the economics and policy of climate change api-35/econ1661 section notes jisung park april 2013...

The Economics and Policy of Climate Change

API-35/Econ1661 Section Notes

Jisung Park

April 2013These slides incorporate material originally produced by Geoffrey Heal, Rich Sweeney, Liz Walker, and Gabe Chan

Outline of next three sections Science

Climate Science Physical impacts

Economics I: Cost-Benefit Analysis of Climate Change Benefits Uncertainty Aggregation – Ethics, Discounting, Inequality Debate on ethical positions and Uncertainty

Economics II: Policy Design / Instrument Choice Overlapping instruments and other temptations REDD Geoengineering and the “Free-Driver” Problem Debate on policy alternatives

Climate Change is sort of a big problem

“Climate change is the mother of all environmental externality problems.”

- Martin Weitzman (2012)

“Climate change is the result of the biggest market failure the world has ever seen.”

- Nicholas Stern (2007)

Hepburn and Park, 2011

What Role can Economics Play? Where to go (How much mitigation?)

Cost-Benefit Analysis Find the “optimal” emissions trajectory? Target level: 350ppm? 450ppm?

How to get there (Which policy tools?) Instrument Choice:

Carbon Taxes? Cap-&-Trade? Top-down, Bottom-up?

Looking Ahead: The Economist’s challenge How to quantify the social welfare losses arising from these

physical impacts, given multiple layers of uncertainty and interdisciplinary contingencies?

Climate Science & Modeling

Physical Environmental Impacts

Economic Valuation of

Impacts

Aggregation of Valuations

SOCIAL COST OF CARBON ($)

Why do we need to learn Econometrics? The Bigger Picture

Policy Analysis

Empirics

Economi

c

Theory

POLICY RECOMMENDATIONS

SOCIAL COST OF CARBON ($)

Outline of next three sections Science

Climate Science Physical impacts

Economics I: Cost-Benefit Analysis of Climate Change Benefits Uncertainty Aggregation – Ethics, Discounting, Inequality Debate on ethical positions and Uncertainty

Economics II: Policy Design / Instrument Choice Overlapping instruments and other temptations REDD Geoengineering and the “Free-Driver” Problem The way forward? Debate on policy alternatives

8

Radiative Forcing and the Greenhouse Effect

The mean annual radiation and heatbalance of the Earth. From Houghton et al., (1996: 58), which used data from Kiehl and Trenberth (1996). Figure from Withgott and Brennan (2007)

Uncharted Territory

10000 5000(yrs before 2005)

Useful rules of thumb: GHG Concentrations/Emissions

10

Annual increase between 2 and 3 ppm Over a decade concentration increases by

roughly 20-30 ppm Currently at 390 ppm: (390 is CO2-only: including all GHGs concentration is

nearer 440) Will reach 410-420ppm by 2020 Current annual emissions: 40 billion tons CO2

equiv Check out:

http://cdiac.ornl.gov/pns/current_ghg.html

Stocks vs Flows

For Climate Change, what matters is the STOCK of GHG’s

Flow

Stock

1212

This is CO2-e not C, from all sources, not just fossil fuels

12

Where is it coming from?

Where is it coming from? Despite popular misconceptions…

Transport is relatively small (13%) Forestry is over 1/6th (17.4%) Building efficiency improvements are

somewhat trivial (7.9%)

Who is responsible?

14

Historically

Who is responsible?

Relative contributions by major countries to a) cumulative CO2 emissions, b) current annual CO2 emissions, c) the growth in CO2 emissions, and d) population

(Raupach, et al., 2007)

Who is responsible?

Relative contributions by developing and developed countries to a) cumulative CO2 emissions, b) current annual CO2 emissions, c) the growth in CO2 emissions, and d) population

(Raupach, et al., 2007)

17

Distributional Inequality in GHG per person

Annex 1: 16.1 tCO2eq / capita

Non-Annex 1:4.2 tCO2eq / capitaBut how much of your carbon footprint is actually within your individual control?

18

Attribution – Anthropogenic?first humans out of AfricaHistorical Atmospheric CO2 Concentration

Outline of next three sections Science

Climate Science Physical impacts

Economics I: Cost-Benefit Analysis of Climate Change Benefits Uncertainty Aggregation – Ethics, Discounting, Inequality Debate on ethical positions and Uncertainty

Economics II: Policy Design / Instrument Choice Overlapping instruments and other temptations REDD Geoengineering and the “Free-Driver” Problem The way forward? Debate on policy alternatives

Weather vs Climate Weather is a short-term realization from a

long-term Climate distribution

21

Temperatures are Rising

Variations in the Earth’s surface temperature in the Northern Hemisphere (IPCC, 2001)

Sea-Level is Rising

222222

Sea level movement

23

Potential Future Sea Level Rise

For those interested in the details…

Epidemiological studies suggest warm nights are more important in determining mortality and morbidity responses from heat waves

Projected Warming Scenarios

313131

Temperature forecasts

Forecast warming greatest in Arctic

Research question: should we care about absolute degree changes or stdev from normal variability?

Ecosystem Services Among the natural processes that will be

affected, which are the ones that will have significant human welfare implications?

Temperature and Precipitation changes will impact.. Water availability and quality Crop Yields and growing seasons Coastline Habitability Soil availability and quality

Biodiversity Loss What about the processes (and entities) that

are not human? Where does biodiversity loss fit in? Up to 30% of species gone by 2100. Only through the social welfare function?

Where UV = use-value, EV = existence value Norton (2010): Economics as a discipline commits the

sin of assumed “value monism”

Physical Impacts: Summary Average temperature increases worldwide

(tremendous regional heterogeneity) Increased temperature variability in some

areas Shifts in rainfall patterns

(even more tremendous regional heterogeneity) Sea-level rise Biodiversity loss (up to 30% of all species by

2100) Ocean acidification -> Coral bleaching Increased storm intensity and frequency in

most regions

Some Figures worth Remembering World GDP ~ $70 trillion US GDP ~ $15 trillion Social cost of carbon estimates: $23-$38/ton

(Greenstone et al, 2013); (-10$ to $200+ with a wider net)

Implied size of potential carbon market: >$800 billion annually

Questions and Comments?(Won’t spend any more time debating the

science)

Outline of next three sections Science

Climate Science Physical impacts

Economics I: Cost-Benefit Analysis of Climate Change Benefits Uncertainty Aggregation – Ethics, Discounting, Inequality Debate on ethical positions and Uncertainty

Economics II: Policy Design / Instrument Choice Overlapping instruments and other temptations REDD Geoengineering and the “Free-Driver” Problem The way forward? Debate on policy alternatives

The Economist’s challenge How to quantify the social welfare losses

arising from these physical impacts?

Climate Science & Modeling

Physical Environm

ental Impacts

Economic Valuation of Impacts

Aggregation of

Valuations

SOCIAL COST OF CARBON ($)

(Refresher)Where to go and how to get there Where to go (How much mitigation?):

Cost-Benefit Analysis Find the “optimal” emissions trajectory? Target level: 350ppm? 450ppm? +2C? +3C?

How to get there (Which policy tools?): Instrument Choice:

Carbon Taxes? Cap-&-Trade? Top-down, Bottom-up?

Disconcerting Issues “Climate change pushes economists beyond

their methodological comfort zone.” (Weitzman)

Key Issues Uncertainty Missing Damages Long-Time Horizons (Discounting) Ethics and Inequality

Uncertainty: Vast and MultiplicativeTemperature and Precipitation Projections

Ecological and Physical Impacts

Valuation Methods and Aggregation Issues

ALL OF THIS NEEDS TO SPIT OUT ONE POLICY-RELEVANT NUMBER?

Uncertainty: Vast and Multiplicative Social Cost of Carbon Estimates:

Vary by two orders of magnitude (Tol, 2008) Most recent “synthesis estimate” by Greenstone

et al (2013):

Missing Damages? Most IAM’s to date are highly incomplete

(Heal, Weitzman, Hanneman) For example, DICE Model (Nordhaus):

Damages driven primarily by… 1) Agriculture 2) Sea-level rise Even within agriculture, substantial controversy

over underestimates due to leaving out effect of rainfall: E.g. (Mendelsohn vs Schlenker)

Missing Damages? Recent research documents significant

Missing Damages: Storm Intensity and Frequency (Hsiang & Jina,

2013) Large, persistent effects on economic growth: up to

70% of present GDP in NPV terms (Japan, South Korea, Phillipines)

Over $4 trillion Highly heterogeneous (Australia and India benefit

slightly) Still inexact – what was the “damage” from

Sandy?

Missing Damages? Labor Productivity (Park & Heal, forthcoming; Dell

et al, 2011) +1 deg C => -1.2% GDP growth per year in poorer

countries Adaptation implication: AC in poor and hot countries?

Missing Damages? Violent Conflict (Miguel et al, 2013; Hsiang et al,

2011) Large and significant increases in civil conflict

Also some suggestive Evidence of Climate Change affecting…

Health and Human Capital Accumulation (Greenstone et al, 2012; Graff-Zivin et al, 2013) Effects on mortality, morbidity, even test scores

Long Time Horizons: Discounting“Climate policy involves time scales hitherto unprecedented in policymaking, periods of at

least100 years.” (Heal, 2008)

At these time scales, the choice of discount rate can DOMINATE the cost-benefit analysis E.g. $1,000,000 in damages occurring 200 years

from now, discounted at 7% has an NPV of $1.32

Discounting

What happens to NPV of SCC at “benchmark” discount rate of 7%?

Discounting and Ethics Becomes a matter, in part, of

Intergenerational Ethics

“The problem of discounting for projects with payoffs in the far future is largely ethical.” -

Kenneth Arrow“Discounting later enjoyments versus earlier

ones is simply a practice that is ethically indefensible.” - Frank P. Ramsey

Discounting and Ethicsr = ρ + ηg

r : discount rate ρ: pure rate of time preference (arguably an

ethical parameter) η: elasticity of marginal utility (also ethical in

the context of global social planner) g: future consumption growth rate

Discounting and Ethics Are later generations worth intrinsically less?

Stern says no, justifying ρ = 0.01

Is Consequentialist Utilitarianism the “right” premise/framework? See: Hepburn et al, 2011; Norton, 2010

Who’s the relevant “unit” of welfare maximization? Nation State? In which case, what to do with

minus infinity welfare of small island states (Gerrard, 2011)

Climate Change, Ethics, Inequality By and large (with caveats about vast

uncertainty aside), CC is a problem caused by developed countries, with consequences borne disproportionately by developing countries.

What’s a “fair” solution?

Let’s have a debate What do you think? Should developing countries receive transfers

from rich industrialized nations? Should reduction allocations be based on per

capita emissions? Per unit GDP produced? What should rho be?

Outline of next three sections Science

Climate Science Physical impacts

Economics I: Cost-Benefit Analysis of Climate Change Benefits Uncertainty Aggregation – Ethics, Discounting, Inequality Debate on ethical positions and Uncertainty

Economics II: Policy Design / Instrument Choice Prices vs Quantities revisited Overlapping instruments and other political temptations REDD Geoengineering and the “Free-Driver” Problem Debate on policy alternatives

Instrument Choice Basics Three Major Types:

1. Market-based mechanisms (Tax, Cap-and-Trade, Hybrids)

2. Voluntary Reductions (Corporate Social Responsibility)

3. Direct Regulation (“Command and Control” mandates)

Jisung Park - University of Oxford

Why Market-based Instruments? Demonstrated efficiency gains from market-

based schemes E.g. Clean Air Act 1990

Encourages innovation Market drives new technologies and sectors that

may not be imaginable at the moment Etc, etc, etc

Tax or Cap?Prices vs Quantities Review Weitzman 1974: Key result is…?

Given MC uncertainty Relative slopes of MB and MC curves matter Determines which policy tool is preferable ex ante (MB uncertainty matters only when?)

Prices vs Quantities applied to Climate Change Useful Heuristic

What is the possible scenario we are worried about?

MB/MC slopes What is the preferred policy?

Environmental catastrophe

Marginal benefit (MB) curve is steeper (or kinked)

Quantity - put a “hard” cap on emissions

Economic overburdening Marginal cost (MC) curve is steeper (or kinked)

Price - put a “limit” on potential costs

Discussion – Tax or Cap? On balance, what seems more sensible? No clear correct answer…

Multiple Instruments: Political Temptations Why can’t we have the best of both worlds?

E.g. Carbon Tax at the state level, Cap and Trade at the National level?

Neatly Dovetail

ed

Kitchen Sink

Political Rationale

Political Rationale

Political Rationale

Economic Rationale

Multiple Instruments in Theory Good Reasons to Combine Instruments:

Multiple Externalities : Environmental externality (carbon) + Innovation externality (technology)

Political ConstraintsRedistribution, action-bias, etc

Multiple Instruments in Practice European Union (EU):

Emissions Trading System (ETS)+ …… carbon taxes in Sweden, Norway, Denmark, and

recently the UK and Ireland…renewable subsidies in Germany, Spain (solar)…additional trading schemes in UK (CRC)

United States:State and Federal RPS Regional and state-level emissions trading schemes

+ CAFÉ standards

Unintended Consequences of Overlapping Instruments Combining multiple overlapping instruments

can lead to severe unintended consequences Collapse of carbon market Leakages Net Efficiency Loss (same abatement at higher

cost) Loss of Credibility

Taxes combined with Cap and Trade

Source: Fankhauser, Hepburn, Park 2011 (Climate Change Economics)

Impact of Taxes combined with Cap and Trade

Source: Fankhauser, Hepburn, Park 2011 (Climate Change Economics)

Technology Standards/Subsidies and Trade Tech-specific subsidies or mandates on top of

a permit trading system Can lead to lower permit prices and greater

inefficiency Three possible scenarios:

Above margin (no effect) Below margin (increases rent) Inter-margin (most problematic)

Subsidies and Trade: Above-margin (e.g. CCS)

Source: Fankhauser, Hepburn, Park 2011

Subsidies and Trade:Below-margin (e.g. Nat gas)

Source: Fankhauser, Hepburn, Park 2011

Subsidies and Trade: Intra-margin

Source: Fankhauser, Hepburn, Park 2011

Jisung Park - University of Oxford

Why is this problematic?

Same abatement, but greater cost ($) Presents the “illusion” of more abatement Undermines long-term viability of carbon

market

Hybrid Alternatives Multiple Instruments ≠ Hybrid Instruments Hybrid instruments are preferable:

Price Ceilings (“Safety Valves”): pay minimum Price Floors: pay maximum Price Collars Auction Reserve

If combining cap-and-trade with standards, make sure to adjust the level of the cap

Other Policy Instruments? We’ll talk about the following two:

REDD Geoengineering?

REDD Reducing Emissions from Deforestation and

Forest Degradation

REDD Pros

Low-Hanging Fruit: low abatement costs per ton (in principle)

Possible “Co-benefits”: Biodiversity conservation, Water filtration

Cons Implementation issues: Monitoring, Permanence,

Financing Whose cap? Unintended side effects: Land grabs, Indigenous

impacts

Geoengineering and the Free-Driver Problem

Geo-Engineering: the “G-word” Definition (Royal Society of Sciences):

“The deliberate large-scale intervention in the Earth’s climate system, in order to moderate

global warming.”

Here, focus on “Albedo Enhancement” or “Solar Radiation Management (SRM)”

1. Solar Radiation Management (SRM) What is SRM?

Geoengineering Supporters Argue Climate change is already happening Mitigation is far from the optimal path Some geo-engineering technologies - Solar

Radiation Management (SRM) in particular - are developing faster than anticipated.

Geoengineering: the “G-word” “Formerly a freak-show in otherwise serious

discussions of climate science and policy, geo-engineering today is a bedfellow, albeit one of which we are wary”

-Victor, 2008

Historical Progression: Climate Science…Mitigation…Adaptation…Geo-

Engineering as Backstop?

Three Stylized observations1. SRM is cheaper, and closer to

implementable reality, than previously believed

2. Climate Damages are likely very heterogeneous

3. No international treaties on SRM (yet)

1. Solar Radiation Management (SRM) SRM Geo-engineering is…

Fast, Cheap, Imperfect, (Keith, 2010)

To offset a doubling of pre-industrial CO2 levels, you need to scatter just 2 % of the light that hits the planet.

Most recent cost estimate: $1-8 billion/year (McClellen et al, 2012)

2. Climate Damage Heterogeneity

Source: http://www.guardian.co.uk/environment/interactive/2009/oct/22/climate-change-carbon-emissions

3. Lack of Policy Architecture Policymakers have begun dialogue as of 2010,

but no treaties exist Can the Genie be kept in the bottle? Can’t detect even if a country were to

“surreptitiously geoengineer” (Keith, 2013)

What happens if an individual country (say, Bangladesh) decides to act unilaterally?

“FREE-DRIVING” Global Public Gob Problem

(not a typo)

“Free-Driving” Given

Vast Climate Damage heterogeneity&

Unilaterally implementable SRM technology

There is some world in which one country chooses the level of the “public bad”, which is sub-optimal for the rest of the world.

Public “gob” – “good or bad”: good for you, bad for others (Weitzman, 2013)

Debate: What’s the best solution available? Geoengineering:

Fund research? Ban research? Ban testing? Negotiate international treaties? Create norms? Transfer to most likely “rogue geoengineers”?

More Broadly: Top-down? Bottom-up? Fund silver-bullet

mitigation technology? Fund adaptation?