Global CO2 Reductions: Domestic and International Consequences

April 1995

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by Dr. Alan S. Manne, Professor Emeritus of Operations Research at Stanford University

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This Special Report, prepared in advance of the first Conference of The Parties, which meets March 28-April 7, 1995 in Berlin, assesses the likely costs associated with taking drastic action to reduce carbon dioxide (CO2) emissions. This issue arose as countries attempted to implement the Framework Convention on Climate Change, which 160 nations signed in Rio de Janeiro, Brazil in June 1992. In his paper, Professor Manne concludes that "an aggressive CO2 abatement policy is unwarranted for the near term." Such action, Manne points out, could result in annual losses equal to 1.0 to 2.5 percent of U.S. Gross Domestic Product (GDP) and hinder OECD (Organization for Economic Cooperation and Development) countries' competitiveness in such basic industries as chemicals, steel, aluminum, petroleum refining, and mining. Professor Manne does not discount the possibility of global warming, but he notes that CO2 buildup is not likely to cause a near-term rise in global temperatures. The most prudent course of action for the next several decades, he argues, is a " hedging strategy" that delays taking strong measures to reduce CO2 emissions until more is known about specific risks to the environment. "Even after 2020," he says, "there would still be enough time to adapt the global economy to a sharp decline in carbon emissions if we learn that such action is warranted."

CO2 Reduction Proposals

Under a typical proposal for greenhouse gas abatement, the United States and other industrialized OECD nations would unilaterally agree to stabilize their carbon emissions between 1990 and 2000, reduce them to 80 percent of this level by 2010, and stabilize them thereafter. Under this proposal, low-income developing nations would be allowed to increase their emissions through 2020, but would thereafter be expected to participate in global stabilization efforts.

Abatement Costs: The Impact on the United States

Using a computer model known as Global 2100 to add together the costs of price-induced energy conservation and also the costs of shifting to low-carbon fuels, we can calculate the direct annual losses due to this type of agreement. By 2000, the costs in the United States approach 1 percent of the GDP, and after 2020 the costs rise to nearly 2.5 percent, as shown in Figure 1. Other investigators have used somewhat different types of computer models, but have arrived at broadly similar quantitative results.

Figure 1 Annual U.S. GDP Losses Due to Carbon Limit

In percentage terms, the costs to the United States of CO2 abatement appear modest. Recall, however, that the GDP is an astronomical number. With the possible exception of health care, almost any program looks small in relation to the GDP. The United States today is spending about 2 percent of its GDP on all forms of environmental protection: air, water, and solid waste disposal. Until a consensus is reached on both the benefits and the costs of CO2 abatement, it is difficult to argue the need for drastic immediate measures to achieve global emissions stabilization. A slower and more deliberate approach might make better sense.

Abatement Costs: Loss of OECD's Trade Competitiveness

From a political perspective, the impact of CO2 reduction on individual industries is perhaps even more significant than the impact on the economy as a whole. This would be particularly troublesome in the case of a unilateral agreement. As a first step toward a global agreement, it is often suggested that the OECD countries (the United States, Canada, Japan, Australia, New Zealand, and Western Europe) take the lead, and that we adopt unilateral measures to reduce carbon emissions.

In any sector where energy inputs are significant (say, 5 to 20 percent of production costs), a unilateral agreement to limit carbon emissions would have serious impacts on our international competitiveness. These sectors include basic industries such as steel, aluminum, copper, petroleum refining, and petrochemicals production. Furthermore, coal is the most carbon-intensive of our fossil fuels, and this could virtually wipe out any prospects for coal exports from the United States.

Moreover, CO2 reduction could lead to major changes in the location of energy-intensive manufacturing industries. Strains would be placed upon trade pacts such as the General Agreement on Tariffs and Trade (GATT) and the North American Free Trade Agreement (NAFTA). Domestic producers would call for protection and subsidies. A high value would be placed on Washington area ("Inside-the-Beltway") specialists with expertise in estimating the direct and indirect carbon content of internationally traded goods.

Despite the apparent enthusiasm of the European Community for CO2 abatement, these industries have been remarkably successful in lobbying for exemptions from the Community's proposed carbon taxes. In the absence of such exemptions, the OECD's energy-intensive manufacturing industries would tend to move offshore to nonparticipants such as China, India, and Brazil. The resulting increase of carbon emissions in those nations would partially offset the reductions undertaken unilaterally by the OECD countries.

Costs and Benefits of Global Abatement

Global warming poses a potential threat to all nations, not just to the United States. Our descendants will be affected not only by the United States' actions, but by those of other major carbon emitters. The impact of five different policies for controlling CO2 emissions is shown in Figure 2. These strategies are based on a five-region description of the world: the USA, other OECD nations, the former USSR, China, and all other nations combined.

The top line of Figure 2 shows how emissions might evolve under a business as usual (BAU) scenario. Conventional oil and gas become exhausted sometime during the twenty-first century, but they are replaced by coal and shale-based synthetic fuels. Sometime later, the world could also run out of coal, and this is why the BAU emissions path eventually trends downward. The second and third lines show what might happen if we were to introduce modest emission taxes (U.S. $5 per ton of carbon) during the next few decades, but have them rise at a sufficiently rapid rate to encourage price-induced conservation and to discourage any shift toward carbon-based synthetic fuels. In place of synthetic fuels, we would eventually turn to high-cost renewables and to unconventional energy carriers such as hydrogen.

Figure 2 Global Carbon Dioxide Emissions

The two lowest emission scenarios describe much more aggressive policies designed to limit climate change. One is a proposal for stabilizing global emission flows at their 1990 levels, the second is still more ambitious: it represents a proposal for stabilizing the stocks of CO2. Concentrations are to be limited to 415 parts per million by volume (ppmv), just a bit higher than the current level of 350 ppmv.
The carbon taxes implied by each of the five alternative policies toward reducing CO2 emissions are shown in Table 1. For orientation purposes, it is worth noting that a carbon tax of U.S. $120 per ton would imply a doubling of the price of coal-or an increase of U.S. $.36 per gallon of refined petroleum products. This is the level of carbon tax required to deter synthetic fuels production in 2050.

Table 1Carbon Taxes Implied by Alternative Policies (1990 dollars per ton of carbon)
Policy200020102020 20502100
Business as usual (BAU)00 000
Delayed tax001333
Early tax581357656
Stabilize CO2 emissions158115133114121
Stabilize CO2 concentrations165275445568522

Both of the aggressive stabilization policies would entail substantial near-term adjustment costs. What are their potential benefits? In order to estimate the benefits, it is typical to rely on general circulation models (GCM). Our simulations show that the aggressive stabilization policies (lines 4 and 5 in Figure 2) would have little impact until 2050 and thereafter. It would not be until the end of the twenty-first century that our descendants would note much difference between these policies and those that are closer to the BAU scenario. In terms of costs and benefits, how does this add up? Abatement costs would have a high impact in the first half of the twenty-first century. The benefits would not be realized until the second half and beyond. At anything like a conventional 5 percent real cost of capital, it is hard to see how the uncertain and distant-future benefits could outweigh the relatively near-term costs.

The global costs and benefits of the four policies that employ taxes to reduce CO2 emissions are shown in Figure 3. The costs of abatement are shown below the line (as negative quantities), and the benefits are shown above the line (as positive quantities). The costs and benefits shown in Figure 3 represent the views of mainstream economic analysis on CO2 abatement. A delayed tax is the only one of these five policies for which the benefits exceed the costs of abatement.

Figure 3 The Present Value of Global Benefits and Costs of CO2 Emission Reduction in 1990 Dollars*

Responding to Uncertainty: A Hedging Strategy

In designing a global emission reduction strategy, it is important to realize that any of our current projections can be wrong.

There are two types of potential errors: (1) premature commitment to costly abatement strategies, and (2) belated attempts to adapt to rapid climate change. The debate is enlivened but not necessarily illuminated by rhetoric on "an irreversible ecological catastrophe" versus "the staggering costs of reducing emissions." Suppose instead we take the view of an insurance purchaser who knows that the climate experts are deadlocked on the chances of a global calamity if we follow a BAU policy. What steps would it be sensible to take today in order to reduce the risks to future generations?

We can use decision theory to select a rational course of action in the face of uncertainty. There are two ways to think about this type of decision problem. In both, there are just two possible outcomes: a favorable and an unfavorable one. One is an upside possibility, and the other is a downside risk. The "learn-then-act" (LTA) approach assumes that we have the opportunity to learn whether the state of the world is favorable or unfavorable before taking action. An alternative way of looking at things is characterized by the phrase "act-then-learn" (ATL). For illustrative purposes, it is assumed that global CO2 uncertainties are resolved sometime shortly after 2020. Prior to 2020, the energy sector's supply and conservation investment decisions must be made under uncertainty about the importance of limiting carbon emissions. Thereafter, the uncertainties are resolved.

For simplicity, suppose that there are just two long-term possibilities: In the favorable case, a global catastrophe will not occur unless the world experiences a 10C increase from 1990 levels. In the unfavorable case, it will occur with only a 3C increase. By a catastrophe, we mean that the world would be willing to allocate its entire GDP to avoid, say, large-scale melting of the polar ice caps.

If the 3C scenario occurs and no corrective actions are taken, there could be a global catastrophe sometime around 2100. Most observers would assign a low probability to this high-consequence event. For illustrative purposes, suppose that this probability is 5 percent. With only two possible outcomes, this means that we would then assign a 95 percent probability to the case in which it takes a 10C increase to lead to global catastrophe.

Figure 4 shows global carbon emissions under the two approaches: LTA (learn-then-act) versus ATL (act-then-learn). Along the dashed lines (LTA:10 and LTA:3), we make all decisions in full knowledge of whether catastrophe would occur at 10C (topmost line) or at 3C (bottom line). The solid forked path (ATL) shows what happens when the outcome remains unknown through 2020. This leads to a hedging strategy that lies somewhere between the two extreme cases shown along the dashed lines, probably much closer to the LTA:10 scenario.

Figure 4 Global Carbon Emissions Under Learn-Then-Act (LTA) and Act-Then-Learn (A


Since global temperatures are not likely to rise significantly during the next several decades, an aggressive CO2 abatement policy is unwarranted for the near term. Such policies, if implemented, could cost many hundreds of billions of dollars. Even after 2020, there would still be enough time to adapt the global economy to a sharp decline in carbon emissions if we learn that such action is warranted.