|July-August 1996 vol. 21, number 4|
A newsletter published by the American Council for Capital Formation
Capital Formation Forum: Senate Majority Leader Outlines Legislative Goals
Capital Formation Forum: Deputy Treasury Secretary Summers Stresses Need to Address Saving Deficit
Issue Brief: The Appropriate Timing of Greenhouse Gas Emission Reductions
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Characterizing his legislative agenda as "minimalist," the new Senate Majority Leader observed that a key issue before adjournment is budget reconciliation. "I hold out the possibility that we may get a budget agreement we can live with, that will be good for the country, and that will help Senator Dole's presidential campaign." He added that he hoped to avoid a repeat of the 1995 budget stalemate that twice caused a partial shutdown of the federal government.
"We also need to continue our efforts to make the tax code more fair," he noted. "Two issues I hope to address in the budget this year are the child credit and capital gains tax cuts."
"Right now, I have a clean slate and I want to write positive things on it," Senator Lott said of his new role. "We have some real challenges ahead and many demands on us, but we are going to make serious and aggressive efforts to find consensus and achieve our goals."
Elected to the Senate in 1988, Trent Lott rose rapidly in the leadership ranks. He was elected Secretary of the Senate Republican Conference in 1992, Majority Whip in 1995, and Majority Leader on June 12, 1996. He served in the U.S. House of Representatives from 1972-88, where he was as Republican Whip from 1980-88. Return to Beginning
|Figure 1||Alternative Emission Time Paths Evaluated by Richels and Edmonds (Source: Richels and Edmonds 1995)|
Richels and Edmonds also estimate the costs of these alternative paths using two different models of long-term energy-economy interactions: Global 2100 and the Edmonds-Reilly-Barns Model (ERB). Figure 2 shows the alternative estimates of the costs of the three emission trajectories. Although the absolute estimates differ, the fundamental finding is the same. Stabilizing emissions at 1990 levels is by far the most costly strategy. Shifting emission reductions to the later years reduces the present value of overall costs substantially, although they are still large in absolute terms. Relative to immediate stabilization, the path labeled 500a reduces estimated costs by about 50 percent according to the Global 2100 model and about 30 percent according to the ERB model.
|Figure 2||Richels and Edmonds' Estimates of the Costs of Alternative Time Paths to a 500 ppmv Concentration (Source: Richels and Edmonds 1995)|
Benefit-Cost Analyses of Alternative Time Paths
The cost-effectiveness analyses discussed in the previous section take a target concentration of CO2 (or temperature) as given for some future year and then compare the costs of alternative paths to reach that goal. That approach avoids the difficult task of estimating the damages (or benefits, in at least some regions) that may be caused by global climate change. However, the cost-effectiveness approach suffers from two important limitations:
Several studies by scholars such as William Nordhaus, Alan Manne, Richard Richels, S. Peck, and T. Teisberg have attempted to avoid these limitations by adopting a broader benefit-cost framework that accounts for benefits as well as costs over time. Despite the differences in approach, these studies come to the same fundamental conclusion: optimal policies do not impose near-term freezes or reductions in emissions, but rather take a more flexible approach.
For example, a recent book by Nordhaus (1994) estimated the costs and benefits of different emission paths for slowing or arresting the rate of global climate change. The cost components of the model are based upon a detailed set of economic relationships. The benefit estimates are based upon geophysical relationships that link emissions of CO2 and other greenhouse gases, atmospheric concentrations of these gases, average temperature change, and damages from global climate change. Nordhaus uses his model to evaluate alternative approaches to climate change policy and to find the policy that maximizes the present value of estimated global net benefits. Return to Beginning
Nordhaus' book is notable for its explicit treatment of the large uncertainties that surround estimates of the costs and benefits of slowing climate change. It is useful to begin by looking at his "best case," one in which Nordhaus determines the time path that maximizes predicted net benefits using his best estimates of the uncertain parameter values. Figure 3 plots three emission paths: the one that Nordhaus estimates to be optimal given his "best" estimates, his projection of BAU, and the ubiquitous alternative of freezing emissions at their 1990 level. Nordhaus' optimal path lies well above that followed under the policy of freezing emissions at 1990 levels. Relative to the BAU line, the reductions under the optimal path are small, rising gradually from just under 9 percent from 1990­p;2010 to a little over 13 percent in the 2070s. The reductions in the first decade include the phaseout of CFCs and the introduction of forestry programs that provide carbon sinks, as well as reductions in CO2 emissions per se. In contrast, although the freeze policy starts off with a 9 percent reduction in CO2 emissions in the 1990s, it rises quickly to 24 percent in 2000-2010 and to 62 percent in the 2070s.
|Figure 3||Comparison of Business-as-Usual (BAU) and Optimal Time Paths Using Nordhaus' Best Estimates of Parameter Values (Source: Nordhaus 1994)|
Policymaking Under Uncertainty
A major problem in designing climate mitigation strategies is that all the estimates of the costs and environmental effects are very uncertain, H&N note. Several studies, including one by Manne and Richels, have analyzed these uncertainties explicitly to see how they affect the optimal policy, and how the possibility of resolving those uncertainties over time should be incorporated into strategies.
According to Manne and Richels, it is unrealistic to think of policy towards greenhouse gas emissions as a one-time decision that can be settled "once and for all." Instead, such policies should be viewed from a long-term perspective, one in which policies can be adjusted over time in response to changing conditions and new information. Choices made today should incorporate the possibility of such future adjustments. Their analysis shows how a rational hedging strategy can help determine policy when the outcome is very uncertain.
Figure 4 shows a situation in which there are two possible future outcomes-the base case and the high damage scenario-and we know which one applies. The dashed lines show the emissions path with such perfect foresight. The upper dashed line shows the optimal emissions path corresponding to the base case, while the lower dashed line shows the optimal path if we knew today that temperature sensitivity and nonmarket damages were both high.
|Figure 4||Carbon Emissions Under Perfect Foresight and Hedging (Source: Manne and Richels 1995)|
In reality, of course, we do not know which outcome will occur, although over time we will gain additional information that will allow us to refine our estimates. For illustrative purposes, Manne and Richels assume that by 2020, we will know whether the high-damage case is correct. In the meantime, what policy is optimal given our uncertainty? With imperfect information about which outcome will occur, the optimal strategy is likely to involve "hedging," picking a path somewhere between the two extremes. Where the optimal path lies within that band depends on various factors, the most important of which is how likely we think it is that the high-damage case will prove to be correct. Because of its extreme nature, Manne and Richels assign it only a 5 percent probability. In that case, the optimal near-term strategy is shown by the solid line in Figure 4. This hedging strategy consists of reducing emissions slightly more than would be optimal under Manne and Richels' base-case assumptions. If we then learn in 2020 which set of assumptions is correct, we can change the policy based on which outcome occurs. If the base-case assumptions are borne out, control efforts can be relaxed a bit, as shown by the rising solid line after 2020. On the other hand, if the high-damage case proves correct, contrary to expectations, then control efforts will have to be tightened significantly, as shown by the falling solid line after 2020.
Conclusion: What Should Be Done Now?
These recent studies reviewed by H&N provide powerful arguments against locking the nations of the world into rigid schedules for freezing or reducing CO2 emissions in the near term. The arguments for avoiding the adoption of rigid emission targets in the near term are even stronger if one takes into account the difficulty of achieving international coordination. The studies summarized in this paper all implicitly assume that the countries of the world act in a unified manner to minimize global costs and maximize global benefits, without regard to the interests of individual countries. Moreover, reductions within each country are assumed to be achieved at the lowest possible cost. In reality, of course, the policies adopted are unlikely to be least-cost, and the world is far from unified on this issue. Few countries are likely to adopt policies that impose large costs on their own citizens to generate potential benefits spread over the world as a whole, H&N conclude.
The problems outlined above with regard to premature commitment to a freeze or other rigid emission schedule do not mean that nothing should be done to address concerns about the possible adverse affects of long-run change in global climate. The studies reviewed here suggest that to the extent that reductions can be achieved through "low-regrets" action, they may be worth making in the near term. The studies that explicitly analyze uncertainty also point to the importance of continued research, not just on potential changes in temperature, but also on other aspects of climate change and technology development.
Finally, countries can develop the institutional capacity to make coordinated decisions on global change. The costs and benefits of policies to affect global climate change are very different for different regions of the world, as well as for different sectors of the world economy. The world community needs to develop mechanisms that take such differences into account while at the same time achieving the gains from coordinated and cost-effective policy choices.
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1. David Harrison, Jr. and Albert L. Nicholas, "Recent Evidence on the Appropriate Timing of Reductions in Greenhouse Gas Emissions," National Economic Research Associates, Cambridge, Mass., July 1996.
Manne, A. and R. Richels. 1995. "The Greenhouse Debate: Economic Efficiency, Burden Sharing and Hedging Strategies." Energy Journal 16(4):1-37.
Nordhaus, W.D. 1994. Managing the Global Commons: The Economics of Climate Change. Cambridge, Mass.: The MIT Press.
Richels, R. and J.A. Edmonds. 1995. "The Economics of Stabilizing Atmospheric CO2 Concentrations." Energy Policy 23(4/5):373-378.
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An intriguing number of international visitors have sought access to ACCF's publications and announcements, including users from Aruba, Australia, Belgium, Canada, China, Costa Rica, Croatia, Denmark, Finland, France, Israel, Japan, Mexico, New Zealand, Philippines, the Russian Federation, Singapore, South Korea, Sweden, Thailand, and the United Kingdom.
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