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GEP10: Climate Change

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Title: GEP10: Climate Change

1
GEP10 Climate Change

The problem (three weeks ago)
Sources
Mechanisms
Consequences (two weeks ago)
Costs of emission reduction (last week)
International climate policy

2
International Climate Policy

International climate policy has a long history
of good intentions
Climate change has been on the scientific agenda
since 1896, but global warming started booming in
the early 1980s
Politicians started paying attention in the late
1980s, and climate change was a major topic on
the United Nations Conference on Environment and
Development, Rio de Janeiro, 1992
There, the UN Framework Convention on Climate
Change (UNFCCC) was negotiated

3
Intl. Climate Policy -2

The FCCC is ratified by almost all countries
The FCCC is a framework convention, that is, it
sets the rules for later negotiations but does
not establish policy targets itself
Except for two.
First, the FCCC acknowledges the common but
differentiated responsibilities of countries,
that is, this is global problem that is of OECD
making, so the OECD should take the lead in
solving it
Second, concentrations should be stabilized ...

4
Intl. Climate Policy -3

UNFCCC Art. 2 The ultimate objectives ... is
to achieve ... stabilization for greenhouse gas
concentrations in the atmosphere at a level that
would prevent dangerous anthropogenic
interference with the climate system. Such a
level should be achieved within a time-frame
sufficient to allow ecosystems to adapt naturally
to climate change, to ensure that food production
is not threatened and to enable economic
development to proceed in a sustainable manner.

5
Intl. Climate Policy -4

The FCCC started a series of negotiations
In 1995, in Berlin, there was almost an agreement
In 1997, in Kyoto, there was one
The Kyoto Protocol specifies
Emission reduction targets
International policy instruments
Unfortunately, the Kyoto Protocol does not
specify
How to define and measure emissions
To what extent instruments may be used
What happens if targets are violated

6
Intl. Climate Policy -5

In The Hague, there could have been an agreement,
but the Europeans were to busy fighting each
other
In Bonn, Clinton had given way to Bush
Then, Bush pulled out
This was a gesture, as the US Senate (who control
US foreign policy) had already rejected Kyoto
(note that the Senate reversed position in 2005)
It was a mistake too, that was hardened by the
reaction in Europe

7
Intl. Climate Policy -5

Finally, in Marrakesh agreement was reached on
measurement of sinks (generous), on instruments
(generous) and on enforcement (none), while
targets were relaxed
Since then, there have been two more conferences,
which were about fine-tuning
The EU offered greater bribes to Russia, and the
Kyoto Protocol entered into force in February
2005
Since then, Canada pulled out, apparently to join
the US, Australia, India, China, Japan and South
Korea

8
The DICE Model

The Dynamic Integrated Climate Economy model of
Bill Nordhaus, dating back to 1990, is the
prototype of most coupled climate-economy models
DICE combines the simplest of economic growth
models with the simplest of carbon cycle and
climate models
Indeed, the only interesting part of DICE is the
interaction between the natural and the
socio-economic system
Let us go through the equations ...

9
DICE Objective

Maximise total welfare
Total welfare equals average welfare times the
number of people
Since the number of people is exogenous, total
welfare equals average welfare
Or, total welfare is the sum of individual
welfare distribution does not matter
Future welfare is worth less than current welfare

10
DICE Economy

Production is a combination of labour and capital
Technology progresses exogenously
Income is spread over consumption and investment
Wages and working hours vary freely with labour
demand and supply
Labourers own the stocks of the companies they
work for
There are a large number of firms, none of which
has market power
All products are substitutable, and can be
divided into small units

11
DICE Carbon and Climate
12
DICE Impact

Climate change damages are a power function of
temperature
Emission reduction costs are a power function of
emission reduction
Both climate change damages and emission
reduction costs lower income, hence consumption
and investment, hence welfare and growth

13
Costs of Emission Reduction
14
Marginal cost estimates

0 1 3
Nordhaus 1994 BG 5
EV 12
Fankhauser 1994 EV 20 (6-45)
Tol 1999 BG 73 23 9
EW 171 60 23
EVW 244 82 35
(143) (51) (22)
Downing 2000 BG 75 46 16
Tol 2000 BG 20 4 -7

15
DICE Overview

10 equations that can be solved in a matter of
minutes on a PC
Balances the costs of emission reduction with the
costs of climate change
Thus yields optimal abatement, that is, emission
reduction that maximises social welfare
If the world were ruled by a benevolent dictator,
what would she do?

16
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17
Optimal Emission Control

If the world were ruled by a benevolent dictator,
what would she do?
A little emission reduction in the beginning,
more later, but not enough to stabilise
concentrations
The first part is robust, the second part is very
sensitive to assumptions
The last part is robust, unless there is a cheap
alternative to fossil fuels
If we consider many countries, optimal emission
reduction goes down!

18
Optimal Emissions Control -2

So, the results of a cost-benefit analysis are
driven by the fact that the marginal costs of
greenhouse gas emission reduction are much higher
than the marginal damage costs of climate change
The cost estimates of emission abatement seem
okay
Emission reduction requires both saving energy
and switching fuels

19
Emission Reduction Costs

The price elasticity of energy use is low this
has to do with the fact that only a relatively
small amount is spent on energy and transport,
and with the fact that energy and transport are
seen as essential inputs
So, the price of energy has to be raised
drastically to have much of an effect
Besides, there is a lot of energy saving going on
already (0.5-1.0 a year)

20
Climate Change Costs

Why are the marginal costs of climate change so
low?
Climate change will occur in a distant future, or
rather, the effect of emission reduction now will
be smeared out over decades, with the peak effect
in 20-60 years
Because of time discounting, climate change is
not valued highly, even though climate change may
cause some 2GDP of damage

21
Climate Change Costs -2

The bulk of climate change impacts occurs in the
rest of the world, particularly in developing
countries
Emission reduction is thus a standard public
good, and each country has an incentive to
free-ride on other countries emission reduction
This is also true for acidification and the hole
in the ozone layer
What is the difference?

22
Emission Reduction Costs -2

Alternative energy sources (wind, solar, waves,
biomass) are expensive compared to fossil fuels,
and have other undesirable characteristics (some
genuine, some institutional)
Besides, alternative energy is already at
capacity to fill the demand of niche markets
So, short-run emission reduction is bound to be
expensive

23
International Policy

Acidification Strong public demand technical
fix co-benefits coincidence small number of
countries point and diffuse sources
Ozone hole Strong public demand technical fix
no coincidence small number of countries point
sources
Climate change Strong public demand no
technical fix co-benefits no coincidence large
number of countries diffuse sources

24
Optimal Emission Control

If the world were ruled by a benevolent dictator,
what would she do?
A little emission reduction in the beginning,
more later, but not enough to stabilise
concentrations
The first part is robust, the second part is very
sensitive to assumptions
The last part is robust, unless there is a cheap
alternative to fossil fuels
If we consider many countries, optimal emission
reduction goes down!

25
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26
Free Riding

Costs of emission reduction for country i
Benefits of emission reduction
The non-cooperative solution is

27
Free Riding -2

The cooperative solution is
The difference in costs is
The difference in benefits if free-riding is

28
Nash and Free Riding

The free-rider compares the situation in which
everybody cooperates, to the situation in which
everybody but the free-rider cooperates
This is a best response function if all other
cooperate and continue to do so regardless of the
behaviour of the free-rider
This is called Nash behaviour (although Nash is
not behind this) that is, strategic behaviour
by a single actor without the interaction with
other players

29
Free Riding -3

If the coalition collapses, the difference in
benefits is not
But rather
However, this is only relevant if the coalition
collapses as a result of free-riding by this
particular player

30
Instability of Kyoto Nash
31
Instability of Kyoto Chwe
32
Cartel Theory

Cartel theory is the most popular way of
investigating coalition formation in
international environmental agreements
The presumption is that the grand coalition
(i.e., all countries) will fail
The question is, can smaller coalitions be
formed?
Cartel theory assumes Nash behaviour, even though
the number of players in a coalition is small

33
Cartel Theory -2

A coalition is said to be stable iff
It is profitable, that is, the coalition members
have a higher welfare than in the Nash
equilibrium
It is internally stable, that is, no coalition
member is better off by leaving
It is externally stable, that is, no
non-coalition member is better off by joining
The grand coalition is externally stable
A profitable coalition of two players is
internally stable

34
Coalition formation

Costs of emission reduction
Benefits of emission reduction
The non-cooperative solution is

35
Coalition formation -2

The cooperative solution is
So, player 1 increases its emission reduction,
and gets increased emission reduction by the
other player in return

36
Coalition formation -3

Difference in costs
Difference in benefits

37
Coalition formation -4

Coalition if
That is, you want to promise a small reduction of
your emissions, and get a big reduction of the
others emissions in return
But, the other player expects the same
Coalition formation is barter trade but without
production, welfare gains are small
Costs are more than linear, benefits are linear,
so changes in emissions are small too
Barrett Either coalition is small, or emission
reductions are small

38
Cartel Theory -3

Essentially, if a player joins a coalition, then
she should decrease her emissions, because she
now also has to take into account the impact of
her emissions on other players
In return, the other coalition members further
reduce their emissions is this welfare
improving or not? And does it reduce emissions?
Most Cartel games are based on myopic/Nash
behaviour far-sighted/Chwe behaviour is more
realistic, but too complicated

39
Short v Long Run

Should we despair?
Is greenhouse gas emission reduction something we
would do primarily for future generations, for
people in far-away lands, and for animals and
plants? (That is, low priority)
Yes, if the problem continues to be phrased as
such
The political situation is clear The US does not
want to play, and the European public does not
accept higher energy prices

40
Short v Long Run -2

If we re-phrase climate policy as energy policy,
the story is quite different
We will run out of gas within 50 years, out of
oil within 100 years (give or take a decade or
two)
This has been said before, and incorrectly so
The main difference is that older projections did
not include technological progress in
exploration, mining and efficiency, and recent
projections do

41
Short v Long Run -3

Our current economies are based on fossil fuels,
and if fossil fuels run out we will have to do
something drastic
That is, well have to replace fuel transport and
transformation processes, cars and power plants,
machines and heaters, companies and RD
strategies and all within twenty years or so
This is quite a bit, but has been done before,
and we see it coming

42
Short v Long Run -4

There are four alternatives to conventional oil
and gas
First, unconventional oil and gas, like tar sands
and clathrates
Second, coal
Third, renewable energy, particularly solar and
biomass
Fourth, nuclear, provided that the waste and
safety problems can be solved

43
Short v Long Run -5

Renewable energy and nuclear are best for climate
change, followed by oil gas, and coal
All four would imply a major reorganisation of
industry, and geopolitical changes
Renewables have unknown environmental
consequences, the others known, negative and
partially solvable ones
Different parts of industry are betting on
different alternatives, but coal and oil gas
seem to be in the lead

44
Short v Long Run -6

Given that this major transformation will come in
one way or another, climate policy should jump on
it and steer it in a desirable direction
Unfortunately, that is not really the case
Environmental and energy policies are typically
at odds with each other
Climate policy takes a short term view, and is
not really technology oriented
Fortunately, climate policy is up for review

45
Short v Long Run -7