Economic analysis of climate change

The economics of global warming relates to the size and distribution of the economic costs and benefits of global warming and of a variety of actions aimed at the mitigation of global warming. Estimates come from a variety of sources, including integrated assessment models, which seek to combine socio-economic and biophysical assessments of climate change.

In 1997, in the runup to the finalization of the Kyoto Protocol, a group of over 2500 economists (including eight Nobel Laureates) endorsed a statement saying that "...there are many potential policies to reduce greenhouse-gas emissions for which the total benefits outweigh the total costs". [1]

Mitigation

The estimated costs of mitigating global warming (i.e. reducing it - it cannot be prevented) depend on a number of factors. One fundamental factor is the target level of atmospheric carbon dioxide: the lower the level, the sooner action must be taken. The sooner action must be taken, the shorter the period over which costs must be spread, and the higher the absolute costs, as cheaper technologies which could be used are not yet available. A common target level (eg assumed by the United Kingdom) is 550ppm (current levels are around 380ppm, and rising at 2-3pppm per year).

Another crucial factor in estimating the costs of climate change is the discount rate to apply. Normally a relatively high rate (eg 8%) is applied, reflecting the cost of capital. However, where intergenerational issues involve potential irreversibilities such as climate change, a low discount rate (eg 4%, a typical rate for social issues) may be applied. The difference is dramatic: at 4%, avoiding $1m worth of climate change damage in 100 years' time is valued at nearly $20,000 today (net present value), whereas at 8% it is valued at less than $500.

Another area for debate is the relationship between technological development and regulatory incentives: if regulation can induce substantial technological change, the costs of mitigation may be much lower.

Cost estimates

IPCC TAR (Synthesis Report) suggested values of $78bn to $1141bn annual mitigation costs, amounting to 0.2% to 3.5% of current world GDP (which is around $35 trillion), or 0.3% to 4.5% of GDP if borne by the richest nations alone. As economic growth is expected to continue, the percentage would fall. In terms of cost per tonne of carbon emission avoided, the range (for a target of 550ppm) is $18 to $80. (House of Lords 2005)

Azar and Schneider (2002) conclude that the cost of "climate insurance" amounts to only a short delay in achieving the very impressive growth in per capita income levels expected over the next century: "If the cost by the year 2100 is as high as 6% of global GDP and income growth is 2% per year, then the delay time is 3 years." Applying the same logic to the Kyoto Protocol, Azar and Schneider conclude that on pessimistic assumptions on cost (1% of Annex 1 countries' GDP) and 2% average economic growth, the Protocol "would imply that we would get 20% richer by June 2010 rather than in January 2010."

A $100 per tonne carbon tax would raise the cost of electricity from natural gas and coal by roughly $0.01 and $0.02 per kWh, respectively, and the cost of gasoline by roughly $0.07 per litre (Azar and Schneider 2002).

Benefits

In addition to avoiding the costs of the business-as-usual scenario, mitigation actions can bring other benefits, depending on factors such as the technology used. These include, for example, the reduced economic impact from oil supply disruptions and/or price rises, if mitigation reduces oil dependence. This may be of particular benefit to non-oil-exporting developing countries, which suffer greater economic impact from oil price rises.[2]

Costs of business-as-usual

• climate surprise
• equity
• natural capital

• higher need for peak-capacity electricity generation (air-con, heating, etc)

Non-economic costs

Tricky question of environment's intrinsic value

Optimal strategies for mitigation

Financial and technological strategies can have a major impact on reaching a particular target atmospheric CO2 concentration.

• Carbon tax
• emissions cap-and-trade
• hybrid systems of permits and user fees (e.g. the Brookings McKibbin-Wilcoxen Blueprint[3])
• regulation
• nuclear power

"no regrets" policies - notably reducing fossil fuel subsidies, which is predicted to increase growth whilst reducing CO2 emissions. Article 2 of the Kyoto Protocol specifies a progressive removal of subsidies and reform of taxes as a means of achieving reduction commitments. [4]

McKibbin and Wilcoxen (2002) argue that a combination of long term carbon price signals and short terms caps on economic cost is needed to address both economic efficiency, equity sharing and political feasability.

Distribution

The costs and benefits of global warming are distributed quite unequally.

• low-lying countries' risk of floods
• many countries subject to increased drought are poor African countries
• ability of poor countries to mitigate / adapt (margin)
• GW increases variability of weather, which implies greater capital requirements for water storage systems, flood defenses, etc as well as individual requirements to cope with wider variation in weather patterns

The costs of mitigation may also be distributed unequally, both within and between countries. [5] Wier et al (2005) showed that carbon taxes, particularly direct taxes on households, are regressive (more so than VAT), suggesting that in order to maintain social acceptance the regressive effect needs to be compensated for either within the environmental tax structure, or in other parts of the tax system. Indirect taxes (on business) are less regressive, and petrol taxes are found to be progressive.

Inter-relationships

Between gases

Brinka et al (2005) showed that the costs of mitigation can be reduced by considering the inter-relationships of different greenhouse gas, and the differential impact that different technological decisions may have on their emissions.

Between countries

Bastianoni et al (2004) note the differences between methodologies for assigning responsibility for greenhouse gas emissions, which include the geographical approach, based on the IPCC guidelines for GHG inventory; the consumer responsibility approach, based on the Ecological Footprint methodology; and the Carbon Emission Added (CEA) approach, which resembles the accounting of a Value Added Tax. Different methodologies can produce quite different results in terms of responsibility for emissions, with consequent impact on policy.

Gradual change vs climate surprises

Baranzini et al (2003) conclude that "(i) gradual, continuous uncertainty in the global warming process is likely to delay the adoption of abatement policies as found in previous studies, with respect to the standard CBA; however (ii) the possibility of climate catastrophes accelerates the implementation of these policies as their net discounted benefits increase significantly."

References

• Australian Greenhouse Office (2004), "Economic Issues Relevant to Costing Climate Change Impacts"
• Christian Azar and Stephen H. Schneider (2002) "Are the economic costs of stabilising the atmosphere prohibitive?", Ecological Economics 42 (1-2)
• Andrea Baranzini, Marc Chesney and Jacques Morisset (2003), "The impact of possible climate catastrophes on global warming policy", Energy Policy 31(8)
• Simone Bastianoni, Federico Maria Pulselli and Enzo Tiezzi (2004), "The problem of assigning responsibility for greenhouse gas emissions", Ecological Economics 49(3)
• P. Buonanno, C. Carraro and M. Galeotti (2003), "Endogenous induced technical change and the costs of Kyoto", Resour. Energy Econ. 25 (2003), pp. 11–34.
• Corjan Brinka, Ekko van Ierland, Leen Hordijk and Carolien Kroeze (2005), "Cost_effective emission abatement in agriculture in the presence of interrelations: cases for the Netherlands and Europe", Ecological Economics 53(1)
• Congressional Budget Office (2005), "Uncertainty in Analyzing Climate Change: Policy Implications", January 2005 - emissions caps vs taxes
• Congressional Budget Office (2003), "The Economics of Climate Change: A Primer", April 2003
• DeCanio, Stephen J. (1997), The Economics of Climate Change, Redefining Progress (also Michael Toman)
• Friends of the Earth (1997), "Putting costs into perspective - economic benefits from fighting climate change", February 1997
• House of Lords, 6 July 2005, The Economics of Climate Change, House of Lords, Select Committee on Economic Affairs, 2nd Report of Session 2005-06
• Mette Wier, Katja Birr-Pedersen, Henrik Klinge Jacobsen and Jacob Klok (2005), "Are CO2 taxes regressive? Evidence from the Danish experience", Ecological Economics 52(2)
• Warwick McKibbin and Peter Wilcoxen (2002) ‘The Role of Economics in Climate Change Policy”, Journal of Economic Perspectives, vol 16, no 2, pp107-130. re-printed in R. Stavins ed(2005) “Economics of the Environment: Selected Readings”, pp479-502. WW Norton and Co, New York
• Warwick McKibbin and Peter Wilcoxen (2002) Climate Change Policy after Kyoto: A Blueprint for a Realistic Approach, Brookings Institution, December, 133 pages (ISBN 0-8157-0608-1)

External links

• Cooler Heads Coalition, economics of global warming
• Pew Center on Global Climate Change, economics of global warming
• EIA: Emissions Cuts Much Cheaper Than Previously Thought
• The Brookings Institution global climate change project,

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