Optimal climate policy Prof. Dr. Carsten Vogt Bochum University of Applied Sciences Summer term 2013

Optimal climate policy Weighing of costs and benefits from climate policy Need for quantifying benefits and costs Moreover: we need to take into account the timing of climate policy Abatement today is more costly than abating emissions in the future (technical progress) In short: We need a model.

Optimal climate policy: DICE (Nordhaus) DICE: Dynamic Integrated model of the Climate and the Economy Contains the important links between economic activity and climate system Is a daynamic optimization model i.e. it allows for calculating the optimal abatement path over time

DICE (2007): model architecture Welfare Population Utility carbon abatement consumption capital emissions output Labour force Global temperature damages

DICE: Equations Welfare: Depends on: Utility from consumption Population size (the more people, the more suffer from climate change) DICE: maximizes the sum of discounted utilities Obvious: core parameter of the model: discount rate Note: DICE approach is purely anthropocentric and utilitarian

DICE: economic equations Utility: Depends on: per capita consumption Population size L Utility function is neoclassical (increasing and concave in consumption

DICE: economic equations Capital rate of return: r: capital rate of return 𝜌: social rate of time preference 𝛼: elasticity of marginal utility g: annual growth rate of per capita consumption

DICE: economic equations Capital rate of return: Important: assumptions about rho, alpha and g determine r ! Note: r defines the discount rate on goods markets! Thus: r gives the opportunity costs of climate policy. DICE: sets r=4.1% heavily influences current value of climate damages!

DICE: economic equations Example: future damage due to climate change 1 trillion € r=1%: Current value is 370 billions € R=4%: CV decreases to merely 20 billions! What is the right number? Society faces different choices: We can invest in: Climate Policy But also, e.g., in: capital accumulation Investment into capital gives a rate of return of about 4% (long run rate of return on capital markets)

DICE: economic equations When is an investment in climate mitigation economically justified? If it gives at least a return as high as capital investment! Climate investment has to cover at least the opportunity costs. Otherwise, society could earn higher returns by investing into capital formation, formation of human capital etc… Note: This is an important question particularly for developing and emerging countries!

DICE: economic equations Output: Standard neoclassical production function Showing decreasing returns to capital and labour : Climate damage factor Climate damages: Increasing in T And convex.

DICE: economic equations Climate damages: what is contained? Based on data from 12 world regions (e.g. US, China, Europe, Africa, Latin America …) Damages from decreased crop yields in agriculture Damages from sea level rise at coastal lines Increased morbidity Empirically estimated in order to give a best fit to the damage data reported in the current literature

DICE: economic equations Abatement costs: Increasing and convex in emissions reduction Output: divides into consumption and investment: Per capita consumption: Capital accumulation: Industrial emissions: Core parameter: carbon intensity 𝜎

DICE: geophysical equations Carbon cycle model: Describes exchanges of carbon between the atmosphere, the upper and the lower layers of the oceans

DICE: geophysical equations Radiative forcing: Describes total incoming energy captured in the atmosphere Depends on: exogeneous amount of energy Depends also on: atmospheric concentration of carbon in the atmosphere relative to its preindustrial level Temperature:

DICE: Results Four scenarios: Baseline: no abatement policy at all Intertemporal Optimum („Optimum“): Efficient abatement suited to maximize social welfare 2 degrees: Policy (often advocated in the political arena) aiming at stabilizing temperature increase at 2°C „Stern“: Scenaio adopting a very low discount rate (as has been used in the Stern-Review)