Topic 18: Economics of Climate Change

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Topic 18 Economics of Climate Change

• David Letson
• Marine Affairs/Economics
• University of Miami

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Main Points

• Climate is an essential economic resource.
• Agriculture, forestry, tourism and fisheries
• Energy, water, construction, transportation
• Greenhouse gases as global externality.
• Protection as public good.
• Benefits from reducing risk. Costs of protection.

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The Murky Crystal Ball
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Outline

• In the News.
• A Complex Problem.
• Local Interest.
• Economic Modeling.
• Economic Policy.
• Conclusions.

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(1) In the News

• IPCC
• NAC
• Kyoto

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Recent Events Intergovernmental Panel on
Climate Change (IPCC) "most observed warming
over the last 50 years is likely due to the
increase in greenhouse gas concentrations."
U.S. National Academy of Sciences (NAS)
reported the IPCC accurately reflects the
current thinking of the scientific community
and that greenhouse gases are accumulating in
the Earths atmosphere, causing surface
temperatures to rise.
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Support for IPCC, NAS Temperatures have been
linked closely to CO2 levels. Atmospheric CO2
concentration now at highest level in 400,000
years 30 higher than pre-industrial
levels. Global surface temperature has increased
1.1 degrees F (0.6 C) during the last century,
faster than any time in 1000 years. Underwater
ocean temperatures in the last several decades
consistent with the observed surface warming on
land and sea. The 1990s was the warmest decade
in the last 1000 years.
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Kyoto Protocol The 1997 agreement committed the
U.S. to reducing its greenhouse gas emission by
2010 to 7 below their 1990 levels. March 2001
Bush Administration declares the Kyoto Protocol
is effectively dead.
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US commitment under Kyoto
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(2) A Complex Problem
Climatic Impacts Physical, biological, chemical
changes Human responses
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Human Systems

• Sensitive Systems
• Water resources
• Agriculture, forestry, fisheries
• Human settlements
• Industry, energy, financial services

• Vulnerabilities
• Food and water security
• Incomes and livelihoods
• Human health
• Infrastructure

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Not Simply Warmer

• 1.4 to 5.8 C increase, says IPCC
• Possible effects might include
• shifts in ocean currents,
• desertification of previously arable lands, and
• frequency and intensity of natural disasters
• Bigger changes next 100 years than last 10,000?

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Extreme Events are Most Critical for Economics
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(3) Local Interest
Tourism Sea Level Rise
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• Florida
• Tourism, Quality of Life
• Climate changes threatens Floridas tourism
  industry.
• In 1999, 59 million tourists came to Florida and
  spent 47 B.
• The 1 draw for residents and tourists alike
  the beach.
• If our beaches disappear, our economy will
  suffer.
• Floridas coastline contains almost 800 miles of
  sand beaches
• and generates over 15 billion for Floridas
  economy.
• 75 of all Floridians, live within ten miles of
  the coast.

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(4) Economic Modeling

• How best to invest scarce resources?
• Many geographic scales of interest.
• Fundamental importance of discounting.
• Decision making under uncertainty.

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Economics

• Choose one
• Consume today,
• invest in productive capital, or
• slow climate change
• Immediate costs and possible future benefits.
• Aggregate estimates of damages
• A few percentage points of world GDP
• high proportion in developing world

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Nordhaus DICE Model
Dynamic, integrated, climate-economy model.
Maximize utility from discounted consumption
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State Equations in DICE

• Q(t) O(t) A(t) K(t)? P(t)1- ?
  (production function)
• K(t) (1 - dK) K(t-1) I(t) (capital
  accumulation)
• E(t) 1 µ(t) F(t) Q(t) (GHG
  emissions)
• M(t) ßE(t) (1dM) M(t-1) (GHG
  sequestration)
• O(t) 1 b1 µ(t)b2 / 1 d(t) (climate
  damages)

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Key Assumptions

• Technical innovation A, µ, F, d
• Productivity growth
• How much can we limit?
• emissions
• fossil fuel use
• damages
• Earth Science systems ß, dM
• Plant uptake
• Deep ocean mixing
• Behavioral Response ?, d
• Adaptation
• Preferences

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Notes on DICE

• Output (Q) is given by a Cobb-Douglas constant
  returns to scale production function in climate
  (S), technology (A), capital (K), and labor,
  (P).
• Total factor productivity (growth of A) assumed
  to be 1.3. Output may be devoted to consumption
  or to investment.
• Capital stock is investment plus depreciated (K)
  previous capital stock.
• Uncontrolled emissions are a constant share (F)
  of output and are reduced by the emissions
  control rate, µ.
• Note F assumed to fall 1.25 annually. Ambient
  CO2 is retained () emissions plus proportion (1
  - M) of previous stock not lost to deep oceans.
• Climate affects output through control costs (µ)
  and damages (d).
• Findings Must consider time paths of
  consumption, investment and emissions to
  determine best control policies. Extremely costly
  to stabilize temperatures because of existing
  GHGs.

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Economic Models Two Types

• Macro Top Down
• Focus on investment dynamics
• Economy-wide effects
• Example of Nordhaus 1992
• Sectoral Bottom Up
• Details of adaptation, technical change.
• Example of Mendelsohn et al. 1994

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Extensions

• Non-market effects
• climate amenity,
• health and morbidity,
• ecosystem loss
• Developing world
• Time paths not isolated points in time
• Adaptation

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(5) Economic Policy

• Alternatives.
• A tougher problem than the ozone layer.
• Case for protection?
• Possible role for incentive policies.

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Policy Alternatives

• Portfolio approach
• climatic engineering
• adaptation
• mitigation
• prevention
• Decisions should be sequential.

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Tough Decisions

• geographic scale
• lengthy time horizon
• distribution of impacts
• long lags between emissions and effects
• substantial uncertainty

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Beware of Free Riders

• numerous relevant nations
• heterogeneous economic interests
• developed nations
• rapidly developing nations
• island nations
• energy producing nations

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Case for protection

• Damages irreversible.
• Risks are asymmetric.
• Catastrophic risks insurance.
• Regional effects.

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No regrets?

• Zero or negative cost options.
• Mitigation and prevention other, local benefits.
• Reforestation as recreational amenity
• Energy conservation
• diminish pollution damages and
• reduce input costs.

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More immediate concerns?

• Air and water kill more pollution today than
  likely to die from climate change.
• A rich nations concern?

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International carbon budget

• Most people live in developing world, where
  energy use is lowest but will grow.
• Coal accounts for 70 of heat content in fossil
  fuel reserves.
• Expanding coal use in India and China.

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Incentive Policies

• Double dividend of carbon taxes?
• Joint implementation (JI).
• Eliminating fuel subsidies.

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(6) Conclusions

• Climate as essential resource
• global scale
• long time horizon
• Inter-temporal economic models
• top down
• bottom up
• To protect or not?
• Incentive approaches
• No regrets

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Further Reading S Fankhauser (1995) Valuing
Climate Change Economics of the Greenhouse.
Island Press. R Mendelsohn, W Nordhaus, D Shaw
(1994) Impact of Climate Change on Agriculture
a Ricardian Analysis Amer Econ Review Vol 84(4)
753-71 W Nordhaus (1992) Optimal Transition
Path for Controlling Greenhouse Gases Science
Vol. 258 1315-19. W Nordhaus (2001) Global
Warming Economics Science Vol 2941283-4. T
Schelling (1992) Some Economics of Global
Warming Amer Econ Review Vol. 82(1) 1-14. M
Toman, ed. (2001) Climate Change Economics and
Policy. RFF. J Weyant (2000) Economics of
Climate Change Policy Pew Center on Global
Climate Change www.pewclimate.org/projects/econ_i
ntroduction.cfm