The Economics of Climate Change Adair Turner Sustainable Development Commission 7 th February 2007

1 Greenhouse gases and temperature: the long-term Source: Hansen, Clim. Change, 68, 269, Thousands of years before 1850

2 Whats black and white and green all over? Another doggy dossier Charles Moore The Daily Telegraph 27 January 2007

3 Sterns conclusion If we dont act, the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year, now and forever. If a wider range of risks and impacts is taken into account, the estimate of damage could rise to 20% of GDP or more. In contrast, the costs of action – reducing greenhouse gas emissions to avoid the worst impacts of climate change – can be limited to around 1% of GDP each year.

4 The economics of climate change Compare through time The economic and social costs of climate change The costs of mitigating climate change The costs of adapting to climate change Maximise the net present value of human welfare, given the changing pattern of the costs through time, and using appropriate discount rates to compare the value of different peoples welfare at different points in time.

5 Emissions scenario Source: Stern Review, Part III, Chapter 9

6 Growth in UK Living Standards: with 60% Emissions Cut GDP per capita 2006= – 2.0% lower Business as usual 60% emissions cut

7 The economic cost of cutting emissions

8 The impact of climate change Changes in agricultural yields Costs of sea defences Losses from extreme weather events Deaths from heatwaves / less deaths from cold Spread of tropical diseases Flooding of coastal areas Political and social disruption movement of people Environmental balance, species, landscape Measurable market impacts Non-market impacts Direct human welfare Socially contingent Subjective Directly effect GDP Expressable as GDP equivalents?

9 Non-linear adverse consequences Temperature Increase Adverse consequences y = e x ? y = x 3 ? y = x 2 ? Trigger points?

10 Impact of a given level of GGH concentration Temperature Increase Probability of occurrence

11 The impact of discount rates £1000 in 2150 is worth Assuming 2% per annum growth: 1% of GDP today is worth

12 Discount rate set by observed market returns, e.g. 4% real Choosing the discount rate: description versus prescription The rate at which you could invest to grow future GDP The rate which reveals underlying preferences / utility functions Discount rate set to reflect a priori logic and ethical value judgements Descriptive Prescriptive What should be the relative importance attached to future generations welfare

13 Prescriptive approach r = η (g) + δ g = growth rate δ = the rate of pure time preference η = the elasticity of the marginal utility of consumption Sterns base case η = 1 g = 1.9 δ = 0.1 r = 2.0% Utility Consumption

14 Arguments against descriptive approach Derive values of η and δ to be compatible with observed market rate, e.g. η = 1.5 δ = 1.0 Future actual rates of return unknown Fund for future generations unrealistic Individual choice within own life span different from the issue of intergenerational equity Individuals can be myopic – even in relation to their own self- interest Simple descriptive approach Restated descriptive approach Problems with restated approach

15 Complexities in setting a discount rate/rates Aggregating market and non-market impacts Winners and losers between and within generations If quality of environment falling over time but consumption rising Environment specific discount rate negative Consumption specific discount rate positive Aggregation to one discount rate depends crucially on relative weights. Average Briton today sacrifices for average Briton in 2010 positive discount rate since latter is richer Average Briton today sacrifices for poorer African in 2010 lower and possibly negative discount rate

16 Sensitivity of results to changing η Costs of climate change in % of GDP equivalent Baseline climate High climate Including catastrophe risk Market impacts only Market and non-market impacts η Source: Stern Review, Table PA.2.

17 The Copenhagen Consensus Question Where should the world invest, say, $50bn extra over the next four years to do most good? Source: Björn Lomborg, Global Challenges, Global Solutions

18 The economic cost of cutting emissions