The Economics of Climate Change

Nick Hanley, Anthony D Owen

• Publisher: Taylor & Francis
• Year: 2004
• eBook ISBN: 9781134445721
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This impressive new collection couldn't come at a better time. With global warming now becoming physically noticeable and the Kyoto treaty stalling in its efforts to get the developed world on board, a look at the economic factors of global warming is very much welcome. With contributions from distinguished authors and covering everything you need

1 Introduction

Anthony D. Owen and Nick Hanley

The impact of climate change is one of the most significant environmental challenges facing the world today. Mitigating this impact will require profound changes in energy production and use, since emission of greenhouse gases from combustion of fossil fuels is the dominant human contribution to climate change. In the short-term, a range of emission reduction strategies is available. For example, both opportunities for enhanced levels of energy efficiency and for fuel switching (from high to low carbon content fuels) are readily available in all sectors of the economy. However, a long-term solution is possible only if technological development receives the appropriate price signals to enable it to proceed in a climate friendly manner.

In the context of environmental economics, three important characteristics make the study of climate change unique:

• it is global in nature;
• its impacts are of an unusually long-term character;
• understanding of both the nature of climate change itself and the effects of policies designed to mitigate it remain deficient.

The global nature of climate change arises from the fact that irrespective of where on earth greenhouse gases are emitted they are rapidly absorbed into the atmosphere and spread around the globe. The consequences of the resulting global climate change, however, are projected to be far from uniform, with some countries expected to suffer far greater adverse impacts than others. In addition, unilateral action by any one country could not alter this situation significantly. It therefore requires concerted remedial cooperative action at the international level to address the problem.

The long-term nature of the impacts of climate change arises from the fact that greenhouse gases comprise a stock in the atmosphere that is continually augmented by new emissions. The natural rate of breakdown of this stock varies from a few decades for short-lived gases such as methane, to hundreds of years (for carbon dioxide), through to thousands of years (for longer-lived gases such as perfluorocarbons). Thus, impacts induced by these emissions, such as global average temperature increases and rises in sea level, will be progressive over long time horizons. These long time lags will also influence remedial measures, where the risks of climate change in the future have to be offset against the costs of undertaking mitigating action today.

The ultimate physical impact of climate change has yet to be determined with a realistic degree of precision. Although this is true for other pollutants, uncertainty over climate change impacts involves a huge scale and breadth of possibilities worldwide. As a consequence, there is uncertainty about the magnitude of damage costs associated with changing weather patterns, changing agricultural patterns and numerous other effects. This makes policy options difficult to determine and encourages decision makers to delay their response until stronger scientific evidence of potential damages becomes available.

In evaluating future emission reduction options economics can play an important role, for example in terms of:

• assessing the cost-effectiveness of alternative measures;
• estimating the impacts on economic growth and sustainable development;
• modelling impacts on social equity.

This book aims to provide a sound analytical environment for assessing these issues. It also aims to show how the general principles of environmental economics can be applied to serious real-world environmental problems.

The structure of this book

In the next chapter, Ian Moffatt provides a concise guide to the science of climate change, with a focus on the construction of climatic data, the causes of climate change and the growth rate of greenhouse gases, and climate change modelling methodology. He concentrates upon climate change over the last two centuries, a period short enough for astronomical and geological processes of climate change to be assumed constant. Thus attention can be focused on the climatic impact of the changing composition of greenhouse gases in the atmosphere over this time-frame. The science underpinning climate change models is illustrated by means of a simple thermodynamic model of the greenhouse effect. More sophisticated models are then discussed, together with the related degree of uncertainty associated with such complex processes. Finally, he examines scenarios exploring possible climate futures, their associated physical impacts, and alternative policy issues and options.

At the 1992 Earth Summit in Rio de Janeiro, the United Nations Framework Convention on Climate Change (UNFCCC) was adopted by more than one hundred nations in order to develop an international coordination framework for addressing climate change. In Chapter 3, Joanna Depledge explores the evolution of the climate change regime over the ensuing 12-year period. After outlining the history of the regime, she focuses first on the Convention and the further development of its rulebook. The chapter then turns to the Kyoto Protocol, looking at its provisions and rulebook, before offering some remarks on the road ahead.

In the following chapter, Jason Shogren discusses what insights economics can offer policy makers in the debate over rational climate protection policy. These include identification of market failure, the costs and benefits of pursuing action (or inaction) for climate protection, risk reduction strategies and the creation of economic incentives that will assign a price to climate protection. However, the fundamental longer-term economic insight identified by Shogren is the evaluation of risk and associated hedges against uncertainty at local, national and global levels.

In Chapter 5, Michael Grubb gives an overview of the economics of the Kyoto Protocol. The intention of the agreement is to tackle the threat of climate change by establishing an efficient regulatory framework that sets an international ‘price’ on emissions of CO₂ and other greenhouse gases. The core mechanism for achieving this is quantified emission commitments, that are given market-based flexibility through the use of emissions trading and other international economic instruments, and with negotiations on subsequent period commitments mandated to follow. Grubb provides an explanation of the basic structure of the Protocol, illustrated with respect to some of the key debates that went into its formation. He then examines the practical economic consequences of the final agreement as elaborated at the Marrakech COP 7 conference, including the economic consequences of withdrawal by the Bush administration. He concludes with some thoughts on the future of the Kyoto system.

Carbon taxes and emissions trading are both policy instruments that in a competitive and transparent market setting are capable of bringing about desired levels of greenhouse gas emissions reductions at the lowest cost. In Chapter 6 Fanny Missfeldt and Jochen Hauff show that both instruments can reach a given emission target at minimum cost in the context of a perfectly competitive, fully transparent and static market. However, when discussing the actual introduction of tradable permits as a policy tool, it is essential to analyse their properties under more realistic assumptions. Issues examined in this chapter include uncertainty, market power, and transaction costs which all make the case for the cost-effectiveness of a tradable permit approach less clear-cut. The authors then address the issue of carbon taxes, at both the international and domestic levels, and highlight the constraints that have restricted their implementation to date.

Cost-Benefit Analysis (CBA) is widely used as a tool for policy and project analysis. In order to improve the quality of decision making using Cost-Benefit analysis, attempts have been made to incorporate the environmental impacts of projects and policies. Many technical problems persist, however, in applying CBA to environmental issues. In Chapter 7, Nick Hanley and Dugald Tinch address some major problems in applying the CBA method to decisions over climate change, and question the appropriateness of CBA in this instance as a way of informed social decision-making. They point out that the costs of a policy must be lower than the perceived benefits for it to be adopted and non-adoption indicates that the costs are thought to be higher than the benefits. It therefore seems rational to suggest that decision makers should be informed by some quantifiable measure of the size of costs and benefits, rather than relying on implicit notions of what these costs and benefits are.

In the following chapter, Warwick McKibbin and Peter Wilcoxen outline the role that economic models have played in the climate change debate. They argue that economic models can play a very useful role but need to be used carefully to form the core of a structured debate rather than the source of definitive answers. Models are particularly useful for analysing the myriad of issues arising in the debate on greenhouse policies because it is impossible to solve the many interdependencies without using a framework that captures these interdependencies transparently. The ultimate usefulness of an economic model is not so much in the numerical magnitudes it produces (although these are very useful in placing debates in context) but in improving our understanding of the key underlying mechanisms that determine any set of numbers. As an illustration of how models are structured and used, they present an outline of the G-Cubed multi-country model and summarize the key insights from this model and others in the climate change debate to date. These insights include issues about baseline projections as well as the evaluation of the costs and benefits of alternative greenhouse policies.

Policies that target energy prices (either directly through taxes/subsidies or indirectly through emission caps) are likely to play an important role in any effort to combat global climate change. Although there has been considerable research effort into the impacts of possible energy pricing policies, there remains a number of unresolved issues and a need for continuing research. In Chapter 9, Brian Fisher and Mike Hinchy summarize the long standing disagreement between proponents of bottom up and top down models over the appropriateness of assumptions and plausibility of results from respective types of these models. In the specific case of the removal of fossil fuel subsidies, the main uncertainty is the size of the second-order repercussions of such a move. It is possible that the reduction in global carbon dioxide emissions could be smaller than suggested by the analysis of first-order impacts.

The Kyoto Protocol created the Clean Development Mechanism (CDM) and Joint Implementation (JI) to generate emission reduction credits that can be used to offset domestic emissions in Annex I countries. In order for the credits generated from CDM or JI projects to be credible, projects have to show that emission reductions they generate are ‘additional’ to any that would occur in the absence of the certified project activity. Further, the emission baselines against which a project performance is compared need to be environmentally sound, and project monitoring needs to be rigorous. In Chapter 10, Jane Ellis examines issues related to assessing a project’s additionality, setting baselines, and monitoring and verifying the emission mitigation effect of projects. She also suggests means to achieve the appropriate balance between environmental integrity and practical feasibility.

Historically, developing countries have been relatively minor sources of GHG emissions and, with just a few exceptions, are likely to remain so for the foreseeable future. Yet they are likely to suffer disproportionately more than developed countries as the impacts of climate change are realized. In Chapter 11, Anil Markandya and Kirsten Halsnaes look at the present and projected share of GHG emissions of developing countries, what different GHG emission allocation rules would mean in economic terms, and evidence on the possible impacts of climate change on developing, in contrast to developed, countries. They then discuss how climate policies are determined, the role of self-interest in the negotiations, and how developing countries have been included in the agreements. Finally, they review mechanisms that have been created specifically to assist developing countries adopt low carbon technologies, whilst simultaneously providing low-cost abatement credits for developed nations.

In the final chapter, Tony Owen reviews life cycle analyses of alternative energy technologies in terms of both their private and societal (that is, inclusive of externalities and net of taxes and subsidies) costs. The economic viability of renewable energy technologies is shown to be heavily dependent upon the removal of market distortions. In other words, the removal of subsidies to fossil fuel based technologies and the appropriate pricing of these fuels to reflect the environmental damage (local, regional and global) created by their combustion are essential policy strategies for stimulating the development of renewable energy technologies in both the stationary power and transportation sectors. However, a number of non-quantifiable policy objectives are also of significance in the planning of future technology options. Currently, the most important of these would appear to be security of oil supplies and their associated transportation and distribution systems.

We hope that this collection of essays will prove helpful both to individuals working in climate change and to those entering the area and seeking insight into the current directions of research and policy. We also hope that the book illustrates the advantages and limitations of environmental economics as a discipline through which environmental problems can be understood, and by which appropriate responses can be chosen.

2 Global warming: Scientific modelling and its relationship to the economic dimensions of policy

Ian Moffatt

Introduction

Global warming is considered by many scientists to be the major environmental problem confronting life on Earth.¹ Whilst it is well established that the Earth has a natural greenhouse effect concern is over the anthropogenic alteration to the composition and quantities of atmospheric greenhouse gases. The anthropogenic alteration of the climate is known as the enhanced greenhouse effect or, more commonly, global warming. In order to understand the processes underpinning global warming a massive scientific programme of research has been undertaken over the past three decades. Several major monographs on the scientific and social responses to global warming have already been produced and vitally important scientific research continues.²

Simultaneous to this research, the last two decades have witnessed increasing political and economic discussions over the ways of reducing greenhouse gases or, at least, exploring ways of adapting to the predicted climatic changes. The Kyoto Protocol, for example, is part of this on-going political and economic debate.³ Clearly, global warming has the potential of impacting directly or indirectly on every sentient being on Earth. Hence, many political leaders, together with the rest of humanity, are concerned over the likely impacts that global warming will have on society and the environment as well as the costs and benefits of coping with this human made threat. The scientific and policy debates continue.

The purpose of this chapter is to focus on scientific modelling of global warming and discuss its relationship with the economic dimensions of policy. In this chapter our attention is focused mainly on climate change over the past 200 years (i.e. short-term change) and we examine some probable changes caused by human activities that will occur by 2050 or 2100.

In the following section a concise guide to the science of global warming is presented. We begin by describing the types of data used in constructing climatic data. Next, the different causes of climate change and the temporal and spatial scales over which they operate are described. This then leads into a brief account of the growth rates of greenhouse gases that represent the basis for one theory of short-term climate change.

We then focus upon the ways in which scientists can model climate change. The basic thermodynamics of climate change are described as a simple one-dimensional dynamic model. Such models were developed in the 1960s but, whilst the thermodynamics are captured in these models, other details of the terrestrial and oceanic environment were not. More recent atmospheric general circulation models (AGCMs) have been developed as a way of representing our knowledge of the processes underpinning global warming. These models also contain some uncertainties and these are described. Despite these uncertainties these sophisticated dynamic models give reasonable simulations of past climatic change over the last 100 years. Generally, these models are then run forward to give alternative scenarios of possible future climate change. It will be argued that until the 1990s the early AGCMs were able to capture the temporal variation in global climatic change but were unable to capture the detailed regional variations associated with global climatic change. Current research, however, has developed models that give more detailed regional descriptions of atmospheric pressure, precipitation and temperature.⁴ These new regional models can provide useful information for politicians, economists and environmental managers (along with other interested people) and are important tools for assessing local and regional effects of global warming. Some of the recent research into models of greater complexity is also noted.

The final section of this chapter examines the relationship between scientific research and policies on global warming. Several scenarios generated by AGCMs giving some possible future changes in the Earth’s climate are presented. These scenarios are not scientific predictions (the latter depend on natural laws and controlled experimental conditions) nor are these scenarios mere weather forecasts. AGCMs’ scenarios are exploring possible climate futures and as we move further into the future the uncertainties grow and hence the forecasts become less reliable. Using a series of different, but realistic, scenarios, alternative...

Table of contents

• Cover Page
• Routledge explorations in environmental economics
• Title Page
• Copyright Page
• Figures
• Tables
• Boxes
• Acknowledgements
• Contributors
• Abbreviations
• 1 Introduction
• 2 Global warming: Scientific modelling and its relationship to the economic dimensions of policy
• 3 From negotiation to implementation: The UN Framework Convention on Climate Change and its Kyoto Protocol
• 4 Climate protection: What insight can economics offer?
• 5 The economics of the Kyoto Protocol
• 6 The role of economic instruments:
• 7 Cost-Benefit Analysis and climate change
• 8 Economic modelling of global climate change
• 9 The role of energy prices in global climate change
• 10 Project-based mechanisms: Baselines, additionality and monitoring
• 11 Developing countries and climate change
• 12 The transition to renewable energy