The Challenge of Global Warming for the Global Economy - GFDRR

The Challenge of Global Warming
for the Global Economy
William D. Nordhaus
Yale University
September 11, 2008
World Bank / GFDRR Seminar Series
Slides are available at http://nordhaus.econ.yale.edu/ and “www.
gfdrr.org”. 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

CO 2 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)
1.2
1.0
0.8
Global Mean Temperature Anomaly
(Relative to 1900)
GISS
Hadley
Degrees C
0.6
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
The emissionsclimate-impactspolicy
nexus:
The DICE-2007
model
Carbon cycle:
redistributes around
atmosphere, oceans, etc.
Impacts on ecosystems,
agriculture, diseases,
skiing, golfing, …
Climate system: change
in radiative warming, precip,
ocean currents, sea level rise,…
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
Temperature increase from 1900 (deg C)
6.0
5.0
4.0
3.0
2.0
1.0
Base 2007
Strong Kyoto
Optimum
2 degree C limit
Base 2008
0.0
10

Concentrations profiles: DICE 2008
1300
Carbon concentrations (ppm)
1200
1100
1000
900
800
700
600
500
Optimal
Baseline
< 2 deg C
Strong Kyoto
Double of
Pre-industrial
level
400
300
11

Carbon prices for major scenarios
Carbon price (2005 US$ per ton C)
1000
900
800
700
600
500
400
300
Optimal
Baseline
< 2 degrees C
Strong Kyoto
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
[$/tC]
Gasoline
All energy
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
Source: NOAA, Hurricane Katrina shortly before landfall
17

Hurricane cartoon
NOAA
18

Napatree point, Watch Hill, RI
September
20, 1938
September
22, 1938
Source: Newsweek, The Great Hurricane of 1938.
19

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
20

Normalized costs of hurricanes, 1950-2008:08
.9
.8
.7
Hurricane cost
(% of GDP/year)
.6
.5
.4
.3
.2
.1
.0
1950 1960 1970 1980 1990 2000 2010
Year
Source: author’s estimates.
21

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)
22

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)
2
R = 0.503; N = 154; standard errors of coefficients in parentheses
23

Estimated mean damages from global warming, central
case and alternative estimates
Case
(1) (2) (3) (4)
Semielasticity
Change in
of tropical sea-
maximum surface
wind speed temperature
w.r.t. T (SST , oC)
Elasticity of
damages
w.r.t.
windspeed
Estimated
increase in
mean
damages
(% 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%
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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(π) ≈ π 1-β
where π is the participation rate and β the convexity of the cost
function.
25

Cost (as fraction of 100% participation)
10
9
8
7
6
5
4
3
2
1
0
Normalized cost as function of participation rate
Top down studies
Bottom up studies
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
27

10
Penalty of non-participation in Kyoto Protocol
Cost (as fraction of 100% participation)
9
8
7
6
5
4
3
2
1
0
Original design
Current participation
Source: Question of Balance 28

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.
29

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)
30

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).
31

Price volatility of emissions permits
12.0
8.0
Price oil
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
32

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.
33

Final thoughts
ankind in spite of itself is
nducting a great geophysical
periment, unprecedented in
man history.”
Roger Ravelle (1957)
34