Climate Policy Michael Springborn Department of Environmental Science & Policy [image: USGCRP, 2010]

Climate policy questions and lenses How aggressively and in what way should society take action to reduce damages from climate change? –balance between expected impacts/costs and policy response options and their costs Mitigation versus adaptation Economics/policy science/ ethics/climate science –game theory, theories on the use of science in policy and analysis of public attitudes. International/national/state

The problem in a nutshell [Trenberth 2009]

Higher GHG concentrations map to uncertain but substantial changes in temperature [Pizer 2007]

The paleoclimatic record suggests anticipated GHG concentrations are quite unusual [Dieter et al. 2008]

The paleoclimatic record suggests anticipated GHG concentrations are quite unusual [NAS, 2014]

Predicted outcomes are uncertain: the recent mismatch between increasing GHG concentrations and flat temperature is a puzzle “The world added roughly 100 billion tonnes of carbon to the atmosphere between 2000 and That is about a quarter of all the CO ₂ put there by humanity since 1750.” James Hansen (NASA): “the five-year mean global temperature has been flat for a decade” [The Economist, 2013]

Temperature is relative to the average. (USGCRP 2013, p. 20) A2 scenario: high population growth, low economic growth, slower technology improvements and diffusion, and other factors that contribute to high emissions and lower adaptive capacity B1 scenario: lower population growth, higher economic development, a shift to low-emitting efficient energy technologies that are diffused rapidly around the world through free trade, and other conditions that reduce the rate and magnitude of changes in climate averages and extremes as well as increased capacity for adaptation. Projected US temperature changes are substantial even for optimistic emissions scenarios From… U.S. Global Change Research Program: National Climate Assessment and Development Advisory Committee Draft Climate Assessment Report (2013).

Undesirable impacts are expected as temperature increases across a range of settings [IPPC 2007]

The intensity of CO2/GDP is falling…but not fast enough to offset increases in GDP and population [Nordhaus, 2012]

Anthropogenic climate change represents the “biggest market failure the world has ever seen” -- Nicholas Stern.

Market failure specifies the root of the problem EPA (2010) “greatest good for the greatest number” results when the actions of an agent (individual or firm) have an uncompensated effect on the wellbeing of other agents.

Climate change externalities (External) cost (damage) from a unit of emissions associated with a given unit of economic activity is not paid for by those producing or consuming the good. –Emissions  inefficiently high Innovators of new technologies (of any kind which addresses the GHG problem) may not receive all of the benefits from their inventions –Innovation is ineffeciently low

Stern, 2013 Each externality associated with climate change motivates consideration of particular policy instruments.

What is the social cost of carbon (SCC) and why are we calculating it? U.S. Interagency Working Group on the SCC: The SCC is “an estimate of the monetized damages associated with an incremental increase of carbon emissions in a given year” [US IWGSCC, 2010]

Integrated assessment models are used to construct and analyze forecasts of the coupled economic-climatic system over centuries [Nordhaus, 2012]

Various IAMs project different levels of loss from temperature increases (IWGSCC 2010)

The SCC increases over time and depends on the discount rate [EPA 2013]

Economists have generally arrived at a consensus on the bottom-line: “Virtually every activity directly or indirectly involves combustion of fossil fuels, producing emissions of carbon dioxide into the atmosphere. Single bottom line for policy: “correct this market failure by ensuring that: –all people, everywhere, and for the indefinite future are confronted with a market price for the use of carbon that reflects the social costs of their activities.” Nordhaus et al. (2008)

Setting stringency: The policy ramp vs. the big bang Climate “policy ramp” –Efficient GHG control policy: “modest rates of emissions reductions in the near term, followed by sharp reductions in the medium and long term.” (Nordhaus, 2007) If implemented via a tax: ~$30/ton of CO 2 initially, rising gradually to $200/ton towards 2100 (Krugman, 2010) The “big bang”** (**Paul Krugman’s term) –Immediate and aggressive GHG control –Stern Review (2006): high profile challenge to the ramp

Stringency of the policy ramp vs. big bang Nordhaus (2007) Stern: big-bang Nordhaus: policy ramp Regardless of whether the policy involves a tax or cap and trade, policy stringency can be expressed in terms of a carbon price

The Ramp The climate-policy ramp (gradualist approach) –Based on output of “integrated assessment models” (IAM) DICE: Dynamic Integrated Model of Climate and the Economy (Nordhaus and colleagues) Mathematical model of economic growth accounting for the effects of global warming. –Dynamic economics: choices over consumption, working (labor), production, investment –Geophysical dynamics: emissions  greenhouse gas stock  climate change Estimated reduction in gross world product: –4.5 o F  2% o F  5% (Krugman, 2010)

Economic logic of the ramp Given that “capital is productive and damages are far in the future … the highest-return investments today are primarily in tangible, technological, and human capital.” (Nordhaus, 2007) –Capital Human capital: stock of skills and abilities of the labor force Technological capital: the tangible means of production (machines, tools, facilities, equipment, infrastructure, etc) –Decision: At each moment in time we can choose whether to “invest” any given dollar in –capital (human, technological, etc) or in –costly actions to reduce GHG emissions.

The Big Bang & the Stern Review (SR) 2006: UK government releases a report: The Economics of Climate Change: The Stern Review, lead by Sir Nicholas Stern (Nobel Laureate) SR estimates of costs of global warming are substantially higher than earlier estimates –Used similar data and methodology (IAM) –Review summary: Unabated, climate change could result in an annual 5-20% decline in global output by –Comparison: US great depression – real GDP fell by 9% Costs to mitigate are around 1% of GDP Policies for strong GHG reductions should be implemented immediately. Why did the SR come to such a starkly different conclusion than the ramp? –Discounting (lower discount rate) –Damages (higher damages)

Ramsey optimal growth model: –central framework for thinking about dynamic investment decisions –organizing principle for setting long-run discount rates The Ramsey equation holds in the welfare optimum r = ρ + ƞ * g Discounting – Ramsey equation real return on capital/ consumption disc. rate social rate of time preference/ utility discount rate elasticity of marginal utility of consumption growth rate of consumption high ƞ low ƞ c: consumption Utility(c) ctct c t+1 growth, g ƞ : specifies how quickly marginal utility falls as consumption rises.

Specifying a social discount rate for long-run climate policy analysis often employs the Ramsey framework Ramsey (1928) optimal growth model: Economy operates as if a “representative agent” selects consumption and savings to max PV of the stream of utility from consumption over time. One implication of the Ramsey model is the following equation: r = ρ + ƞ g r: return to capital (real, long-run) ρ: pure rate of time preference “time discount rate”, due to “impatience” ƞ : elasticity of marginal utility w.r.t. consumption g: average growth in consumption per capita

Two different perspectives on parameterizing the Ramsey discounting equation lead to very different results. ρ: pure rate of time preference; ƞ : elasticity of marginal utility w.r.t. consumption; g: average growth in consumption per capita 1.Descriptive approach/Nordhaus & the DICE model Use economic data to estimate parameters: Nordhaus (2008): r = ρ + ƞ g = 0.04 (average over the next century (Nordhaus, 2008, 10)) –5.5% over first 50 years (61). Economic growth and population growth will slow, rate will fall over time. 2.Prescriptive approach/Stern & the Stern Review (2006) Argument: No ethical reason to discount future generations due to a pure rate of time preference except for the possibility that we might not be here at all (ρ reflects only ann. prob. of extinction). 1.3% growth assumed. r = ρ + ƞ g = *0.013 = 0.014

Nordhaus on Stern’s discounting approach Nordhaus (2008, p. 174)

Comparison of the discount rate The level at any given time t represents the weight given to consumption arriving at year t. Discount weight under various assumptions Discount weight

Damages SR used a level of GHG damage at the high end of the expected range. The ratio of aggregate damages to the size of the economy ($D/$GDP) 100 years from now commonly assumed: 1-4%. (Weitzman, 2007) SR: >= 5% Nordhaus (2008, p. 51)

Some conclusions Weitzman (2007): `On the political side … my most-charitable interpretation of (the Stern Review’s) urgent tone is that the report is … –an essay in persuasion… –that is more about gut instincts regarding the horrors of uncertain rare disasters whose probabilities we do not know… –than it is about (conventional) economic analysis. SR might be right (“act now”) for the wrong reasons (due to bad model parameters instead of a careful analysis of uncertainty).’

The role of uncertainty in climate change policy—Weitzman (2009) What happens to expected utility-based BCA for fat-tailed disasters? –Can “turn thin-tail-based climate-change policy on it’s head” (p. 2). Concretely: a fat-tailed distribution over a climate sensitivity parameter (S) which maps CO 2 changes into temperature changes. Can drive applications of EU theory more than discounting (p. 5).

How do we chose from the large set of policy options?

Economists often favor market- based instruments (MBI) Advantages of MBI’s over C&C (Stavins, 1998) : –Cost effectiveness ( least cost) Flexibility (within and between polluters) Encourage behavior change through market signals rather than with explicit behavioral requirements. Key attribute: MBI’s take advantage of private information that polluters have –RE: means and procedures they could use to reduce pollution –Stronger incentives for technological innovation

Cost effectiveness comparison over alternative instruments -- Clean Air Act

Carbon tax versus cap and trade: can accomplish essentially the same thing but with minor differences Cap and TradeCarbon Tax Known: Unknown: Pollution level Price per unit of pollution Pollution level Revenue: Permit auction: government Free allocation: industry Government

Key design components for a cap and trade policy include: (1) cap, (2) scope, (3) allocation, (4) cost containment, & (5) offsets [Newell, 2012] cap scope

Observed carbon prices over the last several years have been below $20/ton CO2 [Newell, 2012]

Carbon offsets Carbon offsets: a tradable credit for reducing carbon emissions by some amount (e.g. ton) generated outside a regulated system, recognized within a regulated system (e.g. a cap-and-trade regime) as a substitute for holding and using an emissions permit.

Attributes for carbon offset effectiveness Offset issues: is the offset… Real: has the unit of emissions actually been avoided and not just claimed? Additional: was the unit avoided due to the offset policy or would it have been avoided regardless of the offset mechanism? (Was this criteria satisfied in the “Cheat Neutral” ‘example’?) Permanent: is the unit avoided permanently or only temporarily (e.g. will a planted tree just be burned in 10 years)? Verifiable: can we ensure that each attribute above is actually attained so that stakeholders in the over-arching climate policy can ensure that the policy is not being undermined?

Offsets present substantial measurement challenges grey additional (action taken for payment) permanent verifiable? [Beede and Powers, 2013]

Problems with additionality have been substantial. (2009) [Fig.: Newell et al. 2012; Data: Fenhann (2012)]

Measurement uncertainty doesn’t have to preclude mitigation projects confidence deduction E(y): expected level y c : credited level f(y): probability density confidence y: true level of mitigation Verifiability of offsets: Certainty? No.  Meeting or exceeding stated/credited levels with a specified level of confidence.

Managing carbon stocks as a global open access resource: game theory and the prospects for international cooperation

Mitigation goals will be difficult/impossible to achieve for rich countries acting alone [Nordhaus, 2010]

Game theory can provide traction on the “Tragedy” as a strategic action problem “Adam Smith was wrong.”

Game theory & international environmental agreements (IEAs) Game theory: the study of multi-agent decision problems where the payoffs to actions depend on the actions of others. A simplified story of the transboundary/international pollution problem: Two countries, A & B, contribute to emissions of a transboundary pollutant. –Currently, neither A nor B is addressing the pollution issue but both are considering doing so Discrete strategies: each country will choose either to contribute or shirk (not contribute) Non-cooperative game theory: A & B will not negotiate but rather simply choose (irreversibly) a strategy. Each behaves individually rationally Information is complete: payoffs are fixed and common knowledge Static, one-shot game: the actions of A & B are selected once, simultaneously, and are permanent. Any “agreement” to take action must be self-enforcing—there is no higher authority to impose constraints. Finus, M. (2001)

The cost/benefit structure Assumptions: Costs: effective action: 4 total If one country takes effective action (“contributes”) its costs are 4. If both “contribute” then each faces a cost of 2. no action: zero cost Benefits effective action: 3 each Both countries receive benefits of 3 regardless of whether the effective action is due to the efforts of one or both countries no effective action by either: 0 each **This example based on Keohane and Olmstead (2007, p. 79)

(1,1)(-1,3) (3,-1)(0,0) Contribute Contr. Shirk Country B Country A The payoff matrix: for each possible outcome, the net benefits to each country are give by: (NB A, NB B ) Assumptions: Costs: effective action: 4 total If one country takes effective action (“contributes”) its costs are 4. If both “contribute” then each faces a cost of 2. no action: zero cost Benefits effective action: 3 each Both countries receive benefits of 3 regardless of whether the effective action is due to the efforts of one or both countries no effective action by either: 0 each Note: payoffs to A depend on the choice of B and vice versa.

Prisoner’s Dilemna in Action Golden Balls - £100,000 Split Or Steal? 3/14/08

Prediction of the equilibrium Any “agreement” to take action must be self-enforcing Each player’s predicted strategy must be that player’s best response to the anticipated strategy of the other player. C: contributeS: shirk The strategy of player i, given by s i, is chosen from the set {C,S} The strategies { s * A, s * B } are a “Nash equilibrium” (NE) if, for each player, s * i is player i‘s best response to the strategy specified for the other player. (There is no incentive to deviate.) Gibbons (1992)

Nash equilibrium Solution process: check whether each possible outcome satisfies the NE condition: 1.For each player and for each strategy, determine the other player’s best response (and underline that payoff) Consider B’s best response: If A contr.  should B shirk or contr.? If A shirks  should B shirk or contr.? Consider A’s best response: If B contr.  should A shirk or contr.? If B shirks  should A shirk or contr.? (1,1)(-1,3) (3,-1)(0,0) Contribute Contr. Shirk Country B Country A 2.The pair of strategies { s * A, s * B } is a NE if each players’ strategy is a best response to the other’s (i.e. if both payoffs are underlined). Is the predicted outcome Pareto inferior (i.e. can one agent be made better off without making any other agent worse off)?

Model extensions: To capture the wide variety of IEAs requires model extensions: –N>2 countries –Coordination –Dynamic/repeated games (finite, infinite) –Continuous strategy space –Negotiation models –Coalition models See Finus (2001)

U.S. politics and climate change policy The last real opportunity for comprehensive U.S. climate policy was the Waxman-Markey climate bill of [Newell, 2012]

Media slides with black background courtesy of Derek Lemoine, Arizona University

Graham’s policy aide to Lieberman’s aide: