The Economics of Climate Change: Costs
and Benefits of Reducing GHG Emissions
Maureen Cropper
University of Maryland and Resources for the
Future
August 26th 2010
1
Motivation
• “Most of the observed increase in global average
temperatures since the mid-20th century is very
likely due to the observed increase in
anthropogenic greenhouse gas concentrations.”
(IPCC 2007)
Policy Questions:
•
At what level should atmospheric CO2 be
stabilized?
•
What are the costs of reducing GHG
emissions from Business as Usual?
•
What are the benefits of doing this?
2
Likelihood (in %) of exceeding a
temperature increase at equilibrium
Stabilisation level
(in ppm CO2e)
2°C
3°C
4°C
5°C
6°C
7°C
450
78
18
3
1
0
0
500
96
44
11
3
1
0
550
99
69
24
7
2
1
650
100
94
58
24
9
4
750
100
99
82
47
22
9
Source: Hadley Centre: From Murphy et al. 2004
3
Objectives of the Talk
•
Costs of mitigation
–
–
•
Explain what factors drive estimates of the costs of
mitigation and why estimates differ
How costly is it to stabilize at 450 v. 550 ppm
Benefits of mitigation
–
–
•
Overview of state of benefits estimation
How benefits vary geographically
Balancing costs v. benefits
–
How to deal with timing issues, uncertainty? What
does this imply about the optimal stabilization
level?
4
Sources of GHG Emissions, 2000
5
What Determines Fossil Fuel
Emissions?
• Emissions ≡ Population x (GDP per capita)
x (Energy/GDP) x (CO2/Energy)
• Policies to reduce emissions must reduce:
– Energy per unit of GDP (become more energy
efficient)
– Carbon intensity of energy (switch from coal to gas;
fossil fuels to renewables and nuclear)
• Carbon tax or explicit policies needed to promote
move to a low carbon economy
6
How Economists Model Mitigation
Costs
• “Top-down” computable general equilibrium
models
– Divide the world into economically important regions
– Model demand and supply for commodities in all
sectors of the economy
• Estimate costs of mitigation by imposing a
worldwide carbon tax
• Tax causes substitution of low for high carbon
fuel; cost of doing this represents cost of
mitigation
7
What Determines the Cost of
Reaching 550 ppm?
• Ease of substituting energy for other inputs
• Ease of substituting low-carbon for highcarbon fuels
• Assumptions about rate of technical
progress
• Business-as-Usual Concentrations of
GHGs
8
Costs of Meeting Various CO2 Targets
Pathways: default (black), delayed (red) and early action (green) ; Envelopes (set of grey9lines)
Source: den Elzen et al. (2007)
What Are the Benefits of Reducing
GHG Emissions?
• Stabilizing at 550 ppm implies:
– 24% chance of temperature change > 4° C
– 7% chance of temperature change > 5° C
• What does this mean in terms of impacts?
• Following graph shows possible impacts by
sector
• Also danger of “tipping points” – positive
feedbacks that would cause rapid temperature
change
10
Projected impacts of climate change
0°C
Food
Water
Global temperature change (relative to pre-industrial)
1°C
2°C
3°C
4°C
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
Rising intensity of storms, forest fires, droughts, flooding and heat waves
Weather
Events
Risk of Abrupt and
Increasing risk of dangerous feedbacks and
Major Irreversible
abrupt, large-scale shifts in the climate system
Changes
11
Sectors for Which Impacts Have
Been Studied
• Agriculture
• Forestry
• Coastal
infrastructure
• Energy
– Supply & Demand
• Water
– Supply & Demand
• Health impacts
– Malaria
– Malnutrition
– Heat Stroke, floods
• Species loss
• Ecosystem changes
• Climate
Disamenities
12
Projections of Surface Temperatures for
Three IPCC Scenarios
13
Climate Change Damages
• Best studied sectors are market sectors—
agriculture, forestry, energy, water, coastal
infrastructure
• Damages in developing countries—especially low
latitude developing countries—are often a larger
percent of GDP than in high income countries
• To compare with global costs of mitigation, need
to aggregate benefits of mitigation across
countries
• How this is done has a big impact on results:
– Aggregate by GDP or population?
14
The damages of climate change with
increasing global temperatures
4
Percent of world GDP
2
Hope
0
-2 0
1
2
3
4
5
6
Mendelsohn
Nordhaus, output
-4
Nordhaus, population
-6
Tol, output
-8
Tol, equity
-10
-12
Global mean temperature
15
How to Balance Costs and Benefits?
•
Integrated Assessment Models (IAMs)
•
–
Model (a) impact of emissions on temperature;
(b)damages of temperature on GDP and
(c) costs of mitigating emissions
–
Path of emissions chosen to maximize present
discounted value of utility of per capita GDP
Key Integrated Assessment Models
–
–
–
Nordhaus DICE/RICE models
Tol FUND model
Hope PAGE model
16
What Drives IAM Results?
•
Key factors affecting the optimal reduction in
GHG emissions are:
–
Shape of the aggregate damage function
•
–
Impact of emissions/atmospheric concentrations
on temperature
•
–
Steeper in Nordhaus (DICE) and Hope (PAGE) models
than in Tol (FUND) model
Measured by “Climate Sensitivity: - impact on mean
global temperature of a doubling of CO2
Discount rate used to express future damages and
costs in present value terms
17
Importance of Uncertainty & Risk Aversion
•
Impact of atmospheric CO2 on temperature
uncertain
–
–
Climate sensitivity = impact on temperature of a
doubling of atmospheric CO2 from pre-industrial
levels
95% confidence interval = 2.5°C – 5.4°C
•
Nordhaus and Tol Integrated assessment
models treat this parameter as certain; Hope
does not
•
Allowing for risk aversion decreases optimal
level at which to stabilize CO2
18
Importance of Discounting
•
Future costs and damages associated with
GHG emissions expressed in present value
terms
–
–
The present value of $1 received 50 years from
now is the amount I must invest today to have $1
in 50 years
At 4.5%, this is 11 cents; at 1.4% this is 50 cents
•
Cost of mitigation begin today, whereas major
climate damages occur in the future
•
Lower discount rates imply more mitigation
–
Should discount rate reflect market opportunities or
ethical concerns?
19
The Discounting Controversy
•
Nordhaus: Use market interest rates
(approximately 4.5%)
•
Stern/Hope: Use a discount rate that reflects
how we weight the preferences of future
generations v. ourselves
–
–
•
Allowing for the fact they will be better off
Discount rate approximately 1.4%
Next slide shows results of Nordhaus model,
which are conservative given
–
–
Choice of discount rate
Use of expected values
20
Mitigation Benefit and Cost Estimates Relative to No
Mitigation – Nordhaus DICE Model
Benefits
(Reduced
Damages)
Abatement
Benefits
Costs
Minus Costs
$ Trillion (US 2005)
Nordhaus/DICE Optimal
$Trillion
5.24
2.16
3.08
420 ppm
12.60
27.20
-14.6
560 ppm
6.57
3.90
2.67
700 ppm
5.24
2.16
3.08
GHG Concentration Limits
Note: Yale DICE model: Runs set to max. the value of net economic consumption,
assuming complete implementation efficiency and universal participation.
Source: Wheeler (2007)
21
What Can We Conclude About Costs and
Benefits?
•
Conservative estimates suggest that costs of
stabilizing CO2e at 550 ppm passes the
benefit cost test
•
Allowing for uncertainty about climate
sensitivity and risk aversion would increase
the benefits of a 550 ppm target
–
•
So would lowering the discount rate
If this is the case, why are we doing so little?
22
Problems in Reaching an International
Agreement
• Reducing GHGs is a global public good
– If one country reduces, all countries benefit
– Individual countries have an incentive to “free ride”
• Benefits of avoiding climate change occur in the
future, and most benefits accrue to developing
countries
• Developing countries argue that they are not
responsible for the majority of the stock of GHGs
• And, their emissions are very low on a per capita
basis
23