Developing a Framework for Short- and Long-Run Decisions on Climate Change PoliciesOctober 1995
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by W. David Montgomery, Vice President, Charles River Associates. This report is based on a paper prepared for a September 13, 1995 policy conference sponsored by the American Council for Capital Formation Center for Policy Research, and appears in the Center's recently published monograph, An Economic Perspective on Climate Change Policies.
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Recent economic studies of the costs and benefits of reducing greenhouse
gas emissions call into question the approach to climate policy outlined
in the Berlin Mandate. These studies suggest strongly that imposing near-term
goals for emission reductions represents a costly and potentially unnecessary
approach to climate policy. Montgomery advocates an economically rational
approach to climate change policies that addresses three related questions:
(1) What actions can be supported on the basis of current understanding
of climate science and economics; (2) How to make the best use of the new
information that current scientific research and technology development
will provide; and (3) When should emission reductions begin? Montgomery
argues that the Berlin Mandate prejudges all these issues by concentrating
on near-term targets for emissions from industrial countries. He also argues
that "Specific policies and measures must be evaluated, not general
goals. No goal can be assessed without specifying the policies likely to
be used to achieve it."
|Figure 1||Benefits and Costs of Emissions Control|
If the costs of reductions in emissions rise rapidly when emissions are reduced, and if damages from further increases in emissions rise slowly when emissions are increased, then the policy with maximum net benefits will entail relatively small emission reductions-optimal emissions would be at point B. If costs rise slowly when emissions are reduced, but damages rise rapidly when emissions are increased, the opposite is true. Optimal emissions would then be at point A, where large emission reductions are required to achieve maximum net economic benefits. Different conclusions about the likely magnitude of costs and avoided damages lead to different decisions about mitigation strategies. Improved information about the relative worth of large or small reductions in emissions helps avoid incorrect decisions about costs.
The Timing Issue
Climate scientists believe that concentrations of greenhouse gases in the atmosphere have a greater influence on global equilibrium temperatures than do emissions in any given year. Since integrated assessment models can deal explicitly with the connections between emissions, concentrations, and climate effects, a second use of integrated assessment is to analyze questions about when emission reduction policies have their greatest impact at the least cost.
Prominent researchers in integrated assessment models T. Wigley, R. Richels, and J. Edmonds report a remarkable result. For a wide variety of climate goals, it is less costly to allow emissions to rise for a decade or more-following the baseline-and then to make sufficiently large reductions in later years to achieve the climate objective, than it is to begin with emission limits (see Figure 2). Dramatic near-term emission reductions are not warranted.
|Figure 2||Least-Cost Emission Profiles|
There are three major reasons why delay in reducing emissions reduces costs. First, funds devoted to capital investment with a positive return allows greater reduction in emissions in the future than devoting those funds to emission reductions today. Second, future costs will be lower than current costs because it is more costly to make efficiency or emissions changes on existing equipment than to make the same changes when equipment is being replaced at the end of its normal life. Third, it takes time to develop technologies that make possible use of carbon-free energy sources at reasonable cost.
Specific Policies Must be Evaluated
Specific policies and measures must be evaluated, not general goals. Command and control approaches to emission reductions can cost much more than the broadly based economic incentives generally assumed in cost studies. Targeted efforts to reduce market imperfections may produce economic benefits and some emission reductions, but their actual impacts on emissions are impossible to estimate with current data and economic models. With this wide range of possible costs, depending on what policies are chosen, no goal can be assessed without specifying the policies likely to be used to achieve it.
Moreover, other countries have not attained the emission reduction goals they announced several years ago. If the United States does act to carry out its commitments but other countries do not, it is unlikely that the United States will receive benefits commensurate with its costs. Commitments to implement specific policies can be monitored more easily and in a more timely fashion than promises to achieve future goals.
Carbon Contributions of Different Regions
Figure 3 illustrates the problem of omitting countries from the Berlin Mandate. Over the next century the share of responsibility for emissions will be very different from what it was in the past. The United States and other OECD countries will be responsible for only about 25 percent of cumulative emissions over the next century, and the United States alone for only about 10 percent. Unless the developing countries participate, it would be impossible to hold global emissions to current levels even if the OECD countries were removed from the picture entirely.
|Figure 3||Relative Contributions of Different Regions to Global Carbon Emissions|
|Source: A.S. Manne and R.G. Richels (1992), Buying Greenhouse Gas Insurance: The Economic Costs of CO2 Emission Limits, Cambridge, MA: MIT Press.|
The International Free-rider Problem
Table 1 illustrates a hypothetical climate change policy in which all countries participate, at a cost of 2 percent of the country's GDP, and all countries receive benefits in the form of reduced climate change damage equivalent to 2 percent of GDP. Such a policy would be just acceptable, as an economic proposition, for the world as a whole. If only OECD countries (Annex I) participate, benefits would be reduced by 75 percent to 0.5 percent of GDP for each country. Nonparticipating countries get a free ride-they receive benefits but bear none of the costs. Under the assumptions of this example, if only the United States followed the policy, benefits to the United States would be only 0.2 percent of GDP. Thus, a policy that might be acceptable to the United States (or other group of countries accounting for 10 percent of emissions through 2100) if all countries participated on an equal basis turns out to have costs 10 times as large as the benefits if that policy is adopted unilaterally. This is the classic public goods problem, in which it is impossible to exclude countries from the benefits of the policy change.
The Hypothetical International Free-rider Problem|
|Participating Countries||Costs to Participants||Benefits to Participants|
|Entire World||2.0% of GDP||2.0% of GDP|
|Annex I (25% of emissions to 2100)||2.0% of GDP||0.5% of GDP|
|United States (10% of emissions to 2100)||2.0% of GDP||0.2% of GDP|