Economics must be at the heart of any discussion of how to fight climate change.
July 3, 2012
With Responses From
Jul 3, 2012
11 Min read time
Economics must be at the heart of any discussion on climate change
The scientific case on climate change now seems overwhelming: we face an enormous problem and tremendous costs for inaction. The latest science also gives us insight into the magnitude of damage we are risking if we continue to emit greenhouse gases on a business-as-usual basis. If we carry on emitting on this basis, temperature increases by 2035 could well take us outside of human experience, and the costs for disruption to economic and social activity could rise to 20 percent of global GDP. Moreover, to prevent this from happening, stabilization of global emissions would mean cutting annual emissions by at least 25 percent by 2050.
On the brighter side, the cost of stabilization can be limited to around one percent of global GDP a year. But to achieve stabilization at that cost, action over the next few decades is crucial. Like any policy problem, to keep the costs down, it will be necessary to formulate a clear, robust policy framework that uses a mix of instruments (including carbon pricing through trading and taxes, regulation, and technology policy) across sectors and countries in the short and long term. Poorly constructed policy will increase the costs of stabilization.
Action by individual countries is, however, not enough, and it will prove more costly. Climate change is a global problem, and solutions will require coordinated action by rich and poor countries, based on a shared vision of long-term goals and mutually reinforcing approaches at the national, regional, and international level. With a globally shared vision, policy can then reap the benefits of joint action and global markets for the lower carbon technologies that will be necessary. Action need not be anti-business or anti-growth—in fact, failing to act is anti-growth, since it risks the future of growth itself. A transformation of global infrastructure and an investment in energy, transport, buildings, and agriculture offers new opportunities and markets.
But these markets can only be created at scale if an effective global response is realized. Climate change is the biggest market failure the world has ever seen, and strong policy will be necessary to correct it. The UN Framework Convention on Climate Change and the Kyoto Protocol provide a basis for international cooperation, but more ambitious action is required, and economics has to be at the heart of any serious discussion of how to proceed.
Consider where the greenhouse gases come from: mostly from energy use that is central to economic activity. Electricity and heat generation, transport, industry, and other energy is 61 percent of the story. Land use accounts for a large percentage, too: deforestation is 18 percent and agriculture also is another 14 percent. Furthermore, with economic growth, countries become larger sources of greenhouse gases. Thus, the big emitters now are the United States and Western Europe; China is also quite big. Going forward, the increases for China and India are expected to be substantial. My rough rule of thumb is that rich countries are responsible for 79 percent of the cumulative energy emissions over the last 50 years or so; in a decade or so the emissions from the developing countries will overtake those from rich countries; and in 20 to 25 years, the current developing countries will likely be responsible for 70 percent. (The importance of this is that the developing countries currently don’t have targets under the Kyoto agreement, and there will be a major challenge in bringing them into the whole story of emissions.)
What follows from these economic fundamentals?
Global collective action. You can’t conjure collective action out of the air, especially when interests partially conflict. All the players need to understand the implications for them, their growth, their mortality rates, and the survival of species and natural flora and fauna in their country. In addition, policy has to take into account equity and fairness in the burdens of adjustment. The rich countries are primarily responsible for where we are now. But the poor countries are going to be major contributors to future emissions, so even if the rich world takes on responsibility for absolute cuts in emissions of 60 percent to 80 percent by 2050, developing countries must take significant action too. Moreover, the costs of taking action are not evenly distributed across sectors or around the world. So developing countries should not be required to bear the full costs of this action alone. But they will not have to. Carbon markets in rich countries are already beginning to deliver flows of finance to support low-carbon strategies of economic development, including through the Kyoto’s Clean Development Mechanism (which permits countries to achieve emissions reductions by investing in projects in developing countries that reduce emissions and that would not have otherwise happened). A transformation of these flows is now required to support action on the scale required.
The existing literature on the economics of climate change is very useful, but its focus—on the environmental effects of economic growth—is a bit narrow in helping us understand the international collective-action problems that we will face. In particular, we have to look at what economists call the “endogeneity of growth”: the fact that the rate of growth not only shapes environment, but that changed environment also shapes subsequent economic growth. If you disrupt the monsoon in North India, or the advance of the Sahara is accelerated in Africa, that will have a fairly profound effect on the rate of growth in those countries. Projections of the likely effects of climate change on crop yields in Africa look worrying for 20, 30, 40 years ahead—reductions of upwards of ten percent. If you get crop reductions of that magnitude in sub-Saharan Africa, you will have very serious problems. So climate change is likely to increase the case for overseas development aid as an element of collective action.
There will be large economic impacts in rich countries, too. The scorching summer of 2003 could well be normal in 30 to 50 years, and cool by the last quarter of the century. This change is bound to affect opportunities for growth.
Technology. Given the scale of the climate problem, effective reductions in greenhouse-gas concentrations will require action across a broad area. We need to think about halting deforestation (which is a big part of the story), carbon-free electricity generation, transportation adjustments, building construction, and energy efficiency. The relevant technologies vary across these different problems.
Carbon-free electricity, for example, is perfectly possible; it comes with a cost, but it’s perfectly possible. Basically, we have a problem when we take carbon from underground and let it into the air. So you can do one of two things. One is to leave it underground—that means renewables or nuclear, bio fuels and so on. The other is to take it out by using fossil fuels, capture carbon from coal or gas or oil in the generation of electricity, and then send the carbon back underground. So carbon-free electricity generation is possible. It’s also possible to imagine stopping deforestation; you can do it with the right kinds of incentives and institutions and management. Transport is more difficult. But if you’ve got carbon-free electricity, you could have your cars, at least in towns, just plugged in overnight, and you could use electricity.
So what is possible and how close that technology is varies depending upon where you look. And it’s going to be very important to keep an open mind about those technologies. So picking technological winners in this area is something that one should do with care.
Incentives. We have to be aware of these technological issues in order to think about the right kinds of incentives to put in place. There is a challenge in asking oneself how much of a role government or groups of governments should play in developing technologies. Technologies are ideas; they’re public goods. The global atmosphere is a public good, and the technologies to reduce emissions are also public good. So there’s a challenge there in determining how far the public sector should play its role. But I think it’s fairly clear that most of the action—choosing how to save energy, choosing how to reduce carbon—will be made by the private sector. The big question is how does a government set the right kind of incentives for the private sector.
Now, the private sector is actually quite specific on this point. Its slogan is that the incentive structure should be loud, long, and legal. But “loud, long, and legal” is actually the vulgar phrase for “clear, long, and credible.” If you’re thinking about investments in the kinds of infrastructure and durables that we’re talking about, the incentive structure needs to be clear, long-term, and credible. And putting those kinds of incentive structures together is actually quite difficult. You have to try to bind yourself going forward in a way that governments find it quite difficult to do—a problem the economists have studied right across the board in other areas, including monetary policy, competition, and so on. We have to try to put together those kinds of structures.
Growth. President Bush is concerned with the effect of all this on growth and the way of life in the United States. He’s right to be concerned, as are the leaders and people who represent other nations. The challenge for analysts is to try to say systematically what the consequences of different kinds of arrangements and incentives might be for economic growth.
The Indians and Chinese will very understandably put that on the table right at the beginning. Their leaders might be expected to say, “I take it you’re not telling us to grow slower and leave our people in poverty for longer?” And you can understand where they’re coming from. And some people might add, “And further to that, it’s all your fault anyway.”
To address these concerns, you’ve got to be able to understand that if, for example, you want to use carbon capture at the coal power stations that are going to be so important in the generation of electricity in India and China, you have to understand what it’s going to cost. It will cost a bit more. How much more? When? What kind of technologies are available? Are they likely to develop and get much more sophisticated and cheaper? And so on. You’ve got to be able to try at least to give some guidance on those questions: countries need to know if the consequences of some new technology will be destructive for economic growth. And in the case of India and China and the other developing countries, you’ve got to face up to the question of who pays. I think there is a growing understanding that the consumers in rich countries should have something to pay through the price of electricity for reducing carbon emissions elsewhere, so that those countries can grow without ruining the global climate.
Mechanisms. We also have to think about what kind of mechanisms we’re going to bring into those international negotiations. If they’re treaties, are they monitored and enforced? If they’re market mechanisms, what kind of institutional structures do we need to support them? Market-trading mechanisms for carbon use pieces of paper that say that I have produced less carbon than I would otherwise have produced. In many parts of the world, some might claim that if I want a piece of paper that says I have produced less carbon than I would otherwise have produced, I can easily get one if I pay for it. So you need institutional arrangements to verify the credibility of these kinds of statements and the paper they are printed on.
Verification is complicated. When I was in India just about six weeks ago, there was a guy with a dietary supplement for cows to reduce their flatulence, thus reducing atmospheric methane. I thought that was actually a rather interesting idea. But how detailed do you get in checking his results? If a town decides that it’s going to insist on electric cars beginning in 2020, how do you build that kind of action and make it count? You’ve got to have institutional structures that are going to pick up all these kinds of things. If a country uses a significant tax on carbon emissions, if it does it that way, how are you going to bring that to count as a contribution to tackling the problem? This isn’t impossible. None of this is impossible, but all of it requires care and thoughtful attention.
It is very important, then, to think through the institutional and incentive structures. You need to give people information, but you also have to tell good stories and come up with good examples and develop actions and practices that are going to give you support for all these measures. And the institutional challenge is not small. We are already on the way; but we need to move these efforts to a higher plane.
Economics has a great deal to say about all these issues: economists, who think about incentives and about institutions to support those incentives, contribute a great deal more to the world than people who don’t know about the interactions between incentives and institutions. But we also need to pay attention to a set of issues that gets much less attention from economists: issues of persuasion, education, and changing preferences. People smoke less in public places, not simply because somebody’s told them it’s bad for them, or because the price of cigarettes is high; it’s not simply information or incentives. It’s also because they’ve learned what it means for other people and then go a step further to think through what responsible behavior means. The same is true for the climate: children who are educated now have learned much more about climate change at school than some of the older among you ever did, and that affects their view of responsible behavior.
John Stuart Mill talked a lot about the role of public discussion in a democracy. Like earlier political philosophers, Mill understood the important role of public discussion in forming our attitudes and preferences. So incentives—and institutions to support the incentives—will be fundamental, as will information and analysis. But we also need the process of public discussion: of exchanging ideas, changing preferences, constructing new norms and ideas of personal and collective responsibility, and building mutual understanding across nations and across generations. <
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July 03, 2012
11 Min read time