Economics and Policy Issues in Climate Change

William D. Nordhaus

• Publisher: RFF Press
• Year: 2013
• Print ISBN: 9781138376595
• eBook ISBN: 9781135892852
• Topic: Biological Sciences
• Subtopic: Ecology
• Index: Biological Sciences

Although the negotiation of the Kyoto Protocol focused world attention on the global climate, it was just one step in the ongoing process of addressing climate change in all its facets. Research by the UN's Intergovernmental Panel on Climate Change (IPCC) has been ongoing since 1988. An extensive IPCC Working Group report published in 1995 examined the economic and social aspects of climate change. In this volume, eminent analysts assess that IPCC report and address the questions that emerge from it. The result is an instructive and cogent look at the realities of climate change and some methods (and difficulties) of dealing with them. William Nordhaus's introduction establishes the context for the book. It provides basic scientific background on climate change, reviews the IPCC's activities, and explains the genesis of the analyses. Subsequent contributions fall into two categories. Early chapters review analytical issues critical to social and economic understanding of climate change. A second set of chapters address specific economic questions surrounding climate-change policy. The result is an original and significant contribution to the evolving debate on this crucial hot-button topic.

1
Assessing the Economics of Climate Change

An Introduction

William D. Nordhaus

Understanding the science, economics, and policy aspects of global warming has proven one of the most exciting and challenging tasks facing the natural and social sciences over the last decade. Until the late 1980s, few people outside the geosciences had spent more than a fleeting moment reflecting upon the potential for or implications of global warming. Oil, natural gas, coal—these were the fuel for economic growth, the source of natural riches, and the cause of energy shocks. Global environmental change was still beyond the horizon.

The last decade has witnessed a sea change in attitudes and knowledge about many vital global processes, from the prospect of damage from ozone-depleting chemicals to the threat of deforestation and species depletion. But nowhere has research been so intense as in the field of climate change. The intellectual and policy challenges here have mobilized a small army of researchers to investigate every conceivable aspect of the problem. Although economics was a late entrant into the research process, today there are dozens of individual researchers or teams in all major industrialized countries looking at the different questions raised by the threat of climate change.

One of the special features about the phenomenon of climate change is its international dimension. In the language of economics, greenhouse warming is a global public good, or externality, over space and time in the sense that emissions in any one place affect the climate everywhere and for centuries to come. No single nation is responsible for the increasing amount of greenhouse gases, and no nation acting alone is likely to solve the problem. Recognizing the global nature of climate change, nations organized an unusual process for reviewing the scientific and economic findings in this area. This process led to the report that is analyzed in the papers in this volume.

The IPCC Process

The Intergovernmental Panel on Climate Change, or IPCC, was established in 1988 by the World Meteorological Organization (WMO) and the United Nations Environment Programme (UNEP), All countries that are members of either the United Nations or the WMO are automatically members of the IPCC. Other international agencies and nongovernmental organizations often participate in activities of the IPCC, but they do not participate in adoption of reports. All reports are adopted by unanimous consent of the member governments.

As currently constituted, the IPCC has three Working Groups—on climate science; on impacts, adaptations, and mitigation; and on economic and social aspects of climate change. Every country that is a member of the IPCC is also a member of each of the Working Groups. The activities of the IPCC are directed by a Bureau of twenty-seven members. The Working Group Bureau includes two co-chairs: one from a developed country and one from a developing country or a country with an economy in transition. The subject of this volume is Working Group III, which examines economic and social aspects of climate change. This Bureau of Working Group III included two economists, a geographer, and a climate scientist.

The main activity of the IPCC is to assess the scientific literature related to climate change. The first assessment—primarily directed to the scientific issues—was completed in 1990 (IPCC 1990). The second assessment was launched at the IPCC meeting in November 1992, at which time the terms of reference of Working Group III that underlie the report analyzed here were determined. In May 1993 Working Group III held a workshop to develop a report outline and work program, and this work plan was accepted by the IPCC plenary in July 1993.

IPCC reports are written by scientific experts, usually four to twelve experts per chapter. The only restriction is that each writing team must include at least one expert from a developing country or a country with an economy in transition. The IPCC Secretariat solicits nominations for authors from the member countries as well as from international organizations and nongovernmental organizations. The Working Group Bureau selects the writing teams from the list of nominees based on their expertise, while also attempting to obtain reasonable geographic coverage. Once the writing teams have been appointed, the members are free to invite other recognized experts to participate in the work.

The drafts of the IPCC reports and policymakers' summaries prepared by the writing teams are submitted to a technical review, administered by the Working Group Bureaus. The Bureaus identify technical experts and monitor the writing teams to ensure that they address the comments received by the technical review. Following the technical review, the drafts are submitted to government review, also administered by the Working Group Bureaus. The government review provides a formal opportunity for member countries to comment. Writing teams are expected to respond to comments on the basis of scientific merit.

Under the IPCC process for adopting a report, the Working Group must first approve, word-by-word, the Summary for Policymakers. IPCC guidelines specify that the summary should be consistent with the underlying technical chapters. The IPCC Working Group also decides whether to "accept" the technical chapters, but the content of the chapters remains the responsibility of the authors. Not surprisingly, negotiating unanimous word-by-word approval of Working Group Ill's Summary for Policymakers by more than 100 countries operating in six languages proved to be a difficult and time-consuming process.

Once approved, the report is submitted to the IPCC plenary for acceptance, Neither the Summary for Policymakers nor the underlying technical chapters may be changed by the IPCC plenary. All three volumes of the second assessment report were accepted by the IPCC plenary in Rome in December 1994. The three volumes were published by Cambridge University Press between June and August 1995 (IPCC 1996a, 1996b, 1996c).

The Snowmass Meeting and Assessment

The three IPCC reports of 1995 were widely recognized to be uniquely valuable reviews of current knowledge about climate change. These enormous volumes were produced by large teams of experts in the different fields and reviewed vast quantities of studies. At the same time, some of the results and interpretations were questioned. Debate about the validity of the conclusions, particularly about the scientific consensus, sometimes erupted into full-scale controversy. And even if the reports' conclusions did generally represent the current scientific consensus, that was no guarantee of scientific or predictive accuracy. For this reason, the contributors to the present volume thought it useful to stand back and take a careful look at the findings of the economic report to assess its reasoning.

Thus, a workshop was held in Snowmass, Colorado, in August 1996 with the purpose of analyzing in depth the economic and policy issues involved in the governmental consensus laid out in the Working Group III report. This workshop was organized under the aegis of the NBER-Yale Center on International Environmental Issues, funded by the National Science Foundation. For this meeting, recognized scholars who were not centrally involved in the IPCC chapters were asked to analyze the economic and policy issues involved in the assessment report. Each principal author prepared a review of a particular aspect of the report, and these reviews follow in this volume. We asked prominent scholars as well as lead authors of the relevant chapters of the IPCC report to respond to the analyses presented at the meeting. These subsequent comments also appear in this volume.

The chapters herein fall into two general categories. The first set of four chapters are general papers that review major analytical areas that are crucial for assessing the economic and social aspects of climate change. These include Policy Analysis for Decisionmaking About Climate Change by Professor Granger Morgan of Carnegie Mellon University; Equity and Discounting in Climate-Change Decisions by Professors Robert Lind and Richard Schuler of Cornell University; an overall appraisal of the issues involved in weighing costs and benefits in Applicability of Cost-Benefit Analysis to Climate Change by Dr. Paul Portney of Resources for the Future; and a discussion of alternative institutional design issues in Greenhouse Policy Architectures and Institutions by Professor Richard Schmalensee of MIT. These papers examine many of the central issues involved in framing the economic analysis of climate change.

A second set of papers examines specific topics necessary for the understanding of policies to cope with climate change. Perhaps the most intensively studied area involves the costs of slowing climate change. For this area, there are two reviews, one by Dr. Tom Kram of ECN Policy Studies, Netherlands, and the second by Professor John Weyant of Stanford University. Another critical building block is the issue of the benefits half of the cost-benefit analysis, which is discussed in Climate-Change Damages by Professor Robert Mendelsohn of Yale University. The final chapter, which reviews comprehensive models of the economics of climate change, is Integrated Assessment Modeling of Climate Change by Professor Charles Kolstad of the University of California at Santa Barbara.

The purpose of this introduction is to describe briefly the issues and conclusions in this volume and to provide some general background on the global-warming debate. The first section sketches the scientific background of the greenhouse-warming debate. The second section reviews the major analytical issues discussed in Part 1 of this volume. And the third section discusses the specific substantive policy issues raised in Part 2.

The Scientific Background

What is the greenhouse effect? It is the process by which radiatively active gases like CO₂ selectively absorb radiation at different points of the spectrum and thereby warm the surface of the earth. Concern about the greenhouse effect arose because human activities are currently raising atmospheric concentrations of greenhouse gases (GHGs). The most important GHG is CO₂, most of which is emitted as a byproduct of the combustion of fossil fuels. There is no doubt about the accumulation of CO₂ in the atmosphere and little scientific doubt about the prospect of global warming over the next century and beyond if current trends in atmospheric concentrations of GHGs continue.

While the basic physics is well understood, the processes that govern the atmosphere and future climate change are extremely complex. There is therefore great uncertainty about the exact amount of warming, the timing of the climate change, and the regional distribution of the climate change. The uncertainties are enhanced because other atmospheric gases, particularly sulfates, interact with the GHGs. When incorporating uncertainties about both emissions and climate models, the latest round of IPCC projections indicates globally averaged, mean temperature increases of 0.5°C to 4.5°C from 1990 to 2100.

For nonscientists, one crucial question is how seriously to take this issue. As with most important matters, there are heated debates about the extent of greenhouse warming. It must be tempting for a politician with a time horizon of at most a few years, or a business with a time horizon of at most a few decades, to ignore a problem so full of controversy, whose impact will not truly be felt for a century or more. It must be tempting to hope it will go away or that someone will find a fundamental flaw in the science. This approach is ill advised. The basic science behind greenhouse warming is well established, and the basic projections represent mainstream science. There are vast uncertainties in the field, but these should not lead people to conclude that the issue can be ignored. A prudent strategy would be, at the least, to prepare for increasing concern and strong public policy measures in this area.

The Analytical Issues Involved in Climate-Change Policy

In light of the significant prospects for global warming, the next step is to consider the potential impacts of warming on human and nonhuman societies, the means and costs of slowing warming, and the most efficient and equitable policy approaches to tackling the problem. It is here that the Working Group III report enters the stage. Part 1 of this volume considers general analytical issues that frame thinking about or designing global-warming policies.

The Decisionmaking Framework

In many complicated areas the most difficult part of an analysis involves determining the appropriate ways to think about the diverse implications of different courses of action on human and nonhuman societies. As Granger Morgan shows in Chapter 2 on the decisionmaking framework, the challenges inherent in thinking about climate change are especially daunting. Our garden-variety economic analyses of issues such as zoning, drinking-water regulation, or highway expansion generally involve well-defined and relatively homogeneous groups and have relatively limited impacts extending over short time periods. For these issues there is a well-developed (although not always accepted) set of analytical tools and regulatory and legislative mechanisms—including such well-honed tools as cost-benefit analysis and decision theory.

It is natural to look to these tools when trying to sort out different approaches to the climate-change dilemma. Indeed, In later papers of this volume, they are extensively applied and analyzed, being, in a sense, the only analytical games in town. But their familiarity should not lead us into too-easy acceptance of their appropriateness, Morgan insists. The major difficulties with applying the standard analytical tools in this case are the complexity of the climate-change problem, its long time scale, and the fact that addressing it will involve the participation and require the assent of the various groups, generations, and "tribes" in different countries. Even if decisionmakers are persuaded that there is a sound case for taking costly steps to slow climate change, they must persuade legislatures, interest groups, and ultimately public opinion. Indeed, it is just this gap between the certainty of environmental groups and the indifference of the public that led to the schism between the administration and the Congress of the United States as that country formulated its climate-change policy in 1997.

One of the leitmotifs that runs through Morgan's analysis is the array of profound difficulties that arise because of the great uncertainties in climate change. Uncertainties not only raise genuine challenges for analysts, even more so, ambiguities pose daunting problems in educating a public that justifiably has trouble separating advertisement from information and science from advocacy. Uncertainties allow a leading automobile company executive to make the astonishingly misleading statement that most of the CO₂ emissions come from trees. Attempts to gauge uncertainties require complex expert-solicitation protocols, such as the one described by Morgan, but at best these can only generate subjective probabilities. And the traditional societal mechanisms for coping with risk are not well suited to handling the massive uncertainties and potential income redistributions that may arise from future global warming.

Discounting and Intergenerational Equity

One of the major issues that arises in analyzing the economic aspects of climate change is the discounting question. This issue, along with more general questions of equity, is discussed in the contribution of Robert Lind and Richard Schuler. It is easy to lose sight of the fact that alternative discount rates are intended to affect actual policy decisions. In the global-warming context, discount rates affect mitigation or adaptation policies regarding global warming, but they also have implications for the general economic environment.

A few words of background will illuminate the discussion. Beginning with the fundamentals, a discount rate is a pure number per unit of time that allows us to convert values in the future into values today. The most common form of discount rate is the nominal or money interest rate, which is applied to dollar values. When the nominal interest rate is corrected for inflation, we obtain the real interest rate, which converts future constant-dollar values into today's constant-dollar values (or future goods into present goods). Many writers confuse the discount rate on goods and services with the discount rate that applies to utility or general levels of well-being.

To understand the economics of real interest rates, economists often use the optimal-growth framework known as the Ramsey model. The Ramsey model derives the real interest rate from a combination of time discounting, the elasticity of marginal utility, and growth in consumption. Using these, it derives the famous equilibrium equation, r* = αg* + p, where r* = the equilibrium real interest rate, α is the elasticity of the marginal utility of consumption, g* is the growth rate of per capita consumption, and p is the utility discount rate or the pure rate of time preference.

This equation—which is the basis for the discussion of discounting in the IPCC report and the Lind-Schuler critique—can usefully serve to explain the major schools in the debate. There are three major alternative approaches. One approach—sometimes called the descriptive approach—derives the discount rate for climate change from the left-hand side of the fundamental equation and proposes to use the same discount rate for environmental investments as for conventional investments. There may well be controversies about what numbers to use here (including the treatment of risk, taxes, and so forth), but this approach is clear in principle and tends to lead to relatively high discount rates.

A second approach—which has sometimes been called the prescriptive approach—rests on the argument that the discount rates that are actually found in markets are too high to be ethically justifiable because they discriminate against the future. This approach proposes using a lower and ethically justifiable discount rate. Proponents of this approach advocate discount rates as low as 1 % per annum. Because the discount rate is applicable everywhere in the economy, under this approach the economy should increase its overall savings rate sufficiently to drive the return to capital and the discount rate down to ethically justifiable levels.

Under a third scenario—the differential discounting approach—the descriptive discount rate is thought to be too high, but society is unable to generate the political will to reduce consumption. Policymakers would therefore apply special low discount rates to projects in ethic...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Series Page
• About Series Page
• Contents
• Foreword
• Preface
• 1. Assessing the Economics of Climate Change: An Introduction
• Part 1. Major Analytical Issues
• Part 2. Specific Climate-Change Policy Issues
• Index