Some global economics

So far our attempt to balance uncertainty against the need for action has been considered in terms of issues. Is it possible to carry out the weighing in terms of cost? In a world that tends to be dominated by economic arguments, quantification of the costs of action against the likely costs of the consequences of inaction must at least be attempted. It is also helpful to put these costs in context by comparing them with other items of global expenditure.

The costs of anthropogenic climate change fall into three parts. Firstly, there is the cost of the damage due to that change; for instance, the cost of flooding due to sea level rise or the cost of the increase in the number or intensity of disasters such as floods, droughts or windstorms, and so on. Secondly, there is the cost of adaptation that reduces the damage or the impact of the climate change. Thirdly, there is the cost of mitigating action to reduce the amount of climate change. The roles of adaptation and mitigation are illustrated in Figure 1.5. Because there is already a commitment to a significant degree of climate change, a need for significant adaptation is apparent. That need will continue to increase through the twenty-first century, an increase that will eventually be mollified as the effects of mitigation begin to bite. Mitigation is beginning now but the degree of mitigation that is eventually undertaken will depend on an assessment of the effectiveness and cost of adaptation. The costs, disadvantages and benefits of both adaptation and mitigation need therefore to be assessed and weighed against each other.

The models providing estimates of cost need to include all aspects of the climate change issue, for instance, interactions between the factors driving climate change and its impacts both on humans and ecosystems, human activities that are influencing those factors and the response to climate change both of humans and ecosystems - in fact all the elements illustrated in Figure 1.5. This process is often called Integrated Assessment (see box below) and is supported by Integrated Assessment Models (IAMs) that address all the relevant elements in as complete a manner as possible.

At the end of Chapter 7, estimates of the cost of damage from global warming were presented. Many of these estimates also included some of the costs of adaptation; in general adaptation costs have not been separately identified. Many of these cost estimates assumed a situation for which, resulting from human activities, the increase in greenhouse gases in the atmosphere was equivalent to a doubling of the carbon dioxide concentration - under business-as-usual this is likely to occur around the middle of the twenty-first century. The estimates were typically in the range 1% to 4% of GDP for developed countries. In developing countries, because of their greater vulnerability to climate change and because a greater proportion of their expenditure is dependent on activities such as agriculture and water, estimates of the cost of damage are greater, typically in the range 5% to 10% of GDP or more. It was also pointed out in Chapter 7 that the cost estimates only included those items that could be costed in money terms. Those items of damage or disturbance for which money is not an appropriate measure (e.g. the generation of large numbers of environmental

The Rio Declaration 1992

The Rio Declaration on Environment and Development was agreed by over 160 countries at the United Nations Conference on Environment and Development (the Earth Summit) held in Rio de Janeiro in 1992. Some examples of the 27 principles enumerated in the Declaration are as follows.

Principle 1 Human beings are at the centre of concerns for sustainable development. They are entitled to a healthy and productive life in harmony with nature.

Principle 3 The right to development must be fulfilled so as to equitably meet developmental and environmental needs of present and future generations.

Principle 5 All States and all people shall cooperate in the essential task of eradicating poverty as an indispensable requirement for sustainable development, in order to decrease the disparities in standards of living and better meet the needs of the majority of the people of the world.

Principle 7 States shall cooperate in a spirit of global partnership to conserve, protect and restore the health and integrity of the Earth's ecosystem. In view of the different contributions to global environmental degradation, States have common but differentiated responsibilities. The developed countries acknowledge the responsibility they bear in the international pursuit of sustainable development in view of the pressures their societies place on the global environment and of the technologies and financial resources they command.

Principle 15 In order to protect the environment, the precautionary approach shall be widely applied by States according to their capabilities. Where there are threats of serious or irreversible damage, lack of full scientific certainty shall not be used as a reason for postponing cost-effective measures to prevent environmental degradation.

Principle 16 National authorities should endeavour to promote the internalisation of environmental costs and the use of economic instruments, taking into account the approach that the polluter should, in principle, bear the cost of pollution, with due regard to the public interest and without distorting international trade and investment.

refugees) also need to be exposed and taken into account in any overall appraisal.

The longer-term damage, should greenhouse gases more than double in concentration, is likely to rise somewhat more steeply in relation to the concentration of carbon dioxide. For quadrupled equivalent carbon dioxide concentration, for instance, estimates of damage cost of the order of two to four times that for doubled carbon dioxide have been made - suggesting that the damage might follow something like a quadratic law relative to the expected temperature rise.15 In addition the much larger degree of climate change would considerably enhance the possibilities of singular events (see Table 7.4), irreversible change and of possible surprises. The Stern Review (see box in Chapter 7 on page 227) estimates the cost of continuing with business-as-usual beyond 2100 as equivalent to a reduction of 5-20% in current per capita consumption now and for ever with a strong likelihood that it will be in the upper part of that range and with disproportionate losses tending to fall on poorer countries.

Since the main contribution to global warming arises from carbon dioxide emissions, attempts have also been made to express these costs in terms of the cost per tonne of carbon as carbon dioxide emitted from human activities. This is known as the social cost of carbon. A simple but crude calculation can be carried out as follows. Consider the situation when carbon dioxide concentration in the atmosphere has doubled from its pre-industrial value, i.e. when an additional amount of about 5500 Gt of CO2 (1500 GtC) from anthropogenic sources has been emitted into the atmosphere (see Figure 3.1 and recall that about half the carbon dioxide emitted accumulates in the atmosphere). This carbon dioxide will remain in the atmosphere on average for about 100 years. Assuming a figure of 3% of global world product (GWP) - or 2000 billion per year - as the cost of the damage due to global warming in that situation, and assuming also that the damage remains over the 100 years of the lifetime of carbon dioxide in the atmosphere, the cost per tonne of CO2 turns out to be about $US36.

Calculations of the cost per tonne of carbon can be made with much more sophistication by considering that it is the incremental damage cost (that is, the cost of the damage due to one extra tonne of carbon emitted now) that is really required and also by allowing through a discount rate for the fact that it is damage some time in the future that is being costed now. Estimates made by different economists produced for the IPCC 1995 Report ranged from about $US1.5 to $US35 per tonne of CO2 ($US5-125 per tonne C).16 For the 2007 Report, the range of estimates is even greater, the very large range being due to the different assumptions that have been made.17

The estimates are particularly sensitive to the discount rate that is assumed; values at the top end of the range have assumed a discount rate of less than 2%; those at the bottom end have assumed a discount rate of 5% or more.18 The dominant effect of the discount rate will be clear when it is realised that over 50 years a 2% discount rate devalues costs by a factor of about 3 while a 5% rate discounts by a factor of 13. Over 100 years the difference is even larger - a factor of 7 for a 2% and a factor of 170 for a 5% rate. Amongst economists there has been much debate but no agreement about how to apply discount accounting to long-term

Integrated Assessment and Evaluation

In the assessment and evaluation of the impacts of different aspects of global climate change with its large complexity, it is essential that all components are properly addressed. The major components are illustrated in Figure 1.5. They involve a very wide range of disciplines from natural sciences, technology, economics and the social sciences (including ethics). Take the example of sea level rise - probably the easiest impact to envisage and to quantify. From the natural sciences, estimates can be made of the amount and rate of rise and its characteristics. From various technologies, options for adaptation can be proposed. From economics and the social sciences, risks can be assessed and evaluated. The economic costs of sea level rise might be expressed, for instance, most simply as the capital cost of protection (where protection is possible) plus the economic value of the land or structures that may be lost plus the cost of rehabilitating those persons that would be displaced. But in practice the situation is more complex. For a costing to be at all realistic, especially when it is to apply to periods of decades into the future, it must account not only for direct damage and the cost of protection but also for a range of options and possibilities for adaptation other than direct protection. The likelihood of increased storm surges with the consequent damages and the possibility of substantial loss of life need also to be addressed. Further, there are other indirect consequences; for instance, the loss of fresh water because of salination, the loss of wetlands and associated ecosystems, wildlife or fisheries and the lives and jobs of people that would be affected in a variety of ways. In developed country situations rough estimates of the costs of some of these components can be made in money terms. For developing countries, however, the possible options can less easily be identified or weighed and even rough estimates of costs cannot be provided.

Integrated Assessment Models or lAMs are important tools for Integrated Assessment and Evaluation. They represent within one integrated numerical model the physical, chemical and biological processes that control the concentration of greenhouse gases in the atmosphere, the physical processes that determine the effect of changing greenhouse gas concentrations on climate and sea level, the biology and ecology of ecosystems (natural and managed), the physical and human impacts of climate change and the socioeconomics of adaptation to and mitigation of climate change. Such models are highly sophisticated and complex although their components are bound to be very simplified. They provide an important means for studying the connections and interactions between the various elements of the climate change problem. Because of their complexity and because of the non-linear nature of many of the interactions, a great deal of care and skill is needed in interpreting the results from such models.

A number of the components of impact, even for the relatively simple situation of sea level rise, cannot be readily costed in money terms. For instance, the loss of ecosystems or wildlife as it impacts tourism can be expressed in money terms, but there is no agreed way of setting a money measure for the longer-term loss or the intrinsic value of unique systems. Or a further example is that, although the cost of rehabilitation for displaced people can be estimated, other social, security or political consequences of displacement (e.g. in extreme cases the loss of whole islands or even whole states) cannot be costed in terms of money. Any appraisal therefore of impacts of anthropogenic climate change will have to draw together components that are expressed in different ways or use different measures. Policy-and decision-makers need to find ways of considering alongside each other all the components that need to be aggregated in order to make appropriate judgements.14

problems of this sort or about what rate is most appropriate. However, as Partha Dasgupta points out, 'the disagreement is not about economics nor about social cost-benefit analysis nor even about the numeracy of fellow scientists',19 but is in fact more fundamental. He explains that the effects of carbon emissions could bring such large negative perturbations to future economies that the basis is threatened on which discount rates for future investment are set. Further, there are the likely damages that cannot easily be valued in money terms such as the large-scale loss of land - or even of whole countries - due to sea level rise or the large-scale loss of habitats or species. For these, even if valuation is attempted, discounting seems inappropriate. The Stern Review also believes discounting to be inappropriate and argues that the welfare of future generations should be considered on the same basis as the welfare of the current generation.20 This is an example of an ethical question raised by the discounting process. Professor John Broome of Oxford points out that discounting is not only concerned with economics but also brings into play ethical questions that cannot be avoided - although they are frequently ignored.21 If discount rates are to be applied at all to cost estimating for climate change, there seem cogent arguments that a smaller discount rate rather than a larger one should be employed. And in any case, for any cost estimate that is made the discount rate used should be adequately exposed.

After a thorough discussion of the factors influencing the social cost of carbon, the Stern Review, working with the PAGE 2002 IAM and a business-as-usual (BAU) scenario, estimates its value as around $US85 per tonne of CO2.22 The Review also points out that the social cost of carbon will rise with time (as damage increases with time) and at any one time is dependent on the future emissions trajectory (Figure 9.3); for a stabilisation scenario (see Chapter 10, page 311), for instance at 550 ppm CO2e it would be considerably less at around $US30 per tonne of CO2e and at 450 ppm CO2e about $US25 per tonne CO2e. For our broad economic arguments in later chapters we shall use estimates of the social cost of carbon in the range $US25 to $US50 per tonne CO2e.

To slow the onset of climate change and to limit the longer-term damage, mitigating action can be taken by reducing greenhouse gas emissions, in particular the emissions of carbon dioxide. The cost of mitigation depends on the amount of reduction required in greenhouse gas emissions; large reductions will cost proportionately more than small ones. It will also depend on the timescale of reduction. To reduce emissions drastically in the very near term would inevitably mean large reductions in energy availability with significant disruption to industry and large cost. However, less drastic reductions can be made with relatively small cost through actions of two kinds. Firstly, substantial efficiency

Social cost of carbon

Marginal abatement costs

Technical progress in ahaternent

Social cost of carbon

Marginal abatement costs

Technical progress in ahaternent

Time

Emissions reductions

Figure 9.3 The social cost of carbon, marginal abatement costs and emissions reductions. Up to the long-term stabilisation goal, the social cost of carbon will rise over time because marginal costs do so. This is because damage costs tend to rise more rapidly than global average temperature. Abatement costs are illustrated schematically in the right-hand part of the figure. Over time, technical progress will reduce the total cost of any particular level of abatement, so that at any given price there will be more emission reductions. The dashed lines illustrate how the path for the social cost of carbon drives the extent of abatement.

Time

Emissions reductions

Figure 9.3 The social cost of carbon, marginal abatement costs and emissions reductions. Up to the long-term stabilisation goal, the social cost of carbon will rise over time because marginal costs do so. This is because damage costs tend to rise more rapidly than global average temperature. Abatement costs are illustrated schematically in the right-hand part of the figure. Over time, technical progress will reduce the total cost of any particular level of abatement, so that at any given price there will be more emission reductions. The dashed lines illustrate how the path for the social cost of carbon drives the extent of abatement.

gains in the use of energy can easily be achieved, many of which would lead to cost savings; these can be put into train now. Secondly, in the generation of energy, again proven technology exists for substantial efficiency improvements and also for bringing into use sources of energy generation that are not dependent on fossil fuels. These can be planned for now and changes made as energy infrastructure is replaced or new infrastructure constructed. The next two chapters will present more detail about these possible actions and how they might be achieved.

What about the cost of mitigation? Much of it will arise in the energy or transport sectors as cheap fossil fuels are replaced by other energy sources that, at least in the short term, are likely to be more expensive. Some detail is provided in the next chapter of the profile of emissions reductions required to stabilise concentrations of greenhouse gases in the atmosphere at different levels especially at 550 or 450 ppm CO2e (for definition of equivalent carbon dioxide, i.e. CO2e, see Chapter 6, page 147). To stabilise at 550 ppm CO2, a reduction by 2050 of global carbon dioxide emissions back to about 1990 levels would be required (Figure 10.3). The Stern Review estimates the annual cost to the developed world economies of such reductions will be around 1% of GDP.23 As quoted by Stern and by the IPCC, estimates from all sources of this annual cost span a range from minus 1% to around 4% with a mean of about 1%. This large range signifies the large uncertainties in the assumptions that have to be made. As might be expected, the cost is substantially dependent on the target level of carbon dioxide concentration stabilisation. For a 450 ppm stabilisation level the mitigation costs will be higher and a reduction by 2050 of global carbon dioxide emissions by about 60% from 1990 levels will be required. For levels in the range 445 to 535 ppm CO2e the IPCC AR4 report24 cites estimates of less than 5.5% of GDP for mitigation costs by 2050. With typical levels of economic growth being between 2% and 4% per year, the cost of achieving reductions to meet any stabilisation levels mentioned, even as low as 445 ppm CO2e, is less than the equivalent of about two years' economic growth over 50 years.

Although the economic studies on which these estimates are based have taken into account many of the relevant factors, they are bound to be surrounded by substantial uncertainty - as is illustrated by the large range in the estimates quoted. Some of the more difficult factors to take into account are some that contribute to lower costs25 such as the economic effects of introducing new low-emission technologies, new revenue-raising instruments, adequate inter-regional financial and technology transfers and likely future innovation. For the last of these, it is not easy to peer into the crystal ball of technical development; almost any attempt to do so is likely to underestimate its potential. For these reasons the estimates of mitigation cost are almost certainly on the high side.

How do these mitigation (or abatement) costs compare with the damage costs we listed earlier? Compared with the damage costs assuming a BAU trajectory with no significant action being taken this century, they are much less. They are more comparable with the likely damage cost for lower scenarios. However, recalling the warnings, for instance in the Stern Review, that monetary estimates only represent part of the story of the damage costs, mitigation costs appear modest compared with the likely overall damage if little or no mitigating action is taken. The right-hand part of Figure 9.3 is a schematic showing curves of marginal abatement cost (the cost of reducing by one unit of emissions at the margin). These curves rise with emissions reductions as the reductions that are cheaper to achieve will be carried out first. The figure illustrates how abatement cost might be related to the social cost of carbon. However, in practice because of the large uncertainties in future estimates both of damages and abatement costs, factors in addition to money cost estimates will tend to determine the extent of mitigation that is planned or achieved.

However, it should be noted that, even if the carbon dioxide concentration is stabilised at 450 ppm CO2e, the world will have been committed to a very significant degree of climate change, bringing with it substantial costs and demands for adaptation. What is being mitigated is further and even more damaging climate change.

Nature's view of the key meeting to finalise the second IPCC report. Scientific integrity and political and environmental agendas met to thrash out and finally agree on the report, the results of which fed into the Kyoto Protocol. Left to right: Professor Bolin (first Chair of IPCC), myself, and Dr Gylvan Meira of Brazil, (Co-Chair of the science working group in 1995) are taking the temperature of a sick Earth with a clinical thermometer!

Nature's view of the key meeting to finalise the second IPCC report. Scientific integrity and political and environmental agendas met to thrash out and finally agree on the report, the results of which fed into the Kyoto Protocol. Left to right: Professor Bolin (first Chair of IPCC), myself, and Dr Gylvan Meira of Brazil, (Co-Chair of the science working group in 1995) are taking the temperature of a sick Earth with a clinical thermometer!

In considering the costs of the impacts of both global warming and adaptation or mitigation, figures of a small percentage of GDP have been mentioned. It is interesting to compare this with other items of expenditure in national or personal budgets. In a typical developed country, for example the United Kingdom, about 5% of national income is spent on the supply of primary energy (basic fuel such as coal, oil and gas, fuel for electricity supply and fuel for transport), about 9% on health and 3-4% on defence. It is, of course, clear that global warming is strongly linked to energy production - it is because of the way energy is provided that the problem exists - and this subject will be expanded in the next two chapters. But the impacts of global warming also have implications for health - such as the possible spread of disease - and for national security - for example, the possibility of wars fought over water, or the impact of large numbers of environmental refugees. Any thorough consideration of the economics of global warming needs therefore to assess the strength of these implications and to take them into account in the overall economic balance.

So far, on the global warming balance sheet we have estimates of costs and of benefits or drawbacks. What we do not have as yet is a capital account. Valuing human-made capital is commonplace, but in the overall accounting we are attempting, 'natural' capital must clearly be valued too. By 'natural' capital is meant, for instance, natural resources that may be renewable (such as a forest) or non-renewable (such as coal, oil or minerals).26 Their value is clearly more than the cost of exploitation or extraction.

Other items, some of which were mentioned at the end of Chapter 7, such as natural amenity and the value of species, can also be considered as 'natural' capital. I have argued (Chapter 8) that there is intrinsic value in the natural world -indeed, the value and importance of such 'natural' capital is increasingly recognised. The difficulty is that it is neither possible nor appropriate to express much of this value in money. Despite this difficulty, it is now widely recognised that national and global indicators of sustainable development should be prepared that include items of 'natural' capital and ways of including such items in national balance sheets are being actively pursued.

Guide to Alternative Fuels

Guide to Alternative Fuels

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