LSE 2014