Introduction

This chapter continues our inquiry into whether benefit cost (BC) is an appropriate tool for setting global-warming policy. It considers the controversial and related issues of discounting and social weighting. Underlying the discounting debate is a central question: Given that damages will extend over centuries, does the very process of discounting inevitably rule out strong action today to limit global warming? Underlying the social weighting debate is another central question: If we discount the consumption of future generations because they may be richer than us, should we not also weight the losses to the poor more heavily than losses to the rich?

The structure of the chapter is as follows. After some preliminaries, we review the descriptive and prescriptive approaches to the discount rate. Next we examine the so-called Ramsey equation, which underpins most of the global-warming discount literature. The final section considers “social” or “equity” weighting of costs and benefits.

Almost two decades ago, the UNFCCC set as its primary objective the stabilization of atmospheric CO2 at levels that avoid dangerous interference in the climate system. That effort is now tottering. The previous chapter establishes both the need for and the difficulties in reaching a comprehensive and effective international agreement on climate change. The time frame for doings so is narrowing. Emissions reduction obligations under Kyoto expire at the end of 2012 and there is no comprehensive and binding arrangement to take its place. Moreover, the window for attaining moderate concentration and temperature targets is closing.

In the period before the 2009 Copenhagen meeting, many proposals for a post-Kyoto agreement were floated. These ranged from a fully elaborated, gradually implemented cap-and-trade system setting forth emission targets for all countries and all decades (Frankel 2010) to a strategy of supporting “climate accession deals” that would contribute to developing countries’ interests and emission reduction, but which need industrial countries’ financial, technical, or administrative support (Victor 2010). All of these proposals need rethinking in light of outcomes at Copenhagen.

This chapter is for readers who are not familiar with the basic facts of climate change and climate change policy. The Fourth Assessment Report (AR4) of the Intergovernmental Panel on Climate Change (IPCC), released in 2007, provides comprehensive information. It consists of a Synthesis Report and reports from three working groups: WG I (The Physical Science Basis), WG II (Impacts, Adaptation, and Vulnerability), and WG III (Mitigation of Climate Change). The fifth Assessment Report is due in 2014.

The Science

The scientific basis of climate change is well established, although many quantitative relations are subject to great uncertainty. Briefly, certain gases emitted into the atmosphere change the earth’s energy balance by allowing incoming shortwave solar energy to enter but inhibiting exit of longwave energy. The result is that increases in the concentration of these gases in the atmosphere change the energy balance, resulting in a rise in temperature.

Conclusions

There is no “atmospheric economics” distinct from “terrestrial economics.” Analyzing global warming requires the standard economic tools. But because of the unique characteristics of climate change – the time frame, the uncertainty, and the global aspects – some tools have been sharpened or redesigned to meet new challenges. The clearest examples are in discounting, policy under profound uncertainty, integrated modeling of economic and environmental systems, environmental policies using market incentives, policies in second-best contexts, and the economics of global public goods. In addition, value judgments and thus ethical issues permeate global warming economics to an unusual extent and are reflected in the literature.

How successful has economics been in answering the three questions that form the structure of the book? The answers are mixed. Benefit cost (BC) is the main approach to determining how warm is too warm. Its origins in building dams and bridges with public funds are far removed from climate change, and its weaknesses in this latest assignment are easy to document. The main ones are the uneasy relations between efficiency and equity, discounting over many generations, which is a novel task for BC, and the limited ability to accommodate profound uncertainty. These weaknesses are compounded by long-standing difficulties in monetizing environmental effects and in using social weighting. The last is of special importance in light of current and prospective inequities in the international distribution of income and the disproportionate damages to be borne by poor countries.

The policy process typically identifies objectives, establishes targets, and selects tools or instruments to attain the targets. This chapter is mainly concerned with the tools for achieving climate policy objectives and targets. This involves a discussion of the putative advantages of market-friendly tools that use incentives and disincentives to limit greenhouse gas emissions versus regulatory tools. It also involves evaluating the three main types of market-oriented tools: taxes, cap-and-trade schemes, and subsidies. Before starting this discussion, however, it is useful to compare two types of emissions targets. As described in Chapter 9, both types are found in the Copenhagen Accord commitments and are causing some confusion.

Absolute versus Intensity Targets

Emissions of greenhouse gases are the control variable in climate policy. Emissions targets can be set in absolute quantities or in relative terms. Absolute targets are expressed in tons of CO2e and can be set at the sector, national, or global level. Relative targets are commonly known as intensity targets and are set at either the sector or national level. We are mainly interested in national-level absolute targets and in national-level intensity targets expressed per unit GDP – that is, tons of emissions per million dollars of GDP.

Introduction

The laws of physics give de facto property rights to greenhouse gas emitters. The doctrine of state sovereignty leaves control up to individual countries. Although the elegant Coase Theorem suggests that this does not have to be a barrier to negotiating efficient levels of mitigation, the international market for cooperation appears dysfunctional. This chapter provides some partial answers as to why this is so. The subsequent chapter assesses current climate negotiations.

Climate change is a global “public bad” and preventing climate change is a global “public good.” We start with a brief conceptual discussion of these terms. This leads to the conclusion that coordinated international action, presumably through a post-Kyoto international environmental agreement (IEA), is needed. But it also highlights the serious difficulties involved. The next section considers the objectives, timing, and especially the participation in such an agreement. This may be thought of as the willingness to cooperate. A combination of carrots and sticks may encourage that willingness. The necessity for cooperation arises from the need to minimize the cost of greenhouse gas abatement and the rapidly closing window for aggressive climate policy. The case for inclusion of medium and large developing countries (and the United States) in mitigation efforts is compelling. Even with carrots and sticks, however, there appears to be a mismatch between the need for and the willingness to cooperate.

This chapter examines the points at which climate and climate policy intersect with the international trade system. The issue of trade and environment dates to the 1972 United Nations Conference on the Human Environment (Stockholm Conference), and the publication in the same year by the OECD of its “Guiding Principles” concerning the international economic aspects of environmental policies. At that time, the principal concerns were the effects of environmental regulations on trade: the competitive impact of differences among countries in pollution abatement stringency; the use of environmentally related product standards as covert trade barriers; and the appropriate use of trade measures to induce or coerce trade partners into altering their environmental practices. Subsequently, an additional concern was added – the effects of international trade on the environment, and more specifically for us, the effects of trade on global warming. All of these concerns are very much with us today in the debate on trade and global warming policy.

This chapter starts with the more recent issue first – the effect of trade and trade liberalization on climate change. It then takes up the important and controversial issue of the impact of global warming policies on international competitiveness, and the related carbon leakage question. The following section examines carbon labeling, “food miles,” and related issues. The final sections consider permit trading and the so-called Dutch disease, as well as the manipulation of international trade in emissions permits.

This chapter marks a transition from our initial concern with the role of benefit cost (BC) analysis of mitigation to a broader focus on policy responses to climate change. The portfolio of responses starts with accelerated economic development and includes adaptation, a closer look at supply policy, technology, and extreme technology in the guise of geo-engineering. Each can add a useful element to the set of responses but mitigation (abatement) remains the center piece.

The Development Option

An argument can be made that the single most cost-effective response to global warming is accelerated economic development concentrated in poor countries. As discussed in Chapter 3, this strategy has a basis in efficiency and in ethics. Many (not all) economic studies suggest that in the near term, the return to investment in mitigating global warming is trumped by returns to more conventional development investments – physical infrastructure, health, education, and focused research and development. Investments that build productive capacity in developing countries also meet ethical concerns. They help alleviate poverty in the near term and help compensate future generations for climate damages by leaving them a larger productive base. Perhaps most important, all of the adaptation literature demonstrates that the capacity to adapt to higher temperatures is far greater in rich countries than in poor developing countries.

This chapter describes how numbers used in benefit cost (BC) analysis materialize and are assembled. They are not simply plucked from the air, but they are not as solid as we would like, either. Our purpose is not an exhaustive description, but rather to convey the flavor of the process. We start with a brief introduction to Integrated Assessment Models (IAMs), the main tool for empirical investigation of climate policy. At the center of IAMs are damage functions that identify the impacts of climate change and attempt to put monetary values on them. Damage functions are the spline that joins the science and economics of climate change. We then dig down one level to understand where the numbers in two specific impact areas, agriculture and sea-level rise, come from. The costs of global warming include adapting to higher temperatures as well as residual damages. We continue by reviewing some recent attempts to estimate adaptation costs. Finally we look into a specific proposed response to global warming – forestry policy – from the perspective of BC analysis.

Integrated Assessment Models

All climate IAMs have two basic features. They are designed to illuminate the interconnected physical, biological, and socioeconomic elements of climate change. They are also designed to assist in policy formation. IAMs come in two flavors: policy evaluation models (simulation models), and optimization models. The first assesses the physical, ecological, or economic effects of an exogenously proposed climate policy. The second seeks out an endogenously derived optimal policy to maximize welfare or minimize cost. Optimization models generally are less detailed and less complex than policy evaluation models so as not to exceed computational constraints. While simplification involves a cost, it assists in transparency and understanding.

Benefit-cost (BC) analysis comes in two flavors. The standard, “vanilla” flavor examines the monetized costs and benefits of a project or policy. If the benefits exceed the costs, the project is cleared to proceed. This approach, however, is best suited for projects for which there is only one feasible scale or level of intensity. More frequently, there is a choice of scale, and the objective is to maximize net benefits. This more exotic flavor implies two analytical steps – to calculate the scale or intensity where marginal (incremental) benefits equal marginal (incremental) costs, and then to check that at this scale, benefits exceed costs.

Benefit-cost analysis of global warming policy is done using both approaches. Some studies select a target in terms of greenhouse gas emission levels, atmospheric concentrations, or temperature change, and calculate the costs and benefits of attaining the target. In contrast, some studies attempt to calculate the level of emissions such that marginal abatement costs equal marginal benefits, and social welfare is maximized. This latter approach is more difficult as it requires knowledge of costs and benefits over a range of abatement levels. Whichever approach is taken, the least-cost, or most cost- effective, available abatement measures should be examined and selected. And whichever approach is used, costs and benefits should be converted to the same time period, implying discounting.

Scope and Focus

Global warming is the environmental issue of the twenty-first century. Many believe it ranks with war and poverty as one of the greatest challenges to human well-being. But unlike war and poverty, which humanity has confronted for millennia, global warming is a recent concern. And unlike war and poverty, global warming is mainly a prospective threat and one that can in principle be met with pre-emptive action.

Understanding and responding to global warming requires many scientific disciplines including meteorology, climatology, and oceanography; the full array of biological and ecological sciences; and the engineering disciplines. But while science is a necessary component of policy, it is not sufficient.