The Challenge of Global Warming for the Global Economy by agl27658

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									       The Challenge of Global Warming
            for the Global Economy

                          William D. Nordhaus
                             Yale University
                           September 11, 2008

                           World Bank Seminar


Slides are available at http://nordhaus.econ.yale.edu/. Full study is William
Nordhaus, A Question of Balance: Weighing the Options on Climate Change, Yale
University Press, 2008, available in full at author’s web page.



                                                                                1
                      Outline of lecture
1. The science of global warming
2. What is the underlying economic problem?
3. What are the insights of economic integrated
   assessment (IA) models?
4. Major Issues for the Next Round of the International
   Accords (post-Kyoto Protocol)
  -   Impacts
  -   Participation
  -   Taxes v. caps




                                                          2
           CO2 concentrations at Mauna Loa

390

380

370

360

350

340

330

320

310
      60    65   70   75   80   85   90   95   00   05
                                                         3
Instrumental record: global mean temperature index(°C)

                                Global Mean Temperature Anomaly
                                      (Relative to 1900)
                1.2
                              GISS
                1.0
                              Hadley
                0.8

                0.6
    Degrees C




                0.4

                0.2

                0.0

                -0.2

                -0.4
                       1860   1880   1900   1920   1940   1960   1980   2000


                                                                               4
IPCC AR4 Model Results: History and Projections




                        DICE-2007
                        model




                                                  5
What is the economist’s bottom on global warming?
 The fundamental problem is the climate-change externality – a
    “global public good”
 Economic participants (millions of firms, billions of people, trillions
    of decisions) need to face realistic carbon prices if their decisions
    about consumption, investment, and innovation are to be correct.


 1. To be effective, we need a market price of carbon
    emissions that reflects the social costs.
 2. Moreover, to be efficient, the price must be universal
    and harmonized in every sector and country.


 But a major economic question remains: what is the appropriate
   price of carbon? This question is addressed by integrated
   assessment models.
                                                                            6
         Integrated Assessment (IA) Models


What are IA models?
  - These are models that include the full range of cause
  and effect in climate change (“end to end” modeling).

Major goals of IA models:
   Project trends
   Assess costs and benefits of climate policies
   Assess uncertainties and research priorities
   Estimate the carbon price and efficient emissions reductions
      for different goals



                                                                  7
                              Fossil fuel use
                              generates CO2
                                emissions


                        Carbon cycle:
 The emissions-      redistributes around
                   atmosphere, oceans, etc.
climate-impacts-
policy nexus:
                                   Climate system: change
                                in radiative warming, precip,
 The DICE-2007                 ocean currents, sea level rise,…
model
                   Impacts on ecosystems,
                    agriculture, diseases,
                     skiing, golfing, …


                              Measures to control
                            emissions (limits, taxes,
                                 subsidies, …)
                                                              8
        Policy Scenarios for Analysis

1. Baseline. No emissions controls.
2. Optimal policy. Emissions and carbon prices to
    maximize discounted economic welfare.
3. Limit to 2 °C. Climatic constraints with global
    temperature increase limited to 2 °C above 1900
4. Strengthened Kyoto Protocol. Modeled on US proposal
    with rich countries at same time and developing
    countries join after 1 -3 decades.
5. “Ambitious”: Gore/Stern early emissions reductions




                                                         9
                                               Temperature profiles: DICE 2008
                                         6.0
                                                     Base 2007
Temperature increase from 1900 (deg C)



                                                     Strong Kyoto
                                         5.0
                                                     Optimum
                                                     2 degree C limit
                                         4.0         Base 2008


                                         3.0


                                         2.0


                                         1.0


                                         0.0




                                                                                 10
                                     Concentrations profiles: DICE 2008
                              1300
                                        Optimal
                              1200
                                        Baseline
                              1100
                                        <2 degC
                              1000      Strong Kyoto
Carbon concentrations (ppm)




                               900

                               800

                               700
                                                                          Double of
                               600                                        Pre-industrial
                                                                          level
                               500

                               400

                               300




                                                                                    11
                                      Carbon prices for major scenarios
                                    1000
                                                Optimal
                                    900
                                                Baseline
Carbon price (2005 US$ per ton C)

                                    800         < 2 degrees C

                                    700
                                                Strong Kyoto

                                    600

                                    500

                                    400

                                    300

                                    200

                                    100

                                      0
                                           2005 2015 2025 2035 2045 2055 2065 2075 2085 2095 2105



                                                                                                    12
    What do carbon prices mean in practice?


                        Carbon tax,
                           2010       Increase, price of energy, US
                                                    All energy
                          [$/tC]      Gasoline     expenditures

Kyoto: global average      $2           0.2%           0.3%
"Optimal"                  35           3.3%           5.4%
Climate constrained        50           4.8%           7.7%
Gore/Stern                 200         19.0%           30.7%




                                                                      13
         Limitations of DICE Model

•   Version discussed today is global aggregate
    (however, regional model has been developed and is
    being updated).
•   Major uncertainties about many modules
    (particularly future technological change and
    impacts)
•   Many modules are “reduced form” rather than
    structural
•   Enduring controversy and confusion about
    “discounting”




                                                         14
  Major issues for a revised international regime
1. What are the likely impacts of climate change?
2. The economics of participation
3. Cap and trade v. carbon taxes?




                                                    15
         1. The Question of Climate Impacts

Estimating the impact of climate change on society
   is the most treacherous of all areas.
First approximation of climate damages:
  - Relatively minor impacts on market economies of
  “North” for a century (+ 1 percent of output)
  - Likely to have very large impacts on unmanaged
  ecosystems a century out and more




                                                      16
         The Economics of Hurricanes




                                                          17
Source: NOAA, Hurricane Katrina shortly before landfall
                                                                                    Global
                                                                                      intensity




P. J. Webster, G. J. Holland, J. A. Curry, H.-R. Chang, “Changes in Tropical Cyclone Number,
      Duration, and Intensity in a Warming Environment,” Science, Sept. 2005                   18
             Normalized costs of hurricanes, 1950-2008:08

                       .9
                       .8
                       .7
    (% of GDP/year)
      Hurricane cost




                       .6
                       .5
                       .4
                       .3
                       .2
                       .1
                       .0
                        1950   1960   1970   1980   1990   2000   2010
                                             Year


Source: author’s estimates.                                              19
Damage and power for individual hurricanes, 1950-2005
                        4


                        0
     ln (damage/GDP)


                        -4


                        -8


                       -12


                       -16
                          3.6   4.0    4.4    4.8   5.2
                                ln (maximum wind)         20
  Econometrics of hurricane damages (updated to 2008)

“[The] amount of damage increases roughly as the cube of the maximum
    wind speed in storms…” (Kerry Emanuel, Nature, 2005)
“While this may appear to be a relatively insignificant increase, nonlinear
    effects can make even a small increase important in causing damage,
    because damage is proportional to the cube of the wind speed.”
    (Anthes et al, BATIS, 2006)


MAJOR SURPRISE: Super-high elasticity.

(1)       ln(cost/GDP)    8.09 ln (maxwind)  0.023 year
                              (0.66)              (0.0071)
R 2  0.503; N  154; standard errors of coefficients in parentheses


                                                                         21
    Estimated mean damages from global warming, central
                    case and alternative estimates

                                  (1)             (2)           (3)          (4)
                                                Semi-       Change in Estimated
                             Elasticity of   elasticity of tropical sea- increase in
                              damages         maximum         surface       mean
                                w.r.t.       wind speed temperature damages
Case                         windspeed         w.r.t. T     (SST , oC) (% increase)



Central case                      8.0           0.035          2.5         96%

OLS elasticity                    7.2           0.035          2.5         83%
Emanuel semi-elasticity           8.5           0.055          2.5         199%
Conventional damage impact        3.0           0.035          2.5         29%
SST warming since 1950            8.0           0.035          0.4         12%
Higher storm elasticities         8.5           0.125          2.5        2018%



                                                                                  22
       2. The economics of participation
One of the important issues in a climate policy regime is the
  extent of participation :
   - “Free riding” reduces the effectiveness of a policy
   - Free riding makes other countries angry and gives them an
      excuse not to participate.
The excess costs of participation can be estimated as:


(2)    E() ≈ 1-

where  is the participation rate and  the convexity of the cost
  function.



                                                                    23
                                                      Normalized cost as function of participation rate
                                             10
  Cost (as fraction of 100% participation)
                                             9

                                             8

                                             7

                                             6

                                             5

                                             4

                                             3
                                                                                         Top down studies
                                             2
                                                                                         Bottom up studies
                                             1

                                             0
                                                  1   0.9   0.8   0.7   0.6   0.5    0.4    0.3    0.2   0.1
                                                                    Participation rate

Source: IPCC, Fourth Assessment Report, Summary of Mitigation Cost
   Models.
Attrition of Kyoto Protocol: share of global emissions




                                                         25
                                                     Penalty of non-participation in Kyoto Protocol
                                                10
     Cost (as fraction of 100% participation)    9

                                                 8

                                                 7

                                                 6

                                                 5

                                                 4

                                                 3

                                                 2

                                                 1

                                                 0
                                                           Original design       Current participation




Source: Question of Balance                                                                       26
3. Major Policy Approaches for Global Warming
• Internationally harmonized carbon tax – economist’s
  ideal.
• Universal cap and trade – close second if well designed,
  but Kyoto Protocol is not doing well.

____________________________________________

• Regulatory substitutes (CAFE standards, ban on light
  bulbs, …) – very inefficient approaches
• Voluntary measures (carbon offsets) are difficult to
  calculate and verify and probably a useless diversion.


                                                           27
                 Harmonized Carbon Taxes

What are “harmonized carbon taxes”?
   • Raise fossil fuel prices proportional to carbon content
   • All countries would target a comparable tax
   • Level of tax set to meet environmental target
   • Use consumption basis for tax
Many advantages over cap and trade (see slide below)




                                                               28
                Cap and trade v. carbon taxes
1.   The fundamental defect of most quantity regimes is the LACK OF
     CONNECTION between targets (emissions) and objective (climate or
     damages).

2.   QUANTITY LIMITS TROUBLESOME in a world of differential
     economic growth and uncertain technological change.

3.   Because of structure of uncertainty for stock pollutant, emissions taxes
     are MORE EFFICIENT than quantitative standards or auctionable
     quotas. (Weitzman)

4. Quantity-type regulations show EXTREMELY VOLATILE PRICES for
    the trading prices of carbon emissions (see slide).




                                                                           29
                              Price volatility of emissions permits
                     12.0
                                 Price oil
                      8.0        Price SO2 allowances
                                 S&P 500
Price (May 1994=1)




                      4.0
                      2.8
                      2.0
                      1.6
                      1.2

                      0.8


                      0.4
                            94 95 96 97 98 99 00 01 02 03 04 05
                                                                      30
                Cap and trade v. carbon taxes
5. Tax-type mechanisms or auctions have advantage because they raise
    revenues and have potential for REDUCING DEAD-WEIGHT LOSS OF
    TAXATION.

6. Quantity-type systems with international trading are much more
    SUSCEPTIBLE TO CORRUPTION than price-type regimes.

7. The international cap and trade is a RADICAL AND UNPROVEN
    APPROACH, whereas taxes have been used in every country of the
    world.

All these emphasize the difficulty of reaching an effective and efficient
   mechanism for global public goods.




                                                                            31
                           Final thoughts




 ankind in spite of itself is
nducting a great geophysical
periment, unprecedented in
man history.”
Roger Ravelle (1957)




                                            32

								
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