1 William D. Nordhaus Yale University Lecture for the Yale Climate Institute January 15, 2010 Slides are available nordhaus.econ.yale.edu. Economic Perspectives on Climate Change

2 Outline of lecture 1.Some historical background 2.What are economic integrated assessment models (IAM)? 3.What are some insights from IAM? 4.What are the issues in implementing international climate agreements?

3 CO 2 concentrations at Mauna Loa

4 2,000 1,600 1, CO2 emissions US (millions tC/yr)

5 Trend in CO2 emissions relative to GDP, US

6 Instrumental record: global mean temperature index (°C)

IPCC AR4 Model Results: History and Projections 7

8 Projections and the paleoclimatic record

9 The Contribution of Economics: Integrated Assessment (IA) Models What are IA models? These are models that include the full range of cause and effect in climate change (“end to end” modeling). Major goals of IA models: Project trends in consistent manner Assess costs and benefits of climate policies Estimate the carbon price and efficient emissions reductions for different goals

10 Fossil fuel use generates CO2 emissions Carbon cycle: redistributes around atmosphere, oceans, etc. Climate system: change in radiative warming, precip, ocean currents, sea level rise,… Impacts on ecosystems, agriculture, diseases, skiing, golfing, … Measures to control emissions (limits, taxes, subsidies, …) The emissions- climate-impacts- policy nexus: The RICE-2009 model

Fossil fuel use generates CO2 emissions Now focus for a moment on the details of:

Some detail on how output and emissions are generated

The Impacts of Climate Change The Copenhagen Accord, which recognized “the scientific view that the increase in global temperature should be below 2 degrees Celsius.” Is this firmly based in “scientific” estimates of the impacts of climate change? Facts on the ground: –Estimating impacts has been the most difficult part of all climate science: house-to-house combat for analysts. –Very scant empirical support for the 2 degree target 13

What will be the impacts by sector? 14

Aggregate damage estimates from different studies Source: Richard Tol, Jour. Econ. Persp.,

16 1. Baseline. No emissions controls. 2. Economic cost-benefit “optimum.” Emissions and carbon prices to maximize discounted economic welfare. 3. Limit to 2 °C. Climatic constraints with global temperature increase limited to 2 °C above Copenhagen, all countries. Uses US emissions targets joined by other rich countries, with developing countries entering after 1 -3 decades. 5. Copenhagen, rich only. Uses US emissions reductions joined by other rich countries, with developing countries staying out. Policy Scenarios for Analysis

Rate of growth of CO2-GDP ratio: history and Congressional proposals

Baseline projections: IPCC Scenarios and RICE RICE-2009 Model with no policy measures

Temperature profiles: RICE Available at

What do carbon prices mean in practice? 20 Carbon tax, 2010 Increase, price of energy, US [$/tC]Gasoline All energy expenditures Minimal $10 1.0%1.5% “Optimal”353.3%5.4% Climate constrained (ΔT < 2 °C) 504.8%7.7%

Carbon prices for major scenarios 21

Carbon prices for major scenarios 22 Actual equivalent global carbon price = $4 / tC

Carbon prices for major scenarios 23 Actual equivalent global carbon price = $4/tC

24 Net impacts by region to 2050 of Copenhagen proposal

Final Question: How Should Policies Be Implemented 25

Major Policy Approaches for Global Warming Internationally harmonized carbon tax – economist’s ideal. Universal cap and trade – close second if well designed, but Kyoto Protocol is not doing well. ____________________________________________ Regulatory substitutes (CAFE standards, ban on light bulbs, …) – very inefficient approaches Voluntary measures (carbon offsets) are difficult to calculate and verify and probably a useless diversion. 26

27 Harmonized Carbon Taxes What are “harmonized carbon taxes”? Raise prices of GHGs proportional to carbon content All countries would levy a comparable tax Countries would retain all revenues (this is not an international transfer program) Hybrid plans: Auction permits Floor and cap on auction prices

Cap and trade v. Carbon taxes The problems with cap-and-trade systems for climate change, particularly in the international arena, are insufficiently appreciated. Some concerns: Quantity limits are troublesome in a world of differential economic growth and uncertain technological change because of the difficulty of resetting country limits. 28

Quantity-type regimes show extremely volatile prices 29 Source: Nordhaus, Various.

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31 Volatility in EU CO 2 trading system: This volatility is inherent in such a system because of price- inelasticity of supply and demand Source: Metcalf, Carbon Taxes, Hamilton Project.

It is important for governments to capture the revenues (either through 100% auctions or taxes): –raise revenues for distributional policies –reduce the efficiency losses from taxation. 32

33 Cap and trade systems are not attractive regimes for countries to join.

Corruption Quantity-type systems with international trading are much more susceptible to corruption than price-type regimes. International cap-and-trade plans are a three-sided game. There are strong incentives for a corrupt domestic government to collude with corrupt polluting firms to underestimate domestic emissions and hide from international monitors. 34

The problem of offsets Offsets have been part of all plans. Clean Development Mechanism (CDM) in the Kyoto Protocol has been major source of “accounting emissions” and has very questionable additionality. For example, in EU-ETS, there have been virtually no internal emissions reductions. The Clean Development Mechanism in EU has 280 million tons of offsets compared to 130 million tons of emissions reductions for current phase. Another set of defective financial instruments like credit default swaps? 35

The Perils of the Current Regime The international cap-and-trade program is a radical and unproven approach, whereas taxes are well understood and have been used in every country of the world. To bet the world’s climate system and global environment on this untested approach which such clear structural flaws would appear a reckless gamble. 36

37 Final thoughts “Mankind in spite of itself is conducting a great geophysical experiment, unprecedented in human history.” Roger Ravelle (1957)