Insight two confronting costs and benefits
For better public policy decisions, it is useful to evaluate the benefits and costs of climate protection actions or inaction is unavoidable. Economics frames climate protection in benefit-cost terms because scarce resources — natural, physical and human — make it so. By costs, we mean what society forgoes to pursue climate policy. By benefits, we mean the gains from reducing climate change risks by lowering emissions or by enhancing the capacity for adaptation (see e.g. Sohngen and Mendelsohn 1997). Benefits and costs assessment provides policy makers with data to make more informed decisions in setting the stringency of a mitigation policy and deciding how much adaptation infrastructure to create (Chapter 7 takes this up in more detail). Some critics worry that economic benefit-cost analysis might downplay the need for climate protection. But in practice, decision makers use benefit-cost analysis in combination with other concerns about equity and fairness. Decision makers also bring their own judgments about the relevance, credibility and robustness of benefit and cost information and about the appropriate degree of climate change and other risks that society should bear.
The argument for considering benefits and costs is that policy deliberations are better informed if good economic analysis is provided.
The potential benefits from climate protection involves estimating what is avoided — more severe weather patterns, hobbled ecosystems, less biodiversity, less potable water, loss of coastal areas, rises in mean temperature, more infectious diseases such as malaria and cholera. Climate change might actually benefit agriculture and forestry with longer growing seasons and more fertilization. These gains (or losses) can be categorized into four broad sets of increasing difficulty to quantify: the avoided losses to market goods and services, non-market goods, catastrophes, and ancillary effects from less use of fossil fuels (e.g. less air pollution).
Researchers have estimated the impact on Gross World Product from climate change at around 1 or 2 per cent (see Shogren 1999). Even if we include the potential non-market damages, the market and non-market benefits might be at most about 2 per cent of GDP. These impacts are neither trivial nor likely to cause the next global depression. The most significant affect the benefits of protection would be to prevent a sudden catastrophe like a structural change in ocean currents or the melting of the Western Antarctic ice sheet that people cannot adapt to with enough speed.
Estimates of climate protection costs range from modest — 0.5 per cent loss of global GDP, to an 'economic disarmament' — 3 per cent of GDP. For example, the Clinton Administration estimated the costs to the US to meet current emission targets are 'likely to be modest' if reductions are efficiently pursued with domestic and international emissions trading, joint implementation, and the Clean Development Mechanism (a system in which developed nations can buy the carbon reductions in developing nations). By modest, the report means an annual GDP drop of less than 0.5 per cent (roughly US$10 billion dollars); no expected negative effect on the trade deficit; increased gasoline prices of about 5 per cent; lower electricity rates; and no major impacts on the employment rate. But other estimates suggest that the US GDP could take an annual hit of nearly 3 per cent, the trade deficit would increase by billions of dollars; gasoline prices would increase by 50 per cent; electricity prices would nearly double; and two million US jobs would disappear. The net global costs have been estimated at over US$700 billion, with the US bearing about two-thirds of those costs.
The benefits and costs of international cooperation depend on three key elements that underlie climate protection: the real risk of a catastrophe, the degree of flexibility and the origins of technological advance. If one believes catastrophe is imminent, emission reductions cannot come soon enough. If you do not, it is hard to justify the likely costs of emission targets without global emission trading. The degree of flexibility affects costs. Flexibility is determined by the emission trading system, the number of nations participating and whether carbon sinks are included. A stringent, inflexible carbon policy will induce greater economic burden than a loose, flexible policy, since more flexibility allows firms greater agility to search out the lowest-cost alternatives. Estimates suggest that any agreement without the flexibility provided by trading will at least double the costs.
Economic theory has also addressed the idea that the costs of climate protection might be amplified by the existing tax system (for example, Goulder 1995). Labour and capital taxes distort behaviour because they reduce employment and investment levels below what they would have been otherwise. If we add on a carbon tax that discourages consumption and production, we further reduce employment and investment, which then exacerbates the labour and capital tax distortions, maybe by as much as 400 per cent. One could reduce these extra costs by channelling the revenue from the carbon tax, if any existed, to reduce the labour and capital taxes.
The costs of climate protection also depend on the creation, adoption and diffusion of new low-carbon technologies. Engineers argue that many technologies exist today that would reduce emissions at low to no extra costs, e.g. 'no regret' technologies. Economists argue that while these technologies might exist, people will not adopt them if they are too pricey or if other factors feature in their choice beside low-carbon output. Even if new technologies are available, people do not switch unless a price change induces them to switch. People behave as if their time horizons are short, perhaps reflecting their uncertainty about future energy prices and the reliability of the technology. The high initial investment costs also slow down adoption, e.g. replacing all the lights in your house at once with low-energy bulbs.
Regarding the question of ancillary benefits note that reducing carbon emissions is an activity with joint products: protection from climate change and reduced emissions of local air pollutants (see e.g. Lutter and Shogren 2002). The value of one product, reduced emissions of local air pollutants, varies with the stringency and nature of other local pollution control measures. Optimal controls on carbon emissions also depend on such measures. As a result, the optimal geographic distribution of carbon emissions reductions cannot be determined by international markets for carbon emissions permits because these generally reflect only the market cost of reducing carbon, not the extent or value of the ancillary emissions reductions. The size of ancillary benefits depends critically on the flexibility and stringency of local air pollution regulations and international emission trading. In general, international carbon emission trading ignores the ancillary benefits that might arise from local pollutant emissions. Moreover, departures from optimality in local pollution control imply that restricting emissions trading can actually increase the welfare of some countries. And since local air pollution policies in the US appear to have marginal costs many times greater than marginal benefits, the optimal tariff on carbon permit imported into the US, if one wants to count ancillary benefits, could be hundreds of dollars.
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