Economics of Climate Change

Transcription

1 Economics of Climate Change Week 5: Energy and Climate Policy PB AF 595 Michael Lazarus and Matt Steuerwalt 1

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3 Overview Can we afford the future?* The extent and timing of action vs. inaction: what does economics tell us? Economic optimality and other paradigms Challenges of discounting, uncertainty, and quantifying costs How much will it cost to act? Understanding and interpreting mitigation costs Top-down vs. bottom-up perspectives Common cost analysis methods Competitiveness issues 3

4 Why the discord? On the costs and benefits of global action Nicholas Stern: benefits of strong, early action on climate change outweigh the costs (Exec Summ): Costs of inaction: Average 5% reduction of global per capita consumption now and forever ; plus non-market impacts, 11%; plus feedbacks, 14%; plus weight on inequity of burden, 20% Costs of action (550ppm CO2e): 1% of GDP by 2050 William Nordhaus: efficient policies generally involve modest rates of emissions reductions in the near term (Science article) or Bjorn Lomborg (2007): We should tax CO 2 at the economically correct level of about two dollars per ton On the costs of national action: Anne Smith, CRA: If this bill [Lieberman-Warner] becomes law, 3.4 million Americans will lose their jobs. And American consumers will be forced to pay as much as $6 trillion to cope with carbon constraints. (Congress testimony, quoted Sen. Lieberman website (on earlier version of bill): A recent MIT study estimated that our bill would cost approximately $20 per household, and analysts predict that the impact on our GNP would be no more than.01%. A second study by the Tellus Institute predicted that our legislation would save Americans $48 billion in net savings by 2020 due to reduced energy demand. //lieberman.senate.gov/newsroom/release.cfm?id= On WA Climate Advisory Team s recommended suite of actions to meet state climate goals: CAT strategies and recent actions, for which both costs and emission reductions could be assessed, could yield a net cumulative benefit of over $900 million by 2020 (Net Present Value , in $2006), assuming full and timely implementation. CAT report CAT s recommendations would cause tremendous economic pain, consensus of studies indicate American households likely to see reduced standard of living totalling $ per year [as a result of addressing greenhouse gases, nationally] - JamesTaylor, Heartland Institute, Sen. Delvin s minority report How can economic methods yield such divergent findings? 4

5 Stern Review: Why the big fuss? Cameron Hepburn, Oxford University: When the history of the world's response to climate change is written, the Stern Review will be recognized as a turning point. Richard Tol (IPCC co-author): If a student of mine were to hand in this report as a Masters thesis, perhaps if I were in a good mood I would give him a 'D' for diligence; but more likely I would give him an 'F' for fail Quotes: 5

6 The economic optimality / costbenefit approach Benefits: Avoided damage costs Social cost of carbon Costs of inaction Market costs Storm damages, crop losses, etc. Based on what science? Average or worst case? Non-market costs Human lives, biodiversity, etc Can benefits be meaningfully measured in dollars (value of a human life, extinction of a species, etc.)? And benefits of warming Increased yields, reduced winter mortality, tourism, and heat amenity These benefit figure large some studies (Nordhaus, Tol) Depends on investment in adaptation Costs: Mitigation or abatement investments and expenses (net of cost savings) Top-down vs. bottom-up models and perspectives Can cost-saving options exist? Are co-benefits considered? Is technology change considered, built into the models (endogenous)? Integrated Assessment Models Seek to capture feedbacks and resolve the most efficient outcome 6

7 Invest in mitigation until it exceeds damage costs (Stern Review s depiction) 7

8 Challenges for the economic optimality paradigm Discounting and intergenerational equity Uncertainty: Most analyses address average not worst case impacts Distributional impacts among and within societies Market failures Some costs (non-market) are inherently priceless Broader societal choices and directions matter: Most analyses reference to business-as-usual baselines Not all costs are the same (e.g., suffering damage vs. investing in new technologies) 8

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11 Discounting the future years compound present value from now interest 0 $100 $5.20 $ $103 2 $ $ $438 (at 3% interest or discount rate) 100 $1,922 $ $36,936 $100 X T = (1+r) T X 0 X 0 = X T / (1+r) T Bigger r means compound interest grows faster and present value shrinks faster! Slide Credit: Frank Ackerman, SEI 11

12 Why do discount rates matter? A higher discount rate makes it harder to see future costs How much should we do to prevent $1000 of damages 100 or 200 years from now? Present value of $1000 in 2108 At 1.5%: $226 At 3%: $52 At 6%: $3 Present value of $1000 in 2208 At 1.5%: $51 At 3%: $3 At 6%: $0.01 Long-term economic analysis (comparing overall costs and benefits of climate action) supports active climate policy with 1.5% discount rate but not with 6%! Higher discount rates may still be appropriate for comparing costeffectiveness among mitigation options over the next few decades 12 Adapted from Frank Ackerman, SEI

13 Choosing a discount rate What are Stern and Nordhaus (and others) arguing about? Market interest rates? Appropriate for short/medium-term private investments, and for shorter-term cost-effectiveness analyses May not apply to long-term public policy Will future generations be richer and need less help? If they are poorer, will they need more help? Pure impatience: if all generations are equally wealthy, should we discount the future? Is your granddaughter less valuable than your daughter, because she will be born a generation later? If both are equally valuable, the pure impatience component of discounting should be zero Slide Credit: Frank Ackerman, SEI 13

14 Global warming is the biggest market failure the world has ever seen (Stern) Hard to capture in economic model, market failures include among others: Unpriced external costs (pollution, social disruption, quality of life, climate change) Lack of information Lack of access to capital Misplaced incentives (e.g. tenant-landlord) Transaction costs, Bounded rationality, Product unavailability, etc... 14

15 Uncertainty: Worst case or Economic analysis is typically based on average forecasts Averaging across possibilities conceals risk, Stern, ix The greatest fears about climate change are often based on worst-case possibilities Complete loss of the Greenland (or West Antarctic) ice sheet would cause 7 meters of sea level rise; catastrophic impacts on most coastal cities, communities Disintegration is unlikely in this century, could be triggered by this century s emissions average? 15

16 Why buy insurance? People care a lot about unlikely worst cases How much time do you leave to get to the airport? Insurance is not based on average outcomes The average house has a fire every 250 years (0.4% probability per year of a residential fire) But most people have fire insurance Probability that you will die next year is less than 1% until age 61 (under 0.2% until 40) But most young parents have life insurance Probability of enough warming to guarantee loss of Greenland ice sheet is much greater than 1% Should we buy insurance for the planet? Slide Credit: Frank Ackerman, SEI 16

17 Other paradigms Insurance against worst-case outcomes (Weitzman) IPCC implies a 2 percent probability of a temperature increase greater than 6 degrees, a point at which we are located in the terra incognita of what any honest economic modeler would have to admit is a planet Earth reconfigured as science fiction [where] mass species extinctions, radical alterations of natural environments... Weitzman s take on Stern: Right for the wrong reasons Precautionary approach and cost-effectiveness How to achieve a precautionary target in the most economically efficient manner? Turns the economic focus to mitigation cost analysis 17

18 Overview Can we afford the future? The extent and timing of action: what does economics tell us? Economic optimality (minimize mitigation + adaptation + damage costs) and other paradigms Challenges of discounting, uncertainty, and quantifying costs How much will it cost to act? Understanding and interpreting mitigation costs Top-down vs. bottom-up perspectives Common cost analysis methods Competitiveness issues 18

19 Mitigation Cost Analysis Similar tools at local, regional, national, international level Bottom-up methods Top-down methods 19

20 Basis for Stern: Meta-Analysis of Modeled Estimates of Mitigation Cost, 2050 Barker, Qureshi, Kohler 2006 (basis for Stern review) Barker/Stern, 2006: Most studies centered around 1% of GDP (+/- 3%) at about 50% reduction globally. Similar to IPCC (2007) finding: In 2050, global average macro-economic costs for mitigation towards stabilisation between 710 and 445ppm CO2-eq are between a 1% gain and 5.5% decrease of global GDP (Table SPM.7). This corresponds to slowing average annual global GDP growth by less than 0.12 percentage points. {5.6} 20

21 Why the range: Methods and assumptions are critical Average impact on world GDP for 450 ppm CO2 ( ppm CO2e) in 2030 Stern Review, p.243, based on Barker et al, 2006 What s going on here? 21

22 Models for Mitigation Analysis TOP-DOWN Use aggregated economic data Assess costs/benefits through impact on output, income, GDP Typically assume efficient markets, no efficiency gap Capture intersectoral feedbacks and interactions (e.g. energy prices and economic growth) Are commonly used to assess impact of carbon taxes, cap-and-trade and other fiscal or economy-wide policies BOTTOM-UP Use detailed data on fuels, technologies and policies Assess costs/benefits of individual technologies and policies Do not assume efficient markets, overcoming market barriers can offer cost-effective energy savings Capture interactions among projects and policies Are commonly used to assess costs and benefits of projects and programs, and sectoral policies 22

23 Top-down models Simple macroeconomic (econometric): suitable for short-term analysis Input-output captures intersectoral feedbacks but not structural changes in economies Computable general equilibrium (CGE) capture structural changes; assume market clearing; suitable for full market economies 23

24 Cost-effectiveness and bottom-up cost curves Combine cost-effectiveness and emissions reduction potential; shaded area indicates total cost. Net costs Do the cheaper first? Net cost savings ervice/ccsi/pdf/greenhouse_gas 24 _Emissions_Executive_Summar y.pdf

25 Cost curve from WA CAT process Any guesses what types of actions are where on this curve? 25

26 Actions needed across the cost curve? $/tco 2 e x Technical mitigation options grouped by estimated mitigation costs Group 1 Remove non-market barriers to achieve economic benefit Transport efficiency Building efficiency Appliance efficiency Industry efficiency Urban design Group 2 - Establish carbon price/regulation and remove nonmarket barriers Some CCS (e.g. ecbm) Other methane (waste, fuel) Some wind, hydro, biomass Agriculture (soil carbon) Some forestry Some biofuels Fuel switch Power plant efficiency Non-CO 2 GHG (industry) Group 3 - Accelerate tech and institutional development CCS Safe nuclear Hydrogen/electric vehicles and infrastructure Biomass (with CCS) Advanced renewables (solar, wind w/ storage) Advanced biofuels (cellulosic) Avoided deforestation Advanced industrial processes Costs may decline over time due to R&D, learning, etc. Unidentified > ~25 > mitigation potential (@ <$100/t) GtCO 2 e 26

27 Cost Curves Bottom-up methods tend to produce step-wise cost curves (with some negative cost options); topdown methods tend to produce smoothly increasing ones (with no negative cost options) Step-wise curves provide a technique for screening and ranking GHG mitigation options, but limitations should be recognized Care should be taken to consider interdependencies among options (e.g. benefits of fuel switching in power sector may be reduced by end-use efficiency programs). 27

28 Understanding and unleashing mitigation potentials Sathaye et al,

29 Competitiveness and Leakage What does this chart suggest for climate policy? UK data, $30/tCO2e price Source: Stern, Ch.11 Will short-term production and long-term investment move to where there is no price on carbon? How to address concerns Output-based rebates to carbon-intensive, trade-exposure industries? Border taxes? Delay regulation/caps? 29

30 Prior federal legislation (Waxman-Markey) defined energyintensive, trade exposed industries : Energy-Intensity = (Energy & Fuel Costs + Generation) / Value of Shipments Trade-Intensity = (Imports+Exports) / (Value of Shipments+Imports) Source: WRI/Peterson Institute Analysis

31 and provide them with output-based allocations that would make most industries whole 31

32 Conclusion Can we afford the future? (Costs of action vs. inaction) Depends on goal-setting paradigm (economic optimality, insurance, precaution) If economic optimality, then depends on discount rate what costs you count and how How much will it cost to act? Mitigation cost analysis can guide cost-effective path to policy goals Both top-down and bottom-up analysis approaches provide useful insights Understanding analysis methods, assumptions, and limitations is critical to interpreting results and crafting sound policy 32 Photo Credit: Mike Burnett