Economics Of Climate Change Research Paper

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There are two sides to the economics of climate change. The ﬁrst recognizes the economic costs and potential beneﬁts that can be attributed to the physical and natural impacts of a changing climate—warmer temperatures, changes in precipitation patterns, rising sea level, and so on. These economic impacts include the cost of adapting to change in addition to the economic consequences that remain after such adaptation is eﬀected. They also include the beneﬁts that climate change might bring that would otherwise not have been forthcoming. The second side recognizes the economic costs that would be attributed to policies designed to mitigate climate change. These costs, too, include the cost of adapting to policy in addition to the residual consequences that persist in the wake of this adaptation.

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Estimates of the economic impacts on both sides are highly uncertain, given our inability to understand fully the science of climate change and to look many decades into the future with any clarity. Estimates of both are also evolving continuously over time, so any estimate must be read with a sense of what was known at the time that it was published. The coverage oﬀered here will provide some insight into this evolution even as it reports on the latest results that were available at the turn of the twentieth century.

1. The Economic Cost Of Climate Change Impacts

Costs associated with the impacts of climate change are generally judged in terms of economic damage that would be avoided if the change did not occur; beneﬁts are similarly estimated in terms of fortuitous impact that otherwise would not have happened. The Inter-governmental Panel on Climate Change (IPCC) re-ported preliminary estimates of the annual economic impact of a doubling of concentrations of greenhouse gases ( -550 ppmv) and an associated 2.5 C increase in global mean temperature (Houghton et al. 1996). The estimates reported by the IPCC for the United States, for example, ranged from a low of $55.5 billion (1990$) oﬀered by Nordhaus (1991) to a high of $139.2 billion (1990$) authored by Titus (1992). The low and high estimates were calculated to be 1.0 percent and 2.5 percent of anticipated gross domestic product in 2065, respectively. The year 2065 was chosen as a benchmark because that was when the speciﬁed doubling of concentrations was anticipated to occur.

All of the estimates reported in 1995 by the IPCC were dominated by declines in agricultural production. Agriculture is, of course, a sector whose current practices would likely be threatened by higher temperatures and less precipitation. Most of the estimates for agriculture and other sectors were, however, the result of vulnerability studies that paid little attention to the ability of humans and their institutions to reduce economic damage and expand economic opportunity by adapting—that is, by changing practices so that they became less vulnerable to the new climate or so that they could take greater advantage of its appearance. Moreover, most of these early studies relied on relatively primitive methods of tracking the diﬀerent regional consequences of a 2.5°C warming. Global climate modelers have long expected that some regions would see temperatures increase by more than 2.5°C while others might actually get cooler. Some areas would get wetter while others get drier. Seas would rise in some places and actually fall more slowly elsewhere (where the coastline is actually rising at present). Finally, few of the early studies were able to consider the eﬀects of changes in humidity, frequency of extreme temperature events, or any of the other more subtle physical ramiﬁcations of global warming.

More recent cost estimates have begun to overcome these shortcomings. Table 1 presents regional cost estimates of market impacts published by Mendelsohn et al. (2000) for a 2°C warming and a 50 cm increase in sea level. Notice that the overall annual eﬀect on world economic activity, a 0.3 percent reduction, is much smaller than in the earlier studies. Eﬀects on agriculture still dominate, but the regional distribution of impacts is striking. Some regions, notably North America and Europe, are now seen to beneﬁt from warming whereas others such as Africa are severely harmed. These results were based on a statistical approach that looked carefully at how various regions cope with their current climates to see how other regions might respond if their climates changed.

Table 2 gives estimates from Tol (1998) for a 1°C warming in even geographical greater detail. Only Latin America and southern and southeast Asia suﬀer losses in his work, and many regions (including Africa) beneﬁt substantially. Modest warming might, it would seem, be a good thing. Indeed, Mendelsohn et al.’s work also supports this suggestion. Tol’s results do, however, oﬀer a warning about leaping to that conclusion too quickly. Two columns in Table 2 report standard deviations for his estimates. The standard deviation is a measure of uncertainty that indicates roughly a 66 percent likelihood that the true impact of a modest 1°C warming would lie within a range of plus or minus the standard deviation from the recorded ﬁgure. For example, then, Tol suggests roughly a 66 percent likelihood that the annual impact of a 1°C warming on the Paciﬁc members of the OECD would lie between a 0.1 percent loss (=1.0–1.1) in gross domestic product (GDP) and a 2.1 percent gain in GDP. Given current understanding of climate and economic systems, therefore, there is roughly a 17 percent chance that GDP would climb by more 2.1 percent and a 17 percent chance that GDP would fall by more than 0.1 percent of GDP. There is also a 17 percent chance that the economic damage suﬀered by southern and southeast Asia in the wake of a 1°C warming would be larger than 2.8 percent of GDP. The size of the uncertainty within which impact estimates must be contemplated is still enormous, and the distributional ramiﬁcations of this uncertainty can be quite unsettling.

The role of adaptation and learning how to in-corporate physical impacts other than temperature is clearly demonstrated in Table 3. Regional estimates oﬀered by four other scholars plus Tol are depicted there for a 2.5°C temperature increase. Some include adaptation—switching crops, adjusting planting dates, adding or eliminating irrigation, adjusting fertilizer practices, and so on; others do not. Some include the fertilizing eﬀect on plant productivity of higher carbon dioxide concentrations in the atmosphere, while others do not. Notice that carbon dioxide fertilization can turn damages into beneﬁts and that adaptation can reduce damage and increase beneﬁts. Indeed, all of Tol’s estimates with adaptation represent gains. Be warned, though, that he still reports enormous ranges of uncertainty surrounding them.

Finally, all of these results envision smooth if not predictable climate change. The real concern on the impacts side could, however, be the potentially exaggerated eﬀects of sudden, surprising and perhaps irreversible consequences of warming. Economic systems never cope well with sudden changes in their environment, even if the changes are ultimately beneﬁcial. As a result, the estimates quoted above could be dwarfed if the physical impacts of climate change are not smooth. Yohe and Schlesinger (1998) computed the economic cost of sea level rise on the developed coastline of the United States with and without suﬃcient foresight for markets to response to the threat of inundation. The diﬀerence between the two, one estimate under the best of circumstances of the extra cost of surprise, was as large as 100 percent even for sea-level rise trajectories in the middle of its own range of uncertainty.

2. The Economic Cost Of Mitigating Climate Change

The scale and pace of climate change can be inﬂuenced by policy interventions that slow the emission of greenhouse gases. Many researchers have investigated the cost of this sort of climate change mitigation. They have, in particular, focused their attention on energy consumption and the resulting emission of carbon dioxide. Carbon dioxide is a product of burning fossil fuel, and its emission varies from fuel to fuel. Burning coal, for example, emits 25 percent more carbon per unit energy than burning oil, and burning oil emits 43 percent more than natural gas. Burning hydrogen emits no carbon. Hydroelectric, wind, solar, and nuclear power are similarly carbon-free sources of energy. Mitigation simply involves substituting carbon-free sources of energy for carbon-based fuels and low-carbon fossil fuels such as natural gas for high-carbon fuels such as coal. Our ability to eﬀect and to sustain this sort of substitution over the very long run depends upon the availability of new technology and the supply of low-carbon and carbon-free sources of energy.

The most eﬀective means of conveying the cost of mitigation is to track the economic impact of reducing cumulative global emissions through the year 2100 from ‘baseline’ levels that would have been anticipated in the absence of any policy intervention. Fig. 1 displays reductions in cumulative emissions from various baselines through the year 2100 against the estimated tax (marginal cost) that would have to be imposed per ton of carbon to achieve those reductions. The points portrayed there indicate selected estimates published by various researchers through the middle of 1998, and the curve summarizes these cost data as a function of percentage emissions reduction. Fig. 1 shows clearly that the marginal cost of emissions reduction increases at an increasing rate even though the taxes estimated for any particular reduction in emissions are disperse. This dispersion is a reﬂection of the uncertainty with which these costs can be computed—uncertainty caused by assumptions about technology, supplies, and the intensity with which future economic activity would employ energy along the baseline.

2.1 Interventions That Limit Atmospheric Concentrations

The Framework Convention on Climate Change (FCCC) committed the globe in 1992 to holding concentrations of greenhouse gases below levels that would prevent ‘dangerous anthropogenic interference with the climate system.’ The precise concentration target that corresponds with this imperative has not yet been identiﬁed, so many researchers have investigated the economic cost of reducing emissions over the next 100 years so that concentrations do not exceed a range of thresholds. Manne and Richels (1997) estimate that the cost of achieving the most popular threshold, 550 ppmv, could be as high as $3.5 trillion (1990$) or as low as $650 billion (1990$). Estimates from other researchers were comparable; but they diﬀered from one another for the same reasons as mentioned above. Costs for lower thresholds such as 450 ppmv are much higher. However, some possible low-emissions baselines achieve stable concentrations around 750 ppmv without any intervention of any kind.

Cost estimates for meeting concentration thresholds depend critically on the timing and location of each unit of emissions reduction. Wigley et al. (1996) have called the ‘where’ and ‘when’ ﬂexibility components of cost. Their ‘WRE’ results emphasize that costs would be minimized if each ton of emissions reduction were taken from the least costly source regardless of where it is located. Their results also required that emissions should be reduced at any point in time only if the present value of the associated cost is in line with all other reductions at all other times. Compared with emissions reductions suggested by the IPCC (see Houghton et al. 1992), the combined eﬀect of exploiting both types of ﬂexibility allowed the ‘WRE’ path to cut the cost of achieving the same 550 ppmv threshold from the same middle emissions baseline by more than 80 percent.

The ‘WRE’ results are controversial because ‘when’ ﬂexibility implies that early reductions in emissions would be smaller than they would under the IPCC proposal. As a result, the near-term pace of climate change would be larger. Meanwhile, ‘where’ ﬂexibility has served as an anchor for a wide range of proposals that would allow countries to trade permits to emit greenhouse gases. The idea here is that an emerging market for permits would work to ensure that least cost sources of reductions were always exploited.

It is diﬃcult to contemplate near-term mitigation in the absence of any knowledge about the appropriate concentration target and without any real under-standing about whether future baseline emissions will be relatively high or low. Yohe and Wallace (1996) looked as this problem as one of hedging. Policy directed at a low threshold along a high-emissions path would be far more vigorous in the near-term than a policy directed at a high threshold along a low-emissions path. Either would be in error, though, if either the presumed target or the presumed emissions path turned out to be incorrect. As a result, adopting either would impose extra cost on the global economy. Yohe and Wallace reported that least-cost hedging would support focusing on a middle concentration target such as 550 ppm and assuming that emissions would otherwise track slightly higher than commonly accepted ‘best-guess’ baseline. This sort of hedging would increase the costs of meeting a concentration target, but only modestly under the assumption of maximum geographical and intertemporal ﬂexibility.

2.2 The Kyoto Emissions Reduction Protocol

The Third Conference of the Parties of the FCCC agreed in 1997 through the Kyoto Protocol to impose a set of greenhouse gas emissions targets for the world’s developed countries (the so-called Annex I or Annex A countries). The targets were diﬀerent for diﬀerent countries, but their combined eﬀect would reduce total emissions from Annex I countries by nearly 6 percent relative to their 1990 levels and almost 20 percent from their 1999 levels by 2012. Non-Annex I countries were exempted by the Protocol from any emissions reduction.

Subsequent research has raised a large number of issues in regard to achieving any eventual FCCC concentration limit. Some are technical and deal with accounting procedures for counting emissions reductions. Others are more fundamental. First among these is the observation that full compliance by Annex I by 2012 with ﬁxed total Annex I emissions thereafter will not stabilize concentrations at any level for most baselines. It follows that non-Annex I countries will eventually have to accept limits on their emissions, as well, if the FCCC objective of stable concentrations is to be achieved. Indeed, a 550 ppmv threshold would not be achieved along many baselines even if Annex I eliminated all dependence on fossil fuel by the middle of the twenty-ﬁrst century.

Second, Annex I compliance with their Kyoto targets by 2012 does not conform with the cost-minimizing pattern of maximal intertemporal ﬂexibility for most baselines and most concentration targets. Passing through the Kyoto benchmark increases the cost of meeting any threshold above 500 ppmv along all but the most energy intensive baselines.

Finally, negotiations about how to arrange for geographic ﬂexibility within the implementation of the Kyoto Protocol are critical. The equity and cost implications of allowing ﬂexibility with Annex I and/or the ability for Annex I countries to be credited for reductions that they underwrite in non-Annex I countries are enormous. McKibben and Wilcoxen (1999) have argued that changes in the so-called ‘terms of trade’ caused by massive transfers of wealth to non-Annex I countries in exchange for emissions reduction credits could actually lower their economic welfare. In addition, Manne (1999) observed that the partial global coverage of the Protocol could lead to signiﬁcant ‘leakage’ so that global emissions might not fall as far as expected. Why? Because restricted emissions in Annex I would cause the prices of fossil fuels to fall and thereby increase emissions across the developing world.

2.3 Optimal Emissions Reductions

Nordhaus (1991) was the ﬁrst researcher to weigh the present value of the beneﬁts of mitigation policy against the present value of their costs to compute an economically optimal policy trajectory over the long term. His results were based on the anticipation that impacts would be smooth and amount to roughly 1 percent of gross world product if the global mean temperature rose by 2.5 C. Corroborated by his own subsequent work and by others, they support modest early intervention followed by smooth and gradual tightening of emissions restrictions. Indeed, most optimality exercises propose carbon taxes between $10 and $20 around 2000; and most see those taxes increasing over time at 3 percent per year. None of the results achieve stable atmospheric concentrations along most baselines, and none come close to the restrictions imposed on 2012 emissions by the Kyoto Protocol.

3. Synthesis As The Future Unfolds

Synthesizing the economics of climate change and climate policy is an evolving process that will continue well into the twenty-ﬁrst century. As researchers learn more about both, the costs associated with both could easily fall. However, they may not, particularly on the climate side of the calculus. The possibility of sudden and, as yet, unanticipated impacts could change the picture dramatically.

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