Can we afford the future?The economics of a warming world

Frank AckermanU. N. Committee on Development Policy

November 20, 2007

The latest evidence (IPCC, 2007)

Temperature change (relative to 1980-99)

B1

A1B

A2

2020-2029 2090-2099

Climate policy: two excuses for inaction

• Fake science Temperature extremes have softened … the frequency of

hurricanes has been diminishing ... since 1940, weather satellites, tree ring data, and corrected thermometer readings all agree that climate has not warmed -- even though CO2 levels rose. (Fred Singer)

• Conventional economics …efficient or “optimal” economic policies to slow climate

change involve modest rates of emission reduction in the near term… The optimal rate of emissions reduction is 14 percent in 2015, 25 percent in 2050, and 43 percent in 2100. (William Nordhaus, 2007)

We should tax CO2 at the economically correct level of about two dollars per ton (Bjorn Lomborg, 2007)

Many styles of denial

What will you wear to the apocalypse?

Three ideas about climate economics

1. Our descendents are important

2. Uncertainty is inescapable

3. Some costs are better than others

Discounting the future

years compound present valuefrom now interest

0 $100 $5.20 $0.27

1 $103

2 $106

10 $134

50 $438

100 $1,922 $100

200 $36,936 $100

(at 3% interest or discount rate)

XT = (1+r)T X0 X0 = XT / (1+r)T

Bigger r means compound interest grows faster – and present value shrinks faster!

Why do discount rates matter?

• Present value of $1000 in 2107 At 1.5%: $226 At 3%: $52 At 6%: $3

• Present value of $1000 in 2207 At 1.5%: $51 At 3%: $3 At 6%: $0.01

• At a higher discount rate, it is harder for economics to “see” future costs How much should we do to prevent $1000 of damages 100

or 200 years from now?

• Economic analysis supports active climate policy with 1.5% discount rate – but not with 6% !

The future we’ll never know

Choosing a discount rate

• Market interest rates? Appropriate for short/medium-term private investments Need not apply to long-term public policy

• Will future generations be richer and need less help? If they are poorer, will they need more help?

• Pure impatience: if all generations are equally wealthy, should we discount the future? Is your granddaughter less valuable than your daughter,

because she will be born a generation later? If both are equally valuable, the “pure impatience”

component of discounting should be zero

Three ideas about climate economics

1. Our descendents are important

2. Uncertainty is inescapable

3. Some costs are better than others

Things that won’t happen (soon)

Worst case or average?

• Economic analysis is based on average forecasts• Fears about climate change are often based on

worst-case possibilities• Will the Greenland ice sheet melt?

Complete melting, causing sea level rise of 7 meters, is unlikely in this century

But it becomes more likely as temperatures rise Average: no problem this century Worst case: increasing cause for worry

• Other low-probability catastrophes: same issues West Antarctic ice sheet melting Abrupt release of methane from tundra or clathrates Thermohaline circulation failure in North Atlantic

Why buy insurance?

• People care a lot about unlikely “worst cases” How much time do you leave to get to the airport? Airport security is all about worst case possibilities

• Insurance is not based on average outcomes Probability that you will have a residential fire next year is

much less than 1% Probability that healthy young parents will die next year is

much less than 1% But we buy fire insurance and life insurance!

• Probability of enough warming to guarantee loss of Greenland ice sheet is much greater than 1% Should we buy life insurance for the planet?

“Fat tail” uncertainty• What temperature increase is likely from a doubling of CO2?• Blue curve: normal distribution

Applies when uncertainty is well understood from extensive evidence

• Red curve: “Student’s t”Applies when uncertainty is inferred from limited data – as is necessarily true for climate change

• “Fat tail” uncertaintyExtreme values are much more likely with red curve than with blue

• New economic theory (Martin Weitzman, Harvard):

“Fat tail” uncertainty dominates climate analysis Average effect (peak of curve) is much less important

Normal

Student’s t

Expected temperature change(or climate sensitivity parameter)

probability

Three ideas about climate economics

1. Our descendents are important

2. Uncertainty is inescapable

3. Some costs are better than others

Two meanings of “costs”

• Economic models of climate change are based on cost-benefit analysis Benefits must exceed costs in order to endorse a policy

• Numerous problems with methodology Benefits not meaningfully measured in dollars (value of a

human life, extinction of a species, etc.)• See Ackerman and Heinzerling, Priceless

• One more problem: what do we mean by “costs”? Pure physical losses (storm damages) Investment in different industries than we had planned on

Which costs are larger?

• Hurricane Katrina: $135 billion property damage (more than half uninsured)

• Cost of prevention Dutch seawalls are twice as high as New Orleans levees Cost is a small fraction (10% ?) of the Katrina damages

• Difference in kinds of costs Building higher levees creates jobs Letting storms destroy property does not

• Renewable energy, efficiency, conservation will create new industries, technologies, jobs Not the same industries we would otherwise have chosen to

create Is this a “cost”?

Benefits exceed costs

Costs exceed benefits

Conclusion: a new climate economics

• The future matters Your granddaughter’s life is an important one The discount rate should be low (1.5% or less) Future benefits are worth spending money on today

• Uncertainty is decisive Climate policy is insurance against low-probability (but not

impossible) catastrophic events Certainty will not be achieved until it is too late

• Some costs are well worth paying We are “forced” to invent new industries, technologies, and

job opportunities in energy efficiency, renewable energy, and related technologies

• Get it right, and your grandchildren will thank you for leaving them a liveable world