[Senate Hearing 110-52]
[From the U.S. Government Publishing Office]
S. Hrg. 110-52
ECONOMICS OF CLIMATE CHANGE
=======================================================================
HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
TO
RECEIVE TESTIMONY ON THE STERN REVIEW OF THE ECONOMICS OF CLIMATE
CHANGE, EXAMINING THE ECONOMIC IMPACTS OF CLIMATE CHANGE AND
STABILIZING GREENHOUSE GASES IN THE ATMOSPHERE
__________
FEBRUARY 13, 2007
U.S. GOVERNMENT PRINTING OFFICE
35-906 PDF WASHINGTON : 2007
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Committee on Energy and Natural Resources
COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota LARRY E. CRAIG, Idaho
RON WYDEN, Oregon CRAIG THOMAS, Wyoming
TIM JOHNSON, South Dakota LISA MURKOWSKI, Alaska
MARY L. LANDRIEU, Louisiana RICHARD BURR, North Carolina
MARIA CANTWELL, Washington JIM DeMINT, South Carolina
KEN SALAZAR, Colorado BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
JON TESTER, Montana MEL MARTINEZ, Florida
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
Frank Macchiarola, Republican Staff Director
Judith K. Pensabene, Republican Chief Counsel
Johnathan Black, Professional Staff Member
Kathryn Clay, Republican Professional Staff Member
C O N T E N T S
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STATEMENTS
Page
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................ 1
Domenici, Hon. Pete V., U.S. Senator from New Mexico............. 2
Stern, Sir Nicholas, Head of The Government Economic Service,
United Kingdom................................................. 4
Jacoby, Henry, Ph.D., Massachusetts Institute of Technology...... 28
Yohe, Gary, Ph.D., Economics Professor, Wesleyan University...... 33
APPENDIX
Responses to additional questions................................ 61
ECONOMICS OF CLIMATE CHANGE
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TUESDAY, FEBRUARY 13, 2007
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 10:07 a.m., in
room SD-106, Dirksen Senate Office Building, Hon. Jeff
Bingaman, chairman, presiding.
OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW
MEXICO
The Chairman. Why don't we go ahead with the hearing? Thank
you all for being here.
For the past 6 years the United States has done far too
little in my view on the issue of global warming. There are two
reasons for this. First, significant numbers of lawmakers have
not been persuaded that the threat is real, and the critics
have cited too many uncertainties that needed to be resolved
before we took significant policy action. The second reason is
the concern that economic impacts to the country would be too
great and could lead to the United States sacrificing its
ability to compete in world markets, and the loss of jobs and
other factors that would result.
Earlier this month the latest scientific report from the
United Nations, a report by the intergovernmental panel on
climate change, did much to lay to rest the debate on the first
problem. The problem that there are too many scientific
uncertainties the report affirmed with over 90 percent
certainty, that most of the warming of the climate system has
experienced in the last 50 years is due to human-caused
greenhouse gas emissions, and that extreme weather events, heat
waves, and heavy precipitation will become more frequent.
The second concern over the impact to our economy has been
more difficult to overcome. The debate over what we can and
cannot afford has persisted in every discussion on global
warming that has occurred here in the Senate. Now we have the
release of the report by Sir Nicholas Stern, the Stern Review,
on the economics of climate change. Sir Nicholas gave me a copy
yesterday. I've read it to make sure there are no mistakes in
there.
[Laughter.]
But with the issuance of that report we're beginning to
understand and to focus not just on the cost of action, but the
cost of inaction. Since release of the Stern Review and the
November elections in the United States the ground on this
issue has shifted substantially. I believe there's an
opportunity for us to move forward with legislation on global
warming this year. My colleague Senator Domenici was just
pointing out that this is one of three hearings on this issue
this morning here in the Congress so clearly there is great
interest and focus on the issue.
The challenge now will be to get a majority of the Congress
to agree on specific proposals. There are a number of proposals
introduced and circulated already this year. I think it's vital
that in trying to craft a proposal that would make good policy
sense, we work together and try to get something enacted sooner
rather than later. Science tells us that action is needed
immediately and that the longer we delay, the more difficult
the problem will be.
Let me call on Senator Domenici for his opening statement
and then I'll introduce our witnesses.
STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM NEW
MEXICO
Senator Domenici. Well Mr. Chairman, you indicated that
there are three hearings today in the U.S. Congress on the
issue. I would think that maybe our witnesses would figure that
with that many hearings, maybe by this afternoon or maybe the
day after tomorrow, we'll be able to solve this problem. But
frankly the number of hearings, Mr. Chairman hasn't produced
significant proposals that this Senator would be willing to
sign on to. Yours comes closest to any, for which I complement
you. I don't know where the others will be coming from.
I have a statement. I'd ask you to put it in the record,
because I think we want to hear from these witnesses. But I do
want to say in my opening remarks that Sir Nicholas Stern
accepted a big job, and he produced a big report, but there is
no question that it is vulnerable. It is vulnerable in a big
way with reference to the way he uses the economic
calculations. We can do that by asking him questions--far
smarter people than I have said that, so I'm not dreaming it
up--and I believe it's understandable what he has done, but I
think it's probably not something we're going to take seriously
in terms of a bill. That is, the way he calculated, the way he
put in the discount, which is a little bit different than most
would have used.
I also want to say that I grow more and more fearful with
the passage of each month. What's going to happen to this
world, to our country if we go out and try to settle this issue
here and nothing significant is done with reference to China
and India?
I just want to state for the record, because the facts
begin to develop and begin to get very frightening, and begin
to say to me that somebody in a big leadership role has to get
together with the Chinese and the Indians and decide whether
they have a stake or not, and if they do, that we try to do
something together.
China uses more coal than the United States, Europe and
Japan combined. It has increased coal consumption 14 percent in
each of the past 2 years and every week to 10 days, another
coal-fired power plant opens somewhere in China. That's big
enough to serve all the households in Dallas or San Diego. In
fact, China's economy continues to grow at 10 percent on an
annual basis and it is projected to continue to do so in the
near future. We must say at the same time the United States has
not built a new power plant. We have a consortium in Texas that
plans to build 11 over a rather long period of time. I'm not
sure that they will be able to complete that because we're in
such a state of flux, as to whether we want those or don't want
them or what we want to do with reference to clean up.
My last observation would be that all the nations of the
world--in my opinion including the big two that I just
mentioned, and America--must join together and put up large
amounts of capital for research efforts, the likes of which we
have never seen. If we intend to attack this issue with new
technology and sequestration and permanent placement of the CO
underground or someplace, we can't do that one alone. Somebody
must bring China and India in, and even then when you look at
the dimensions of the clean-up we're talking about with new
technology, it is rather--just almost defies doing. Sometimes I
think that the suggestion that maybe we ought to set up some
group to start analyzing how we're going to adapt to this might
be in order. Maybe we ought to do that rather quickly, and let
them start looking at how we might adapt, because we might just
have to. I yield. Thank you very much.
[The prepared statements of Senators Domenici and Sanders
follow:]
Prepared Statement of Hon. Pete V. Domenici, U.S. Senator From
New Mexico
I want to add my thanks to our distinguished panel of witnesses for
participating in our hearing today.
Last month, this Committee held a hearing to consider an analysis
of Chairman Bingaman's draft climate change legislation done by the
Energy Information Administration. The EIA report estimated that the
effect of the proposal on our national GDP would be perhaps 0.25
percent below baseline projections in 2030.
However, the EIA analysis did not consider whether energy intensive
industries might relocate to nations that do not impose costs on
carbon--nations such as China and India. I continue to be concerned
about the implications for our economy of limiting carbon emissions if
other key nations do not impose similar requirements. Some industries
would be facing difficult consequences under carbon-limiting
legislation, both now and in the long-term.
The projected growth in emissions from India and China is daunting.
Even with dramatic cuts in our own greenhouse gas emissions, we will
not solve the problem without key developing countries. Limiting our
own emissions without the participation of these nations would not only
harm our economy, but would also accomplish nothing for the climate.
I do thank Chairman Bingaman for holding a second hearing on the
economics of climate change. I believe that economic analysis is
crucial to the climate change policy debate. We have to make every
effort to know exactly the effects on our citizens of whatever course
of action we pursue.
I understand that the Stern Review's methods have been the subject
of controversy among economists. Several highly respected economists--
including our panelists Professor Jacoby and Professor Yohe--have
published papers questioning some of the Review's methods.
For example, both Professors Jacoby and Yohe have questioned the
very small ``discount rate'' used in the Stern Review. The discount
rate gives a comparative weight to spending money now, compared to
spending money later. This is an important point in an issue like
climate change, which took generations to create and would take
generations to address.
If we are confident that the world economy will continue to grow,
then we can be confident that people living in future decades will be
much wealthier than people living today. It only makes sense that some
of the costs of our response to climate change should be shared among
generations.
Future generations will also have the advantage of improved
technologies that will be better able to address climate change. I
believe an essential part of today's response to climate change is to
increase our commitment to developing new energy technologies. Research
and development funding, both public and private, is vital to
addressing many of our nation's energy challenges, and the climate
change issue is no exception.
I am interested in learning as much as I can about the Stern
Review, and the questions surrounding it.
______
Prepared Statement of Hon. Bernard Sanders, U.S. Senator From Vermont
Chairman Bingaman, Ranking Member Domenici, as you both know,
global warming threatens the very future of the planet--its people, its
places, and its life-sustaining resources. The world is longing for
leadership to address the threat and if I have anything to do with it,
the United States will rise to the occasion and send clear signals that
we understand the magnitude of the problem.
One of the issues that, up to this point, has stifled progress on
addressing global climate change is the question of what it will cost
to do so. While I have no doubt that acting with purpose and vision on
this most important environmental issue will actually create new jobs
and save us money in the long run, I understand that there are those
who disagree with me. And that's why I sincerely appreciate the
Committee leadership holding today's hearing on the Stern Review of the
Economics of Climate Change.
The Stern Review, written by Sir Nicholas Stern, a former chief
economist of the World Bank, tells us that it is a lack of bold vision
that will financially cost us. In turning the old economic arguments
against taking action on climate change on their head, the report
suggests that taking aggressive action to combat global warming will,
in fact, save industrial nations money and that failing to act to
boldly to curb global warming is what will cost us--and he says it
won't be cheap. I think his report is groundbreaking and having him
testify today helps to highlight the fact that acting on climate change
is a pro-growth strategy.
I thank all of the witnesses here today and look forward to their
testimony. Their thoughts will surely be referenced time and time again
as the Senate moves closer to passing global warming legislation.
The Chairman. Thank you very much. Let me introduce our
witnesses here. First, let me acknowledge--he's not a witness,
but has joined us this morning as an observer--is Ambassador
David Manning, from the British Embassy. We're very pleased to
have you here and thank you for coming.
Sir Nicholas Stern, who is the head of the government
economic service and advisor to her majesty's government on the
economics of climate change, the author of the Stern Review
which I mentioned before, will be our first witness.
Accompanying him is Siobhan Peters, who is head of the review
team that worked with Nicholas Stern on the development of this
Review, and we appreciate her being here as well. Professor
Henry Jacoby from MIT is here and we very much appreciate his
presence, a very respected economist who has insights on this
same issue. Also Gary Yohe, who is a professor at Wesleyan
University, is a respected economist as well. So we have three
very distinguished witnesses and we look forward to hearing
from each of you.
Why don't we just take any written statement that you have,
include it in the record and why don't you take whatever time
you'd like and summarize the main points that you think this
committee should understand. Then, of course, we'll try to ask
some questions after that. Let me start with you, Sir Nicholas
Stern.
STATEMENT OF SIR NICHOLAS STERN, HEAD OF THE GOVERNMENT
ECONOMIC SERVICE, UNITED KINGDOM
Mr. Stern. Thank you very much. Chairman, Senators, it's an
honor to be with you today. Thank you for the opportunity to
address this committee.
Uncontrolled climate change will transform the physical
geography, and thus the human geography, of the world. That
means where we live and how we live our lives.
It involves great risks of economic and social disruption,
migration and conflict. The recent report that the U.N.'s
expert panel of climate scientists to which you referred, Mr.
Chairman, confirms that global average temperatures have
already risen 0.7 degrees centigrade from pre-industrial
levels. If emissions continue to rise, the panel's central
estimate that further warming for the end of this century is 4
degrees centigrade. This would also give a greater than 50
percent probability of increases over 5 degrees centigrade.
Those of you who like to speak in Fahrenheit, that's 9 degrees
Fahrenheit in the next century, so more than 50 percent
probability of increases of over 5 degrees Fahrenheit in the
next century, if we go on under business as usual.
Their analysis is exactly in line with the analysis
presented in the Stern Review last year. Warming on this scale
is associated with widespread and serious impacts on the
availability of water, on human health, on food production, and
the environment. The impacts in the United States are likely to
be substantial; for example, an increase in the intensity of
hurricanes in the Gulf of Mexico, still greater water stress in
California, sea level rise in Florida, and an increased risk of
storm surges in New York. We've already seen how long-term
shifts in weather patterns interact with other factors to
generate movements of people and the conditions for conflict,
for example in Darfur and Sudan.
Abrupt regional shocks become more likely as average
temperatures rise, including the risk of sudden changes to
monsoon rains in densely populated regions in South Asia, or
significant reductions in water flow in the river Nile--
affecting 10 countries in North and East Africa. To reduce
these risks in manageable proportions, we'd have to keep the
atmospheric concentration of greenhouse gases below around 550
parts per million, a CO2 equivalent. Even at this
level there are serious risks--indeed there's only a 50 percent
chance that the eventual temperature rise would not exceed 3
degrees centigrade.
So how can we reduce the risks? My initial observation is
that previous delay in action means that we do not start in a
good place. We cannot control the stock of gases already
released in the atmosphere but we can, as a world, control the
future flows. A global problem requires a global response. And
equity demands that rich countries take the lead. It's they who
are responsible for the bulk of the problem, and it's the poor
countries who will be hit earliest and hardest.
Controlling emissions will not remove all the risks of
future climate change, but it can drastically reduce them, and
we've shown in the Stern Review that the cost of controlling
these flows is much less than the damages that are thereby
averted. The case for taking strong action across the world is
compelling and actually is urgent. The later we leave it, the
greater the risks, and the higher will be the cost of
controlling them.
So how much will it cost to reduce the risks? We estimated
the cost of the global economy of around 1 percent of GDP, a
cost similar to one-off increase in the price of cost index,
one-off. The models give the range of plus or minus 3 percent--
a big range here. We're uncertain about these costs, but higher
estimates embody rather pessimistic assumptions about progress
in technologies. Of course the cost of 1 percent extra is not
trivial, but it's similar to the costs we accommodate all the
time, for example by changes in exchange rates. That will not
slow growth. It is failing to act that will eventually damage
growth.
The message from the economics and climate change is clear.
We must act strongly and we must act now. The damages that this
strategy would avoid can be estimated in various ways, taking
account of the more serious risks that are now evident. Simple
economic models suggest that the damage is averaged over time
and over the range of possible outcomes, or at least 5 percent
of global consumption. There are uncertainties, there are
technical challenges in the modeling, but there is no case to
believe that the economic impacts will be small. Indeed on a
number of key dimensions, the models we used underestimated the
damages. For example, we excluded irreversibilities and a
number of relevant risks.
So what are the key elements in the strategy? First we must
ensure that we correct the biggest market failure the world has
ever seen. People should pay in the prices they face for the
cost of their actions--in this case, cost to the climate.
Pricing carbon directly through either tax or carbon trading or
implicitly through regulation is fundamental to a policy
response. Given the global nature of the market failure and the
efficiency that comes from using economic instruments,
developing a global price for carbon is crucial. In Europe
we've long had strong taxes on fuel. The European Union has
established the world's largest emissions trading scheme and is
taking steps to ensure that it's long-term, ambitious, and open
to trade with others.
I hope that as your committee scrutinizes proposals for
U.S. policy, including the range of different suggestions for
cap and trade, you will bear in mind not only the potential
gains in terms of cost reductions of creating schemes that can
link to those in the EU, Australia and elsewhere, but also the
value of using carbon finance as one key element in building
cooperation on climate change with China and India and other
developing countries, as Senator Domenici described.
The United States has shown how regulation and standards
can build markets, for example in energy efficient domestic
appliances, and tackling other environmental problems, such as
lead in gasoline. Leadership in the world's largest markets
sets the pace elsewhere. Indeed, the Sudan now uses lead-free
gasoline. China and India are taking steps of their own: for
example China is implementing a domestic goal of reducing the
energy intensity by 20 percent in 5 years, and India, too, is
focusing on energy efficiency and increasing renewable energy.
But they can and will go further and faster with international
support.
The second element of the strategy after the pricing
element: we must invest in policy to bring forward low carbon
technologies. Spending on public energy research worldwide is
halved over the last 20 or 30 years and public and private
investment are highly correlated, of course. As a world we must
double public R&D spending on energy and we must promote the
development of key technologies, such as renewable energy and
carbon capture and storage. Carbon capture and storage is a
strategy that will allow us to continue to make use of abundant
reserves of coal, vital for energy security without causing
unacceptable harm to the environment.
Urgent steps are required to move toward widespread
deployment of this technology, as rich and poor countries alike
invest in a new generation of coal-fired power generation
plants. In transport, new technologies such as plug-in hybrid
cars and the use of cellulosic ethanol could go a very long way
to reducing emissions without changing our basic mobility.
Further, these low carbon technologies will create
opportunities: markets for low carbon power generation
technologies alone could be worth $500 billion a year by 2050.
The third, final element to the strategy is that we have to
recognize there are many ways to reduce emissions now that do
not need new technology. Energy efficiency and combating
deforestation are very inexpensive ways to reduce emissions,
but they require decisions and action on policy and changes in
behavior--for example, problems in building regulations in
tenant-landlord contracts--can prevent energy efficiency
investments being made. In the case of deforestation, solutions
should be based on supporting the countries in which the trees
stand, to develop their own approaches to this complex problem.
So given this, why would anyone deny this case for action?
I've heard three reasons to do so. They are all in my view
profoundly mistaken. The first is that the science is
incorrect. I need to do no more than to refer to the
conclusions at the recent U.N. panel on the science, which you
mentioned, Mr. Chairman, which reported so clearly and strongly
only 10 days ago.
The second reason for denial is that we can adapt as a
human race to any rising temperatures. That in my view is
reckless. It ignores the risk of very high temperature
increases. Business-as-usual growth in emissions over the next
100 years will be likely to take the next century to a world
that will be 5 or 6 degrees centigrade, more than 9 degrees
Fahrenheit hotter than today. That's a change which is
equivalent to the difference between now and the last ice age
10,000 or 12,000 years ago. It would transform the world,
involving massive dislocation and in all probability, conflict.
A third reason for refusing to act is that such risks and
their impacts will happen a long way into the future and we, as
this current generation, have little interest in what happens
in the future. I trust that many of you would find this
argument ethically untenable.
Mr. Chairman, Senators, uncontrolled climate change
constitutes a risk that as a global community we cannot afford
to take. We have an understanding of the scale of action
necessary and of the economic policies to deliver this action.
Now is the time to act, urgently, strongly and internationally.
Strong leadership from the United States of America is of the
utmost importance. The decisions made by this committee will be
fundamental in creating that leadership. Thank you very much.
[The prepared statement of Mr. Stern follows:]
Prepared Statement of Sir Nicholas Stern, Head of the Government
Economic Service, United Kingdom
there is still time to avoid the worst impacts of climate change, if we
take strong action now
The scientific evidence is now overwhelming: climate change is a
serious global threat, and it demands an urgent global response.
The recent report by the U.N.'s expert panel of climate scientists
confirms that global average temperatures have already risen 0.7
degrees C from pre-industrial levels. If emissions continue to rise,
the panel's central estimate of further warming for the end of this
century is 4 degrees C. This would also give a greater than 50%
probability of increases over 5 degrees C in the next century beyond
2100--exactly in line with the analysis presented in the Stern Review
last year.
The Stern Review assessed a wide range of evidence on the impacts
of climate change and on the economic costs, and has used a number of
different techniques to assess costs and risks. From all of these
perspectives, the evidence gathered leads to a simple conclusion: the
benefits of strong and early action far outweigh the economic costs of
not acting.
Warming on the scale implied by allowing emissions to grow on
business-as-usual basis is associated with widespread and serious
impacts--on the availability of water, on human health, on food
production, and the environment. The impacts in the U.S. are likely to
be substantial--an increase in the intensity of hurricanes in the Gulf
of Mexico, still greater water stress in California, sea level rise in
Florida, an increased risk of storm surges in New York.
We have already seen how long-term shifts in weather patterns
interact with other factors to generate movements of people and the
conditions for conflict--for example in Darfur. Abrupt regional shocks
become more likely as average temperatures rise--including the risk of
sudden changes to monsoon rains in densely populated regions of South
Asia, or significant reductions in water flow in the River Nile
affecting 10 countries in North and East Africa.
To reduce these risks to manageable proportions, we would have to
keep the atmospheric concentration of greenhouse gases below around 550
ppm CO2 equivalent. Even at this level there are serious
risks: indeed, there is only a 50% chance that the eventual temperature
rise would not exceed 3 degrees C.
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 global GDP each year. The models give a range of +/3%--but higher
estimates embody pessimistic assumptions about progress in technologies
and other issues. A cost of 1% is not trivial--but it is similar to a
one-off increase in the price index, the kind of cost that we
accommodate all the time, for example, through changes in exchange
rates. It will not slow growth. It is failing to act that will damage
growth. The message from the economics of climate change is clear: we
must act strongly and we must act now.
The investment that takes place in the next 10-20 years will have a
profound effect on the climate in the second half of this century and
in the next. Our actions now and over the coming decades could create
risks of major disruption to economic and social activity, on a scale
similar to those associated with the great wars and the economic
depression of the first half of the 20th century. And it will be
difficult or impossible to reverse these changes.
So prompt and strong action is clearly warranted. Because climate
change is a global problem, the response to it must be international.
It must be based on a shared vision of long-term goals and mutual
understanding that will accelerate action over the next decade. It must
build on mutually reinforcing approaches at national, regional and
international level.
climate change could have very serious impacts on growth and
development
If no action is taken to reduce emissions, the concentration of
greenhouse gases in the atmosphere could reach double its pre-
industrial level as early as 2035, virtually committing us to a global
average temperature rise of over 2 degrees C. In the longer term, there
would be more than a 50% chance that the temperature rise would exceed
5 degrees C. This rise would be very dangerous indeed; it is equivalent
to the change in average temperatures from the last Ice Age to today.
Such a radical change in the physical geography of the world must lead
to major changes in the human geography--where people live and how they
live their lives.
Even at more moderate levels of warming, all the evidence--from
detailed studies of regional and sectoral impacts of changing weather
patterns through to economic models of the global effects--shows that
climate change will have serious impacts on world output, on human life
and on the environment.
All countries will be affected. The most vulnerable--the poorest
countries and populations--will suffer earliest and most, even though
they have contributed least to the causes of climate change. The costs
of extreme weather, including floods, droughts and storms, are already
rising, including for rich countries.
Adaptation to climate change--that is, taking steps to build
resilience and reduce the costs of impacts--is essential. It is no
longer possible to prevent the climate change that will take place over
the next two to three decades, but it is still possible to protect our
societies and economies from its impacts to some extent--for example,
by providing better information, improved planning and more climate-
resilient infrastructure and crops. Adaptation will cost tens of
billions of dollars a year in developing countries alone, and will put
still further pressure on already scarce resources. Adaptation efforts,
particularly in developing countries, should be accelerated.
the costs of stabilising the climate are significant but manageable;
delay would be dangerous and much more costly
The risks of the worst impacts of climate change can be
substantially reduced if greenhouse gas levels in the atmosphere can be
stabilised between 450 and 550ppm CO2 equivalent
(CO2e). The current level is 430ppm CO2e today,
and it is rising at more than 2ppm each year. Stabilisation in this
range would require emissions to be at least 25% below current levels
by 2050, and perhaps much more.
Ultimately, stabilisation--at whatever level--requires that annual
emissions be brought down to more than 80% below current levels.
This is a major challenge, but sustained long-term action can
achieve it at costs that are low in comparison to the risks of
inaction. Central estimates of the annual costs of achieving
stabilisation between 500 and 550ppm CO2e are around 1% of
global GDP, if we start to take strong action now and follow sound and
economically efficient policies.
Costs could be even lower than that if there are major gains in
efficiency, or if the strong co-benefits, for example from reduced air
pollution, are measured. Costs will be higher if innovation in low-
carbon technologies is slower than expected, or if policy-makers fail
to make the most of economic instruments that allow emissions to be
reduced whenever, wherever and however it is cheapest to do so.
It would already be very difficult and costly to aim to stabilise
at 450ppm CO2e. If we delay, the opportunity to stabilise at
500-550ppm CO2e may slip away. Business as usual emissions
for the next 30 years would already take us well over 500ppm
CO2e.
action on climate change is required across all countries, and it need
not cap the aspirations for growth of rich or poor countries
The costs of taking action are not evenly distributed across
sectors or around the world. Even if the rich world takes on
responsibility for absolute cuts in emissions of 60-80% by 2050,
developing countries must take significant action too. But developing
countries should not be required to bear the full costs of this action
alone, and they will not have to. Carbon markets in rich countries are
already beginning to deliver flows of finance to support low-carbon
development, including through the Clean Development Mechanism. A
transformation of these flows is now required to support action on the
scale required.
Action on climate change will also create significant business
opportunities, as new markets are created in low-carbon energy
technologies and other low-carbon goods and services. These markets
could grow to be worth hundreds of billions of dollars each year, and
employment in these sectors will expand accordingly.
The world does not need to choose between averting climate change
and promoting growth and development. Changes in energy technologies
and in the structure of economies have created opportunities to
decouple growth from greenhouse gas emissions. Indeed, ignoring climate
change will eventually damage economic growth.
Tackling climate change is the pro-growth strategy for the longer
term, and it can be done in a way that does not cap the aspirations for
growth of rich or poor countries.
a range of options exists to cut emissions; strong, deliberate policy
action is required to motivate their take-up
Emissions can be cut through increased energy efficiency, changes
in demand, and through adoption of clean power, heat and transport
technologies. The power sector around the world would need to be at
least 60% decarbonised by 2050 for atmospheric concentrations to
stabilise at or below 550ppm CO2e, and deep emissions cuts
will also be required in the transport sector.
Even with very strong expansion of the use of renewable energy and
other low-carbon energy sources, fossil fuels would still probably make
up over half of global energy supply in 2050. Natural resources dictate
that coal will continue to be important in the energy mix around the
world, including in fast-growing economies. If it proves a viable
technology as expected, extensive carbon capture and storage will be
required to allow the continued use of fossil fuels without damage to
the atmosphere.
Cuts in non-energy emissions, such as those resulting from
deforestation and from agricultural and industrial processes, are also
essential.
With strong, deliberate policy choices, it is possible to reduce
emissions in both developed and developing economies on the scale
necessary for stabilisation in the required range while continuing to
grow.
Climate change is the greatest market failure the world has ever
seen, and it interacts with other market imperfections. Three elements
of policy are required for an effective global response. The first is
the pricing of carbon, implemented through tax, trading or regulation.
The second is policy to support innovation and the deployment of low-
carbon technologies. And the third is action to remove barriers to
energy efficiency, and to inform, educate and persuade individuals
about what they can do to respond to climate change.
climate change demands an international response, based on a shared
understanding of long-term goals and agreement on frameworks for action
Many countries and regions are taking action already: the EU,
California and China are among those with the most ambitious policies
that will reduce greenhouse gas emissions. The U.N. Framework
Convention on Climate Change and the Kyoto Protocol provide a basis for
international co-operation, along with a range of partnerships and
other approaches. But more ambitious action is now required around the
world.
Countries facing diverse circumstances will use different
approaches to make their contribution to tackling climate change, and
will use different combinations of policy tools. As far as possible, a
common carbon price across different sectors and countries will ensure
that reductions are made in the most efficient way around the world. It
is essential to create a shared international vision of long-term goals
to provide the context for domestic policy, and to build the
international frameworks that will help each country to play its part
in meeting these common goals.
Key elements of future international frameworks should include:
Emissions trading.--Expanding and linking the growing number
of emissions trading schemes around the world is a powerful way
to promote cost-effective reductions in emissions and to bring
forward action in developing countries: strong targets in rich
countries could drive flows amounting to tens of billions of
dollars each year to support the transition to low-carbon
development paths.
Technology cooperation.--Informal co-ordination as well as
formal agreements can boost the effectiveness of investments in
innovation around the world. Globally, support for energy R&D
should at least double, and support for the deployment of new
low-carbon technologies should increase up to five-fold.
International cooperation on product standards is a powerful
way to boost energy efficiency.
Action to reduce deforestation.--The loss of natural forests
around the world contributes more to global emissions each year
than the transport sector. Curbing deforestation is a highly
cost-effective way to reduce emissions; large-scale
international pilot programmes to explore the best ways to do
this could get underway very quickly.
Adaptation.--The poorest countries are most vulnerable to
climate change. It is essential that climate change be fully
integrated into development policy, and that rich countries
honour their pledges to increase support through overseas
development assistance. International funding should also
support improved regional information on climate change
impacts, and research into new crop varieties that will be more
resilient to drought and flood.
responses to the stern review
Since publication, the Review team have travelled widely,
presenting the results of the Review and listening to the reactions of
policymakers, academics and business leaders, in particular in the EU,
China, India, Japan, Africa and the U.S.
In the academic literature, many people have supported the approach
taken in the Review, but some have raised questions about particular
technical aspects of the analysis--often based on misconceptions of the
approach undertaken in review. We are publishing a detailed paper
responding to the critiques this week. In summary, the economic
analysis in the Review remains robust. The costs of inaction on climate
change are much greater than the likely costs of early action to reduce
the risks.
the analysis is built on the existing literature, but the estimates of
the cost of damages were higher for three reasons
First, crucial advances of the science in the past few years have
allowed estimates to be made of the probabilities of temperature rises
associated with increases in the quantity of greenhouse gases in the
atmosphere. These estimates point to significant risks of temperature
increases above 5 degrees C under a business-as-usual scenario by the
early part of the next century. Previous studies have mainly focused on
2-3 degrees C temperature rises and our results for these temperatures
are consistent with existing studies.
Second, we have taken account of the impact on wellbeing across the
full range of possible outcomes, including worst- and best-case
scenarios, and have explicitly built in aversion to risk. Risks and
uncertainties are the heart climate change modelling, and risk aversion
entails giving more weight to the worse outcomes, as people routinely
do in their daily lives, for example, in buying insurance. That,
together with the risks of higher temperatures, and an ethically
supportable approach to valuing future lives, is what drives our
results. These results are supported by a detailed analysis of the
economic impacts of climate change at the regional and country level.
The review examines the application of discounting to the
particular characteristics of climate change and the ethical issues
involved. With higher discount factors, it becomes easy to see why
climate change--which results in significant impacts in the future--
gets a relatively low ethical weight. For example, a discount rate of
3% would give individuals existing at the end of this century roughly
one tenth of the ethical weight of the current generation and only a 1%
weight by 2200. Because we know that future generations will exist and
that their consumption and welfare will be affected by the climate that
they experience, we adopt a low pure time discount rate that gives
future generations equal ethical weight. But this is only one element
of the discount rate. How much we discount the future depends also on
how much richer we expect to be. Risks and uncertainties surrounding
climate change imply that strongly divergent paths for future growth
are possible, so the use of a single discount rate is inappropriate.
The discount rates used in the Review do include the appropriate rate
of economic growth for each model run.
Discounting has been the subject of much attention since
publication of the Review, and rightly so, since it does drive the
results to some extent. We welcome the legitimate debate on the values
chosen given the ethical implications of different choices. But the
discount rate is not the only factor driving the case for climate
change. Our sensitivity analysis demonstrates that the treatment of
risk and uncertainty and the extent to which projections of impacts
reflect progress in the scientific literature are of roughly equal
importance.
Given that the assumptions underlying our model can be shown to be
plausible and unbiased, the question is often asked why our results
show a higher valuation of the impacts of climate change under business
as usual when compared with previous studies? The answer should by this
stage be clear:
Our study takes on the published findings of the latest
science including a probabilistic assessment of high climate
change impacts.
We have explicitly accounted for the economics of risk,
which has hitherto been mostly ignored.
We have taken an ethical judgement about the way we value
future generations that is time-consistent and allows the
Review to be objective with conclusions that do not
discriminate on the basis of birth dates.
Having assessed the model properties and characteristics and
compared the results with the disaggregated impacts associated with a
business as usual emissions path, we remain confident that our
estimates are very much in the centre of any plausible range of model
projections.
since the publication of the review, momentum in national and
international policy-making has increased
The messages in the Review have been well received by policymakers
and business, and momentum has continued to build towards more
effective domestic policies and more effective international links
between them.
The development of policy in the EU has accelerated significantly
in the last few months. The European Commission rejected several of the
draft National Allocation Plans for Phase II of the EU ETS, asking for
allocations to be reduced in a number of countries--a move that will
increase the credibility of the market for 2008-2012. This has sent a
strong signal on the role of carbon markets at the centre of the EU's
strategy to deliver deeper emissions cuts. The EU's Strategic Energy
Review, published in January 2007, recommends a target for the EU to
reduce greenhouse gases by up to 30% by 2020, and proposes other
mandatory targets on energy efficiency, renewables and biofuels.
In China and in India, policymakers are also demonstrating a strong
interest in moving towards more secure and sustainable energy use. In
China, we heard about the wide range of measures that China is
beginning to implement towards its domestic target to improve energy
intensity by 20% by 2010: energy efficiency audits and major investment
projects for manufacturing industry, and tariffs on the export of
energy-intensive products including for cement, iron and steel and
aluminium. In India, we saw how the Integrated Energy Policy under the
11th Five Year Plan is being taken forward--including changes to energy
subsidies, plans for more efficient coal-fired power plant and further
development of innovative new technologies for renewable energy.
In Japan, debates between government, industry and civil society on
the challenges of designing further domestic and international action
are intensifying. There was encouraging news of rapid technological
progress--confidence on the role of plug-in hybrid vehicles and
imminent breakthroughs in solar technology. There was increasing
recognition of the role of trading and investment strategies in
creating stronger co-operation with China and India, and interest in
sectoral approaches that could mitigate concerns about competitiveness.
In Africa, climate change has risen sharply up the agenda. The
decision by the African Union to make climate change one of the key
themes for its Summit in January 2007 has drawn the attention of
African leaders to the vulnerability of their countries, and to the
opportunities for adaptation, sustainable land management and low-
carbon development.
The U.S. has shown how regulation and standards can build markets,
for example in energy efficient domestic appliances, and in tackling
other environmental problems such as lead in gasoline. Leadership in
the world's largest markets sets the pace elsewhere--even the Sudan now
uses lead-free gasoline. In the 2007 State of the Union President Bush
outlined further plans to improve efficiency, reduce emissions and
improve energy security particularly in the transport sector.
In the light of these developments, there are clear opportunities
to build momentum towards effective international collective action on
climate change.
conclusion
Our analysis suggests that uncontrolled climate change constitutes
a risk that we cannot afford to take. Three main reasons have been put
forward to reject this conclusion. They are all profoundly mistaken.
The first is that the science is incorrect. This is not borne out by
the conclusions of the recent U.N. panel on the science, which reported
so clearly and strongly only ten days ago. The second is that we can
adapt as a human race to rising temperatures. That is reckless; it
ignores the risk of very high temperature increases. Business-as-usual
growth in emissions over the next hundred years would be likely to take
us to a world that would be 5 or 6 degrees hotter than today--a change
which is equivalent to the difference between now and in the last Ice
Age. It would transform the physical geography of the world and that
would, in turn, transform the human geography. It would involve massive
dislocation and in all probability conflict. The final reason for
refusing to act is that such risks and their impacts will happen a long
way into the future, and we have little interest in what happens in the
future. Many would find this argument ethically untenable.
We have an understanding of the case for action, of the scale of
action necessary, and of the economic policies to deliver this action.
However, the scale of the response will have to increase dramatically
in the coming decades. A shared vision of the goals for long-term
climate polices will provide an essential reference point for the
development of international and national policy.
If we are to stabilise at 550ppm CO2e or below, reducing
the risks of very high temperature increases, global emissions must
peak in the next 10-20 years. Now is the time to act: urgently,
strongly and internationally. Strong leadership from the U.S. is of the
utmost importance in this endeavour.
The full report of the Stern Review on the Economics of Climate
Change is published by Cambridge University press and is available to
download for free, along with supporting material and more recent
papers, at www.sternreview.org.uk.
Also available from this site is the 30 page executive summary,
frequently asked questions, papers published since the launch and
supporting commissioned research.
______
STERN REVIEW: The Economics of Climate Change
executive summary
The scientific evidence is now overwhelming: climate change
presents very serious global risks, and it demands an urgent global
response.
This independent Review was commissioned by the Chancellor of the
Exchequer, reporting to both the Chancellor and to the Prime Minister,
as a contribution to assessing the evidence and building understanding
of the economics of climate change.
The Review first examines the evidence on the economic impacts of
climate change itself, and explores the economics of stabilising
greenhouse gases in the atmosphere. The second half of the Review
considers the complex policy challenges involved in managing the
transition to a low-carbon economy and in ensuring that societies can
adapt to the consequences of climate change that can no longer be
avoided.
The Review takes an international perspective. Climate change is
global in its causes and consequences, and international collective
action will be critical in driving an effective, efficient and
equitable response on the scale required. This response will require
deeper international co-operation in many areas--most notably in
creating price signals and markets for carbon, spurring technology
research, development and deployment, and promoting adaptation,
particularly for developing countries.
Climate change presents a unique challenge for economics: it is the
greatest and widest-ranging market failure ever seen. The economic
analysis must therefore be global, deal with long time horizons, have
the economics of risk and uncertainty at centre stage, and examine the
possibility of major, non-marginal change. To meet these requirements,
the Review draws on ideas and techniques from most of the important
areas of economics, including many recent advances.
The Benefits of Strong, Early Action on Climate Change Outweigh the
Costs.
The effects of our actions now on future changes in the climate
have long lead times. What we do now can have only a limited effect on
the climate over the next 40 or 50 years. On the other hand what we do
in the next 10 or 20 years can have a profound effect on the climate in
the second half of this century and in the next.
No-one can predict the consequences of climate change with complete
certainty; but we now know enough to understand the risks. Mitigation--
taking strong action to reduce emissions--must be viewed as an
investment, a cost incurred now and in the coming few decades to avoid
the risks of very severe consequences in the future. If these
investments are made wisely, the costs will be manageable, and there
will be a wide range of opportunities for growth and development along
the way. For this to work well, policy must promote sound market
signals, overcome market failures and have equity and risk mitigation
at its core. That essentially is the conceptual framework of this
Review.
The Review considers the economic costs of the impacts of climate
change, and the costs and benefits of action to reduce the emissions of
greenhouse gases (GHGs) that cause it, in three different ways:
Using disaggregated techniques, in other words considering
the physical impacts of climate change on the economy, on human
life and on the environment, and examining the resource costs
of different technologies and strategies to reduce greenhouse
gas emissions;
Using economic models, including integrated assessment
models that estimate the economic impacts of climate change,
and macro-economic models that represent the costs and effects
of the transition to low-carbon energy systems for the economy
as a whole;
Using comparisons of the current level and future
trajectories of the 'social cost of carbon' (the cost of
impacts associated with an additional unit of greenhouse gas
emissions) with the marginal abatement cost (the costs
associated with incremental reductions in units of emissions).
From all of these perspectives, the evidence gathered by the Review
leads to a simple conclusion: the benefits of strong, early action
considerably outweigh the costs.
The evidence shows that ignoring climate change will eventually
damage economic growth. Our actions over the coming few decades could
create risks of major disruption to economic and social activity, later
in this century and in the next, on a scale similar to those associated
with the great wars and the economic depression of the first half of
the 20th century. And it will be difficult or impossible to reverse
these changes. Tackling climate change is the pro-growth strategy for
the longer term, and it can be done in a way that does not cap the
aspirations for growth of rich or poor countries. The earlier effective
action is taken, the less costly it will be.
At the same time, given that climate change is happening, measures
to help people adapt to it are essential. And the less mitigation we do
now, the greater the difficulty of continuing to adapt in future.
The first half of the Review considers how the evidence on the
economic impacts of climate change, and on the costs and benefits of
action to reduce greenhouse gas emissions, relates to the conceptual
framework described above.
The Scientific Evidence Points to Increasing Risks of Serious,
Irreversible Impacts From Climate Change Associated With
Business-As-Usual (BAU) Paths for Emissions.
The scientific evidence on the causes and future paths of climate
change is strengthening all the time. In particular, scientists are now
able to attach probabilities to the temperature outcomes and impacts on
the natural environment associated with different levels of
stabilisation of greenhouse gases in the atmosphere. Scientists also
now understand much more about the potential for dynamic feedbacks that
have, in previous times of climate change, strongly amplified the
underlying physical processes.
The stocks of greenhouse gases in the atmosphere (including carbon
dioxide, methane, nitrous oxides and a number of gases that arise from
industrial processes) are rising, as a result of human activity. The
sources are summarised in Figure 1 below.*
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* Graphic has been retained in committee files.
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The current level or stock of greenhouse gases in the atmosphere is
equivalent to around 430 parts per million (ppm) CO2\1\,
compared with only 280ppm before the Industrial Revolution. These
concentrations have already caused the world to warm by more than half
a degree Celsius and will lead to at least a further half degree
warming over the next few decades, because of the inertia in the
climate system.
---------------------------------------------------------------------------
\1\ Referred to hereafter as CO2 equivalent,
CO2e.
---------------------------------------------------------------------------
Even if the annual flow of emissions did not increase beyond
today's rate, the stock of greenhouse gases in the atmosphere would
reach double pre-industrial levels by 2050--that is 550ppm
CO2e--and would continue growing thereafter. But the annual
flow of emissions is accelerating, as fast-growing economies invest in
high-carbon infrastructure and as demand for energy and transport
increases around the world. The level of 550ppm CO2e could
be reached as early as 2035. At this level there is at least a 77%
chance--and perhaps up to a 99% chance, depending on the climate model
used--of a global average temperature rise exceeding 2 degrees C.
Under a BAU scenario, the stock of greenhouse gases could more than
treble by the end of the century, giving at least a 50% risk of
exceeding 5 degrees C global average temperature change during the
following decades. This would take humans into unknown territory. An
illustration of the scale of such an increase is that we are now only
around 5 degrees C warmer than in the last ice age.
Such changes would transform the physical geography of the world. A
radical change in the physical geography of the world must have
powerful implications for the human geography--where people live, and
how they live their lives.
Figure 2* summarises the scientific evidence of the links between
concentrations of greenhouse gases in the atmosphere, the probability
of different levels of global average temperature change, and the
physical impacts expected for each level. The risks of serious,
irreversible impacts of climate change increase strongly as
concentrations of greenhouse gases in the atmosphere rise.
Climate Change Threatens the Basic Elements of Life for People Around
the World--Access to Water, Food Production, Health, and Use of
Land and the Environment.
Estimating the economic costs of climate change is challenging, but
there is a range of methods or approaches that enable us to assess the
likely magnitude of the risks and compare them with the costs. This
Review considers three of these approaches.
This Review has first considered in detail the physical impacts on
economic activity, on human life and on the environment.
On current trends, average global temperatures will rise by 2-3
degrees C within the next fifty years or so.\2\ The Earth will be
committed to several degrees more warming if emissions continue to
grow.
---------------------------------------------------------------------------
\2\ All changes in global mean temperature are expressed relative
to pre-industrial levels (1750-1850).
---------------------------------------------------------------------------
Warming will have many severe impacts, often mediated through
water:
Melting glaciers will initially increase flood risk and then
strongly reduce water supplies, eventually threatening one-
sixth of the world's population, predominantly in the Indian
sub-continent, parts of China, and the Andes in South America.
Declining crop yields, especially in Africa, could leave
hundreds of millions without the ability to produce or purchase
sufficient food. At mid to high latitudes, crop yields may
increase for moderate temperature rises (2-3 degrees C), but
then decline with greater amounts of warming. At 4 degrees C
and above, global food production is likely to be seriously
affected.
In higher latitudes, cold-related deaths will decrease. But
climate change will increase worldwide deaths from malnutrition
and heat stress. Vector-borne diseases such as malaria and
dengue fever could become more widespread if effective control
measures are not in place.
Rising sea levels will result in tens to hundreds of
millions more people flooded each year with warming of 3 or 4
degrees C. There will be serious risks and increasing pressures
for coastal protection in South East Asia (Bangladesh and
Vietnam), small islands in the Caribbean and the Pacific, and
large coastal cities, such as Tokyo, New York, Cairo and
London. According to one estimate, by the middle of the
century, 200 million people may become permanently displaced
due to rising sea levels, heavier floods, and more intense
droughts.
Ecosystems will be particularly vulnerable to climate
change, with around 15-40% of species potentially facing
extinction after only 2 degrees C of warming. And ocean
acidification, a direct result of rising carbon dioxide levels,
will have major effects on marine ecosystems, with possible
adverse consequences on fish stocks.
The Damages From Climate Change Will Accelerate as the World Gets
Warmer.
Higher temperatures will increase the chance of triggering abrupt
and large-scale changes.
Warming may induce sudden shifts in regional weather
patterns such as the monsoon rains in South Asia or the El Nino
phenomenon--changes that would have severe consequences for
water availability and flooding in tropical regions and
threaten the livelihoods of millions of people.
A number of studies suggest that the Amazon rainforest could
be vulnerable to climate change, with models projecting
significant drying in this region. One model, for example,
finds that the Amazon rainforest could be significantly, and
possibly irrevocably, damaged by a warming of 2-3 degrees C.
The melting or collapse of ice sheets would eventually
threaten land which today is home to 1 in every 20 people.
While there is much to learn about these risks, the temperatures
that may result from unabated climate change will take the world
outside the range of human experience. This points to the possibility
of very damaging consequences.
The Impacts of Climate Change Are Not Evenly Distributed--The Poorest
Countries and People Will Suffer Earliest and Most. And If and
When The Damages Appear It Will Be Too Late To Reverse the
Process. Thus We Are Forced To Look a Long Way Ahead.
Climate change is a grave threat to the developing world and a
major obstacle to continued poverty reduction across its many
dimensions. First, developing regions are at a geographic disadvantage:
they are already warmer, on average, than developed regions, and they
also suffer from high rainfall variability. As a result, further
warming will bring poor countries high costs and few benefits. Second,
developing countries--in particular the poorest--are heavily dependent
on agriculture, the most climate-sensitive of all economic sectors, and
suffer from inadequate health provision and low-quality public
services. Third, their low incomes and vulnerabilities make adaptation
to climate change particularly difficult.
Because of these vulnerabilities, climate change is likely to
reduce further already low incomes and increase illness and death rates
in developing countries. Falling farm incomes will increase poverty and
reduce the ability of households to invest in a better future, forcing
them to use up meagre savings just to survive. At a national level,
climate change will cut revenues and raise spending needs, worsening
public finances.
Many developing countries are already struggling to cope with their
current climate. Climatic shocks cause setbacks to economic and social
development in developing countries today even with temperature
increases of less than 1 degree C. The impacts of unabated climate
change--that is, increases of 3 or 4 degrees C and upwards--will be to
increase the risks and costs of these events very powerfully.
Impacts on this scale could spill over national borders,
exacerbating the damage further. Rising sea levels and other climate-
driven changes could drive millions of people to migrate: more than a
fifth of Bangladesh could be under water with a 1 m rise in sea levels,
which is a possibility by the end of the century. Climate-related
shocks have sparked violent conflict in the past, and conflict is a
serious risk in areas such as West Africa, the Nile Basin and Central
Asia.
Climate Change May Initially Have Small Positive Effects for a Few
Developed Countries, but Is Likely To Be Very Damaging for the
Much Higher Temperature Increases Expected by Mid- to Late-
Century Under BAU Scenarios.
In higher latitude regions, such as Canada, Russia and Scandinavia,
climate change may lead to net benefits for temperature increases of 2
or 3 degrees C, through higher agricultural yields, lower winter
mortality, lower heating requirements, and a possible boost to tourism.
But these regions will also experience the most rapid rates of warming,
damaging infrastructure, human health, local livelihoods and
biodiversity.
Developed countries in lower latitudes will be more vulnerable--for
example, water availability and crop yields in southern Europe are
expected to decline by 20% with a 2 degrees C increase in global
temperatures. Regions where water is already scarce will face serious
difficulties and growing costs.
The increased costs of damage from extreme weather (storms,
hurricanes, typhoons, floods, droughts, and heat waves) counteract some
early benefits of climate change and will increase rapidly at higher
temperatures. Based on simple extrapolations, costs of extreme weather
alone could reach 0.5-1% of world GDP per annum by the middle of the
century, and will keep rising if the world continues to warm.
A 5 or 10% increase in hurricane wind speed, linked to
rising sea temperatures, is predicted approximately to double
annual damage costs, in the U.S.
In the U.K., annual flood losses alone could increase from
0.1% of GDP today to 0.2-0.4% of GDP once the increase in
global average temperatures reaches 3 or 4 degrees C.
Heat waves like that experienced in 2003 in Europe, when
35,000 people died and agricultural losses reached $15 billion,
will be commonplace by the middle of the century.
At higher temperatures, developed economies face a growing risk of
large-scale shocks--for example, the rising costs of extreme weather
events could affect global financial markets through higher and more
volatile costs of insurance.
Integrated Assessment Models Provide A Tool for Estimating the Total
Impact on the Economy; Our Estimates Suggest That This Is
Likely To Be Higher Than Previously Suggested.
The second approach to examining the risks and costs of climate
change adopted in the Review is to use integrated assessment models to
provide aggregate monetary estimates.
Formal modelling of the overall impact of climate change in
monetary terms is a formidable challenge, and the limitations to
modelling the world over two centuries or more demand great caution in
interpreting results. However, as we have explained, the lags from
action to effect are very long and the quantitative analysis needed to
inform action will depend on such long-range modelling exercises. The
monetary impacts of climate change are now expected to be more serious
than many earlier studies suggested, not least because those studies
tended to exclude some of the most uncertain but potentially most
damaging impacts. Thanks to recent advances in the science, it is now
possible to examine these risks more directly, using probabilities.
Most formal modelling in the past has used as a starting point a
scenario of 2-3 degrees C warming. In this temperature range, the cost
of climate change could be equivalent to a permanent loss of around 0-
3% in global world output compared with what could have been achieved
in a world without climate change. Developing countries will suffer
even higher costs.
However, those earlier models were too optimistic about warming:
more recent evidence indicates that temperature changes resulting from
BAU trends in emissions may exceed 2-3 degrees C by the end of this
century. This increases the likelihood of a wider range of impacts than
previously considered. Many of these impacts, such as abrupt and large-
scale climate change, are more difficult to quantify. With 5-6 degrees
C warming--which is a real possibility for the next century--existing
models that include the risk of abrupt and large-scale climate change
estimate an average 5-10% loss in global GDP, with poor countries
suffering costs in excess of 10% of GDP. Further, there is some
evidence of small but significant risks of temperature rises even above
this range. Such temperature increases would take us into territory
unknown to human experience and involve radical changes in the world
around us.
With such possibilities on the horizon, it was clear that the
modelling framework used by this Review had to be built around the
economics of risk. Averaging across possibilities conceals risks. The
risks of outcomes much worse than expected are very real and they could
be catastrophic. Policy on climate change is in large measure about
reducing these risks. They cannot be fully eliminated, but they can be
substantially reduced. Such a modelling framework has to take into
account ethical judgements on the distribution of income and on how to
treat future generations.
The analysis should not focus only on narrow measures of income
like GDP. The consequences of climate change for health and for the
environment are likely to be severe. Overall comparison of different
strategies will include evaluation of these consequences too. Again,
difficult conceptual, ethical and measurement issues are involved, and
the results have to be treated with due circumspection.
The Review uses the results from one particular model, PAGE2002, to
illustrate how the estimates derived from these integrated assessment
models change in response to updated scientific evidence on the
probabilities attached to degrees of temperature rise. The choice of
model was guided by our desire to analyse risks explicitly--this is one
of the very few models that would allow that exercise. Further, its
underlying assumptions span the range of previous studies. We have used
this model with one set of data consistent with the climate predictions
of the 2001 report of the Intergovernmental Panel on Climate Change,
and with one set that includes a small increase in the amplifying
feedbacks in the climate system. This increase illustrates one area of
the increased risks of climate change that have appeared in the peer-
reviewed scientific literature published since 2001.
We have also considered how the application of appropriate discount
rates, assumptions about the equity weighting attached to the valuation
of impacts in poor countries, and estimates of the impacts on mortality
and the environment would increase the estimated economic costs of
climate change.
Using this model, and including those elements of the analysis that
can be incorporated at the moment, we estimate the total cost over the
next two centuries of climate change associated under BAU emissions
involves impacts and risks that are equivalent to an average reduction
in global per-capita consumption of at least 5%, now and forever. While
this cost estimate is already strikingly high, it also leaves out much
that is important.
The cost of BAU would increase still further, were the model
systematically to take account of three important factors:
First, including direct impacts on the environment and human
health (sometimes called `non-market' impacts) increases our
estimate of the total cost of climate change on this path from
5% to 11% of global per-capita consumption. There are difficult
analytical and ethical issues of measurement here. The methods
used in this model are fairly conservative in the value they
assign to these impacts.
Second, some recent scientific evidence indicates that the
climate system may be more responsive to greenhouse-gas
emissions than previously thought, for example because of the
existence of amplifying feedbacks such as the release of
methane and weakening of carbon sinks. Our estimates, based on
modelling a limited increase in this responsiveness, indicate
that the potential scale of the climate response could increase
the cost of climate change on the BAU path from 5% to 7% of
global consumption, or from 11% to 14% if the non-market
impacts described above are included.
Third, a disproportionate share of the climate-change burden
falls on poor regions of the world. If we weight this unequal
burden appropriately, the estimated global cost of climate
change at 5-6 degrees C warming could be more than one-quarter
higher than without such weights.
Putting these additional factors together would increase the total
cost of BAU climate change to the equivalent of around a 20% reduction
in consumption per head, now and into the future.
In summary, analyses that take into account the full ranges of both
impacts and possible outcomes--that is, that employ the basic economics
of risk--suggest that BAU climate change will reduce welfare by an
amount equivalent to a reduction in consumption per head of between 5
and 20%. Taking account of the increasing scientific evidence of
greater risks, of aversion to the possibilities of catastrophe, and of
a broader approach to the consequences than implied by narrow output
measures, the appropriate estimate is likely to be in the upper part of
this range.
Economic forecasting over just a few years is a difficult and
imprecise task. The analysis of climate change requires, by its nature,
that we look out over 50, 100, 200 years and more. Any such modelling
requires caution and humility, and the results are specific to the
model and its assumptions. They should not be endowed with a precision
and certainty that is simply impossible to achieve. Further, some of
the big uncertainties in the science and the economics concern the
areas we know least about (for example, the impacts of very high
temperatures), and for good reason--this is unknown territory. The main
message from these models is that when we try to take due account of
the upside risks and uncertainties, the probability-weighted costs look
very large. Much (but not all) of the risk can be reduced through a
strong mitigation policy, and we argue that this can be achieved at a
far lower cost than those calculated for the impacts. In this sense,
mitigation is a highly productive investment.
Emissions Have Been, and Continue To Be, Driven by Economic Growth; Yet
Stabilisation of Greenhouse-Gas Concentrations in the
Atmosphere Is Feasible and Consistent With Continued Growth.
CO2 emissions per head have been strongly correlated
with GDP per head. As a result, since 1850, North America and Europe
have produced around 70% of all the CO2 emissions due to
energy production, while developing countries have accounted for less
than one quarter. Most future emissions growth will come from today's
developing countries, because of their more rapid population and GDP
growth and their increasing share of energy-intensive industries.
Yet despite the historical pattern and the BAU projections, the
world does not need to choose between averting climate change and
promoting growth and development. Changes in energy technologies and
the structure of economies have reduced the responsiveness of emissions
to income growth, particularly in some of the richest countries. With
strong, deliberate policy choices, it is possible to `decarbonise' both
developed and developing economies on the scale required for climate
stabilisation, while maintaining economic growth in both.
Stabilisation--at whatever level--requires that annual emissions be
brought down to the level that balances the Earth's natural capacity to
remove greenhouse gases from the atmosphere. The longer emissions
remain above this level, the higher the final stabilisation level. In
the long term, annual global emissions will need to be reduced to below
5 GtCO2e, the level that the earth can absorb without adding
to the concentration of GHGs in the atmosphere. This is more than 80%
below the absolute level of current annual emissions.
This Review has focused on the feasibility and costs of
stabilisation of greenhouse gas concentrations in the atmosphere in the
range of 450-550ppm CO2e.
Stabilising at or below 550ppm CO2e would require global
emissions to peak in the next 10--20 years, and then fall at a rate of
at least 1--3% per year. The range of paths is illustrated in Figure
3.* By 2050, global emissions would need to be around 25% below current
levels. These cuts will have to be made in the context of a world
economy in 2050 that may be 3--4 times larger than today--so emissions
per unit of GDP would need to be just one quarter of current levels by
2050.
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To stabilise at 450ppm CO2e, without overshooting,
global emissions would need to peak in the next 10 years and then fall
at more than 5% per year, reaching 70% below current levels by 2050.
Theoretically it might be possible to ``overshoot'' by allowing the
atmospheric GHG concentration to peak above the stabilisation level and
then fall, but this would be both practically very difficult and very
unwise. Overshooting paths involve greater risks, as temperatures will
also rise rapidly and peak at a higher level for many decades before
falling back down. Also, overshooting requires that emissions
subsequently be reduced to extremely low levels, below the level of
natural carbon absorption, which may not be feasible. Furthermore, if
the high temperatures were to weaken the capacity of the Earth to
absorb carbon--as becomes more likely with overshooting--future
emissions would need to be cut even more rapidly to hit any given
stabilisation target for atmospheric concentration.
Achieving These Deep Cuts in Emissions Will Have a Cost--The Review
Estimates the Annual Costs of Stabilisation at 500-550ppm
CO2e To Be Around 1% of GDP by 2050--A Level That Is
Significant but Manageable.
Reversing the historical trend in emissions growth, and achieving
cuts of 25% or more against today's levels is a major challenge. Costs
will be incurred as the world shifts from a high-carbon to a low-carbon
trajectory. But there will also be business opportunities as the
markets for low-carbon, high-efficiency goods and services expand.
Greenhouse-gas emissions can be cut in four ways. Costs will differ
considerably depending on which combination of these methods is used,
and in which sector:
Reducing demand for emissions-intensive goods and services;
Increased efficiency, which can save both money and
emissions;
Action on non-energy emissions, such as avoiding
deforestation;
Switching to lower-carbon technologies for power, heat and
transport.
Estimating the costs of these changes can be done in two ways. One
is to look at the resource costs of measures, including the
introduction of low-carbon technologies and changes in land use,
compared with the costs of the BAU alternative. This provides an upper
bound on costs, as it does not take account of opportunities to respond
involving reductions in demand for high-carbon goods and services.
The second is to use macroeconomic models to explore the system-
wide effects of the transition to a low-carbon energy economy. These
can be useful in tracking the dynamic interactions of different factors
over time, including the response of economies to changes in prices.
But they can be complex, with their results affected by a whole range
of assumptions.
On the basis of these two methods, central estimate is that
stabilisation of greenhouse gases at levels of 500-550ppm
CO2e will cost, on average, around 1% of annual global GDP
by 2050. This is significant, but is fully consistent with continued
growth and development, in contrast with unabated climate change, which
will eventually pose significant threats to growth.
Resource Cost Estimates Suggest That an Upper Bound for the Expected
Annual Cost of Emissions Reductions Consistent With a
Trajectory Leading To Stabilisation at 550PPM CO2e
Is Likely To Be Around 1% of GDP by 2050.
This Review has considered in detail the potential for, and costs
of, technologies and measures to cut emissions across different
sectors. As with the impacts of climate change, this is subject to
important uncertainties. These include the difficulties of estimating
the costs of technologies several decades into the future, as well as
the way in which fossil-fuel prices evolve in the future. It is also
hard to know how people will respond to price changes.
The precise evolution of the mitigation effort, and the composition
across sectors of emissions reductions, will therefore depend on all
these factors. But it is possible to make a central projection of costs
across a portfolio of likely options, subject to a range.
The technical potential for efficiency improvements to reduce
emissions and costs is substantial. Over the past century, efficiency
in energy supply improved ten-fold or more in developed countries, and
the possibilities for further gains are far from being exhausted.
Studies by the International Energy Agency show that, by 2050, energy
efficiency has the potential to be the biggest single source of
emissions savings in the energy sector. This would have both
environmental and economic benefits: energy-efficiency measures cut
waste and often save money.
Non-energy emissions make up one-third of total greenhouse-gas
emissions; action here will make an important contribution. A
substantial body of evidence suggests that action to prevent further
deforestation would be relatively cheap compared with other types of
mitigation, if the right policies and institutional structures are put
in place.
Large-scale uptake of a range of clean power, heat, and transport
technologies is required for radical emission cuts in the medium- to
long-term. The power sector around the world will have to be least 60%,
and perhaps as much as 75%, decarbonised by 2050 to stabilise at or
below 550ppm CO2e. Deep cuts in the transport sector are
likely to be more difficult in the shorter term, but will ultimately be
needed. While many of the technologies to achieve this already exist,
the priority is to bring down their costs so that they are competitive
with fossil-fuel alternatives under a carbon-pricing policy regime.
A portfolio of technologies will be required to stabilise
emissions. It is highly unlikely that any single technology will
deliver all the necessary emission savings, because all technologies
are subject to constraints of some kind, and because of the wide range
of activities and sectors that generate greenhouse-gas emissions. It is
also uncertain which technologies will turn out to be cheapest. Hence a
portfolio will be required for low-cost abatement.
The shift to a low-carbon global economy will take place against
the background of an abundant supply of fossil fuels. That is to say,
the stocks of hydrocarbons that are profitable to extract (under
current policies) are more than enough to take the world to levels of
greenhouse-gas concentrations well beyond 750ppm CO2e, with
very dangerous consequences. Indeed, under BAU, energy users are likely
to switch towards more carbon-intensive coal and oil shales, increasing
rates of emissions growth.
Even with very strong expansion of the use of renewable energy and
other low-carbon energy sources, hydrocarbons may still make over half
of global energy supply in 2050. Extensive carbon capture and storage
would allow this continued use of fossil fuels without damage to the
atmosphere, and also guard against the danger of strong climate-change
policy being undermined at some stage by falls in fossil-fuel prices.
Estimates based on the likely costs of these methods of emissions
reduction show that the annual costs of stabilising at around 550ppm
CO2e are likely to be around 1% of global GDP by 2050, with
a range from 1% (net gains) to +3.5% of GDP.
Looking at Broader Macroeconomic Models Confirms These Estimates.
The second approach adopted by the Review was based comparisons of
a broad range of macro-economic model estimates (such as that presented
in Figure 4* below). This comparison found that the costs for
stabilisation at 500-550ppm CO2e were centred on 1% of GDP
by 2050, with a range of 2% to +5% of GDP. The range reflects a number
of factors, including the pace of technological innovation and the
efficiency with which policy is applied across the globe: the faster
the innovation and the greater the efficiency, the lower the cost.
These factors can be influenced by policy.
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The average expected cost is likely to remain around 1% of GDP from
mid-century, but the range of estimates around the 1% diverges strongly
thereafter, with some falling and others rising sharply by 2100,
reflecting the greater uncertainty about the costs of seeking out ever
more innovative methods of mitigation.
Stabilisation at 450ppm CO2e is already almost out of
reach, given that we are likely to reach this level within ten years
and that there are real difficulties of making the sharp reductions
required with current and foreseeable technologies. Costs rise
significantly as mitigation efforts become more ambitious or sudden.
Efforts to reduce emissions rapidly are likely to be very costly.
An important corollary is that there is a high price to delay.
Delay in taking action on climate change would make it necessary to
accept both more climate change and, eventually, higher mitigation
costs. Weak action in the next 10-20 years would put stabilisation even
at 550ppm CO2e beyond reach--and this level is already
associated with significant risks.
The Transition to a Low-Carbon Economy Will Bring Challenges for
Competitiveness but Also Opportunities for Growth.
Costs of mitigation of around 1% of GDP are small relative to the
costs and risks of climate change that will be avoided. However, for
some countries and some sectors, the costs will be higher. There may be
some impacts on the competitiveness of a small number of
internationally traded products and processes. These should not be
overestimated, and can be reduced or eliminated if countries or sectors
act together; nevertheless, there will be a transition to be managed.
For the economy as a whole, there will be benefits from innovation that
will offset some of these costs. All economies undergo continuous
structural change; the most successful economies are those that have
the flexibility and dynamism to embrace the change.
There are also significant new opportunities across a wide range of
industries and services. Markets for low-carbon energy products are
likely to be worth at least $500 bn per year by 2050, and perhaps much
more. Individual companies and countries should position themselves to
take advantage of these opportunities.
Climate-change policy can help to root out existing inefficiencies.
At the company level, implementing climate policies may draw attention
to money-saving opportunities. At the economy-wide level, climate-
change policy may be a lever for reforming inefficient energy systems
and removing distorting energy subsidies, on which governments around
the world currently spend around $250bn a year.
Policies on climate change can also help to achieve other
objectives. These co-benefits can significantly reduce the overall cost
to the economy of reducing greenhouse-gas emissions. If climate policy
is designed well, it can, for example, contribute to reducing ill-
health and mortality from air pollution, and to preserving forests that
contain a significant proportion of the world's biodiversity.
National objectives for energy security can also be pursued
alongside climate change objectives. Energy efficiency and
diversification of energy sources and supplies support energy security,
as do clear long-term policy frameworks for investors in power
generation. Carbon capture and storage is essential to maintain the
role of coal in providing secure and reliable energy for many
economies.
Reducing the Expected Adverse Impacts of Climate Change Is Therefore
Both Highly Desirable and Feasible.
This conclusion follows from a comparison of the above estimates of
the costs of mitigation with the high costs of inaction described from
our first two methods (the aggregated and the disaggregated) of
assessing the risks and costs of climate change impacts.
The third approach to analysing the costs and benefits of action on
climate change adopted by this Review compares the marginal costs of
abatement with the social cost of carbon. This approach compares
estimates of the changes in the expected benefits and costs over time
from a little extra reduction in emissions, and avoids large-scale
formal economic models.
Preliminary calculations adopting the approach to valuation taken
in this Review suggest that the social cost of carbon today, if we
remain on a BAU trajectory, is of the order of $85 per tonne of
CO2--higher than typical numbers in the literature, largely
because we treat risk explicitly and incorporate recent evidence on the
risks, but nevertheless well within the range of published estimates.
This number is well above marginal abatement costs in many sectors.
Comparing the social costs of carbon on a BAU trajectory and on a path
towards stabilisation at 550ppm CO2e, we estimate the excess
of benefits over costs, in net present value terms, from implementing
strong mitigation policies this year, shifting the world onto the
better path: the net benefits would be of the order of $2.5 trillion.
This figure will increase over time. This is not an estimate of net
benefits occurring in this year, but a measure of the benefits that
could flow from actions taken this year; many of the costs and benefits
would be in the medium to long term.
Even if we have sensible policies in place, the social cost of
carbon will also rise steadily over time, making more and more
technological options for mitigation cost-effective. This does not mean
that consumers will always face rising prices for the goods and
services that they currently enjoy, as innovation driven by strong
policy will ultimately reduce the carbon intensity of our economies,
and consumers will then see reductions in the prices that they pay as
low-carbon technologies mature.
The three approaches to the analysis of the costs of climate change
used in the Review all point to the desirability of strong action,
given estimates of the costs of action on mitigation. But how much
action? The Review goes on to examine the economics of this question.
The current evidence suggests aiming for stabilisation somewhere
within the range 450--550ppm CO2e. Anything higher would
substantially increase the risks of very harmful impacts while reducing
the expected costs of mitigation by comparatively little. Aiming for
the lower end of this range would mean that the costs of mitigation
would be likely to rise rapidly. Anything lower would certainly impose
very high adjustment costs in the near term for small gains and might
not even be feasible, not least because of past delays in taking strong
action.
Uncertainty is an argument for a more, not less, demanding goal,
because of the size of the adverse climate-change impacts in the worst-
case scenarios.
The ultimate concentration of greenhouse gases determines the
trajectory for estimates of the social cost of carbon; these also
reflect the particular ethical judgements and approach to the treatment
of uncertainty embodied in the modelling. Preliminary work for this
Review suggests that, if the target were between 450-550ppm
CO2e, then the social cost of carbon would start in the
region of $25-30 per tonne of CO2--around one third of the
level if the world stays with BAU.
The social cost of carbon is likely to increase steadily over time
because marginal damages increase with the stock of GHGs in the
atmosphere, and that stock rises over time. Policy should therefore
ensure that abatement efforts at the margin also intensify over time.
But it should also foster the development of technology that can drive
down the average costs of abatement; although pricing carbon, by
itself, will not be sufficient to bring forth all the necessary
innovation, particularly in the early years.
The first half of the Review therefore demonstrates that strong
action on climate change, including both mitigation and adaptation, is
worthwhile, and suggests appropriate goals for climate-change policy.
The second half of the Review examines the appropriate form of such
policy, and how it can be placed within a framework of international
collective action.
Policy To Reduce Emissions Should Be Based on Three Essential Elements:
Carbon Pricing, Technology Policy, and Removal of Barriers to
Behavioural Change.
There are complex challenges in reducing greenhouse-gas emissions.
Policy frameworks must deal with long time horizons and with
interactions with a range of other market imperfections and dynamics.
A shared understanding of the long-term goals for stabilisation is
a crucial guide to policy-making on climate change: it narrows down
strongly the range of acceptable emissions paths. But from year to
year, flexibility in what, where and when reductions are made will
reduce the costs of meeting these stabilisation goals.
Policies should adapt to changing circumstances as the costs and
benefits of responding to climate change become clearer over time. They
should also build on diverse national conditions and approaches to
policy-making. But the strong links between current actions and the
long-term goal should be at the forefront of policy.
Three elements of policy for mitigation are essential: a carbon
price, technology policy, and the removal of barriers to behavioural
change. Leaving out any one of these elements will significantly
increase the costs of action.
Establishing a Carbon Price, Through Tax, Trading or Regulation, Is an
Essential Foundation for Climate-Change Policy.
The first element of policy is carbon pricing. Greenhouse gases
are, in economic terms, an externality: those who produce greenhouse-
gas emissions are bringing about climate change, thereby imposing costs
on the world and on future generations, but they do not face the full
consequences of their actions themselves.
Putting an appropriate price on carbon--explicitly through tax or
trading, or implicitly through regulation--means that people are faced
with the full social cost of their actions. This will lead individuals
and businesses to switch away from high-carbon goods and services, and
to invest in low-carbon alternatives. Economic efficiency points to the
advantages of a common global carbon price: emissions reductions will
then take place wherever they are cheapest.
The choice of policy tool will depend on countries' national
circumstances, on the characteristics of particular sectors, and on the
interaction between climate-change policy and other policies. Policies
also have important differences in their consequences for the
distribution of costs across individuals, and their impact on the
public finances. Taxation has the advantage of delivering a steady flow
of revenue, while, in the case of trading, increasing the use of
auctioning is likely to have strong benefits for efficiency, for
distribution and for the public finances. Some administrations may
choose to focus on trading initiatives, others on taxation or
regulation, and others on a mix of policies. And their choices may vary
across sectors.
Trading schemes can be an effective way to equalise carbon prices
across countries and sectors, and the EU Emissions Trading Scheme is
now the centrepiece of European efforts to cut emissions. To reap the
benefits of emissions trading, schemes must provide incentives for a
flexible and efficient response. Broadening the scope of trading
schemes will tend to lower costs and reduce volatility. Clarity and
predictability about the future rules and shape of schemes will help to
build confidence in a future carbon price.
In order to influence behaviour and investment decisions, investors
and consumers must believe that the carbon price will be maintained
into the future. This is particularly important for investments in
long-lived capital stock. Investments such as power stations,
buildings, industrial plants and aircraft last for many decades. If
there is a lack of confidence that climate change policies will
persist, then businesses may not factor a carbon price into their
decision-making. The result may be overinvestment in long-lived, high-
carbon infrastructure--which will make emissions cuts later on much
more expensive and difficult.
But establishing credibility takes time. The next 10 to 20 years
will be a period of transition, from a world where carbon-pricing
schemes are in their infancy, to one where carbon pricing is universal
and is automatically factored into decision making. In this
transitional period, while the credibility of policy is still being
established and the international framework is taking shape, it is
critical that governments consider how to avoid the risks of locking
into a high-carbon infrastructure, including considering whether any
additional measures may be justified to reduce the risks.
Policies Are Required To Support the Development of a Range of Low-
Carbon and High-Efficiency Technologies on an Urgent Timescale.
The second element of climate-change policy is technology policy,
covering the full spectrum from research and development, to
demonstration and early stage deployment. The development and
deployment of a wide range of low-carbon technologies is essential in
achieving the deep cuts in emissions that are needed. The private
sector plays the major role in R&D and technology diffusion, but closer
collaboration between government and industry will further stimulate
the development of a broad portfolio of low carbon technologies and
reduce costs.
Many low-carbon technologies are currently more expensive than the
fossil-fuel alternatives. But experience shows that the costs of
technologies fall with scale and experience, as shown in Figure 5*
below.
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Carbon pricing gives an incentive to invest in new technologies to
reduce carbon; indeed, without it, there is little reason to make such
investments. But investing in new lower-carbon technologies carries
risks. Companies may worry that they will not have a market for their
new product if carbon-pricing policy is not maintained into the future.
And the knowledge gained from research and development is a public
good; companies may under-invest in projects with a big social payoff
if they fear they will be unable to capture the full benefits. Thus
there are good economic reasons to promote new technology directly.
Public spending on research, development and demonstration has
fallen significantly in the last two decades and is now low relative to
other industries. There are likely to be high returns to a doubling of
investments in this area to around $20 billion per annum globally, to
support the development of a diverse portfolio of technologies.
In some sectors--particularly electricity generation, where new
technologies can struggle to gain a foothold--policies to support the
market for early-stage technologies will be critical. The Review argues
that the scale of existing deployment incentives worldwide should
increase by two to five times, from the current level of around $34
billion per annum. Such measures will be a powerful motivation for
innovation across the private sector to bring forward the range of
technologies needed.
The Removal of Barriers to Behavioural Change Is a Third Essential
Element, One That Is Particularly Important in Encouraging the
Take-Up of Opportunities for Energy Efficiency.
The third element is the removal of barriers to behavioural change.
Even where measures to reduce emissions are cost-effective, there may
be barriers preventing action. These include a lack of reliable
information, transaction costs, and behavioural and organisational
inertia. The impact of these barriers can be most clearly seen in the
frequent failure to realise the potential for cost-effective energy
efficiency measures.
Regulatory measures can play a powerful role in cutting through
these complexities, and providing clarity and certainty. Minimum
standards for buildings and appliances have proved a cost-effective way
to improve performance, where price signals alone may be too muted to
have a significant impact.
Information policies, including labelling and the sharing of best
practice, can help consumers and businesses make sound decisions, and
stimulate competitive markets for low-carbon and high-efficiency goods
and services. Financing measures can also help, through overcoming
possible constraints to paying the upfront cost of efficiency
improvements.
Fostering a shared understanding of the nature of climate change,
and its consequences, is critical in shaping behaviour, as well as in
underpinning national and international action. Governments can be a
catalyst for dialogue through evidence, education, persuasion and
discussion. Educating those currently at school about climate change
will help to shape and sustain future policy-making, and a broad public
and international debate will support today's policy-makers in taking
strong action now.
Adaptation Policy Is Crucial for Dealing With the Unavoidable Impacts
of Climate Change, but It Has Been Under-Emphasised in Many
Countries.
Adaptation is the only response available for the impacts that will
occur over the next several decades before mitigation measures can have
an effect.
Unlike mitigation, adaptation will in most cases provide local
benefits, realised without long lead times. Therefore some adaptation
will occur autonomously, as individuals respond to market or
environmental changes. Some aspects of adaptation, such as major
infrastructure decisions, will require greater foresight and planning.
There are also some aspects of adaptation that require public goods
delivering global benefits, including improved information about the
climate system and more climate-resilient crops and technologies.
Quantitative information on the costs and benefits of economy-wide
adaptation is currently limited. Studies in climate-sensitive sectors
point to many adaptation options that will provide benefits in excess
of cost. But at higher temperatures, the costs of adaptation will rise
sharply and the residual damages remain large. The additional costs of
making new infrastructure and buildings resilient to climate change in
OECD countries could be $15-150 billion each year (0.05-0.5% of GDP).
The challenge of adaptation will be particularly acute in
developing countries, where greater vulnerability and poverty will
limit the capacity to act. As in developed countries, the costs are
hard to estimate, but are likely to run into tens of billions of
dollars.
Markets that respond to climate information will stimulate
adaptation among individuals and firms. Risk-based insurance schemes,
for example, provide strong signals about the size of climate risks and
therefore encourage good risk management.
Governments have a role in providing a policy framework to guide
effective adaptation by individuals and firms in the medium and longer
term. There are four key areas:
High-quality climate information and tools for risk
management will help to drive efficient markets. Improved
regional climate predictions will be critical, particularly for
rainfall and storm patterns.
Land-use planning and performance standards should encourage
both private and public investment in buildings and other long-
lived infrastructure to take account of climate change.
Governments can contribute through long-term polices for
climate-sensitive public goods, including natural resources
protection, coastal protection, and emergency preparedness.
A financial safety net may be required for the poorest in
society, who are likely to be the most vulnerable to the
impacts and least able to afford protection (including
insurance).
Sustainable development itself brings the diversification,
flexibility and human capital which are crucial components of
adaptation. Indeed, much adaptation will simply be an extension of good
development practice--for example, promoting overall development,
better disaster management and emergency response. Adaptation action
should be integrated into development policy and planning at every
level.
An Effective Response to Climate Change Will Depend on Creating the
Conditions for International Collective Action.
This Review has identified many actions that communities and
countries can take on their own to tackle climate change.
Indeed, many countries, states and companies are already beginning
to act. However, the emissions of most individual countries are small
relative to the global total, and very large reductions are required to
stabilise greenhouse gas concentrations in the atmosphere. Climate
change mitigation raises the classic problem of the provision of a
global public good. It shares key characteristics with other
environmental challenges that require the international management of
common resources to avoid free riding.
The U.N. Framework Convention on Climate Change (UNFCCC), Kyoto
Protocol and a range of other informal partnerships and dialogues
provide a framework that supports co-operation, and a foundation from
which to build further collective action.
A shared global perspective on the urgency of the problem and on
the long-term goals for climate change policy, and an international
approach based on multilateral frameworks and co-ordinated action, are
essential to respond to the scale of the challenge. International
frameworks for action on climate change should encourage and respond to
the leadership shown by different countries in different ways, and
should facilitate and motivate the involvement of all states. They
should build on the principles of effectiveness, efficiency and equity
that have already provided the foundations of the existing multilateral
framework.
The need for action is urgent: demand for energy and transportation
is growing rapidly in many developing countries, and many developed
countries are also due to renew a significant proportion of capital
stock. The investments made in the next 10-20 years could lock in very
high emissions for the next half-century, or present an opportunity to
move the world onto a more sustainable path.
International co-operation must cover all aspects of policy to
reduce emissions--pricing, technology and the removal of behavioural
barriers, as well as action on emissions from land use. And it must
promote and support adaptation. There are significant opportunities for
action now, including in areas with immediate economic benefits (such
as energy efficiency and reduced gas flaring) and in areas where large-
scale pilot programmes would generate important experience to guide
future negotiations.
Agreement on a broad set of mutual responsibilities across each of
the relevant dimensions of action would contribute to the overall goal
of reducing the risks of climate change. These responsibilities should
take account of costs and the ability to bear them, as well as starting
points, prospects for growth and past histories.
Securing broad-based and sustained co-operation requires an
equitable distribution of effort across both developed and developing
countries. There is no single formula that captures all dimensions of
equity, but calculations based on income, historic responsibility and
per capita emissions all point to rich countries taking responsibility
for emissions reductions of 60-80% from 1990 levels by 2050.
Co-operation can be encouraged and sustained by greater
transparency and comparability of national action.
Creating A Broadly Similar Carbon Price Signal Around the World, and
Using Carbon Finance To Accelerate Action in Developing
Countries, Are Urgent Priorities for International Co-
Operation.
A broadly similar price of carbon is necessary to keep down the
overall costs of making these reductions, and can be created through
tax, trading or regulation. The transfer of technologies to developing
countries by the private sector can be accelerated through national
action and international co-operation.
The Kyoto Protocol has established valuable institutions to
underpin international emissions trading. There are strong reasons to
build on and learn from this approach. There are opportunities to use
the UNFCCC dialogue and the review of the effectiveness of the Kyoto
Protocol, as well as a wide range of informal dialogues, to explore
ways to move forward.
Private sector trading schemes are now at the heart of
international flows of carbon finance. Linking and expanding regional
and sectoral emissions trading schemes, including sub-national and
voluntary schemes, requires greater international cooperation and the
development of appropriate new institutional arrangements.
Decisions Made Now on the Third Phase of the EU ETS Provide an
Opportunity for the Scheme To Influence, and Become the Nucleus
of, Future Global Carbon Markets.
The EU ETS is the world's largest carbon market. The structure of
the third phase of the scheme, beyond 2012, is currently under debate.
This is an opportunity to set out a clear, long-term vision to place
the scheme at the heart of future global carbon markets.
There are a number of elements which will contribute to a credible
vision for the EU ETS. The overall EU limit on emissions should be set
at a level that ensures scarcity in the market for emissions
allowances, with stringent criteria for allocation volumes across all
relevant sectors. Clear and frequent information on emissions during
the trading period would improve transparency in the market, reducing
the risks of unnecessary price spikes or of unexpected collapses.
Clear revision rules covering the basis for allocations in future
trading periods would create greater predictability for investors. The
possibility of banking (and perhaps borrowing) emissions allowances
between periods could help smooth prices over time.
Broadening participation to other major industrial sectors, and to
sectors such as aviation, would help deepen the market, and increased
use of auctioning would promote efficiency.
Enabling the EU ETS to link with other emerging trading schemes
(including in the U.S. and Japan), and maintaining and developing
mechanisms to allow the use of carbon reductions made in developing
countries, could improve liquidity while also establishing the nucleus
of a global carbon market.
Scaling Up Flows of Carbon Finance to Developing Countries To Support
Effective Policies and Programmes for Reducing Emissions Would
Accelerate the Transition to a Low-Carbon Economy.
Developing countries are already taking significant action to
decouple their economic growth from the growth in greenhouse gas
emissions. For example, China has adopted very ambitious domestic goals
to reduce energy used for each unit of GDP by 20% from 2006-2010 and to
promote the use of renewable energy. India has created an Integrated
Energy Policy for the same period that includes measures to expand
access to cleaner energy for poor people and to increase energy
efficiency.
The Clean Development Mechanism, created by the Kyoto Protocol, is
currently the main formal channel for supporting low-carbon investment
in developing countries. It allows both governments and the private
sector to invest in projects that reduce emissions in fast-growing
emerging economies, and provides one way to support links between
different regional emissions trading schemes.
In future, a transformation in the scale of, and institutions for,
international carbon finance flows will be required to support cost-
effective emissions reductions. The incremental costs of low-carbon
investments in developing countries are likely to be at least $20-30
billion per year. Providing assistance with these costs will require a
major increase in the level of ambition of trading schemes such as the
EU ETS. This will also require mechanisms that link private-sector
carbon finance to policies and programmes rather than to individual
projects. And it should work within a context of national, regional or
sectoral objectives for emissions reductions. These flows will be
crucial in accelerating private investment and national government
action in developing countries.
There are opportunities now to build trust and to pilot new
approaches to creating large-scale flows for investment in low-carbon
development paths. Early signals from existing emissions trading
schemes, including the EU ETS, about the extent to which they will
accept carbon credits from developing countries, would help to maintain
continuity during this important stage of building markets and
demonstrating what is possible.
The International Financial Institutions have an important role to
play in accelerating this process: the establishment of a Clean Energy
Investment Framework by the World Bank and other multilateral
development banks offers significant potential for catalysing and
scaling up investment flows.
Greater International Co-Operation To Accelerate Technological
Innovation and Diffusion Will Reduce the Costs of Mitigation.
The private sector is the major driver of innovation and the
diffusion of technologies around the world. But governments can help to
promote international collaboration to overcome barriers in this area,
including through formal arrangements and through arrangements that
promote public-private co-operation such as the Asia Pacific
Partnership. Technology co-operation enables the sharing of risks,
rewards and progress of technology development and enables co-
ordination of priorities.
A global portfolio that emerges from individual national R&D
priorities and deployment support may not be sufficiently diverse, and
is likely to place too little weight on some technologies that are
particularly important for developing countries, such as biomass.
International R&D co-operation can take many forms. Coherent,
urgent and broadly based action requires international understanding
and co-operation. These may be embodied in formal multilateral
agreements that allow countries to pool the risks and rewards for major
investments in R&D, including demonstration projects and dedicated
international programmes to accelerate key technologies. But formal
agreements are only one part of the story--informal arrangements for
greater coordination and enhanced linkages between national programmes
can also play a very prominent role.
Both informal and formal co-ordination of national policies for
deployment support can accelerate cost reductions by increasing the
scale of new markets across borders. Many countries and U.S. states now
have specific national objectives and policy frameworks to support the
deployment of renewable energy technologies. Transparency and
information-sharing have already helped to boost interest in these
markets. Exploring the scope for making deployment instruments tradable
across borders could increase the effectiveness of support, including
mobilising the resources that will be required to accelerate the
widespread deployment of carbon capture and storage and the use of
technologies that are particularly appropriate for developing
countries.
International co-ordination of regulations and product standards
can be a powerful way to encourage greater energy efficiency. It can
raise their cost effectiveness, strengthen the incentives to innovate,
improve transparency, and promote international trade.
The reduction of tariff and non-tariff barriers for low-carbon
goods and services, including within the Doha Development Round of
international trade negotiations, could provide further opportunities
to accelerate the diffusion of key technologies.
Curbing Deforestation Is a Highly Cost-Effective Way of Reducing
Greenhouse Gas Emissions.
Emissions from deforestation are very significant--they are
estimated to represent more than 18% of global emissions, a share
greater than is produced by the global transport sector.
Action to preserve the remaining areas of natural forest is needed
urgently. Large-scale pilot schemes are required to explore effective
approaches to combining national action and international support.
Policies on deforestation should be shaped and led by the nation
where the particular forest stands. But those countries should receive
strong help from the international community, which benefits from their
actions to reduce deforestation. At a national level, defining property
rights to forestland, and determining the rights and responsibilities
of landowners, communities and loggers, is key to effective forest
management. This should involve local communities, respect informal
rights and social structures, work with development goals and reinforce
the process of protecting the forests.
Research carried out for this report indicates that the opportunity
cost of forest protection in 8 countries responsible for 70 per cent of
emissions from land use could be around $5 billion per annum initially,
although over time marginal costs would rise.
Compensation from the international community should take account
of the opportunity costs of alternative uses of the land, the costs of
administering and enforcing protection, and the challenges of managing
the political transition as established interests are displaced.
Carbon markets could play an important role in providing such
incentives in the longer term. But there are short-term risks of
destabilising the crucial process of strengthening existing strong
carbon markets if deforestation is integrated without agreements that
strongly increase demand for emissions reductions. These agreements
must be based on an understanding of the scale of transfers likely to
be involved.
Adaptation Efforts in Developing Countries Must Be Accelerated and
Supported, Including Through International Development
Assistance.
The poorest developing countries will be hit earliest and hardest
by climate change, even though they have contributed little to causing
the problem. Their low incomes make it difficult to finance adaptation.
The international community has an obligation to support them in
adapting to climate change. Without such support there is a serious
risk that development progress will be undermined.
It is for the developing countries themselves to determine their
approach to adaptation in the context of their own circumstances and
aspirations. Rapid growth and development will enhance countries'
ability to adapt. The additional costs to developing countries of
adapting to climate change could run into tens of billions of dollars.
The scale of the challenge makes it more urgent than ever for
developed countries to honour their existing commitments--made in
Monterrey in 2002, and strengthened at EU Councils in June 2005 and at
the July 2005 G8 Gleneagles Summit--to double aid flows by 2010.
Donors and multilateral development institutions should mainstream
and support adaptation across their assistance to developing countries.
The international community should also support adaptation through
investment in global public goods, including improved monitoring and
prediction of climate change, better modelling of regional impacts, and
the development and deployment of drought-and flood-resistant crops.
In addition, efforts should be increased to build public-private
partnerships for climate-related insurance; and to strengthen
mechanisms for improving risk management and preparedness, disaster
response and refugee resettlement.
Strong and early mitigation has a key role to play in limiting the
long-run costs of adaptation. Without this, the costs of adaptation
will rise dramatically.
Building and Sustaining Collective Action Is Now an Urgent Challenge.
The key building blocks for any collective action include
developing a shared understanding of the long-term goals for climate
policy, building effective institutions for co-operation, and
demonstrating leadership and working to build trust with others.
Without a clear perspective on the long-term goals for
stabilisation of greenhouse gas concentrations in the atmosphere, it is
unlikely that action will be sufficient to meet the objective.
Action must include mitigation, innovation and adaptation. There
are many opportunities to start now, including where there are
immediate benefits and where large-scale pilot programmes will generate
valuable experience. And we have already begun to create the
institutions to underpin co-operation.
The challenge is to broaden and deepen participation across all the
relevant dimensions of action--including co-operation to create carbon
prices and markets, to accelerate innovation and deployment of low-
carbon technologies, to reverse emissions from land-use change and to
help poor countries adapt to the worst impacts of climate change.
There Is Still Time To Avoid the Worst Impacts of Climate Change if
Strong Collective Action Starts Now.
This Review has focused on the economics of risk and uncertainty,
using a wide range of economic tools to tackle the challenges of a
global problem which has profound long-term implications. Much more
work is required, by scientists and economists, to tackle the
analytical challenges and resolve some of the uncertainties across a
broad front. But it is already very clear that the economic risks of
inaction in the face of climate change are very severe.
There are ways to reduce the risks of climate change. With the
right incentives, the private sector will respond and can deliver
solutions. The stabilisation of greenhouse gas concentrations in the
atmosphere is feasible, at significant but manageable costs.
The policy tools exist to create the incentives required to change
investment patterns and move the global economy onto a low-carbon path.
This must go hand-in-hand with increased action to adapt to the impacts
of the climate change that can no longer be avoided.
Above all, reducing the risks of climate change requires collective
action. It requires co-operation between countries, through
international frameworks that support the achievement of shared goals.
It requires a partnership between the public and private sector,
working with civil society and with individuals. It is still possible
to avoid the worst impacts of climate change; but it requires strong
and urgent collective action. Delay would be costly and dangerous.
The Chairman. Thank you very much, and as I said we'll have
some questions, but before we go to the questions, let me call
on our other two witnesses.
Professor Jacoby, why don't you go ahead?
STATEMENT OF HENRY JACOBY, PH.D., MASSACHUSETTS INSTITUTE OF
TECHNOLOGY
Mr. Jacoby. Thank you, Senator. It's a privilege to be
invited to speak to your committee.
The Stern Review argues that climate change is a challenge
of risk management akin to other problems in private life and
public policy, from controlling your cholesterol to defense
against epidemic disease. Further, it argues that the risks are
serious and we ought to be doing more to reduce them,
importantly including the imposition of financial penalties on
greenhouse gas emissions. I agree.
Now the Review's application of methods of economic
analysis to bolster this position has been the subject of
controversy among economists, as has been its call for urgent
action. I'm pleased to give my interpretation of the issues
raised. First the Review argues that failure to control
greenhouse gas emissions will impose risks of damage that are
the equivalent of 5 percent of GDP each year, and maybe as high
as 20 percent, and that action to greatly reduce these risks
need cost only about 1 percent of global GDP. These two
numbers, 20 percent and 1 percent, have been prominent in
public discussion of the Review. Then I will comment on its
main recommendation, which is that we must mount an urgent
global response to meet an extremely high capital on the
atmospheric concentrations of greenhouse gases.
First, the damage estimate. The 5 and 20 percent loss
figures are based on cascaded projections, human emissions
impact; there is a climate which leads to negative and positive
effects on market and non-market systems which creates gains
and losses that are then converted into a common monetary
measure. These projections extending to the year 2200 and
beyond take account of estimates in the literature of
uncertainty in temperature response and net damage to construct
a picture of global risk in economic terms.
Then to recognize potential events in the extreme upper
tail of natural climate outcomes, the authors added
consideration of major changes in the climate system and
hypothesized catastrophic damages that are not normally
incorporated in formal analysis of climate response, because
their likelihood and timing are so poorly understood. All these
phenomena, both the well-understood and the more speculative,
and the effects near-term and in the distant future, deserve
attention in the discussion of climate change risk. They all
figure, in my subjective judgment, but to interpret the
Review's monetary damage numbers, three issues need to be
sorted out.
The first is the handling of events of high consequence and
unknown probability. To account for these effects the Review
authors simply impose an upward shift in the range of outcomes,
and this subjective judgment is a key to the expansion from 5
percent to 20 percent loss. I would have preferred to keep
these extreme risks in the discussion but out of the formal
monetary calculation.
A second task is to interpret the way the Review weighs up
economic loss over time--that is, the discount rate--which has
a huge effect on the results. The authors apply a standard
discounting formula but they choose a set of parameters that,
taken together, produce a rate substantially below the range
judged in the literature to be consistent with the way the
economy operates. Now because climate change is such a long-
term problem, the authors justifiably may have wanted to ensure
that distant risks were taken into account. Moreover, they may
have felt that climate change should be treated differently
from other economic sectors, but pushing the standard
discounting formula outside of conventional bounds was arguably
not the best or the most transparent way to accomplish that
result. At the very least, the text should have made clear what
fraction of the 5 percent and 20 percent losses are
attributable to modeled damages that come 200 or more years in
the future.
A third concern is the Review's application of monetary
measures to non-market effects like human mortality, species
loss, or forced migration, the task at which economists lack
adequate methods. These damage estimates are poorly documented,
so the reader has a hard time judging whether to accept them as
reasonable. My own view is that the non-market effects are the
heart of the issue. Many are described in the Review, but to
provide a basis for interpretation, I wish they had presented a
few summary indicators in natural units (people, hectares,
species) alongside a more clear statement of the monetary
values attached.
So how to pull all of this together? I believe the first
concern implies that an underestimate of uncertainty and the
second an overweighting of distant events. Opening up the
evaluation of non-market damage to closer scrutiny could lead
either way, depending on what is inevitably a subjective
evaluation. However one comes out on the specific damage
numbers, however the Review does present ample justification of
a serious global and environmental risk. It would be a shame,
in my view, if useful insights into these risks were clouded by
controversy over benefit-cost methods, or by charges that the
Review goes too far in an effort to raise a sense of alarm.
Now to the mitigation cost: underlying the 1 percent
estimate is a policy scenario whereby nations take universal
collective action to reduce greenhouse gases and stop forest
destruction. The assumed control regime yields an average price
of $100 per ton CO2 in 2015. Analysis recently
completed by the U.S. Climate Change Science Program indicates
that the 2050 cost would be higher than 1 percent under these
conditions, but nonetheless that within intelligent policies
and global participation, climate risk can be greatly reduced
without taking a substantial bite out of GDP. More worrisome is
the implied stringency of emissions mitigation within the next
few years. The emissions price implied by the analysis is at
least $100 per ton CO2 and likely substantially
higher. My own view and that of most previous economic studies
of climate policy is that an emissions penalty substantially
below this level is appropriate at the outset, to allow for
adjustment of existing capital stock, and then a price rising
steadily over time.
Finally, the issue of urgency and the question of, ``What
now?'' We don't live in a world of universal participation, and
the first step in approaching it is acceptance by 20 or so of
the largest emitters of an international structure for
negotiating equitable levels of national effort. The GATT is an
example of such an arrangement. The Architecture for Ozone
Destroying Chemicals is another. The Kyoto Protocol was the
first try for the climate issue, but it has now fragmented, as
serious research for a workable alternative will await further
action by the United States. If this judgment is correct, then
near-term U.S. decisions about new emissions measures have the
character of a strategic move in a complicated multi-party
game. With no additional U.S. action, the international process
will stall. But decisions about new U.S. measures need consider
not only the urgency of the problem, but also issues of
international competitiveness, when trading partners lag
behind.
The Review has made useful recommendations regarding policy
instruments in this circumstance with a heavy emphasis on
market-based measures. Among these, a universal national carbon
tax, or cap and trade system, can serve the need. Moreover,
either approach can provide flexibility to adapt to an evolving
level of commitment by other nations. So if we can take a sense
of urgency from the Stern effort, then I would suggest it is to
move ahead with a careful consideration of these options and
early adoption of one or another on a national basis. Thank
you.
[The prepared statement of Dr. Jacoby follows:]
Prepared Statement of Henry D. Jacoby, Ph.D., Massachusetts Institute
of Technology
interpreting the stern review on the economics of climate change
introduction
The Stern Review conveys a number of useful points about the nature
of the climate threat on which there is broad agreement among analysts
of this issue.
Human-induced climate change is a problem of risk
management. It cannot be proved that the outcome will be dire
or shown with certainty that it will not. As with other
problems we face in private life and public policy, from
controlling your cholesterol level to defense against epidemic
disease, uncertain dangers can warrant reasonable measures to
reduce risk.
Capping the level of greenhouse gas concentrations in the
atmosphere at different levels is a useful way to think about
long-term objectives in dealing with this risk.
Because of the long lives of these gases in the atmosphere,
waiting to take action on emission mitigation has the effect of
gradually ruling out options for controlling the ultimate human
influence on the climate system.
Economically efficient and effective control will require
efforts to develop low-emissions technology and the imposition
of direct price and regulatory pressure on the emissions
themselves. Neither is sufficient to make much difference
alone.
With intelligent policies and global cooperation, climate
change risks could be limited without taking a substantial bite
out of GDP growth.
My conclusion from these points is that the major nations,
importantly including the United States, should be taking more action
to reduce climate change risks.
The widespread visibility of the Review comes in large part from
its two striking conclusions about risk and cost and its ultimate
recommendation. First, the Review holds that if we don't control
greenhouse gas emissions the risks of future climate damage will be the
equivalent of 5% of GDP each year, beginning now and continuing
forever, and maybe as high as 20%.\1\ And the second main conclusion is
that greatly reducing these risks need cost only around 1% of global
GDP each year. These two numbers, 20% and 1%, have dominated public
discussion of the Review and are used to bolster its main
recommendation: we must mount an urgent global response to hold an
extremely tight cap on the atmospheric concentration of greenhouse
gases.
---------------------------------------------------------------------------
\1\ This way of expressing damages can be thought of as an annuity,
indexed to GDP, that has the same welfare implications over time as the
as the projected damages. By this translation damage that occurs in
particular years gets evened out across all time.
---------------------------------------------------------------------------
These results and the methods used to reach them have stirred both
enthusiastic support and controversy. Let's look at each of these three
points in turn--climate damage, cost of action and urgent global
response--and how they might be interpreted.
climate damage
First the climate damage estimate. The 5% and 20% loss figures
result from a policy scenario in which no action is ever taken to limit
emissions. Estimates were made of the resulting economic loss based on
a cascade of projections: human emissions impact the Earth's climate,
which leads to negative and positive effects on market and non-market
systems, which creates losses and gains that are converted to a common
monetary measure. These projections, extending to 2200 and beyond, take
account of uncertain ranges in the temperature response and in the
damage estimates, in order to construct a picture of global risk in
economic terms. Then to recognize potential events in the extreme upper
tail of potential climate outcomes the authors added consideration of
major changes in the climate system that are not normally incorporated
in formal analysis of the range of climate response because their
likelihood and timing are poorly understood (e.g., see IPCC, 2007), and
they applied what were necessarily very rough assumptions about
catastrophic social effects beyond those quantified in the current
literature.
All these phenomena--both the well-understood and the more
speculative, and effects near-term and in the distant future--deserve
attention in a discussion of climate change risk. They all figure in my
subjective judgment. But when I come to interpret the Review's specific
monetary damage numbers three issues need to be sorted out. The first
is the handling of events of high consequence but unknown probability.
The risk calculation requires estimates of the probabilities of climate
outcomes and associated social costs, and the Review breaks this into
two parts: (1) estimates based on the current literature, and (2)
extreme events for which likelihood estimates are not available. To
account for the latter Review authors simply imposed an upward shift in
the range of outcomes, and this subjective judgment is a key element of
the expansion from 5% to 20% loss. I would have preferred to keep these
extreme risks in the discussion but out of the formal calculation.
Also, I will note that the analysis was not able to consider
uncertainty in the baseline emissions forecast. Our MIT analysis of
temperature change to 2100 indicates that about half the uncertainty
originates in the Earth science and half comes from uncertainty in
projections economic growth, technical change and greenhouse gas
emissions (Webster et al., 2003).
A second task is to interpret the way the Review weighs-up economic
loses over time--their discount rate. Its selection has a huge effect
on the results. The authors apply a standard discounting formula but
they choose a set of its parameters that, taken together, produces a
rate that is substantially below the range judged in the literature to
be consistent with the way the economy operates.\2\ The result is a low
discount rate that, if applied to other realms of economic life, would
justify increases in the savings rate and thus large reductions in
current consumption to increase that of (much richer) people in the
distant future. Because climate change is such a long-term problem the
authors justifiably may have wanted to insure that distant risks were
taken into account. Moreover they may feel that climate change should
be treated differently from other economic choices. But pushing
parameters of the standard discounting formula outside conventional
bounds was arguably not the best or a transparent way to accomplish
that result. At the very least the text should have made clear what
fraction of the 5% and 20% losses are attributable to modeled damages
that come 200 or more years in the future.
---------------------------------------------------------------------------
\2\ The triplet of inputs at issue are the social discount rate or
pure rate of time preference, set effectively to zero in the
calculations, the elasticity of the marginal utility of consumption
(the social weight attributed to a small increase in an individual's
consumption) set to 1.0, and the rate of economic growth.
---------------------------------------------------------------------------
A third concern is the Review's application of monetary measures to
non-market effects (e.g., human mortality, species loss, forced
migration)--a task for which economists lack adequate methods. How
these effects were handled is not clearly documented, so the reader has
a hard time judging whether to accept the estimates as reasonable. My
own view is that the non-market effects are the heart of the issue.
Many are described in early chapters of the review, but more effort was
needed to develop a few summary indicators in natural units (people,
hectares, species), to be presented alongside a clearer statement of
the monetary values attached (see Jacoby, 2004).
So how to pull all this together? I believe the first concern
implies an under-estimate of uncertainty and the second an
overweighting of distant events in the GDP calculation. Opening up the
valuation of market damage to closer scrutiny could lead to either
higher or lower estimates depending on what is inevitably a subjective
valuation. However one comes out on the Stern economic analysis there
is ample evidence in the Review to indicate that we face a serious
global economic and environmental risk. It would be a shame if useful
insights about the risk were clouded by controversy over benefit-cost
methods or charges that the authors went too far in an effort to convey
their level of alarm.
the cost of action
With regarding to mitigation cost, underlying the estimate of a 1%
GDP cost of mitigation in 2050 is a policy scenario whereby all
nations, rich and poor, take universal collective action--reducing
fossil and other industrial greenhouse gases and stopping forest
destruction--by applying same emissions penalty everywhere, beginning
now and continuing into the future.\3\ This cost result estimate
assumes a control regime that imposes measures with an average price of
$100 per ton CO2 in 2015, this cost falling over time as
assumed technological change kicks in.
---------------------------------------------------------------------------
\3\ In a study just completed for the U.S. Climate Change Science
Program a similar calculation was carried out by three U.S. modeling
groups (CCSP, 2006). For the case closest to the one analyzed in the
Review the GDP loss in 2050 ranged from 1.5% to 5% (among modeling
groups that is; this was not an uncertainty analysis). The CCSP authors
are careful to point out that these likely are minimum estimates
because computer models are very good at identifying mitigation actions
of an economic efficiency that political processes rarely match.
---------------------------------------------------------------------------
I will make just a couple of points in interpreting this result.
First, the modeling approach adopted by the Review was capable of
analysis only to 2050. What cost levels would be if the analysis were
extended over a longer time period is not discussed. Whether the cost
would rise or fall with time depends on the outcome of a race between
economic growth and technological change. My expectation is that costs
would rise.
A second concern is the implied stringency of emissions mitigation
in the early years. The Review does not report what marginal cost (and
therefore emission price) is implied in 2015. Because there are some
relatively cheap reductions in the mix it is somewhere above $100 per
ton CO2 and probably substantially above. This result may be
compared with what the futures markets say is the likely price in the
European Trading System (ETS) in the first Kyoto period, which is $15
per ton. My own view, and that of most previous economic studies of
climate policy, is that an emissions penalty closer to the neighborhood
of this ETS level is appropriate at the outset, to allow for adjustment
of existing capital stock, then a price rising steadily over time.
an urgent global response
Whether or not one accepts the Review's stabilization target, a
judgment that nations should do something more to reduce the risk
raises the question ``what now?'' We don't live in the world of
universal participation, and a necessary step in achieving it is
acceptance by 20 or so of the largest emitters of an international
structure for the difficult negotiations over equitable levels of
national effort. The trade regime established at the end of World War
II was one such arrangement, and the architecture for negotiating
reductions in ozone destroying chemicals was another. The Kyoto
Protocol was the first try at such a regime for the climate issue, but
it has now fragmented. These most important nations will not seriously
pursue the search for a workable architecture until the U.S. takes
additional action on emissions, independent of any international
agreement.
If my judgment about the international prospects is correct, then
near-term U.S. decisions about new emissions measures have the
character of a strategic move in a complicated multi-party game. If the
U.S. doesn't take additional mitigation measures the international
process will stall. But decisions about how stringent a policy to adopt
need to consider not only the urgency of the problem and likely
domestic economic effects but also issues of international
competitiveness when trading partners lag behind and the tangle of this
issue with our other foreign relations. The Review has very useful
things to say about policy instruments, with a heavy emphasis on the
use of market-based measures to the degree possible, and the fostering
of more R&D and international technology cooperation. Among the market-
based approaches a universal national carbon tax is the favorite of
many economists. A cap-and-trade system, like the ETS or the one we
apply to sulfur emissions, can serve the same purpose. Moreover either
approach can provide flexibility to adapt to an evolving level of
commitment by other nations. If we can take a sense of urgency from the
Stern effort, then, I would suggest it is to move ahead with a careful
exploration of these options and the adoption of one or the other on a
national basis.
The Chairman. Thank you very much, and now let's hear from
Professor Yohe. Thank you very much for being here.
STATEMENT OF GARY YOHE, PH.D., ECONOMICS PROFESSOR, WESLEYAN
UNIVERSITY
Mr. Yohe. Thank you. Mr. Chairman, Senator Domenici, and
members of the committee, I thank you very much for your
invitation to present testimony today. It's indeed an honor,
and I have to say it's a particular honor to be on the same
panel with Sir Nicholas. His credentials speak for themselves,
but I would like to emphasize that Sir Nicholas is a world-
class economist whose contributions to our knowledge extend
well beyond the issues of climate change and the specifics of
his service to the World Bank and to her majesty's treasury.
I also fully recognize as I'm here that this is a hearing
on the Stern Review, and not climate policy, but as you've
heard these two issues are really quite inseparable, so that my
remarks will sort of wander back and forth.
I'd like to begin by expressing appreciation for the Stern
team for taking on the enormous challenge of constructing
convincing economic argument in support of taking immediate
action to reduce the emission of greenhouse gases in general
and carbon dioxide in particular. I think that a case can be
made in a variety of different ways, as the economics of
climate policy do indeed tell us unambiguously that it's time
to act.
The major messages of the Review's assessment of the
current science are sound; indeed, as has been said already,
they're completely consistent with the conclusions presented by
Working Group 1 of the Intergovernmental Panel on Climate
Change in Paris. They are consistent, in other words, with the
conclusions about the underlying science that were unanimously
accepted by the representatives of the signatory nations of the
United Nations from a convention on climate change who attended
the meeting in Paris.
To my mind the major messages are as follows: climate is
changing faster than was anticipated only 5 years ago in the
third assessment report of the IPCC; significant climate
impacts have been calibrated in terms of multiple metrics, some
of which are economic and some of which are not; and thresholds
of associated climate risk have been identified in terms of
increases in global main temperature. Many of the temperature
thresholds of critical impacts are now thought to be closer and
lower than they were only 5 years ago. Achieving any
concentration target, however, can not guarantee that any
specific temperature threshold can be guaranteed. Achieving a
concentration target can only reduce the likelihood of crossing
these thresholds. This is evidence that we need not only
mitigation in the short term, but also the adaptation that was
mentioned earlier.
Figure two of the executive summary of the Stern Review has
been reproduced here for the committee and for the audience,
and in my mind it is a concise portrait of these essential
results. If you look at it carefully you can see thresholds of
critical impacts, you can see associations with temperature,
and you can see ranges of concentration targets that would
indicate certain likelihoods. Once you take a careful look at
that, it follows that the confirmation of the IPCC conclusions
in the Stern Review makes the case that some sort of policy
innovation based on the economics of applied cost and benefit
analysis couched in waste management terms will be required. It
is important to note, though, that it is impossible to write
climate policy in 2007 that will be valid for the entire
century. Coping with thresholds and uncertainty over the long
term will require adopting an adaptive risk management approach
where a series of medium-term policy decisions will be formed
by the evolutional long-term objectives. Taking medium-term
action will require political leadership, but it strikes me
that framing the mechanisms by which the long-term goals can be
achieved will take political vision.
The Stern Review's estimates are--as has been noted by
Jake--quite controversial, in part because they're difficult to
understand, and partly because they're highly dependent on
underlying assumptions about discounting, aversion to risk,
aversion to inequality and evaluation of non-economic metrics
of impacts and other significant risks.
In my written testimony I go through and make reference to
a wide range of papers that have been published. Since the
release of the Stern Review, it's actually turned out to be
pretty much of a full employment act for economists who know a
little bit about climate. To emphasize just a few, as Jake has
mentioned, the damage estimates are difficult to understand,
because they're expressed in terms of certain equivalent
annuity metrics that convert expected discounted welfare values
computed across thousands of possible futures into a single
number, and those are the single numbers that get quoted. The
Stern authors are very careful to say that these damages are
equivalent to a 5.3 percent reduction in per capita consumption
for now and forever. Unfortunately, a lot of times the
conditional clause gets left off and people are left wondering
where their 5.3 percent reduction of per capita consumption
that was supposed to happen now actually is.
The damage estimates have been criticized because they're
based on very low discount rates, a rate that virtually
guarantees very high values. The damage estimates have also
been criticized because they seem to be calibrated at the high
end of current understanding about impacts and they sometimes
miss the opportunity for adaptation, especially in the future
where incomes become higher around the world. The mitigation
cost estimates are expressed in terms of percentage losses and
GDP, so it's difficult to make a comparison of the sorts that
might be appropriate, in terms of expected losses and for
mitigation as well as for climate damages.
So with all of that controversy, I would respectfully ask
that the members of the Senate, specifically, and the members
of the policy-making community in Washington, more generally,
not to fall into the trap of focusing all of our attention on
the controversies that surround the specific estimates, because
you could easily miss the most important messages of the
Review. I would urge you to let the economics profession
continue to work the problems that we have identified, while
you work on the near-term policy in recognition of the
important insights of the Stern Review. Focus on the risks of
climate change, that it identifies. Understand the efficiency
grounds for buying insurance against the economic consequences
of climate change and also the economic consequences of rapidly
ramped-up climate policy in the future that would be required
if nothing is done now.
As soon as you recognize that some sort of policy will be
required in the near term--and I think reference to Figure 1
and the now verified science makes that easy--simple economics
says that the least cost approach always means starting now.
The conclusion is true in large measure because atmospheric
concentrations depend on cumulative emissions over time, so
achieving a specific concentration target is fundamentally an
exhaustible resource problem. The long-standing hotelling
result that I teach my students in their first course in
environmental and resource economics therefore applies: to
maximize the discounted value set in initial scarcity rent and
let it go up at the rate of interest, and it is this persistent
and predictable increase in price that gives the policy
attraction. Setting the initial tax can be an exercise in
determining the appropriate short-term incentives for carbon
saving inventive investments and energy conservation, rather
than an exercise in solving the climate problem, since no
policy created in 2007 will indeed solve that problem. It is
possible and maybe even desirable for this committee to step
out from under the burden of trying to solve the climate
problem, and try to answer the question, ``What do we do now
and how do we make progress toward a future that we can all be
proud of?''
It's too early to state with any confidence what the
political implications of the Stern Review might be. Initial
fears in some circles that the Review's estimates were so
suspect that they could only backfire and further polarize the
debate have not materialized, but the climate doubters and
policy opponents have certainly continued their attempts to
focus their attention away from the fundamental messages. You
simply don't want further evidence to be put forward that the
climate is changing faster than we previously thought.
Perhaps most productively the Stern Review does seem to
have induced a wider appreciation that climate can be
approached as an economics problem, and that its questions
about the appropriateness of emissions reduction can be
illuminated with the tools of decision analysis. If that is
true, then we ought to be grateful for Sir Nicholas and his
team for having the courage to deliver his Review for us for
our review and our consideration. Thank you.
[The prepared statement of Dr. Yohe follows:]
Prepared Statement of Gary W. Yohe, Woodhouse/Sysco Professor of
Economics, Wesleyan University
Mr. Chairman, Senator Domenici, and Members of the Committee on
Energy and Natural Resources, thank you for your invitation to present
testimony on the Stern Review on the Economics of Climate Change. It is
indeed an honor to be here, today. It is especially an honor to be on
the same panel with Sir Nicholas Stern. His credentials speak for
themselves, but I would like to emphasize that Sir Nicholas is a world
class economist whose contributions to our knowledge extend well beyond
the issues of climate change and the specifics of his service to the
World Bank or to Her Majesty's Treasury.
With my testimony, I will try to tell a story that supports the
fundamental conclusion of the Stern Review that the discipline of
economics can play a significant role in understanding how we should
respond to the risks of climate change even as it identifies some of
the reasons why the Review has been so controversial. I recognize fully
that the Stern Review and not climate policy is the topic of this
hearing, but I submit that the two issues are inseparable. The point of
the Review is to make an economic case for immediate action to reduce
the emission of greenhouse gases; and so it is as important to discuss
the validity of that claim, based on the evidence presented, as it is
to examine the validity of the underlying economic estimates.
Therefore, my story will try to do both.
Before I start, I would like to acknowledge the contributions of
Richard Tol, an economist from the University of Hamburg who is
currently the Senior Research Officer at the Economic and Social
Research Institute in Dublin, Ireland. Richard and I have collaborated
on many things over the past ten or fifteen years, and we have authored
a series of papers on the Review over the past three months. I have
made those papers available to the Committee.
I begin by expressing our appreciation to the Stern Team for taking
on the enormous challenge of constructing a convincing economic
argument in support of taking immediate action to reduce the emissions
of greenhouse gases, in general, and carbon dioxide in particular.
The Stern Review goes a long way in demonstrating how economics has
something to say in informing the climate policy debate. Its release
amounted to a full employment act for economists who know something
about climate (and some who do not). Its release also inspired some
scientists and others who don't know much economics to enter the fray,
but that is fine, too.
To be honest, Richard and I are not convinced that the Review is
the definitive word in this regard. Its numerical results are
controversial and value-laden, but that is the nature of the economic
science. Please do not interpret the controversy over the numerical
results as anything more than economists being economists--arguing over
every point to make sure that the fundamental conclusions are sound. We
have participated in that discussion, and I will highlight some of our
concerns, today. I assure you, though, that we are both convinced that
the Review provides sufficient evidence to support its fundamental
conclusion with very high confidence: the economics of climate policy
tell us unambiguously that it is time to act.
The major messages of the Review's assessment of the current
science are sound. Indeed, they are completely consistent with the
conclusions presented by Working Group 1 in its contribution to the
Fourth Assessment Report of the Intergovernmental Panel on Climate
Change (the IPCC). They are consistent, in other words, with the
conclusions about the underlying science that were unanimously accepted
by representatives of the signatory nations of the United Nations
Framework Convention on Climate Change who attended the IPCC plenary
meeting in Paris two weeks ago. They include:
a. Climate is changing faster than was anticipated only 5
years ago (in the Third Assessment Report of the IPCC).
b. Significant climate impacts have been calibrated in terms
of multiple metrics (some are economic, but many are not), and
thresholds of associated climate risk have been identified in
terms of changes in global mean temperature.
c. Many of the temperature thresholds for critical impacts
are now thought to be lower than anticipated only 5 years ago.
It follows that we are approaching them more quickly than we
thought, and so we will reach them sooner than we thought.
d. Achieving any concentration threshold cannot guarantee
achieving a specific temperature threshold; but achieving a
concentration target can reduce the likelihood of crossing
those thresholds at any point in time.
e. Achieving any concentration threshold may, however, only
delay the inevitable unless the rate of change in temperature
is diminished by persistent policy intervention over the entire
century and perhaps beyond.
Figure 2 in the Executive Summary of the Stern Review offers a
concise portrait of the essential results of the most recent science. I
attach a version here as Figure 1. Notice that temperature thresholds
are identified for truly dangerous impacts in many dimensions in the
lower portion of the figure; their location in terms of warming are the
basis for believing Senator McCain's assertion last month that the
debate over the science is over.
The imprecise links between temperature targets and concentration
targets are meanwhile illustrated in the upper portion of Figure 1.
They summarize current understanding to show, for example, that holding
concentrations
below 750 ppm means a greater than 95% chance of exceeding 2
degrees (Centigrade) of warming above current levels and a 70%
chance of exceeding 3 degrees of additional warming,
below 650 ppm means a 95% chance of exceeding 2 degrees and
a 60% chance of exceeding 3 degrees,
below 550 ppm means around a 70%-80% chance of exceeding 2
degrees and a 50% chance of exceeding 3 degrees,
below 450 ppm means a 50% chance of exceeding 2 degrees and
a 25% chance of exceeding 3 degrees, and
below 400 ppm means roughly a 30% chance of exceeding 2
degrees and still a 5% chance of exceeding 3 degrees.
Putting the two parts of the figure together allows the reader to
judge the sensitivity of our experiencing any specific risk to changes
in policy. It is, indeed, a spectacularly powerful portrait of the
policy predicament.
It follows from its confirmation of the IPCC conclusions that the
Stern Review makes the case that some sort of policy intervention,
based on the economics of applied cost-benefit analysis couched in risk
management terms, will be required.
It is important to note that it is impossible to write climate
policy in 2007 that will be valid for the entire century. Coping with
thresholds and uncertainty over the long term will require adopting an
adaptive risk management approach where series of medium-term policy
decisions will be informed by the evolution of long-term objectives.
Designing such a program will be difficult, because it will need to
give clear signals of intention over the medium-term even as it
maintains flexibility so that it can respond to
changes in scientific understanding,
changes in social valuations of impacts, and
changes in our expectations of how the policies are working.
In every case, however, this flexibility must somehow be immune to
political and/or economic manipulation, and so designing such a
mechanism will require a considerable amount of political
leadership.\1\
---------------------------------------------------------------------------
\1\ It strikes me, as an aside, that the Federal Reserve System of
the United States (the FED) is an example of an institution designed to
accomplish all of these tasks. While surely in a different context, the
FED confronts the same sorts of short-term versus long-term tensions
with the same sorts of price or quantity policy tools and protected
from political manipulation by carefully designed insulation.
---------------------------------------------------------------------------
The Stern Review's estimates of economic damages and the cost of
mitigation have been controversial in part because they are difficult
to understand and in part because they are highly dependent on
underlying assumptions about discounting, aversion to risk, aversion to
inequality, and the valuation of noneconomic metrics of impact and
significant risk (abrupt change and extreme events, for example).
The controversies surrounding the damage estimates are fraught with
detailed discussions of the technicalities involved in applying
economic analysis to a complex problem like climate change. I highlight
a few, here, but will shortly argue that the case for immediate action
survives the controversy, especially if one takes a slightly different,
but nonetheless economically rigorous tact.
The damage estimates are difficult to understand because they are
expressed in terms of a ``certainty equivalent and equity equivalent
annuity'' metric that converts expected discounted welfare values
computed across thousands of possible futures into a single number.
The analysis underlying the computation of this metric is sound, if
not brilliant; see Mirrlees and Stern (1972) for the details of its
development. Its application to the climate problem is path-breaking,
but it is vulnerable to the sort of misinterpretation that will make
people roll their eyes and wonder if any of us know what we are talking
about. The authors of the Review are careful to say that ``total cost
over the next two centuries . . . are equivalent to an average
reduction in global per capita consumption of at least 5%, now and
forever''. When the results are reported in the popular press, however,
the conditional phrase about equivalence is usually deleted, and that
is a problem. Readers can react by saying ``It's now, and I don't see
my 5.3% reduction in consumption. Where is it? It's still now! Still
not here!''
Notwithstanding this presentation problem, it is important to note
that the damage estimates include not only the economic ramifications
of climate impacts as they play out over time, but also a ``risk
premium'' tied to the current level of uncertainty about the future as
displayed in the simulation model. It is here that aversion to risk and
aversion to inequality have an effect on the estimates. Weitzman (2007)
argues that the Stern estimates undervalue these contributions because
the tails of the distributions of our understanding of the climate
impacts are so ``thick''. in other words, the representations of
uncertainty upon which the underlying simulations are conducted do not
adequately consider the likelihood of extreme consequences.
The damage estimates have been criticized because they are based on
a very low discount rate--a rate that virtually guarantees high values.
Dasgupta (2006), Maddison (2006), Nordhaus (2006), Tol (2006), Tol
and Yohe (2006), Tol and Yohe (2007), Varian (2006), Yohe (2006) and
Yohe and Tol (2007) all make this point. Some argue that imposing such
a low discount rate on investments to mitigate climate change in a
world where other investments are required to earn higher returns is a
prescription for the inefficient allocation of resources over time.
Others argue that public investments can earn lower than market returns
if they complement private investment; see for example, Ogura and Yohe
(1977). Still others, including the Stern Review itself, make an
ethical case for minimizing the rate at which impacts that will be felt
by future generations are discounted in current policy deliberations.
Regardless of how one comes down on this debate, and the choice of
a discount rate is in the purview of policy-makers, it is important to
recognize the sensitivity of the damage estimates to that choice. Tol
and Yohe (2007) report, on the basis of a simply model calibrated to
the Stern Review baseline scenario where damages create the equivalent
of a 5.3% reduction in per capita consumption, that lowering the rate
further would have very little effect on the estimate while increasing
the discount rate to 3% would reduce damages to the equivalent of a
1.6% decline in equivalent per capita consumption.
It should finally be noted that Weitzman (2007) expresses concern
that the economic profession at large has not yet solved the problem of
exactly how to discount the distant future when intergenerational
transfers of wealth must be considered. His point is simple: there is a
lot of fundamental work still to be done in this regard.
The damage estimates have also been criticized because they seem to
have been calibrated to the high end of current understanding of
impacts, because they sometimes miss the opportunity for adaptation
especially in a future where incomes will be higher, and because they
add estimates of catastrophic damages to a baseline that already
included estimates of the willingness to pay to avoid such calamity.
Tol (2006), Tol and Yohe (2006) and Yohe and Tol (2007) have made
these points, but it is important to note that the range of uncertainty
reflected in the underlying simulations is not tied entirely to these
upper-end estimates. Tol and Yohe (2007) confront the ``So what?''
question that we begged in their earlier comments by exploring the
implications of simply assuming that the developing world's capacity to
adapt will grow toward the current level of the world developed
countries as their economies grow. The result is a reduction in
discounted damages of more than 50%. Why so large? Because the small
discount rate rewards increases in future adaptive capacity as heavily
as it punishes future impacts.
Mitigation costs are estimated in terms of percentage losses in
GDP, and so it is difficult to compare the costs of policy with its
benefits (calibrated in terms of losses in equivalent per capita
consumption).
Mendelsohn (2006) has remarked that the mitigation cost estimates
are too low. Others have noted that they seem to run only through 2050.
Tol and Yohe (2006) wonder why the conventional 550 ppm concentration
target from earlier work persists as a policy target when damage
estimates are so much higher than before. Perhaps most importantly,
however, the Review never presents the net effect of mitigation in
terms of the equivalent per capita consumption metric employed to track
damages. Tol and Yohe (2007) have attempted to do so for a simple model
calibrated, again, to support a 5.3% loss absent any intervention. They
find that achieving a 550 ppm concentration target would reduce damages
to 2.2%, that a achieving a 650 ppm target would reduce damages to
3.0%, and that achieving a 400 ppm target would reduce damages to 0.8%.
These are not net benefit estimates, of course, because they do not
include the cost of mitigation. They do show, however, that no amount
of mitigation can be expected to eliminate economic harm expressed in
terms of per capita consumption equivalents even though mitigation does
reduce the uncertainty with which we view future impacts.
I would respectfully ask members of the Senate, specifically, and
members of the policy-making community in Washington more generally not
to fall into the trap of focusing all of their attention on the
controversies that surround the specific estimates because you could
easily miss the most important message of the Review. Let the economic
profession continue to work the problems that we have identified while
you work to define near-term policy in recognition of the important
insights of the Stern Review. Focus on the risks of climate change that
it identifies. Understand the efficiency grounds for ``buying
insurance'' against economic consequences of climate change and the
economic consequences of rapidly ramped climate policy in the future if
nothing is done now.
As soon as you recognize that some sort of policy will be required
(and that recognition follows directly from Figure 1*), simple
economics says that taking the least cost approach means starting now.
---------------------------------------------------------------------------
* Graphic has been retained in committee files.
---------------------------------------------------------------------------
This conclusion is true in large measure because atmospheric
concentrations of greenhouse gases depend on cumulative emissions over
time, so achieving a targeted concentration target (and thus a
corresponding range of possible temperature increases and associated
climate risks) is fundamentally an exhaustible resource problem. The
long-standing Hotelling result that I teach my students in their first
course on environmental and resource economics therefore applies (at
least to a first approximation): to maximize the discounted value of
welfare derived from an exhaustible resource (that is, to minimize the
discounted costs of limiting cumulative emissions over the long-term),
simply calculate the appropriate initial ``scarcity rent'' (in this
case, an initial price for carbon for 2007) and let it increase over
time at the rate of interest.
Adjustments over time in the concentration target (borne of
uncertainty about the climate system specifically and the future more
generally) confound the issue, to be sure, but I have shown in Yohe, et
al. (2004) that some hedging based on the Hotelling minimum cost result
minimizes expected costs even if there is a chance that we will
discover sometime in the future that the climate problem fixes itself
and climate policy initiated now was unnecessary. Why? Not because it
generated some energy independence for the United States, even though
that would be a good idea. Rather, because the expected costs of
adjusting to more pessimistic climate news sometime in the future if we
delay taking action are higher than the expected costs of doing too
much too soon (even with discounting at the market rate of interest).
To be more specific, the Hotelling result means that it is enough
to specify an initial tax on carbon (or perhaps setting targeted permit
price for a cap and trade system). This tax should be designed to get
the attention of American business and to show political leadership in
the face of a serious problem. It need not, however, be set so high
that it would cause undo economic harm in the short-run. Allowing the
tax to increase at the rate of interest year after year (following
Hotelling) and acknowledging that adjustments for new knowledge about
performance and risk will have to be accommodated over time will give
the policy traction.
I personally favor a tax because permit markets can be volatile,
and because responding to this volatility by building in a ``safety
value'' on the price of permits sets up a loophole in the policy that
could easily be manipulated. Indeed, it undermines the power of the
policy. A tax, increasing at the rate of interest, would produce a
persistent and predictable increase in the cost of using carbon that
would inspire cost-reducing innovation and fuel switching in the
transportation, building, and energy supply sectors of our economy.\2\
---------------------------------------------------------------------------
\2\ The tax should increase, in real terms, at the real rate of
interest. If expressed in nominal terms downstream, then it should
increase at the nominal rate of interest.
---------------------------------------------------------------------------
Be assured that providing incentives for American business to
prepare for a carbon scarce future will put them in a good position
when it comes time to compete in world markets, especially if their
competitors in China and India do not follow suit. This is why 10 major
corporations are on record in support of a U.S. (federal) climate
policy that has some teeth and is predictable. There is money to be
made, but only if uncertainty about climate policy is reduced.
Setting the initial tax can be an exercise in determining the
appropriate short-term incentives for carbon-saving investments and
energy conservation rather than an exercise in ``solving the climate
problem''.
Since no policy created in 2007 will ``solve the climate problem'',
it is possible and even desirable for this Committee to step out from
under that burden to confront a more manageable problem (while still
making progress towards an ultimate solution to the climate problem).
You are not trying to ``Solve the climate problem.'' You are trying to
``Acknowledge and confront the climate problem in 2007 with the best
information available.'' More specifically, your problem is ``What do
we do now?"
The answer is to design something for the near-term that will
discourage long-term investments in energy, transportation, and
construction that would lock in high carbon intensities for decades to
come. Moving decisions in that direction would be consistent with long-
term programs designed to ``solve'' the climate problem (however our
understanding of it evolves) and with the minimization of long-term
economic costs of the policies.
As an example, one might consider investments that are pending to
replace coal-fire power plants along the eastern seaboard of the United
States. Tens if not hundreds of power plants will be replaced over the
next 4 or 5 decades, and new plants will be required to meet growing
demand. They might be replaced with coal-fired plants, because that
would be the efficient choice given current expectations of alternative
fuel prices (absent any climate policy) over the next few decades. All
or some of these plants could, however, be replaced by plants that burn
natural gas with a 60% reduction in carbon emissions per unit of
electricity.
People who know the business claim that a $30 per ton tax on carbon
dioxide (a $110 per ton tax on the carbon content of fossil fuel) would
make natural gas the more economical choice, but it is not necessary to
impose a $30 tax in 2007 to inspire complete conversion to natural gas.
Since investment decisions turn on the discounted value of returns over
50 or 60 year time horizons, the price of carbon would not have to
reach $30 per ton for another 15 or 20 years to make natural gas the
economical choice this year for investments in power plants that will
come on line 5 or so years hence. Of course, Hotelling tells us to
increase the tax by the rate of interest, and that helps.
Assume for the moment that private investors use a 5% discount rate
in their present value calculations. So what are the options? The $7
per ton of carbon dioxide charge envisioned in the legislation being
considered in this Committee would reach $30 per ton in 2036--probably
too late to capture plants being designed this year, but sufficient to
bring most of the plants constructed between now and 2050 over to a
lower carbon technology. A $15 per ton charge in 2007 would reach the
decision threshold in 2021.
That would do if the goal were to achieve 100% fuel switching, but
what would it cost? A $15 per ton charge would add almost $6 to a
barrel of oil. We have seen monthly variation in oil prices bigger than
that, recently; the difference here is that it would be predictable,
and it would affect different fossil fuels differently. It would add 14
cents to a gallon of gasoline. Given current fuel configurations for
electricity generation in the United States, it would increase electric
bills by 10% to 30% depending on location, but that percentage would
decline over time. It would generate something like $90 billion in tax
revenue in 2007 if it were paid on every ton of carbon embodied in
every gallon of fossil fuel consumed in the United States. This is
revenue that could be used to offset the regressive nature of an energy
tax, invest in alternative energy sources that could lower the $30 per
ton threshold, and otherwise reduce our dependence on foreign sources
of oil without looking to domestic sources like the Alaskan wilderness.
It is too early to state with any confidence what the political
implications of the Stern Review might be. Initial fears in some
circles that the Review's estimates were so suspect that they could
only backfire and further polarize the debate have not materialized.
Climate doubters and policy opponents have certainly continued their
attempts to focus attention away from the fundamental messages that can
be drawn from its literature survey if not its economic synthesis. They
simply do not want further evidence to be put forward that the climate
is changing faster than previously thought and that no specific
temperature target can be guaranteed by holding atmospheric
concentrations of greenhouse gases below any specific threshold.
Despite their attempts, however, the Stern Review has not interrupted a
perceptible, sometimes slow, and sometimes noisy march towards
meaningful climate policy, but neither has it done anything to halt
wild exaggeration from all sides.
Perhaps most productively, the Stern Review does seem to have
induced a wider appreciation that climate change can be approached as
an economic problem, and that questions about the appropriateness of
emission reduction can be illuminated (but perhaps not yet answered)
with the tools of decision analysis. If that is true, then economists
ought to be grateful to Sir Nicholas for having the courage to deliver
Stern Review to us for ``review'' and consideration.
The Chairman. Thank you very much. Thank all of you. Let me
start with the questions. We'll do 6 minute rounds of
questions. Let me start and ask a few.
Sir Nicholas, in your statements, you say climate change is
the greatest market failure that the world has ever seen. What
leads you to that conclusion? Why is this different than other
market failures that seem to be all around us?
Mr. Stern. Thank you, Mr. Chairman. The climate change is
the greatest market failure the world has seen because of the
range of the causes and the range of the consequences. Every
one of us in our actions, every industry is involved in
emitting greenhouse gases in some shape or form. It's very hard
to think of other kinds of externalities--an externality is
economist language for when we do something which affects
directly the consumption or production possibilities of other
people--that are associated with everybody around the world.
It's the greatest market failure in the sense that everybody's
involved in producing these damages. Second, it's the greatest
market failure the world has seen in terms of consequences. The
impact will be on everybody. Third, it's the greatest market
failure the world has ever seen because it's the potential
scale of the damages, as we tried to describe in the report and
as is illustrated in the diagrams that Gary Yohe put out there.
The Chairman. Let me also ask: I think I heard Professor
Yohe refer to your Review as advocating an adaptive risk
management approach to the problem. Is that an accurate
statement of what you said, Professor Yohe?
Mr. Yohe. That is an accurate statement of what I said.
The Chairman. Is that an accurate description of what you
in fact have concluded with the recommendations coming out of
your Review?
Mr. Stern. Yes, it is. It's understood as being about the
economics of risk and reducing greenhouse gases in order to
reduce risks, looking at the costs and benefits of doing that,
and it also emphasizes that in the Review. It also emphasizes,
as Gary Yohe and Jake Jacoby have, the importance of
adaptation. We do know that even with strong action the climate
will change quite strongly over the next 30, 40, 50 years and
that means that we're going to have to adapt, so those two
parts of the statement--adaptation and economic risk--are
absolutely at the heart of what we did.
The Chairman. One of the issues that is going to be central
to our debate here, on how to actually come to grips with this
in a legislative way, is whether or not a cap and trade
system--if we're able to get a consensus to enact a cap and
trade system--whether there should be something that most to us
refer to as a safety valve, which would essentially ensure that
those who are emitting greenhouse gases would not have to pay
more than a certain amount per year for those emissions, and
that amount could then rise. This is something that's contained
in the draft legislation that I've worked on with Senator
Specter and others, that's not in many of the other bills that
are proposed.
Sir Nicholas, did you have any thoughts as to whether that
kind of approach would make any sense? I think Professor Yohe's
testimony indicates that he thinks that would defeat the
purpose of a cap and trade system, as I understand his
comments.
Mr. Stern. I think the answer to that question, Senator,
has to depend on the other parts of the story in which a cap is
situated. I do think that it could have a role to play, to help
with the transition--to give a certain amount of certainty in a
new departure in a new kind of policy instrument. But I think
the context is crucial, and in that I would emphasize that
strong ambition in terms of carbon reduction is crucial to the
whole story. So that means that one should not set any cap too
low, and you judge ``too low'' in relation to the kind of
quantity reductions you would expect, or that you find along
the way.
Second, I think it's important to look at other possible
ways of giving the kind of stability, the kind of ability to
make decisions in the stable environment, that is behind the
idea of a cap. There I think the importance not only is the
ambition in the production but also in the size of the market
and the openness of the market. If you have big markets and
open markets, then you're more likely to get stability than
when you have narrow and closed markets, so that route to
stability in terms of ambition, openness and long-term nature
of the challenge is also very important.
A third element to bear in mind when you think of caps is
the ability to link up with other trading schemes. Linking up
with other trading schemes will allow not only more stability,
but also an efficiency in the allocation worldwide and an
ability to start to produce carbon finance flows to developing
countries that could help bring them along and establish the
kind of coalition that Senator Domenici was describing. So
within that broader context, I do think that in terms of
stability and in helping people to adjust to a new regime, that
safety valves could have a role to play, but it would be a
problem if they were set too low.
The Chairman. Thank you very much. Senator Domenici.
Senator Domenici. I'm going to let Senator Thomas take my
place for one round.
The Chairman. Alright, Senator Thomas.
Senator Thomas. Ok, thank you. Well, thank you gentlemen. I
appreciate that very much.
Mr. Stern, you mentioned the United Nations report in your
testimony, the IPCC. That panel predicted a rise of 3 feet by
2100. Your new study cuts that figure to 17; how do you explain
the variation in prediction from the same route within 5 years
in their report?
Mr. Stern. Of course I'm not a member of the IPCC, so I'm
not here to answer for them. But the IPCC is quite cautious in
including different forms of evidence, and when it feels that
there's some indications, but it's not sure or it doesn't feel
the evidence is strong enough, then it can revise on that
basis. Some of the impacts it revised upwards and some of the
impacts it revised downwards. For example, it revised upwards
its estimate of the frequency of intense tornadoes. It did some
adjustment downwards--you're right--in the sea level story, but
that's based on a group of scientists simulating and looking
carefully at different forms of evidence. It's not for me to
answer for them.
Senator Thomas. I see. I guess it's one of the questions we
ask ourselves as we get different kinds of reports from
scientific studies with respect to this. Eighty percent of the
world's energy comes from fossil fuels: this number is
projected to be up to 40 billion tons by 2030. Your report says
international cooperation is necessary, yet the Kyoto Protocol
has been a failure. How do you have an alternative proposal
with enough detail to accurately implement it?
Mr. Stern. The story that we emphasize in the Review is to
for rich countries around the world particularly to take strong
action through their own ambitions. So the European Union has
got strong ambitions for its third phase of the European Union
Emissions training scheme, ambitions being discussed now to cut
greenhouse gases emissions by 20 or 30 percent by 2020. That's
an ambition which it has taken on itself. Within that context
France has taken on a 75 percent ambition for its reduction by
2050, UK over 60 percent. I do appreciate that California is
not a country but it has its own ambitions of 80 percent
reductions.
Senator Thomas. But the Kyoto agreement has not had much of
an impact.
Mr. Stern. Well what I'm saying is that the Review itself
points to the importance of strong action and strong ambitions,
country by country, which can then be linked up by trading
schemes. If that can be fitted into a broader protocol
internationally, then that would be very good. But what I'm
saying is that we do not depend on the particularities of the
Kyoto Protocol for making strong progress in this. What is does
depend on is the strong ambitions of the rich countries,
working in a way that is likely to bring in the poorer
countries, and in that sense the international community can
move strongly forward without necessarily getting all the
details of an international agreement right.
In thinking about Kyoto, of course, we have to think that
it is a very short-term agreement and it was something that set
us along a path. I believe if you look at it in that context
and ask if the kinds of issues that it raised, the kinds of
ambitions it set itself, initially--are those right? I think
they are. They're the right kind of level of ambition because
they were short-term ambitions, but you could fit them in the
longer one. So I think the kinds of ambitions it set were right
and the kind of mechanisms it pointed to, of trading, is right
also. I think that is underlined in the discussions, if I
understand correctly, that are taking place now on cap and
trade, so I think a lot of the principles and ambitions of
Kyoto were sound. We have to think how things will move forward
after 2012.
Senator Thomas. None of you mentioned particularly what
some of the things are that we're doing now. We have a coal
plant in my State that's going to eliminate CO2.
We're going to move more toward nuclear. We're doing quite a
little bit, moving toward automobiles and so on. Do you think
we're making progress at this point?
Mr. Stern. Yes, I do. If I might return to the issue of
China in that context that Senator Domenici raised: we've
traveled a great deal since the publication of the Review, and
indeed prior to publication of the Review we did visit the
biggest countries around the world from this perspective--
including the United States, India and China--and we went back
there after the Review. We spent a lot of time in China
explaining and underlining and emphasizing that the United
States is taking strong action. We pointed to the examples of
California. We pointed to examples of the Northeastern States.
We pointed to the importance of the technology investment and
research that the United States is taking, and that is a big
part of our argument in China. But also when we come here to
the United States we emphasize just how much China is doing. If
I could give you just a few examples, it's a very important
context for the whole story. They're building collaboration.
China is no longer deforesting. It is now reforesting.
China has, as I mentioned in my testimony, a 20 percent
reduction in the energy intensity target within 5 years. Their
eleventh 5-year plan started last year and they're implementing
and working on that in a very strong way--for example, through
direct targets for the 1,000 biggest firms in China, recently
extended considerably to below our tier terms. You cannot sell
an American car in China because it doesn't meet the emissions
standards, which are pretty high. Beijing has made $8,000 tax
on SUVs. China in late November, early December instituted an
export tax on energy-intensive goods, such as aluminum, steel
and cement. So China is grappling with this problem. There's a
tremendous amount more that many of us believe it should be
doing but I think it's not correct to say that China is doing
nothing, and we try to explain through the examples I've just
given how China is beginning to get its arms around this
problem. Just as when we are in China, we emphasize very
strongly what the United States is doing.
Senator Thomas. Thank you.
The Chairman. Senator Domenici wanted to go next, so you go
right ahead.
Senator Domenici. Thank you. Sir Nicholas, I did not know
that you shared with China the information that you have
gathered about what the United States is doing. I personally
appreciate that you're doing that. You are probably doing more
and better at it than we are, so we thank you for it. We only
wish that we could get with it and I think that they would
listen. They sell us an awful lot of merchandise, for which
they build many of those power plants, so they build the
capacity for that.
I had some questions which were going to be critical of
your report but let me just say I'll submit them in writing. I
understand that from this discussion what the criticism is, and
applaud you for your report in spite of the fact that there is
some room for arguing with some of the economics that you use.
I think that probably would have been there with any report
like this, but I found that to be rather credible from some who
submitted it.
Now I'm going to suggest this and ask for you, any of you
to help us. I look at this and am very pleased to see that you
have talked about adaptation, because now after 2 months or so
of reading what I can, it is obvious that the capture of carbon
or the capacity to get the world to greatly diminish its use is
almost impossible. We can do some, but we can't do the big job,
and part of that is because we cannot find a way to invest
sufficient capital in the research for new equipment that will
solve the problem of sequestration. We are spending money, but
I ask that we check how much. It really won't get the job done.
There has to be some way to get all of the countries of the
world to put in, literally billions of dollars in some major
research effort and decide whether sequestration and return of
that carbon is doable. If it is, it becomes a major undertaking
and I'm not selling that short. If you could do it we don't
know that you would find the money to do it, it's so expensive.
We don't even know if we can do it and that has to take place.
Having said that, I believe that an adaptation policy is in
order and that we ought to start thinking about it up here
because States and others ought to be looking at what they
might do. I thank you for bringing that subject up with a
little more clarity. I wonder if you would agree about the need
for more research money from the world and the areas that are
contributing to this problem, and if you have any ideas on how
we might get that done: any of you?
Mr. Jacoby. I'll respond to that.
Mr. Stern. Jake Jacoby will respond after me, if that's
okay with you, Mr. Chairman. Jake knows a great deal about
research and development in these areas.
On the various questions that economists around the world
have raised on the report, let me first say that the report was
never intended to be the last word. That would have been
foolish and I hope that we didn't make that mistake. We welcome
the discussions that have taken place. I believe that we have
sound answers to all the questions that have been raised,
including on the treatment of discounting. We did put three
papers up on the web at the beginning of this week which deal
with the some of the discussions that have taken place. We will
be discussing them with academic colleagues at Yale later this
week, so we absolutely welcome that public discussion. I would
offer a fairly cheerful and robust response to the various
points that have been raised and look forward to discussing
these in detail with my academic colleagues. I was 30 years in
academic life before I went into the service in international
institutions and her majesty, and I will go back to academic
life in the near future, and those are exactly the kinds of
discussions that I welcome. But as I say, we stand by what
we've done and we give the reasons for that.
The emphasis you place on research and development and
deployment I think is absolutely fundamental, and I do believe
that the world taken together has been remiss in funding
expenditures--public expenditures in our research and
development declined by a factor of 2 over this last 25 or 30
years. Collectively, we made a big mistake. Now you can look at
the reasons why we did that, and no country is alone in this
story. It's a pattern around the world. But that's something I
think we must act very quickly to correct.
Most economists, and we would be amongst them would say,
``Let's see a price to carbon, let's correct this market
failure, let's invest in research and development, both public
and private.'' They're very highly correlated, public and
private expenditures now are indeed. Let's do those things and
let's see which technologies come forward. We're seeing pretty
rapid change in solar technologies as we find ways to do
photovoltaics which are different from silicon and using
plastics and other materials for the photovoltaic effect. We
could well see quite strong progress in cellulosic sources of
bio-fuels, not just sugar and corn but switch grasses and rough
grasses and other kinds of residue which could be grown on the
marginal lands around the world. If we did find progress there,
it would open up opportunities for bio-fuels far greater than
if we keep it narrowly to sugar and to corn. So there are
margins wherever you look on these technologies where we have
strong progress, and I hope that we can be reasonably
optimistic. But it will require a kind of effort on the scale
which you so eloquently described.
There's one technology which we did emphasize and which you
have emphasized, I believe rightly so, and that's carbon
capture and storage for coal. The reason for that is because
it's so widely used, around 50 percent of electricity
consumption around the world. It will be over 70 percent in
India and China for the foreseeable future. Why? Because
they've got lots of coal, it's under their ground, they don't
have to import it, and it can be done quickly. You can get
those fire stations up quickly and they're there in a hurry
because their economies are growing, and lots of their people
and industries don't have electricity supplies. So it's pretty
obvious that they're going to be using coal over electricity-
powered generation for quite a long period of time. So, too,
Poland and Germany and United States; it's not just India and
China. But particularly in India and China, there's an issue
there on coal.
What's the answer to that? In the short term, to use coal
much more efficiently than they do, move to super critical,
ultra super critical burners. That's the kind of technology
which the rich countries can help with in terms of ordinary,
private investment activities. But we have to have an open view
and encourage the transfer of those kinds of technologies, and
as soon as we can, we have to move to the carbon capture and
storage for coal. We have to learn to do that well.
I have lived and worked in India for more than 30 years
now, in various places. I've lived and worked in China for
nearly 20 years. I've seen those two countries change quite
remarkably in the last year or so in their attitudes toward
energy efficiency and their attitudes to the environment. There
is some way to go, but I believe that there is a partnership
there of the kind you describe that can be forged. Friends say
to us: you're emphasizing carbon capture and storage for coal,
sounds like a good idea. It will be more expensive so we'll
need some help with the carbon finance. It will require changes
in technology and in development and deployment of these
technologies. We'd like some help with that, too; in
particular, show it works in your own countries. So I think if
Europeans argue that carbon capture and storage is a good thing
for India and China, they ought to show it works in Europe. I
think it's a fair challenge, my friends in India and China, but
I believe that we can rise to that challenge. That is a
particular area where I think the United States and its
ingenuity and creativity in technologies right across the board
can not only have a big role in creating these technologies,
but can also show how they can be deployed and indeed, get
business from so doing.
So I think your emphasis is absolutely right. I would
certainly share it. I don't believe that any one country should
carry all the burden of the R&D. It should be shared around.
One thing that we can do, or one thing that you can do as
leaders of your nations, is to try to work out with your
counterparts in other parts of the world just how those R&D--
and deployment, of course--efforts can be built and shared.
Mr. Jacoby. May I respond?
The Chairman. Yes, if you can make a reasonably short
response, we'd appreciate it.
Mr. Jacoby. Let me second, Senator, your comment about
coal. It's located all over the world. It's cheap. It's not
located in places that are security problems and it's hard to
imagine we're not going to burn it over the next century, so
carbon capture and storage is one of the essential
technologies. If we can't make that work, we're in deep
trouble. So I would just say that we're near the completion of
a study in which I participated at MIT, on the future of coal.
That study, which should be out within a month, is going to
argue that we should be spending a lot more effort on the
development of coal capture and storage technology, doing
studies at commercial scale.
We are spending a lot of money in the United States. We do
have the FutureGen program, but the argument is that is not
enough. We don't know which is the right technology. We need
more experimentation with the joint operation of these
complicated chemical technologies that remove the
CO2 and generate electric power jointly with the
storage process itself. We need more experience with that.
There's an argument that we should not have one, but five or
six of these, and that given the magnitude of the problem
that's a small expenditure. You're going to hear a blast from
the north on this topic in a few weeks. I think you're exactly
right; I would second you with great enthusiasm.
The Chairman. Senator Dorgan was ready to go with his
questions. Did you have a comment you just have to make,
Professor?
Mr. Yohe. Yes, I'm just going to be very brief about the
other part of the question about adaptation.
It's absolutely essential that we think about adaptation.
We are committed to warming even if we stopped emissions of
greenhouse gases tomorrow. There was, as you know, in Paris the
release of the Working Group One report from the IPCC. There
will be a second one, Working Group Two, released in April. I
am on the writing team for that; its topic is adaptation
vulnerability and sustainable development. It works to the
nexus of the development and adaptation issues, as well as
related to mitigative capacity of various countries, so stay
tuned for that, please.
The Chairman. Well, thank you very much.
Senator Dorgan.
Senator Dorgan. Mr. Chairman, thank you very much. Let me
say that I agree with Senator Domenici in respect to the use of
coal. Mr. Jacoby we are going to use coal, the question just
isn't ``whether'', the question is ``how'' do we use coal and I
think these projects are very important to find ways for the
development of zero emission coal-fired appliances, for
example. We have in my State of North Dakota the only plant in
America that produces synthetic gas from lignite coal.
About three decades ago we were going to produce a lot of
those, build a lot of those plants. Only one was completed. We
now produce synthetic natural gas from lignite coal. We have
the largest application of sequestration of CO2 at
that plant. We take the CO2 from this plant that
turns lignite coal into synthetic natural gas. We pipe the
CO2 to the oil fields in Alberta, Canada, and invest
that CO2 back into the marginal oil wells to
increase the productivity of oil wells. We sequester the
CO2 from the synthetic gas plant. You dramatically
increase the marginal capability of these marginal oil wells.
It is exactly the kind of thing we ought to look to do as we
produce all of these bio-fuels. We ought to take a look at
location, with respect to using and capturing CO2,
to further enhance the productivity of oil development.
But having said all that, Mr. Stern, first of all, thanks
for your work, thanks to all of you for participating today.
When I hear your description of China, India, I mutter under my
breath, ``I hope so.'' It sure does sound optimistic to me, but
I hope so. I hope you're right about this. It appears to me
that there is a natural tension and conflict with respect to
the global economy and this issue of global participation with
respect to climate change.
When we take a look at the jobs from the U.S. or England
migrating to China or India in search of cheap labor, those
jobs are also in search of not just cheap labor, but also less
regulation and lower costs. One of the aspects of that has
nothing to do with laws on the books of China or the laws on
the books of other countries. Many countries have really strong
laws dealing with the environment or minimum wages, but they
are never enforced, in a number of circumstances that I have
pointed out previously.
So my question is this: isn't there a natural tension with
respect to the agents of production and the global economy's
searching for the lowest labor cost and the lowest production
cost, therefore less environmental regulation? Search around
the world where they have those opportunities and the
opportunity even in those countries, less developed countries,
to oppose the kind of regulatory structure we have already
imposed upon ourselves. We see it everyday. We see it all the
time; see it in China and in India. If that's the case, if
there is this natural tension and I believe there is, what
makes you so optimistic with respect to both China and India?
Then if I might make one other comment.
Mr. Stern. I'm sorry.
Senator Dorgan. You say climate change is the greatest
market failure the world has ever seen. I think there's
probably a germ of an idea in my question about this issue of
market failure, and I'd like to have you describe what you
meant by that.
Mr. Stern. Just on that second question, it is an important
one and I did try to answer it a little earlier.
Senator Dorgan. Senator Bingaman just told me, go ahead and
skip that, if you'd answer the first question.
Mr. Stern. Thank you. What I said about China and India, I
should say emphasized a bit more strongly for China than for
India. I think that China's moving a bit faster than India was
about direction of movement. I think that those countries,
those two countries are changing very rapidly in their attitude
to energy efficiency and the environment. They both realize
that global warming really matters to them. Just for example,
from the point of view of the receding snow and glaciers in the
Himalayas: that would increase water stress in much of the year
for both countries, both India and China which rely to a very
large extent on water that originates in the Himalayas. Of
course the glaciers and the snow act as sponges, and they
spread it out over the year. Without that, you'll have torrents
and floods in the rainy season and dry rivers in the dry
season, so they really do understand increasingly strongly, how
much it matters to them. They also realize their increasing
weight in the world economy and their responsibilities as key
players in the world economy. It's movement in the right
direction.
I'm optimistic about movement in the right direction, but
not necessarily about whether it will be fast enough and a big
enough scale to deal with this problem. That's why I think
collaboration and participation, as Senator Domenici was
describing, is so important. But in order to do that, to
collaborate effectively with other people, I think you do have
to recognize what they are trying to do.
Just as I explained a little earlier, when we're in China
we go to great lengths to emphasize just what the United States
is doing. Because in China, you'll be told that the United
States is doing nothing about this, and they're not going to
move much more strongly unless the United States does. We try
to show that that argument is not well-founded, that actually
there's intense discussion and a lot of action in the United
States on those issues; for example, the kind of plant that you
described in your own State as well as the ambitions of
California, the trading in the Northeast States, many cities in
the United States, and so on. So we do emphasize that very
strongly and it's vital to build the collaboration to have that
mutual understanding.
On the migration of jobs we try to take that issue on
directly in Chapter 11 of the report, to review the evidence
that there is on the mobility in response to environmental
regulations, and to think that through in relation to the
increased costs. It could be an effect. The question is how big
that effect is likely to be, and we have to get quantitative
about that. If we're right that the extra cost to production
costs to getting serious about climate change, it is at the
order of 1 percent of GDP. That's like a 1 percent one-off
increase of costs. That's significant but in very few cases, I
think would it be the kind that would trigger a big movement.
That is small in relation to difference in wage rates at 5, 10,
15 a factor of, 5, 10, or 15.
So I think if you look at it carefully and empirically and
look at the numbers and see how things move, that that
particular aspect of the story, the extra costs in trying to do
things differently in terms of energy, would be a very small
part of that story and by itself, I think unlikely to trigger a
massive movement. It could be different in a few industries,
and in those few industries I think it's important to try to
look for international agreement--steel, aluminum, cement--and
we discuss those kinds of agreements in Japan and in China, and
I think in those few industries which are very energy-
intensive, it would be possible to build sectoral agreements.
But that would involve governments and private sector working
together.
Senator Dorgan. Well, Mr. Stern, thank you and I certainly
hope you're right. I understand what you're saying now. This is
about direction rather than progress. If you feel that the
Chinese have at least started to think in terms of moving in a
constructive direction, that's different then quantum progress,
so I understand what you're now saying.
I would only observe--I don't mean to be either an optimist
or a pessimist about this--that the agents of production,
particularly those that have become much, much larger than they
were decades ago, have always resisted additional regulations.
When they move to find the lowest cost unit of production
capability in China or India or the Philippines, they will
similarly resist regulation just as they did here for many
decades. Most of what we have achieved through regulation has
been over the objection of some very substantial interests in
this country.
This doesn't relate to the environmental issue but it
relates to the same thing I'm talking about. The president of
the Philippines, some while ago said, ``I think we need to
increase the minimum wage in the Philippines.'' One of our
corporations that's in the Philippines, the very next day said,
``You do that, we leave.''
The same approach with respect to trying to retain low-cost
production in these areas: I just ask the question, is there
tension with respect to the global economy and the agents of
production searching for the lowest cost? Is there a need for
not only regulatory capability but enforcement that would
produce real progress rather than just a positive direction in
some of these countries?
So let me thank you all for being here. I apologize that I
was late--I have three committee hearings going on at the same
time--but I do think this is a very constructive opportunity
for us, and I hope for you to exchange views on something that
is very important to this country and to the world.
The Chairman. Senator Corker.
Senator Corker. Yes, sir. Well, thank you for the testimony
and for your leadership on the committee.
As you look at the various tensions that do take place and
you look at the fact that any kind of legislation that may take
place here in America--and I know there's going to be a lot of
legislation introduced to deal with this--really drives
investment by entrepreneurs and therefore ends up being
something that both large companies that are investing large
capital, small entities that are seeking capital need to count
on in order to move in a certain direction. Based on the
experiences that you've had in the European Union, where I
suppose the cap and trade legislation over there has been not
perfect, if you will, as it relates to trying to meet the
guidelines that have been laid out--what are the components in
your opinion of the perfect piece of legislation for a country
like America?
Seriously, what would be those components that you would
lay out knowing that again you look at discount rates? I was a
former finance commissioner. I understand you can just with a
small, small change make huge differences in outcomes. What
would be the type of legislation that you would propose be put
in place, that allows for changes that will take place, that we
all know will take place? Our assumptions will not be correct,
to allow a dynamic market, if you will, to adjust and take into
account proper legislation.
Mr. Stern. Perfection's a tough ask. I think you need a
combination of measures. In the report we argue that regulation
and standards can play an important role in giving confidence
in the direction of a market. If you require unleaded gasoline,
and you state that that's going to come in, and it's definitely
going to come in, people can plan clearly on that basis.
Similarly with catalytic converters or the Star schemes that
you have for electrical appliances. Those kinds of regulations,
either direct regulations or regulation on transparent
information can, I think, develop markets. The United States
has shown the way in many cases on that. So partly I think
regulation will have a role to play.
Second, cap and trade policies have a powerful role to
play. They will have a role to play in different areas from tax
policies. Cap and trade in Europe covers about half of Europe's
emissions; I mean, it's a big scope of the scheme. It's been
going for 2 years and we've learned a lot along the way and
what we've learned is beginning to get embodied in our plans
for the next stage.
One thing we learned, which may come in the category of the
blindingly obvious, but it is that if you give away too many
permits, you're going to have a very low price for a permit.
That's economics 101, I guess, and that's something which did
happen in the early stages and which we've taken lessons from
now. In the second stage of the scheme which runs from 2008 to
2012, the plans for the permits around Europe are coming in now
and the environment commissioner has to deal with them. He's
taking a much more robust line than was the case the first time
around, so the scheme itself is a good scheme, but the way it's
operated, and the kinds of ways in which permits are issued,
will of course make a very big difference.
So I think your emphasis on learning as you go, both of how
the scheme operates and about how the technologies are coming
forward to give you more opportunities, those kinds of ways
have to be enshrined and embodied in the schemes. So you have
to be strong on the ambition. You have to have scarcity
otherwise markets don't work.
You also have to in this case, look long. Our third phase
in Europe will be 2012 to 2020. The current periods of up to
2012 are far too short for people to make investment decisions
in these kinds of industries. So going long is an important
part of the design of a scheme. Being open to other trading
schemes, being open to the possibilities of linking up with
Northeastern States, with California, with Australia as it
comes through, with India and China as they start to develop;
openness, I think will be important part of that story.
So within cap and trade, I'd emphasize scarcity, long-time
horizons and openness with the ability to adjust along the way
as information comes in. In Europe, taxation on gasoline is a
very important part of the policy, and I think that has a role
to play as well. So I would look across regulation, cap and
trade, taxation, and we've already--with Senator Domenici--laid
strong emphasis on research and development, and deployment, so
I wouldn't cover that again. I think the cap and trade is going
to be crucial, but as part of the suites of measures, the
suites that policies, that look across the board in the way I
just tried to describe.
Senator Corker. Comments from any other?
Mr. Jacoby. I think a suite is correct. I realize this is
perhaps an economist moving out of his area to talk about
politics, but I'm sorry we don't have more discussion of the
possible choice of taxes or cap and trade. You don't seem to be
able to talk about a carbon tax as a possible mechanism. That
would be worth some consideration, I believe. I think that cap
and trade, as I indicated in my testimony, could do the same
thing. Thank you.
Mr. Yohe. I would just like to agree with what Jake just
said. It would be nice if taxes weren't so taboo, because they
do all sorts of good things and could generate revenue with
which you could fund adaptation, equity considerations, and R
and D, as well as looking into carbon sequestration and a
variety of things like that.
Of course, Senator I'm sure you realize that the converse
of your question, that uncertainty about the regulatory
environment and uncertainty about where carbon policy or
climate policy is going to go, leads to uncertainty in the
investment world. It has the potential of locked indecisions in
very high carbon intensity technologies with which we will be
dealing for 30, 40, 50 years, perhaps, and that increases the
economic costs of making adjustments in climate policies as the
future unfolds.
Senator Corker. Thank you. Mr. Chairman.
The Chairman. Thank you.
Senator Salazar.
Senator Salazar. Thank you very much, Chairman Bingaman,
for holding this hearing on this very important subject. Thank
you for assembling this stellar panel that you have here today.
I have a question to you, Dr. Jacoby, and then a general
question and I'd appreciate it if each of you would respond.
Again we're under a time limitation, so I'd appreciate it if
your responses are short.
First with you, Dr. Jacoby, a question on carbon
sequestration: the work that you are currently doing, would it
be beneficial for us here in the U.S. Congress to move forward
with conducting a national assessment of where we can
geologically move forward with respect to carbon sequestration
opportunities here in our own Nation? So if you will respond to
that question. Then second, for the entire panel: we started
getting into a conversation here about emissions trading
approaches versus putting a tax on carbon emissions--would you
amplify which one of those two approaches, a few of you already
spoke to it, but would each of you take a minute and give us
some guidance as to the policy choice between moving forward
with the cap and trade system versus putting a tax on carbon
emissions? What you would pursue if you happen to be king for a
day? So, Mr. Jacoby, and then why don't we just move across the
rest of the panel?
Mr. Jacoby. I'm not familiar with the details, but I
believe under the DOE programs there already is substantial
effort on a set of regional studies to identify potential
areas, particularly saline aquifers where you could do this
storage. A lot of that work also went on in the competition
that went on among various regions of the country to get the
FutureGen project, which is the major DOE activity to bid your
R&D commercial demonstration. So I think there's quite a bit
going on here. I'm not really confident to say whether it's
enough, but there is a lot already going on to identify these
geological areas.
Senator Salazar. And my second question: why don't we start
with you, Gary, and move across.
Mr. Yohe. Okay, thank you. I do favor a tax approach, and I
describe that a little bit in some of my testimony that's
written before you: an idea that would start somewhere around
say $15 a ton of CO2 go up at the rate of interest
to inspire the appropriate decision-making in investments
decisions, then avoid locked-in investments, as I spoke before.
Fundamentally, one of the reasons that I worry so much
about the cap and trade is that volatility in the price that
could obscure the signal. It is not where you set the initial
tax that gives this policy or the carbon price its traction. It
is its predictable, persistent increase, year after year after
year, in ways that don't damage the economy but send a signal
that carbon will be more expensive tomorrow than it is today,
and it will be more expensive next year than it is tomorrow.
Those inspire the appropriate decisions at times when they can
be made at least cost. When they get buried inside signals of
variability, it's a little bit harder to see that happening, so
that the $15 that I'm talking about is $6 a barrel of oil.
Senator Salazar. That would be your preferred approach----
Mr. Yohe. It would be, yes.
Senator Salazar [continuing]. In dealing with this issue?
Dr. Jacoby.
Mr. Jacoby. I would prefer a tax system, but not terribly
strongly. I don't want to lose the good in fighting for the
perfect here. So I think the cap and trade system can be quite
satisfactory. I regret we don't spend more time thinking about
the details of the two approaches.
On the volatility issue, two potential corrections can be
built into these systems. One is the safety valve; now we can
have more discussion if you want about the level of the safety
valve, but that is what that's about and how it's set is
important in terms of influencing volatility. The other thing
that gets built into the current bills that are before you is
banking, where you can do more now and save it to do more in
the future. Banking also has an influence on reducing
volatility, and if I may take off on Sir Nick's comment, on
what's happened in the European trading system. One of the
reasons that the European trading system's current price is so
low is that there is so much restrictions on the banking into
the next period. So banking has a big effect on this.
Senator Salazar. Thank you.
Mr. Jacoby [continuing]. So there are ways to moderate the
volatility problem.
Senator Salazar. Thank you. Why don't we go to Ms. Peters
and then come back to you for the final comment on this
question, Mr. Stern?
Ms. Peters. Just also picking up on volatility and other
ways of managing it, using offset mechanisms to make any scheme
which is open to trade with others is another very helpful way
to manage volatility in emissions trading scheme, once it is
established, once the rules of the game are established, and
once there are clear guidelines to how to recognize emissions
reductions evading across other schemes. So the cap and trade
in its early stages is likely to be quite volatile, but I've
seen some more established--you can do that rising long-term
predictable price signal, which I highly agree is appropriate.
Senator Salazar. Sir Nick.
Mr. Stern. I think the controls on volatility that Jake on
my left and Siobhan on my right have described are very
important parts of the design mechanism, and can be taken
forward in a way that does give you reasonable stability.
I would use cap and trade in some parts of the economy and
taxation in other parts of the economy. In the European Union
electricity generation and the big industries are particularly
appropriate for cap and trade, but it's reasonably easy to
observe what's happening in just a few plants. It does have the
advantage, emissions trading, of allowing interaction with
other countries. It allows you, through your own actions, to
help build the international coalition that's going to have to
be part of a whole story. So I think it's a great advantage in
terms of international exchange and cooperation associated with
emissions, trading. Also it gives you a take on the total
quantity of the action. You have a take on just how much you're
trying to reduce emissions which isn't so easy with a tax
instrument.
Tax on the other hand can be more appropriate where you
have lots of small firms where everybody uses gasoline in some
shape or form. I would have a tax on gasoline rather than cap
and trade on gasoline. So I would look at different parts of
the economy. Look at what they offer, look at the advantages,
and I think you get to some pointers as to where you'd want to
use emissions trading and where you'd want to use taxation. But
I would use them both, not at the same time or in the same
place, in different parts of the economy.
Senator Salazar. Thank you very much.
The Chairman. Senator Murkowski.
Senator Murkowski. Thank you, Mr. Chairman and thank you to
the very distinguished panel here this morning. You probably
didn't notice since your back was to them, but earlier this
morning there was probably 25 or 30 young people who were
standing in the back. I'd like to think that the reason that
they're still not here after almost 2 hours of hearing is that
they had to move off to their classes, but I think it
demonstrates the significance of the issue here before us. It's
particularly important that our young people are part of the
discussion as well.
I appreciate the focus that all of you have had in the
discussion that has been had to this point on the adaptation.
Dr. Yohe, you mentioned the term ``adaptive risk management
approach'' and in your report, Sir Stern, you focus to a fair
degree on the adaptation. Just reading my Alaska clips from
home this morning, I'm reading about a new initiative at our
university which is an endeavor at the university to get the
research information into the hands of the policy-makers. So
it's not just the scientists that are taking advantage of the
research and then not moving forward further with it. They're
using the example that if you're a shipping company, it's going
to be helpful to know what the ice conditions might be over the
period of the next decade or so. This is important as we move
forward and recognize that we are dealing with climate change,
and certainly in my State we know it, because we can see it,
but we also know that we have got to figure out how we can be
adaptive, how we can be responsive, so I do appreciate that
discussion.
Sir Stern, I want to ask you: in your report, you state
that the removal of barriers to behavioral change is the third
essential element, and you say particularly as it relates to
cost-effective energy efficiency measures. We had a hearing in
this committee yesterday, in our subcommittee on energy
efficiency. It was very interesting. You recognize how much
more we can do in that area. Can you develop further how we can
attempt to remove these barriers to energy efficiency that we
are currently facing?
Mr. Stern. Thank you. I would share with the others on this
panel, and it's emphasized very strongly in the report, the
importance of adaptation. What you're seeing and what we're all
seeing is the effects of the temperature increase of 0.7
centigrade relative to pre-industrial times. I think it's clear
that however strong we are, and we hope we're very strong on
reducing emissions, we'll probably see something like 2 to 3
degrees centigrade all together. So we've got another probably
2 degrees centigrade or close to 2 degrees centigrade coming,
and we're only seeing at the moment the consequences of 0.7
degrees centigrade. So a lot of climate change will be there
and even if we act very strongly. I think the adaptation story
is fundamental, and information of course is fundamental, to
people being able to adapt intelligently. I would certainly
share that.
The removal of barriers to behavioral change in energy
efficiency, they come in a number of ways, but one of them I
think is just people's appreciation of the magnitude of the
problem and the importance of their own personal actions. That
I think comes with sharing of ideas, hearings of this kind, and
education in schools, so that people understand what the
consequences of their actions are. I do think they're
influenced by more than simply the prices and taxes and
subsidies and incentives that they face. They're also
influenced by their understanding of the problem, so that
itself is one part of the story, and the schools, of course,
have a very important role to play in that.
There are problems in capital markets. How easy is it to
borrow against the returns that you get from energy efficiency?
The European Bank for Reconstruction and Development, which
lends to eastern Europe and the former Soviet Union, has been
quite innovative in coming forward with various kinds of loans
which recoup, or which get their repayments, through energy
efficiency. But I think capital markets are not well structured
around that issue.
Regulation of new buildings: often people who are putting a
building together might feel that the extra cost of the extra
insulation wouldn't be too understood, wouldn't be too known by
buyers, and they wouldn't get their full returns. So I think
regulation on new buildings is one way forward as well.
Senator Murkowski. Let me ask, because I just have a minute
left here. I wanted to pose a question to you, Dr. Jacoby and
to Dr. Yohe. It's been suggested, I think it was you, Dr. Yohe,
that said that we needed to be flexible in developing whether
it's a cap and trade system or a carbon tax, so that it can
change with the scientific understanding and perhaps the
changing expectations. Recognizing that you're suggesting we've
got to be flexible, does this send perhaps a conflicting or
inconsistent message? We've indicated, and Dr. Jacoby you've
said, we need to send a strong signal on the importance of
climate policy. Can we do both? Can we be flexible and still
send a consistent message to other nations?
Mr. Yohe. That's fundamentally one of the questions. We
will learn more about the climate. We will learn more about the
drivers of climate change as the century progresses, but
investment decisions need to be taken in an environment where
there's predictable and persistent policies for the short- to
medium-term. It's a matter of timing and it's a matter of being
very creative in constructing the institutions by which new
science and new understanding can be brought to bear long-term
policy objectives while short-term policies are being set. The
only example that I can refer you to off the top of my head
that does something like that is the Federal Reserve system of
the United States. They have long-term economic growth as a
major objective but they set monetary policy at least quarterly
and occasionally every month.
Senator Murkowski. Dr. Jacoby, can we be flexible?
Mr. Jacoby. I think you've hit on one of the big problems
that Congress has: how to do this in a way that provides
flexibility?
I think it should start with some sort of scheme that puts
a price on emissions, like a cap and trade system, with a plan
for 5 or 10 years as to what you're going to do and to commit
to that. It's not as if, with the schemes that we're likely to
do, we're going to do significant damage or go very wrong in
terms of cost in relation to what the rest of the world does.
So the trick is to get something on the tracks with enough
horizons so it has an influence on investment, on investment
incentives, on expectations, for 5 to 10 years. We're never
going to at any one time set a policy for a century. What you
want is a policy that's long enough to have that influence, but
is not so long that you give away the flexibility that you
would need to adapt to what the rest of the world does, or
adapt to what we learn about the problem.
Senator Murkowski. Thank you, Mr. Chairman.
The Chairman. Thank you very much.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. I want to thank
you for assembling a very distinguished panel here on a
critical issue and I appreciate all of their testimony. Sir
Nicholas, I appreciate your report, which I think creates an
added sense of urgency that some have not adapted to this view.
I think it's very important to look at this with a greater
sense of urgency. Time flies quickly and I'm afraid that there
are many who are still not of the belief that we need to move
forward. While this is certainly a global issue, I sometimes
think when we think locally, we may act differently.
In my home State of New Jersey, I look at the consequences
of an action and I think of the tremendous cost of unmitigated
climate change that you describe in your report. We have
fragile barrier islands that provide homes and jobs for
hundreds of thousands of residents, support a $26 billion
tourist economy, and protects the rest of the State from storm
surges, just to name a few things. So rising sea levels would
either drown out these islands or they'd require expensive
levees or sea walls or other protective measures, and I think
about that in a way in which the residents of my State can
think about their stake in a meaningful way. So one of the
things I'd like to explore with you is that here in the Senate
I've heard a lot of my colleagues--and rightfully so--be
concerned about the impact of any carbon reduction proposals. I
think some of the discussion that has been going on here is
along that line on the U.S. economy. The Energy Information
Administration has done a number of analyses on a series of
legislative proposals that are out there, and I was wondering
if you, Sir Nicholas or any of the panelists, are familiar with
any of that work?
Mr. Stern. I've seen some of that analysis, Senator, but
I'm not sufficiently close to it to answer in any detail.
I would like to emphasize what I think is the right
approach to the problem of urgency because we are already at
430 parts per million. We're adding 2.5 parts per million a
year, and that's rising as a world, so if we do nothing in 30
or 40 years time we'll be pretty close to the 550 parts per
million that I suggested was the upper level of where we want
to be. Because that level of stabilization would involve
eventually a 50 percent chance of being above 3 degrees
centigrade relative to pre-industrial times, hugely more than
0.7 degrees we've seen already. I think the urgency part of the
story points strongly to a joint understanding around the world
of a stabilization target that we argued in the Review should
be no higher than 550 parts per million.
On the costs to economists, we do our own calculations in
the Review and we come up with roughly 1 percent of GDP; that's
like a one-off 1 percent increase in cost.
Senator Menendez. I don't know any of the other panelists'
views, but it seems to me from what I can gather from the
information that there's no analysis of the costs of inaction.
While we seem to be focused on the costs of any particular
course of action, what I'm concerned about is, shouldn't we
also be looking at the costs of inaction? Shouldn't there be an
accounting for the benefits that we'll get by implementing
these proposals, and for stalling a rise in temperature?
Mr. Stern. That is the kind of calculation, sir, we tried
to do in the Review. And we came to the conclusion that the
costs of inaction were much bigger than the cost of action, and
the cost of acting strongly and urgently was very good
economics.
Mr. Jacoby. The one thing that's going on is that under the
climate change science program there's a set of synthesis and
assessment products. One of them is out, one of them is about
to come out. Those are a sequence of studies that are due to
come out in coming months which draw together the information
that's available in the climate science world, to answer
questions like that. So there is work like that going on.
It will not go all the way that Sir Stern meant to, in
monetary numbers, because the climate science program is not
going to do that. But going down to the levels of changes in
climate variables and then on to what might be some of the
regional implications, that work is being drawn together. I
don't know exactly the horizon of it, but those synthesis
assessment products are one of the major activities within the
U.S. Government. Of course, out in the academic world people
are doing this all the time, not really official studies.
Senator Menendez. It seems to me it's an incredibly
important part of the ledger----
Mr. Jacoby. Yes.
Senator Menendez [continuing]. That isn't necessarily being
considered. We can look at how we fine-tune a strategy so that
it has a minimum impact in the economy, but if we don't
consider the consequences in the out-years just as we're having
a great debate--I just left the budget committee before I was
able to come here, having a great debate about entitlements and
the costs in the out-years. Well, if we don't look at the out-
years we certainly can't form policy now as a way in which to
deal with the costs of rising entitlements. Similarly, it seems
to me if we're not looking at the out-years of an action, the
consequences in the long term are somewhat exponential. Doctor?
Mr. Yohe. Yeah, there are a couple of points. The second
and third working groups of the IPCC will be issuing their
reports later this year and both of them will have comments
about such things. In particular, Working Group Two will be
able to, not only for New Jersey in the United States, but for
all of the continents and major sectors, have information from
which you can glean answers to questions about the cost of
inaction.
I would also, though, like to suggest that the cost of
inaction is in some ways a simpler problem. Because if you look
at these figures here, you see that it's quite likely that some
sort of climate policy will be required. So you could say,
``Well, what if we delay for 10 or 15 years?'' Then the cost of
inaction is the cost of ramping up the policy much more quickly
than otherwise would have been required.
I did a paper with some colleagues a couple of years ago
and asked the question, ``What if we don't do anything for 30
years?'' Waiting for the next batch of new science, but we had
sort of an equal likelihood of certain temperature targets, 2
degrees, 2.5, 3 degrees or whatever, and one of the
possibilities was this climate business turns out to be a hoax
and in 2035 we found out that we shouldn't have been doing
anything at all. The least-cost solution, which was the least
minimum adjustment cost solution and expected value over that,
was $10 a ton of CO2.
For sure if our climate turns out not to be a problem, we
overdid it early. But because of the possibility that 2 degrees
was the target, we wanted the cost of inaction to be No. 1, a
huge amount of ramping up that cost a lot of money, even
discounted at 5 percent back to the future. No. 2, there were
temperature targets that were now precluded; we just couldn't
get there from here, because we had thrown so much up into the
atmosphere, the warming was already there. We were committed by
our inaction to temperature increases that were above what
might be reasonable targets, according to certain definitions
of what's dangerous.
Senator Menendez. I appreciate that. I mean there's other
values here too, including the cost of the value to public
health and some of these issues as well, that we haven't even
equated.
Mr. Chairman, if I could just make one very last question,
since I see that no one else is here. I appreciate your
courtesy.
Part of what you say in the report as a key finding is
action required to address deforestation, which is estimated to
represent more than 18 percent of global emissions--more than
the entire global transport sector. I sit on the Senate Foreign
Relations committee, on the committee that deals with
international environmental issues as well as foreign
assistance, and wonder if you have any suggestions as to how we
stem the tide of deforestation in the report?
Mr. Stern. I think it's crucial to work very closely with
the countries in which the trees stand--in Brazil, Indonesia,
Malaysia, Papua New Guinea, and so on. The vast majority of the
deforestation occurs in seven or eight countries, so I think
it's a question of building collaboration with those countries
and indicating to them that if they come up with good plans for
dealing with deforestation--plans that only they themselves can
produce, because only they understand the environments, the
communities, and social structures in which they live--if they
come up with strong plans, they'll get very powerful
international support. I think that's something which the World
Bank could do a great deal on. I believe they are moving in
that direction, and I think strong support from the
shareholders at the World Bank, will be absolutely fundamental.
But as you say, Senator, this is very much about foreign
relations and building collaboration. I think building
collaboration with developing countries in the ways that you
describe--on deforestation, and in other ways--that we
discussed earlier on carbon trading and sharing technology,
will be fundamental. I also believe that a strong alliance
between the European Union and the United States on these
issues could have an enormous influence on the speed and scale
on which we tackle this problem.
Senator Menendez. We'll look forward to exploring it with
the World Bank at one of our hearings. Thank you, Mr. Chairman.
The Chairman. Thank you very much. Let me just ask one
additional question. I believe Senator Domenici is trying to
get back to the hearing and he may before the answer is
completed, in which case he may have a question.
Sir Nicholas, you indicated, as I understood your
testimony, that one of the things we need to work on long-term
is getting to a global price for carbon. Could you just briefly
describe how you see us going from where we are today to a
global price for carbon? That seems to me to involve some
fairly major hurdles that need to be overcome.
Mr. Stern. The key element in that would be building an
international trading scheme, so that when you design your cap
and trade scheme, sir, for the United States, you should bear
in mind that the technicalities of linking it with European
Union trading schemes should be a big part of the story, so
it's trading schemes that can speak to each other. The two
biggest will be the European Union, which is on the way, and
that of the United States, which is already in its early forms.
I think with your leadership it will grow so the building of an
international price depends on the linking of those schemes,
and then the further linking as time goes by with India, China
and the other main countries. I think that will be the main
method.
Another method, of course, is if we go the tax route. We
have to look at the taxes that other people are charging and
try to do what you can to bring them into line. I don't think a
formal structure in that case would be likely to get very far,
but awareness of what others are doing and linking your tax
prices to your cap and trade prices would, I think, bring that
kind of harmony in a way that wouldn't be formal or heavy, that
could actually create it.
The Chairman. Well, thank you very much. You've all been
very generous with your time and it's very useful testimony. I
think obviously a lot of the questions have demonstrated the
interest the committee has on this subject, so thank you all
very much for being here.
If there are additional questions, if Senator Domenici has
any additional questions, or anyone else, we may submit those
to you and ask you to respond if you could for the record, but
again thank you for being here and we will adjourn the hearing.
[Whereupon, at 11:56 a.m., the hearing was adjourned.]
APPENDIX
Responses to Additional Questions
----------
Responses of Sir Nicholas Stern to Questions From Chairman Bingaman
Question 1. In your testimony, you say that ``Climate change is the
greatest market failure the world has ever seen.'' Can you explain what
you mean by this? Why is this different from other market failures?
Answer. Economic activities which emit greenhouse gases directly
affect, via climate change, the consumption and production decisions of
others. They are thus, in the language of economics, an externality.
Climate change is a market failure since, without climate change
policy, the costs of these impacts are not considered by consumers or
producers when they make decisions that lead to greenhouse gas
emissions.
There are two reasons why I believe that it is the greatest market
failure the world has ever seen. First is the breadth of human
activities that are involved. Most production and consumption actions
have some greenhouse gas emissions associated with them (though a large
proportion of emissions come from a limited number of activities). The
sources of greenhouse gas emissions are diverse in their nature and
motivation. As greenhouse gas emissions add to a global stock, it does
not matter where the emission comes from--the impact is global. Each
emission affects everyone on the planet albeit in a very small way. The
actions of everyone have an impact on everyone. This is in contrast
with other externalities such as road congestion and acid rain where
the sources of the externality are fewer and the impacts are generally
felt locally.
The second reason is the scale of the potential impacts. Other
market failures may lead to under-provision of particular goods or
higher prices for consumers whereas this market failure has the
potential to seriously threaten the way we can live our lives in the
future. If emissions continue to rise, following business-as-usual, by
the end of the century there is a very real possibility of atmospheric
concentrations such that, next century, we will see increases of 5
degrees C temperature change from pre-industrial levels. This is
equivalent to the change between now and the last ice age and it is
inevitable that this would have a profound effect on the physical and
thus the human geography of the world. Some of these impacts are
highlighted in Figure 2 of the Executive Summary that Professor Yohe
brought to the Committee's attention and outlined in more detail in
Chapters 3-5 of the Review.
Question 2. Dr. Yohe says in his testimony that building in a
``safety valve'' to a cap and trade program sets a loophole in the
policy that could easily be manipulated. We are considering such a
mechanism in the legislation that I have circulated and I would like to
ask your thoughts on whether or not it makes sense to use such a thing.
Answer. Introducing a safety valve--some sort of cap on the price
of allowances in an emissions trading scheme--is thought to have two
potential advantages--one economic and one political. The supposed
economic advantage is that it can reduce price volatility in the market
by reducing the risk of any price spike, and also minimize uncertainty
on the upper limit of prices by capping it. When prices reach the cap
level, emissions are allowed to increase without a consequent increase
in prices.
If such a cap on prices or `safety valve' were in place for a short
duration of time, then there are minimal risks to the environment, as
it the total stock of emissions in the atmosphere that cause warming,
rather than the timing of those emissions. In particular, if a safety
valve were to operate over a long period of time, this could put the
environmental credibility of the scheme at risk. Although it is the
total stock of emissions in the atmosphere that cause warning, rather
than the timing of those emissions, over a long period of time, the
flow of emissions would cumulatively increase,\1\ and the environmental
risks would therefore increase. Over short time periods, it may be
efficient to avoid high abatement costs or price peaks, because
adjustments are more difficult to make in the short-term.\2\ This leads
to the political advantage of price caps; they can be used to avoid
price spikes that may undermine support for emission reductions policy.
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\1\ When the safety valve was triggered.
\2\ Much of the same reasoning can also apply to a price floor (a
minimum price for permits) since when prices are very low it is
efficient to take advantage of low cost abatement. This can provide
security to those investing in low-carbon infrastructure and thus
potentially reduce the trading price. It does, however, suffer many of
the same potential problems and as also a major risk to public
finances.
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I am however skeptical of the merits of the price cap via a `safety
valve' and believe there are better ways to manage the risks of price
volatility. First of all, it is difficult to ascertain how much a
safety valve can contribute to minimizing uncertainty for investors.
The price at which it is set would be a political decision, that is
therefore subject to political risk in terms of when and at what level
it would be set, what and how changes would be made to its level.
Investors may not find the safety valve itself much more certain than
estimating where the free market price of carbon could peak during a
particular time frame.
Secondly, policy makers can use good market design to overcome some
of the risks of peaking prices. There are a few design features that
can help this. One is to have long trading periods (say at least 10
years), allowing banking of allowances between periods of trading.
Allowing firms the flexibility in compliance options over time reduces
risks of forcing abatement in short time periods and the subsequent
peaks in abatement costs. A second is broadening trading schemes to
include more diverse economic sectors that have different abatement
costs and that are subject to different influences will tend to deepen
markets and help to stabilize carbon prices. A third design feature is
to expand trading schemes to allow them to link to purchases of
emission reductions from the developing world (for example via Clean
Development Mechanism credits or a revised equivalent) thus reducing
overall compliance costs and therefore limiting the level of any price
peaks. Unlike a safety valve mechanism where firms have unlimited
emission rights once prices exceed the safety valve, using a link to
reduction-credits in the developing world maintains the environmental
credibility of the policy as it involves buying emission reductions
from elsewhere. Importantly, linking to the CDM or similar mechanisms
also builds co-operation with developing countries and provides options
for them to benefit from investment in lower carbon technologies.
Thirdly, any price cap, by setting an upper limit on future prices,
will reduce firm's central expectation of future prices. This is
particularly the case if the cap is set too low and the price is
expected to ``hug the ceiling''.\3\ The safety valve reduces the
incentive to invest in mitigation and increases the likelihood that the
cap will be triggered. It also impacts on the incentive to innovate and
adopt technologies that are currently higher in price but may fall.
This means that either these technologies will not be adopted or that
much greater support through other policies is required.
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\3\ The price cap when set very low effectively takes the form of a
tax rather than a trading scheme.
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Finally, and crucially in terms of the benefits of moving towards a
more efficient, least cost global carbon market, price caps form a
potential obstacle to linking with other trading schemes. Linking
schemes is efficient as it allows a given target to be met through
reducing emissions wherever it is cheapest. It also reduces price
volatility by increasing market liquidity. Countries will be reluctant
to join another scheme with a low safety valve, as it will reduce the
environmental credibility of their scheme, as their firms will pay the
low price of the safety valve in another scheme. It also increases the
risk of manipulation by firms operating across borders. Technical fixes
to these problems are available but increase the complexity of the
scheme.
In summary a well designed safety valve does have some potential
advantages but these advantages can be enjoyed through other features
of the scheme and a badly designed or very low safety valve will limit
the effectiveness of any scheme.\4\ The potential disadvantages of a
cap are significant and so they should such an approach should be
avoided if possible.
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\4\ For more on the design of emissions trading schemes see Chapter
15 of the Stern Review and Box 15.2 for price caps and floors.
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Question 3. You say that the three elements of policy required for
an effective global response are: a carbon price, implemented through
tax, trading, or regulation; support for innovation and the deployment
of low carbon technologies; and action to remove barriers to energy
efficiency, and to increase public awareness and engagement. I think we
are familiar with some of the mechanisms needed to accomplish the first
two, but what can we do to remove the barriers to energy efficiency and
to increase public awareness and engagement, especially in places like
China and India?
Answer. Action to remove further barriers, particularly relating to
energy efficiency, is explored in more detail in Chapter 17 of the
Stern Review. The choice of policy depends on the issue that is being
addressed. We split the policy response to address these barriers into
3 categories:
Regulation.--Regulation has an important role, for example
in product and building markets by: communicating policy
intentions to global audiences; reducing uncertainty,
complexity and transaction costs; inducing technological
innovation; and avoiding technology lock-in, for example where
the credibility of carbon markets is still being established.
Information.--Policies to promote: performance labels,
certificates and endorsements; more informative energy bills;
wider adoption of energy use displays and meters; the
dissemination of best practice; or wider carbon disclosure, can
all help consumers and firms make sounder decisions and
stimulate more competitive markets for more energy efficient
goods and services.
Investment/Finance.--Private investment is key to raising
energy efficiency but there may be market distortions (for
example in property markets) or problems in obtaining finance
for good investments. Generally, policy should seek to address
the source of market failures and barriers. Investment in
public sector energy conservation can reduce emissions, improve
public services, fostering innovation and change across the
supply chain and set an example to wider society.
Public discussion and awareness can have an important effect on
individual behavior. It can also lead to society to act as an
enforcement mechanism, ensuring that their national government sets
policy and acts internationally in a manner that they consider
responsible. How this can occur throughout the world was highlighted in
Box 21.6 in the report.\5\
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\5\ The issues of public awareness and responsible behavior are
explored in more detail in Section 21.4 and 17.7 respectively.
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Both China and India have a significant emphasis on energy
efficiency in their respective 11th 5 year plans. More can be done to
support this. While not always the case, developing countries often
install less efficient plant as they do not have access to or the
capacity to adopt technologies with higher efficiency that are cost
effective. Developed countries can do more to support the transfer of
technologies to developing countries particularly by helping to build
the capacity to adopt new technologies. This is explored in Section
23.4 of the Review.
Question 4. We talked quite a bit about China at the hearing. Can
you expand on some of the points you made about what is going on in
China right now?
Answer. During my travels in preparation of the review and since
its release it was clear that there was often little understanding of
the action undertaken by other countries. There is a tendency to
underestimate action by others and falsely assume that in acting to
reduce emissions any country would be acting in isolation. We outlined
the goals of the 10 largest countries in Table 21.1 of the Review.
Building a shared understanding of what other countries are doing helps
encourage international co-operation and strengthen national action.
Turning specifically to China--as I outlined in the hearing--I have
experience of working in living in China over the past twenty years and
am pleasantly surprised by the huge shift in attitudes towards the
environment that began in the early 1990s and accelerated rapidly in
the past two years. The 11th 5 year plan has two headline targets--the
growth target and a national objective to reduce energy intensity of
GDP by 20% from 2005 to 2010. This includes a 10% reduction in air
pollutants and 15% of energy from renewables within the next ten years.
China has an impressive track record at meeting its targets.
China already has the world's largest renewable sector and is
reforesting not deforesting. To achieve the efficiency targets the
government announced its intention to give targets to the largest 1,000
enterprises \6\ for which their chief executive is accountable.
Enthusiastic local implementation has seen targets extended to the
largest 8,000 enterprises. China is also seeking to close the
`dirtiest' sources of emissions. Efficiency standards for cars are
higher than the U.S. and SUVs face an $8,000 tax in Beijing.
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\6\ Covering 47% of industrial energy use.
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Such strong policy objectives are justified by the three inter-
related objectives of local environment, climate change and energy
security. There is much concern in rich countries about a shift of
carbon activities to jurisdictions with less active policies but China,
for example, has introduced export duties on energy intensive products
(iron, steel, cement, aluminum, coal and copper) ranging between 5% and
15%. In most cases this is a larger price effect than would have been
the case if Chinese firms had been subject to the carbon price from
throughout the first trading period of the EU emissions trading scheme.
I interpret this as a clear desire to avoid China becoming the locus of
the world's pollution and energy intensive products.
That said, there is currently a rapid growth in the Chinese energy
sector to sustain economic growth, giving rise to oft quoted statistics
of the number of new coal-fired power stations that are produced each
week. Lifting more of the population out of poverty through economic
growth is an understandable priority in China (and India).
Consideration of cost, local availability and speed dictates that coal
will be the major fuel for energy growth and is forecast to remain at
least 75% of electricity production for the coming decades. This
emphasizes the importance of developing carbon capture and storage
technologies and the transfer of efficient generation technology. It
must be remembered when evaluating China's green credentials that even
when China overtakes the U.S. as the leading emitter of greenhouse
gases in the coming years the difference in population means that China
will have a less than a quarter of the emissions per head of
population.
Responses of Sir Nicholas Stern to Questions From Senator Domenici
Question 1. Your review concludes, ``the overall costs and risks of
climate change will be equivalent to losing at least 5 percent of
global GDP, now and forever.'' Economist Richard Tol calls this claim
``preposterous,'' pointing out that society could adjust to higher
temperatures and higher sea levels by developing technologies to adapt.
Isn't it possible that adapting to climate change might be best for
the world economy?
Answer. Adapting to climate change is indeed wise for the world
economy--it makes little sense to act as if there is no climate change
when we are already seeing it and more is on the way. As set out in my
written testimony--we strongly argue that adaptation is a crucial and
central part of the response to the challenges of climate change.
Without adaptation the costs of climate change will be significantly
higher. Even with strong mitigation, adaptation will be required to
address the impacts of climate change. Adaptation is discussed in more
detail in the three chapters in Part V of the Review.
Adaptation can mute impacts, but cannot solve the problem of
climate change. There are residual costs and limits to what adaptation
can achieve particularly in the case of natural systems and due to sea
level rise in the longer-term.\7\ Adaptation can, at a cost, reduce the
impacts of climate change but cannot be a substitute for mitigation.
Adaptation does not address the issue of risk, which is at the heart of
the story. The impacts at higher levels of temperature change are
potentially very large. It is obvious that if these were borne out
assuming that we could adapt would prove reckless. Local benefits
ensure that much action will be autonomous but this is dependent on
good information on future impacts and is difficult for poorer members
of society.
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\7\ In shorter time periods in low lying and poorer areas
particularly low lying Island states and countries such as Bangladesh.
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When discussing the aggregated modeling of climate change impacts
it is important to remember their role in assessing the risks of
climate change. Modeling is inevitably dependent on aggregating much
information and replacing much with simplistic assumptions. It loses
much of the important detail and is dependent on often value-laden
assumptions and what is included in the models. As was clearly
expressed by Professor Yohe, the simplest way to look at the problem is
to look at the disaggregated impacts alongside the cost of reducing
emissions and consider whether it is worth paying for mitigation to
avoid the risks associated with higher temperatures. That was the main
argument of the review. Only Chapter 6 (30 pages of 700) embodies this
type of modeling. The modeling supplements this approach and helps tell
us what is important in terms of economic modeling approaches,
scientific variables and ethical considerations.
The modeling in the Stern Review, using Professor Chris Hope's PAGE
model, has produced cost of damage estimates that are higher than the
existing literature for what I believe to be justifiable reasons. The
major changes are, (i) the incorporation of the latest scientific
information (ii), including the economics of risk and (iii) a full
consideration of the economic and ethical implications of how we treat
costs and benefits over time.
The model we used included a wide range of impacts and allows
policy-makers to measure much of what counts rather than just counting
what can be measured but many risks and potential costs are still
excluded. In its construction it is based on the existing impacts
literature and is thus in line with the cost estimates relative to
temperature change in the literature. Many approaches do not include
important impacts and effectively assume they are zero. Our estimates
still exclude social contingent impacts such as the impacts of large-
scale migration and conflict so is likely to be an under-estimate as so
much is left out. Incorporating the latest science and the economics of
risk does mean that the impacts at higher temperature are more likely
to be triggered increasing average cost estimates.
Responding to developments in the science the Review, I believe,
added considerable value to the economics of climate change by
incorporating the economics of risk. Understanding risk and
incorporating the full range of risk when making decisions is desirable
when making sound policy decisions. Rather than using point estimates
the Review incorporates probabilities and thus the worst- and best-case
scenarios, and has explicitly built in aversion to risk. Risks and
uncertainties should be the heart climate change modeling. It is this
that concerns many people and it is important that economics reflects
the distribution of potential impacts as otherwise the numbers are
biased downwards.
Probabilities of temperature change from the science allowed
outcomes to be weighted by their likelihood to ensure they are included
in a balanced fashion. For climate change the damages increase more
rapidly as temperatures rise. The distribution has a long tail so there
are low probability high impact effects and these pull the average
upwards. This is preferable to using a point estimate that does not
include the full range of risk. The review also includes an aversion to
large losses, as people routinely do in their daily lives, for example,
in buying insurance. People are risk averse about a low probability of
their house being destroyed and hence purchase insurance.
The modeling in the Review, using the PAGE model, assumed
adaptation to 90% of the impacts of climate change in developed
countries, but only adaptation to 50% of the impacts in developing
countries where capacity to adapt is lower. Some have criticized this
as being too optimistic (i.e. overstate the degree of adaptation and
this underestimates damages). It is important to recognize that
adaptation is not costless and that adapting to the impacts becomes
increasingly difficult and more expensive as temperatures rise.\8\ Our
modeling does include the costs of adaptation though we do assume it is
relatively cheap. Other approaches do this implicitly with lower
impacts. Unless added later this removes the cost of adaptation from
comparisons between costs and benefits of action.
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\8\ Adaptation costs are convex--see Box 3.1. As an intuitive
example consider the following illustrative escalation of costs
relative to temperature: at between zero and two degrees warming,
agricultural output can be adapted and crops can change; some regions
will see higher yields and longer growing seasons, levies can be
strengthened and irrigation projects enhanced; between two and four
degrees warming, new agricultural plant and processes may be required,
levies and barriers must be rebuilt and new irrigation sources found;
between four and six degrees some coastal areas must be abandoned and
populations moved and former agricultural land must be abandoned. It is
clear that the costs and impact of residual effects and adaptation
costs are highly disproportionate--convex--to the linear change in
temperature. Five degrees C temperature change would redraw the
physical geography of the world and thus the human geography. It would
ultimately lead to population movements on a massive scale that would
inevitably entail great costs.
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Further sensitivity analysis on assumptions and modeling is
available in the postscript and subsequent papers.\9\ This shows that
our main conclusions from this exercise--that the costs of strong
action are less than the costs of damage avoided--are robust to a range
of input assumptions. The question should be as to why the earlier
estimates are so low. The main answer is that they ignored risks that
we now know to be real and underestimated emissions.
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\9\ www.sternreview.org.
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Question 2. Notable economists have written that the Stern Review
drew selectively from studies of the impacts of climate change,
emphasizing those with high damage estimates--even when the studies
were highly speculative.
Did the Stern Review intentionally seek studies that supported the
worst-case scenario? If so, is this accepted practice among economists?
Answer. The Stern Review did not select the studies with worse case
scenarios. It used only peer reviewed science and all key scientific
assumptions have since been endorsed by the Working Group 1 report by
IPCC \10\ released in February 2007. The Stern Review only summarized
the science. The IPCC remains the most comprehensive summary of the
science and the Review team took advice from its contributing
scientists to ensure that the Review was based on the best available
science.
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\10\ Inter-governmental Panel on Climate Change www.ipcc.ch/
SPM2feb07.pdf.
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The Stern Review presented the impacts in two general forms,
firstly through a disaggregated analysis based on peer-reviewed
literature and secondly, through integrated assessment modeling.
Neither of these approaches focused on worst-case scenarios.
The disaggregated analysis presented estimated ranges of
damages at different temperature levels for several key
indicators, such as water availability and population at risk
from coastal flooding. This analysis demonstrated the
dependence of impacts on temperature, showing clearly that the
impacts of climate change become more negative, severe and
widespread as temperatures increase. The analysis also
illustrated that the risk of surprise climate events, such as
loss of the ice sheets, and large-scale socially contingent
effects, such as mass migration and conflict, increase as
temperatures rise.
The integrated assessment\11\ made the treatment of risk
explicit. It used a model that explores probabilistically the
range of possible outcomes. The model is based on the existing
impacts literature and is not an outlier in any sense. The task
requires considerable aggregation to make it feasible.\12\ This
loses the important detail of the disaggregated impacts that
are set out in the early part of the Review. Many costs and
risks are left out (such as weakened carbon cycles) or not
treated formally (such as intra-generation distribution) in
this approach. Had these been included the damage estimates
would have been higher.
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\11\ Chapter 6 of the Review.
\12\ There is not a comprehensive set of global studies for each
impact that allows a bottom-up cost estimate from disaggregated
studies.
Economic and ethical assumptions do have a significant role to
play. Economic assumptions such as the emissions path were based on the
latest economic forecasts (using the International Energy Agency's
World Energy Outlook 2006). Ethical factors are not related to best/
worse case scenarios but rather the ethics and values that underpin
them. We made these assumptions explicit.
On the costs of mitigation we present the full range and are
central within the literature. The subsequent analysis in the IEA's
World Energy Outlook 2006 released after the report found costs to be
lower than our central estimate. Any claim that the Review always using
worse case scenarios is absolutely untrue.
Question 3. Why did the British Government fail to subject the
Stern Review to a peer review process before it officially released the
document?
Answer. The Stern Review was an independent review that was
commissioned by and reported to the UK Chancellor and Prime Minister.
UK Government does not undertake peer review on commissioned reviews so
this was not an option. We did hold a full call for evidence that
provided some significant contributions (available on our website). We
published papers outlining our approach as it developed and gave many
presentations around the world that made our emerging thinking clear.
Stakeholders were engaged throughout the Review and drew from the vast
wealth of peer-reviewed literature, as the IPCC does in its own
process. In an area such as climate change where it is subject to the
media spotlight there are risks of early confused coverage if the
reports contents were somehow leaked. The review also had a set
timetable, which would have constrained the scope for peer-review given
the time needed for review of a document of this size.
While the Review did seek to build on the foundations of the
academic literature on the economics of climate change its target
audience was not only academics but also policymakers, business and
individuals. This diverse audience means that reviewing the document
from only an academic perspective may have reduced the impact on other
audiences. One of the things that has pleased me most since the release
of the report, is the diverse range of people from around the world
that have engaged with the report.
In many ways some peer review has been carried out since the
Review's release in the public domain. Immediately following the Senate
Hearing I had a public seminar on the review in Yale alongside
Professors Nordhaus, Yohe, Sachs, Barrett, Cline and Mendelsohn.\13\
The Review has been given the attention of many critiques, which we
have responded to. I believe that process showed that our analysis and
conclusions were very robust. Most of the attention was focused on
ethical valuations on which reasonable people can differ, but we give
powerful arguments for the ranges selected. Many of the other comments
are based on misconceptions and false assumptions about what the Review
did or failure to read the whole report. So, fortunately, there is
nothing significant that I would change if this peer review had been
conducted before the release of the Review, other than to include the
sensitivity analysis for Chapter 6 (contained in a Postscript) in the
main body of the Review.
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\13\ For more details and video see http://www.ycsg.yale.edu/
climate/index.htm.
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Question 4. In your written testimony, you referred to the Fourth
Assessment report of the Intergovernmental Panel on Climate Change
(IPCC), stating that ``the panel's central estimate of further warming
for the end of this century is 4 degrees C. This would also give a
greater than 50% probability of increases over 5 degrees C in the next
century beyond 2100--exactly in line with the analysis presented in the
Stern Review last year.''
I understand that the IPCC has a longstanding policy not to attach
probabilities to its distinct emissions scenarios, and moreover does
not identify any one scenario as a ``central estimate.'' The Summary
for Policy Makers of the Working Group I report does include ``best
estimates'' of temperature change for the six scenarios range from 1.8
degrees C to 4.0 degrees C. The mean of 2.8 degrees C is clearly
presented in table SPM-3 on page 13.
Can you explain the apparent discrepancy between your testimony and
the IPCC report?
Answer. You are correct that the IPCC does not attach probabilities
to emissions scenarios.
Your quote from my testimony is missing the first part of the
initial sentence, which is ``If emissions continue to rise''. This
introduction to my statement was critical to its meaning. The Stern
Review, in line with estimates from the International Energy Agency,
concludes that in the absence of abatement policies, emissions of
greenhouse gases will likely continue to rise at a rapid rate, roughly
doubling by the middle of the century (see Chapter 7). This puts us in
the range of the three higher SRES marker scenarios: A1B, A2 and A1Fl.
The average of the IPCC's `best estimate' temperature increases for
these scenarios is 4 degrees C in 2100 (adding on 0.6 degrees C to
change the baseline from 1990 to pre-industrial). However, the world
would see a further warming after 2100, even if emissions fell to zero
in 2100. This is called the commitment to warming: the inertia in the
climate system means that the world would be committed to warming for
decades after atmospheric concentrations are stabilized. It is this
warming that I referred to in my statement.
The Stern Review states that if emissions continue to rise, by the
end of the century we would be committed to at least 50% chance a
warming of 5 degrees C above pre-industrial levels. This is consistent
with the findings of the new IPCC report. For example, the A1B
scenario, the lowest of the three discussed above, reaches a greenhouse
gas level of 850ppm CO2e in 2100 and applying the IPCC's
`likely' climate sensitivity range, this equates to a warming of
between 3.2 and 7.2 degrees C above pre-industrial at stabilization, or
a best estimate of 4.8 degrees C (i.e. around 50% chance of greater or
less than 4.8 degrees C). The A2 and A1Fl scenarios reach well over
1,000ppm CO2e, giving an even greater warming. Thus, my
statement of ``greater than 50% probability'' was consistent.
The question of probabilities associated with different emissions
scenarios is an important one and is now being discussed extensively
within both the science and economics communities. Our analyses,
alongside others, suggest that the lower emissions scenarios of the
IPCC may be optimistic, including either low levels of economic growth
or some sort of exogenous technological progress that allows emissions
to fall autonomously.\14\ Technological progress that substantially
reduces the carbon intensity of economic growth seems unlikely without
a pull from mitigation policies. Lower emission scenarios also mean
that the cost of abatement is far cheaper than we estimated. Since
emissions fall anyway reductions would be cheap and to a large extent
free. The emissions scenario we chose did mean relatively higher
temperature change but also implied that more mitigation was required.
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\14\ Lower scenarios are manifestly implausible as assumptions of
business as usual--they are likely to involve policies of the kind we
discuss.
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The scenario we chose has a plausible emissions path and thus
impact estimates but does incorporate questionable population
assumptions that can have an effect on the impacts calculus if they
were brought in line with latest U.N. estimates.\15\ Estimating
emissions scenarios is an unenviable task that may be re-visited before
the next IPCC report. The IPCC scenarios were developed in 1997 and
subsequent growth in energy demand in rapidly growing developing
countries since then is one of the reasons why the higher scenarios
look more plausible. We did not create a new scenario for our modeling,
as it is important to ensure that there is comparability with
scientific estimates (which are based on the specific scenarios used by
the IPCC).
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\15\ This is explored in the sensitivity analysis on our website
and further emission scenarios will be the subject of future analysis.
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Question 5. If the world economy continues to grow, then future
generations will be far wealthier than people are today. Future
generations will also have more technology options for responding to
climate change.
Doesn't it make sense to share the burden with future generations
who in many ways will be better equipped to address it?
Answer. The modeling in the review does share the burden with
future generations. All modeling in the Review incorporates the fact
that future generations are expected to be richer: economic growth
implies discounting precisely to take account of the higher incomes of
future generations. The extent to which future generations are better
off controls the extent to which we discount costs and benefits in the
future.\16\
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\16\ There is also a cautious estimate that we will not be around
in the future that is included and assumptions on attitude to risks and
inequality (the Elasticity of Social Marginal Utility of Consumption)
also have an impact and along with other issues on discounting are
explored in far more detail in Annex A of Chapter 2, the postscript and
subsequent papers available on the internet.
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Climate change has a non-marginal impact on growth as it can affect
future growth rates. To reflect this correctly when estimating costs in
the future we discounted each of the thousands of the model runs on the
basis of the growth rate in that run. This is a more accurate approach,
but it is more complicated and has led to some false assumptions from
commentators over discounting in the Review's modeling.
The cost of mitigation is expected to remain at around 1% of GDP so
it remains a relatively constant share of GDP as people get richer,
spreading the burden across generations. The mitigation paths \17\
generally assume a slowing of emissions growth before increasing
reductions before leveling off in the future. This path spreads costs:
Initial reductions are smaller while mitigation technologies are
developed but subsequent steady declines place pressure on future
generations as low hanging fruit are taken earlier so it becomes harder
and potentially more costly to get the final reductions requiring
advanced technologies in the future.
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\17\ As illustrated in Figures 8.4 and 8.2 and from technology
approach to modeling Figure 9.3.
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The cost of mitigation may be shared between generations but the
cost of climate change impacts are not. The long-term nature of the
impacts of greenhouse gases in the atmosphere ensures that the cost of
actions now will be felt for more than the next two centuries. So we
are asking to share the burden of mitigation but ensuring future
generations bear the burden of emissions we release in terms of impacts
and adaptation costs.
There are many legitimate differences between climate change and
traditional project appraisal involving an investment marginal to a
growth path. As discussed, the outcomes with climate change are non-
marginal as it can affect growth. Many impacts are also irreversible
and the costs of overcoming many others will be very high. There are a
number of reasons why a smaller scale project such as a new road may
not be as valuable, or indeed relevant at all, in several years time as
circumstances change. However, avoiding the impacts of climate change
(the value of a stable climate, human life and ecosystems) are likely
to continue to be relevant. The planet is unlikely to vanish
(abstracting from climate change itself here). Further, as people
become richer and environmental goods become scarcer it seems likely
that, rather than fall, their value will rise very rapidly. Thus
investing elsewhere and using the resources to compensate any later
environmental damage may be very costly. This is not yet reflected in
the modeling but is likely to be important in determining the value of
impacts over time.
Though experts may differ over the initial pace and scale of
emissions reductions, all economists agree that for any given target it
is cheapest to start now. Failure to act strongly enough eliminates
options we may retrospectively have preferred.
Responses of Sir Nicholas Stern to Questions From Senator Martinez
Question 1. I am concerned about the impacts of climate change. I
believe it is happening and that humans at some point play a part in
its exacerbation. I think you will find a lot of members on this
Committee who share that opinion, but like me are confronted with a
variety of proposals about what to do about it. Given the large amounts
of legislation that have proposed cap and trade programs, how would you
go about creating a carbon regulatory program that would not negatively
impact the U.S. economy?
Answer. While mitigation will have some costs, only extremely badly
designed or drastic and rushed policy action could have a major
negative impact at a macroeconomic level. The effect will be modest
rise in costs but not enough to have an effect on growth of any
magnitude across the economy. It would be more pronounced in a very
limited number of `carbon intensive' sectors. This cost is a good
investment against the potential impacts of climate change. Having
explored the costs of mitigation we concluded that the costs are likely
to be in the region of 1% of GDP in 2050. This is equivalent to a 1%
increase in a cost index: that is the sort of thing economies react to
all the time such as a result of exchange rate fluctuations. This is
not the sort of effect that can derail growth. There is some
uncertainty around this figure of around +/-3% but the extremes of this
range are unlikely. Successful innovation could lead to a negative cost
(boost growth due to a `Schumpetarian' burst of innovation) but
conversely a lack of progress could increase costs.
Some policy actions may lead to rapid positive returns such as
through improved energy efficiency. It is also important to consider
the long run as well as short-run impact on growth and competitiveness.
Failure to address the cost of emissions now will allow investments
that lock-in a high carbon infrastructure, that would not be
competitive in a move to a low-carbon world and risk costly premature
retirement of investments. It would also fail to spur the innovation
and expertise in sectors and products that are would dominate these
sectors in such a world.
If policy-makers are specifically concerned about competitiveness
it is important to get quantitative. Many ``competition'' claims are
without numbers and refer to very narrow sectors of the economy. The 1%
additional cost is very small compared to wage differentials between
rich and poor countries. There are only a limited number of traded
sectors where energy costs have a significant impact on prices. Even in
these sectors studies show that environmental legislation has not
traditionally played a major role in site location. Concern over
competitiveness impacts should be harnessed in the push for
international policy mechanisms, as this is the easiest way to avoid
distortions and provide suitable incentives. It is possible to achieve
this in the absence of over-arching carbon constraints such as through
sectoral agreements (explored in Section 23.5). These can help prevent
distortions and encourage participation of developing countries for
this limited section of their economy. This is made more feasible by
the prevalence of large multinational firms in these sectors.
Alternatively it is possible to consider the allocation or tax
treatment of vulnerable sectors, but this must be set against the long-
run implications in these sectors of shielding them from the
environmental cost.
Mitigation policy should look to address emissions from all sources
and ensure that instruments gain benefits from scale but, where
appropriate, are also tailored to the idiosyncrasies of individual
sectors. Effective design of policy structures outlined in Part IV of
the report. They include pricing the carbon, spurring technological
innovation and removing barriers and changing behavior to reduce
deforestation and improve energy efficiency. Within this framework it
is important to look to make instruments international in the future to
reduce costs and reinforce international action. This is explored in
Chapters 22-24 of the Review.
Question 2. The Stern Report has received criticism from the
Economist, the Copenhagen Consensus headed by Bjorn Lomborg, as well as
other economists for either putting too much of the emphasis of climate
change abatement on rich Western nations or not enough focus on the
developing world. How would you respond to that assertion?
Answer. I had thought that Bjorn Lomborg's critique was more
focused on his belief that climate change is less important to tackle
immediately than many other world problems such as aids and malaria. I
am not aware of specific criticism from these sources concerning the
balance between rich Western nations and the developing world but I
will address this shortly. But let me begin by stating why I think
Lomborg's analysis, under the guise of the Copenhagen Consensus, was
deeply flawed in many ways.
Many of the economists that participated in that process said
afterwards that climate change should not have been on the list of
issues considered--it is incomparable in so many ways with the other
issues. His approach asks the wrong question. Correcting an externality
is not like spending public money and does not come from a limited pot
of finance. Requiring decision makers to reflect their impact on others
is basic market economics.
The techniques used in the analysis are badly applied. They fail to
deal with many dimensions of the problem such as the economics of risk
(possibility of large temperature change and severe impacts we now know
are possible) and the urgency of the reductions to achieve
stabilization (costs of action for any stabilization level rise rapidly
and ultimately become impossible if action is delayed). Indeed
Lomborg's analysis truncates the kinds of spending that could be made;
on aids and malaria it was only preventing the spread of the disease
not eliminating it. More importantly, the analysis did not take account
of the fact that dealing with climate change itself can help deal with
many of these problems in the future. The impacts of unmitigated
climate change on health could be very severe, particularly in
developing countries. It is not a discrete choice between competing
options--tackling climate change has many, varied co-benefits.
Your question raises the issue of equity of effort between rich and
developing nations. Several ethical perspectives have been advocated at
international discussions--historical responsibility, per capita
rights, ability to pay. All of these endorse the notion of ``common but
differentiated responsibility'' recognized in the United Nations
Framework Convention on Climate Change (UNFCCC). This discussed in Part
VI of the Review--Chapter 22 in particular. The different ethical
perspectives all point in a similar quantitative direction: Developed
countries should take responsibility for reductions of around 60-90%
\18\ in 2050 as art of a global reduction of 20-30% to achieve 550ppm
CO2e.\19\
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\18\ Not necessarily within their own borders.
\19\ Which is at the top of the range of stabilization goals we
suggest--between 450 and 550 ppm CO2e.
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Asking poorer people to pay a proportionally larger share of the
cost of avoiding a problem others played a larger role in would seem
unethical to many. However, the equity split advocated above does
includes significant reductions from these countries relative to
business-as-usual. Developing countries have an active stake in a
desirable stabilization outcome and should be prepared to contribute
subject to an equitable allocation of costs. Much of the review
addresses the challenges faced by developing countries (e.g. Chapter
20) and how to reduce emissions in these countries (e.g. Chapter 23).
Developing countries give priority to securing the economic growth
to lift their people out of poverty: their efforts should be supported.
Strong targets and carbon trading in richer countries can generate
private flows of capital that can support emissions savings and
investment in low-carbon infrastructure in developing countries. The
scope for countries free-riding on a global problem means that it is
important to create the conditions where all countries will be moved to
participate. Equity considerations will be crucial given the history of
rich country emissions.
Question 3. It is my understanding that the basic premise of the
Stern Report is that our international response should act similarly to
an insurance policy--pay some now to avoid big problems later.
Considering that its recommendations urge spending 1 percent of global
GDP per year (roughly $450 billion) to prevent climate change, how
would nations be forced to comply? How would nations respond during
economic downturns or recessions? Would other nations be required to
pick up the difference if another country experiences severe economic
circumstances?
Answer. Answered in combination with [sic.]
Question 4. Who would control the collection and allocation of
funds to combat climate change under the Stern Report model?
Answer. It is important to be clear the 1% of global GDP is not a
bill to be paid but rather an incremental cost that is spread
throughout the market. It is not a measure of government spending but
rather the additional cost of a low-carbon economy which affects people
largely through price, tax and regulatory system. Taxes, trading and
regulation all encourage firms and individuals to chose low-carbon
approaches at an additional cost (though as discussed earlier this may
prove to be at negative cost through innovation or energy efficiency
savings). This also applies to deployment support for low-carbon
technologies for which the costs are usually passed directly onto the
consumer. These funds are not collected but allocated through the power
of the market (if using market instruments). Depending of the choice
and design of the carbon pricing policy tool, this can lead to
transfers to governments in the form of revenue, but these are not a
cost and are assumed to offset costs or taxation elsewhere.
One of the advantages of international emissions trading is that
the market helps reduce emissions wherever it is cheapest, allowing
flows to developing countries to be managed by the market minimizing
total costs. Using tax instruments requires politically sensitive
transfers to achieve this and recipients to use these funds
effectively.
Furthermore, mitigation policy is likely to be counter-cyclical in
that it does not exacerbate economic upturns or downturns but serves to
moderate them slightly. At times of recession, the reductions in
economic activity and reduced consumption ensure that emissions target
are easier to meet and may provide a resource in trading schemes. In
times of boom the targets are more stringent, but there is extra
resources available to cover any additional costs.
There are some areas where direct public support is required to
support the introduction of public goods such as at the R&D stage of
innovation and adaptation. As outlined in Chapters 23 to 26 there is an
international element to these public goods that can be supported by
international co-operation. This can generally be done through existing
multilateral organizations. This may involve expanding their role and
capacity and there may be some cases where separate agreements and
institutions may be preferable. In the case of developing fusion
technology \20\ the scale of the costs ensured an international
approach was preferable and the EU, U.S., Russia, China, India, Japan
and the Republic of Korea agreed terms to split the costs.
International agreement can reduce duplication, reduce costs and
increase the scale of action by spreading the risk.
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\20\ www.iter.orq/.
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International agreements on emissions reductions are useful in
building a shared understanding of appropriate action and building
confidence in markets on the future direction of policy. Building a
powerful enforcement mechanism is likely to be very difficult in the
medium term. Formal compliance mechanisms are likely to only be
effective for specific and limited infractions. However, we argue that
such a mechanism is not necessary since the will of the domestic
population and the desire to behave in a responsible manner is the most
effective enforcement mechanism. Global public concern and awareness
about climate change are growing rapidly. They both influence and
sustain international co-operation, national aspirations and private
sector leadership on climate change. Countries failing to act in a
responsible manner will be pressured by their population and may damage
international relationships elsewhere. California, France, the EU and
China are all examples of countries or regions taking on stringent
targets or policies without international agreements underpinning them.
Question 5. One figure that is often quoted by some critical of the
Stern Report is the ``social cost'' of carbon dioxide. Under the Stern
Report, that comes to $85 dollars a ton while the Yale economist
William Nordhaus has determined that cost to be $2.50 per ton. Why is
there such a large difference in these approaches?
Answer. It is very important to be clear exactly what the social
cost of carbon relate to. The estimate you quote from our report
relates to the business-as-usual social cost of carbon (the cost if we
do nothing to reduce carbon emissions) for a more ``sensible'' path of
emissions, stabilization at 550 ppm CO2e, we estimate the
cost to be around $30 per ton of carbon dioxide. Figures from Professor
Nordhaus relate to an ``optimal carbon price'' which is the damage cost
under what the model estimates to be the most efficient mitigation
path. The comparison is not life-to-like and business as usual (no
policy) estimates of the social cost of carbon will always be higher
than under a policy path since the aim of the policy is to reduce the
damages. More recent estimates from an updated model by Professor
Nordhaus are higher than $2.50 \21\ per ton of carbon dioxide at $4.67
per ton of carbon.\22\
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\21\ In his comment on the Stern Review he outlines the optimal
carbon prices in the DICE-2006 model as being $17.12 in 2005 $84 in
2050 and $270 in 2100 (all per ton of carbon).
\22\ Equivalent to 4.67 per ton of carbon dioxide.
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The reason our estimates are higher than much of the existing
literature have been outlined earlier and are, I believe, for good
reasons. Estimates of the social cost of carbon are heavily dependent
on the modeling approach. Previous low estimates reflect high discount
rates, omitted impacts and significant benefits from warming in the
early decades.
Recently Professor Ackerman published a paper \23\ using different
variables in Professor Nordhaus' model and produced much higher
estimates. Professor Sachs added what he believes are more plausible
and up to date variables in the same model and reached figures much
closer to our own. This highlights the importance of using models as a
tool highlighting potential scale and what the important variables are.
The ethical and structural parameters both have a significant impact on
estimates of impacts. It is important to consider carefully the
variables used, whether they are accurate or uncertain, and the
implicit ethics of different approaches.
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\23\ Ackerman, F. and Finlayson, I (2007) The Economics of Inaction
on Climate Change: A Sensitivity Analysis, Climate Policy 6:4.
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The social cost of carbon is a useful indicator but using it for
policy is subject to a number of further considerations.\24\ Our
approach to pricing policies was different because of the constraints
and uncertainties in estimating a social cost of carbon. We advocated
the approach of picking a stabilization goal, which leads to a
quantitative target and using the power of the market to determine the
prices to meet this target. Market instruments determine the cost of
reaching the target, an approach that bypasses the social cost of
carbon. Comparison with estimates of the social cost of carbon is one
of the ways of considering whether the goal is too stringent or not
ambitious enough when this goal is under periodic review.
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\24\ Such as problems in quantifying many of the expected impacts
of climate change. Other factors that suggest that the social cost of
carbon cannot be assumed to be a suitable level of taxation. See
section A7 of Paper A: The case for action to reduce the risks of
climate change.
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Question 6. When conducting economic analysis of the future impacts
on climate change, what type of prognostications are usually given for
hurricanes and other unforeseen weather disasters?
Answer. Basic science and climate modeling points towards an
increase in the prevalence of many types of extreme events as the world
warms. This includes intense hurricanes (and tropical storms in
general), heat waves, heavy rainfall events and droughts. It remains
unclear how the numbers and paths of hurricanes will be affected.
There has been significant debate over current trends in
hurricanes. The IPCC concludes that there is evidence for an increase
in intense tropical cyclone activity in the North Atlantic since about
1970, in line with rising tropical sea surface temperatures, but no
clear trend in the number of hurricanes.
The economic impact of hurricanes is very sensitive to even small
increases in intensity. This is well understood from studying past
events. One study found that an increase in intensity of 5-10% leads to
costs doubling. Thus, future warming could cause significant effects.
One study found that a doubling of CO2 levels would lead a
6% increase in the intensity of hurricanes, but this remains highly
uncertain. Based on current knowledge, the cost of extreme weather
events, including hurricanes and many other weather events, could rise
to 0.5% to 1% of global GDP by the middle of this century. It should be
noted that adaptation is a key factor in predicting future hurricane
risks. For example, much of the current increase in damages from
hurricanes is thought to be associated with the increase in population
in hurricane risk areas.
______
Responses of Henry D. Jacoby to Questions From Chairman Bingaman
Question 1. You say that capping greenhouse gas emissions is a
useful way to think about long-term objectives in dealing with this
risk. What about in the short-term? Is it feasible, or economical to
make some of the drastic reductions that are being called for within
the next decade?
Answer. It is not feasible or economical, or indeed even necessary,
to make drastic reductions within a period as short as a decade.
Climate change is a century-scale problem and the urgent need in the
current decade is to get started on policies that will raise the price
of emissions and augment efforts to develop low-emitting technologies.
These early efforts can then lead to drastic reductions below a
business-as-usual path over coming decades.
Question 2. Do you have any thoughts on how the developing
countries are weighing the risks of climate change against the need for
rapid economic growth?
Answer. In most developing countries there is a growing cadre of
environmentalists and public officials who are concerned about the
climate change issue, and who argue for national policy to reduce
emissions. At the level of national policy, however, the risks of
climate change still rank below concern with the short-term economic
well being of their citizens. This observation would apply most
importantly to big countries like China, India, Brazil, and Indonesia.
Others, like Singapore or South Korea, may be closer to taking action
because their per-capita incomes are at a level where the issue can
rise higher among social and political priorities.
Responses of Henry D. Jacoby to Questions From Senator Domenici
Question 1. A paper co-authored by Dr. Yohe criticized the Stern
Report for failing to include a proper cost-benefit analysis. In
particular, it notes that the analysis should compare marginal costs to
marginal benefits. Instead the Stern Review compares total costs to
total benefits.
If the cost-benefit analysis was done improperly, isn't the Stern
review fatally flawed?
Answer. Chapter 13 of the Review contains an analysis of the
benefits of moving from one level of atmospheric stabilization such as
650 ppmv to a tighter one like 550 ppmv. This calculation yields a
rough estimate of marginal benefits of tighter long-term targets. The
benefits of this tightening are then argued to be larger than the
estimate of the cost of achieving the tighter target. This is a first
step toward a benefit-cost analysis, but the Review does not carry this
idea through to a complete marginal analysis. Most important, this
component of the Review is confined to Chapter 13 and is not prominent
in either the Review summary or in press coverage.
Whether because of this crude benefit-cost approach the Review as a
whole is ``fatally'' flawed is quite another question. Its intent, in
my view, was to raise the public visibility of the issue and argue that
corrective actions would not be economically disastrous. In that sense
the report can be argued to have achieved its objective.
Question 2. Could you please explain why it is difficult to
calculate the economic cost of extreme, but highly unlikely, events?
Answer. Two types of information are required to support a monetary
valuation of some possible extreme climate event. First, there is a
need to define in a meaningful way what the event is. And second, an
estimate is needed of how likely it is to occur: it makes a big
difference whether it is a chance of one in 10 or one in 1,000. For
some of the more troublesome potential outcomes of climate change,
e.g., a rapid loss of Greenland or Antarctic ice sheets, the nature of
the event and its likelihood are poorly known. In such a case these
potential consequences should be prominent in any discussion of the
climate change treat, but in my view their inclusion in the formal
economic analysis tends to dilute the value of calculations for those
parts of the problem that are well defined.
The fact that poorly understood but extreme outcomes are left
outside the dollar valuation does not mean they are unimportant in
climate decision-making, and here an analogy may help. The potential
economic cost of the mutation to human transmissible form of the Avian
flu virus is not well known: we do not know precisely how infectious
the virus might become or how deadly, or how effective medicines might
prove to be. Also, epidemiologists cannot give a confident estimate of
how likely this mutation is to occur. This lack of specific information
does not imply, however, we should be any less concerned with the
threat, or less active in seeking ways to lower the risk.
Question 3. In your written testimony, you raise concerns over the
methods used in the Review to monetary measures to ``non-market
effects.''
What is accepted practice among economists for estimating the
values of ``non-market effects''?
Can you give us some examples, and contrast them with the methods
used in the Stern Review?
Answer. The methods used to try to put dollar values on non-market
effects of environmental change fall into three rough categories.
Methods that apply indirect information from related
markets, as when real estate values are seen to incorporate the
value of cleaner air that may be found in some neighborhoods
compared to others. Statistical methods are applied to sort out
the value of clean air from the larger mix of influences that
determine the market value of a house.
The construction of surrogate markets, often using data on
consumer activity that can be used to impute value to a non-
market resource. Examples in this area include the use of
information on the transportation expenses that people undergo
to use a public park as an indication of its value to them and
by extension to society, or the application of data from
aspects of personal behavior regarding risk-taking and
insurance to estimate a value for human life.
The construction of hypothetical markets, through a
methodology that has come to be known as ``contingent
valuation''. Here two approaches are applied. In one, survey
techniques are used to estimate what people would pay (perhaps
in increased taxes) to achieve a particular environmental
value, or to avoid its destruction. In a second method subjects
are put into an experimental setting, trading small amounts of
money in a ``make-believe'' market in which the environmental
assets can be bought and sold. Contingent valuation methods
came to prominence in the wake of the Exxon Valdez incident,
when they were applied to the valuation of lost amenities and
damage to native species.
These methods can be informative in application to non-market
changes that are well understood and of relatively small scale (e.g.,
local air quality or the destruction of animal life in an oil spill).
However, I question their adequacy when applied to large-scale, poorly-
understood effects that may attend climate change (e.g., the loss of
all arctic tundra).
The Stern Review did not itself do any analysis of this type but
rather quoted results from a number of other studies, some of which
used these methods and some which simply made rough guesses about the
damage of climate change. Also, the non-market valuations included in
the PAGE2000 model from which many of the Review's results were drawn
is not sufficiently well documented to support an evaluation of the
procedure employed.
Question 4. If the world economy continues to grow, then future
generations will be far wealthier than people are today. Future
generations will also have more technology options for responding to
climate change.
Doesn't it make sense to share the burden with future generations
who in many ways will be better equipped to address it?
Answer. Our generation will without doubt share the burden of any
emissions mitigation with future generations as most studies show that
the cost of reducing emissions continues into the future, with the
magnitude of the task increased by growing population and rising
incomes. Also, future generations will not have an opportunity to share
the costs of climate damages in our current one. The question, rather,
is how long our generation should wait before taking substantial action
to reduce risks for future generations--which of course include our
current children and grandchildren among those to come later. Because
of the stock of long-lived greenhouse gases we are building in the
atmosphere the longer we wait to begin emissions mitigation the more
difficult the task we pass on. Also, although we hope our R&D our
investments will yield much cheaper mitigation technologies we cannot
know for sure that this form of technical fix will appear. Finally,
although future generations probably will be wealthier than ours, and
better able to deal with market-based effects of climate change, there
likely will be effects on the natural environment which they will have
no ability to correct or to compensate by their greater wealth.
Responses of Henry D. Jacoby to Questions From Senator Martinez
Question 1. I am concerned about the impacts of climate change. I
believe it is happening and that humans at some point play a part in
its exacerbation. I think you will find a lot of members on this
Committee who share that opinion, but like me are confronted with a
variety of proposals about what to do about it. Given the large amounts
of legislation that have proposed cap and trade programs, how would you
go about creating a carbon regulatory program that would not negatively
impact the U.S. economy?
Answer. Any carbon regulatory program will have impacts, both
negative and positive, on particular sectors of the economy and regions
of the country. But a well-designed policy need not have a substantial
impact on the economy as a whole. A study carried out for the U.S.
Climate Change Science Program indicates that the U.S. would continue
to experience healthy economic growth even under ambitious targets for
emissions mitigation.\1\ If the policy is well designed the concern
need not be with risk to the national economy but rather the
compensation of those who may be hurt as the economy adjusts. A
national policy that would minimize economic cost but achieve
environmental objectives would start with a relatively low price on
emissions, say in the neighborhood of $10 per ton CO2-
equivalent, and establish a procedure for this price to grow steadily
and predictably over time. This pattern of increasing stringency would
allow time for the natural turnover of the capital stock and
adjustments in the labor market. Complementing the imposition of a
price on emissions should be an aggressive program of government-
supported R&D and commercial demonstration of emissions-avoiding
technologies.
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\1\ See U.S. CCSP [Climate Change Science Program], 2006: U.S.
Climate Change Science Program, Synthesis and Assessment Product 2.1,
Part A: Scenarios of Greenhouse Gas Emissions and Atmospheric
Concentrations (L. Clark, J. Edmonds, H. Jacoby, H. Pitcher, J. Reilly,
R. Richels). http://www.climatescience.gov/Library/sap/sap2-1/sap2-1a-
draft3-all.pdf.
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Question 2. The Stern Report has received criticism from the
Economist, the Copenhagen Consensus headed by Bjorn Lomborg, as well as
other economists for either putting too much of the emphasis of climate
change abatement on rich Western nations or not enough focus on the
developing world. How would you respond to that assertion?
Answer. The Stern Review calls for universal participation in
greenhouse gas mitigation and attempts to show the advantages to the
global economy if it can be achieved. Like almost everyone else dealing
with this issue, however, the Stern Review authors do not have a clear
plan of activities that will bring all nations to take mitigation
commitments in the short term, although they do suggest that direct aid
to developing countries may be useful, and that nations may be brought
to control emissions through participation in a global emissions
trading mechanism. Rather, the focus of the Review is on the essential
first step in achieving some sort of global response, which is for the
rich countries to take greater action than now. Clearly, developed
countries like the U.S. can be expected to go only so far down the path
the Review recommends without a substantial response by major
developing countries, but without such leadership universal
participation likely is impossible.
Question 3. It is my understanding that the basic premise of the
Stern Report is that our international response should act similarly to
an insurance policy--pay some now to avoid big problems later.
Considering that its recommendations urge spending 1 percent of global
GDP per year (roughly $450 billion) to prevent climate change, how
would nations be forced to comply? How would nations respond during
economic downturns or recessions? Would other nations be required to
pick up the difference if another country experiences severe economic
circumstances?
Answer. As with all international agreements there is no global
institution that can force sovereign nations to comply. Incentives can
be given through diplomat pressures or threats of trade restriction,
but the participation in an international effort by any individual
country ultimately will be determined by its perception of the effect
of climate change on its own national interest. This is the core of the
climate change problem. Nations have found it to be in their interest
to participate in community responses to environmental issues that are
similar to the climate threat, such as the Montreal Protocol, the
Whaling Convention, etc., but the greenhouse gas control problem is a
larger and more complicated challenge.
Regarding the response during recessions: over the past fifty years
these types of economic fluctuations have been relatively short term in
duration, lasting from a few months to a year whereas greenhouse gas
control policies are longer-term measures, gathering in intensity over
decades. In a recession pressure might arise to relax some aspects of
greenhouse gas control policy, but we would not likely see a frontal
assault on the whole campaign. Similarly, I would not expect provisions
of an international regime to change in the face of one or more of its
parties experiencing short-term economic difficulty, or that other
nations would be expected to take additional effort while one was in
difficulty. Indeed, during a recession emissions tend to decline, so it
likely the troubled economy would likely over-comply during such a
period.
Question 4. Who would control the collection and allocation of
funds to combat climate change under the Stern Report model?
Answer. The Stern Review does not recommend a new international
institution that would collect funds to fight climate change. It does
support a continuation and augmentation of the existing Global
Environmental Fund to which countries make voluntary contributions, and
it calls for increases in bilateral aid and technology transfer. The
proceeds of an emissions tax, or revenue from a cap-and-trade system
with auctioning of permits, would accrue into the treasury of the
implementing country. Proposals have been put forth of an international
agency funded by mandatory taxes on individual countries, or their
international emissions trades, but these ideas have not gotten serious
attention in international discussions and the Review does not argue
for this approach.
Question 5. One figure that is often quoted by some critical of the
Stern Report is the ``social cost'' of carbon dioxide. Under the Stern
Report, that comes to $85 dollars a ton while the Yale economist
William Nordhaus has determined that cost to be $2.50 per ton. Why is
there such a large difference in these approaches?
Answer. Several differences among these two studies, including the
estimates of future damages, contribute to this variation in the
estimate of the social cost. But the overwhelming source of the
difference is the discount rate. The Stern Review applies a much lower
discount rate than does the Nordhaus study, and Stern discounts damages
that are occurring over many future centuries, leading to a much larger
marginal cost for an additional unit of emissions today.
Question 6. When conducting economic analysis of the future impacts
on climate change, what type of prognostications are usually given for
hurricanes and other unforeseen weather disasters?
Answer. Only preliminary analysis is available of the potential
increase in damage from severe storms caused by climate change. There
is evidence of increasing intensity of hurricanes in response to rising
sea surface temperatures, but no indication of increasing frequency or
knowledge of potential changes in storm tracks and likelihood of
landfall. Ultimately research on this topic may produce meaningful
monetary estimates of the potential damage from these consequences of a
changing climate, but as of now this threat is mainly treated as a risk
to be kept in mind, yet difficult to quantify. To my knowledge there is
no evidence of increasing frequency or intensity of tornadoes. Attempts
have been made to calculate potential effects of increased frequency of
floods and droughts, although these threats also are difficult to
quantify in monetary terms because of uncertainty in projections of
climate change at regional scale.
______
Responses of Gary Yohe to Questions From Senator Domenici
Question 1. The value of the ``social discount rate'' is clearly
important in estimating damages that occur in the distant future. We've
heard that the Stern Review made a controversial choice for this value.
Should the Stern Review have included a discussion of how sensitive the
cost estimates were to the choice of the discount rate?
Answer. I think that it was almost irresponsible not to do so.
Tjalling Koopmans, a Noble laureate economist who was expert in optimal
growth and discounting often remarked that reporting the results of a
discounting exercise should always include a sensitivity analysis
because the answers to any discounting question were so highly
dependent on the underlying discount rate. Indeed, the relative
valuations of alternative investment projects can be altered by the
choice of a discount rate.
As indicated in my testimony, many economists have highlighted this
issue in the Stern Review. In our own deconstruction of the underlying
model--a simpler version calibrated to a 5.3% discounted damage
estimate for a discount rate of 0.1%, Richard Tol and I have shown the
following correlation:
[Amounts in percent]
------------------------------------------------------------------------
Discounted
Discount Rate Damages\1\
------------------------------------------------------------------------
0.01........................................................ 5.4
0.1......................................................... 5.3
1.0......................................................... 3.6
3.0......................................................... 1.6
------------------------------------------------------------------------
\1\ Calibrated in lost ``certainty equivalent per capita consumption''.
It is clear from these calculations that the rate used by the Stern
authors was so low that it was nearly impossible to produce bigger
damage estimates. Moroever, assuming the more conventional 3% would
reduce damages even given the Stern calibration by almost 70%. A
postscript to the Review does report the results of a sensitivity
analysis; their results are entirely consistent with the ones quoted
above.
Question 2. The Stern Review authors claim on their website that
their damage estimates are higher than other studies because the Review
uses more recent literature from the science. But a leading expert,
William Nordhaus, contends that their higher damages are based on their
choice of discount rate--not on new scientific findings. Which do you
believe to be true?
Answer. I have known William Nordhaus for more than 30 years, and
we have had several discussions about the Review. We were on the same
panel discussing the Review at Yale University of February 15, 2007--
the academic exercise about which Sir Nicholas spoke during his
testimony. Truth in advertising--Professor Nordhaus and I have done a
lot of work together over the years. He was a reader of my PhD
dissertation at Yale; and I am in the climate field because he phoned
in 1982 to invite my participation in the preparation of Changing
Climate--one of the National Academy's first analyses of the climate
problem.
I am convinced that the choice of discount rate is the primary
reason why the Review's estimates are so high. There is, though, some
merit to its authors' claim, especially given the way they tended to
choose high-end impacts analyses when they calibrated their model. Much
of the new science is high-end, of course, but not all.
Figure 1 below shows where the Stern Review's estimates fit in a
survey of results published over the last 10 years (mostly over the
last 5 years). Stern's $310 per tonne of carbon ($85 per tonne of
carbon dioxide) estimate is at the 95th percentile among all estimates,
but it is well above the 95th percentile for estimates reported in the
peer-reviewed literature. Notice, though, that it is around the 80th
percentile for estimates derived using a discount rate (pure rate of
time preference or ``PRTP'') of approximately 0%. Even though none of
the studies from which higher damages estimates were gleaned, this
suggests that the low discount rate alone cannot explain fully why the
estimate is so high.
Question 3. Should the Stern Review have been the subject of peer
review before its release by the British Government?
Answer. Absolutely. Figure 1 shows clearly that its damage
estimates lie outside the range of comparable estimates reported in the
peer-reviewed literature. Sir Nicholas, himself, expressed interest in
an ex post peer review; that is why he agreed to participate in the
Yale event on the 15th of February. In his response to criticism that
the Review had not been subject to peer review, he spoke of a concern
about leaks to the press; but that response does not ring true to most
of us. The press had copies of the Review well before the academic
community was allowed access; indeed, many of us who were denied pre-
release copies by the author team were able to obtain copies from
friends in the media.
Question 4. If the world economy continues to grow, then future
generations will be far wealthier than people are today. Future
generations will also have more technology options for responding to
climate change. Doesn't it make sense to share the burden with future
generations who in many ways will be better equipped to address it?
Answer. Absolutely, but the critical word here is ``share''.
Sharing does not mean postponing all expense, even if future
generations will be better off. It means making prudent investments now
so that the discounted cost of achieving a climate policy target is
minimized across all generations. It means beginning now to minimize
the risk that climate impacts that could overwhelm even future
generations' capacities to adapt. It means not foreclosing the
possibility of holding critical climate variables below thresholds that
may trigger these overwhelming impacts. Of course, it does not mean
imposing an excessive burden on present generations, either.
Responses of Gary Yohe to Questions From Senator Martinez
Question 1. I am concerned about the impacts of climate change. I
believe it is happening and that humans at some point play a part in
its exacerbation. I think you will find a lot of members on this
Committee who share that opinion, but like me are confronted with a
variety of proposals about what to do about it. Given the large amounts
of legislation that have proposed cap and trade programs, how would you
go about creating a carbon regulatory program that would not negatively
impact the U.S. economy?
Answer. I argued in my testimony that setting the initial price of
carbon in 2007 can be an exercise in determining the appropriate short-
term incentives for carbon-saving investments and energy conservation
rather than an exercise in ``solving the climate problem''. Since no
policy created in 2007 will ``solve the climate problem'', it is
perhaps even desirable to step out from under that burden to confront a
more manageable near-term problem while still making progress towards
an ultimate response to an evolving understanding of climate risk.
The answer to the ``What do we do in the near-term?'' question is
to design something that will (1) discourage long-term investments in
energy, transportation, and construction that would lock in high carbon
intensities for decades to come and (2) encourage development of
alternative energy sources, carbon sequestration technologies and
efficiency.
As an example of how the first goal might be achieved, consider
what it would take to make it economic to run existing natural gas-
fired electric generators more, and run coal-fired generators
correspondingly less (gas-fired generators emit only about half as much
CO2 per unit of electricity). Because natural gas is a
considerably more expensive fuel than coal, it takes a substantial
CO2 cost to overcome this fuel cost disadvantage--about $30/
tonne, on current fuel price expectations in the U.S.
On the other hand, consider pending investments to add new
generating capacity in the United States over the next few decades.
Much of this capacity is currently planned as conventional coal-fired
technology. What would it take, in terms of a price for CO2,
to make it economic to install new gas-fired capacity instead, thereby
cutting by half the carbon emissions from this new capacity? On current
gas price expectations, a CO2 price of only $5 per tonne
would be sufficient to make new gas-fired generators as economical as
new coal-fired plants, based on the present value of fixed and variable
costs.
This number is much lower for new plants than the $30/tonne seen
above for existing plants because the lower cost of building a new gas
plant compensates for some of its higher fuel cost. Several factors may
necessitate a somewhat higher CO2 price to achieve this
economic equivalence, however--e.g., greater fuel price volatility
makes gas capacity relatively less attractive and increased gas demand
might push up gas prices beyond current expectations. Even so, only a
modest CO2 price is needed to make lower-carbon gas-fired
technologies attractive.
To make the full step to near zero carbon technologies (e.g.,
carbon capture and sequestration) would require a somewhat higher
CO2 price--estimated at around $25/tonne CO2 by
several sources. Since power generators last 30 to 40 years, if the
CO2 price increases over time, adding some cost for
CO2 emissions would make sequestration technologies
attractive in the near term even if the price does not reach this
``tipping point'' until some years after the new plant starts
operating.
The $7 per tonne of carbon dioxide charge envisioned in the
legislation being considered by this Committee, if it were to climb at
the rate of interest, would reach $30 per tonne after 2035--probably
too late to inspire fuel switching in existing plants over the
foreseeable future or much investment in carbon sequestration. It
would, though, likely be sufficient to bring most of the plants
constructed between now and 2050 over to a lower carbon technology. A
$15 per tonne charge in 2007 would reach the $30 threshold around 2020,
and that could be sufficient to affect the retrofitting switch in most
places in the very near future and inspire appropriate development of
enhanced sequestration techniques.
Cap and trade systems have become the stock in trade of many who
try to advocate climate policy, but this preference may be based on
little more than an allergic reaction to the use of the word ``tax''.
Since concentrations depend on cumulative emissions over long periods
of time, there is no economic reason to favor a policy that would fix
annual emissions in a way that otherwise minimizes the cost of hitting
such a target. Fixing total emissions of any pollutant in any year of
short-term period of time only makes sense if variability around a
targeted average (that would improve economic efficiency) would
unnecessarily increase expected damages over the long term, and this is
clearly not the case for carbon emissions.
In addition, many have expressed concerns that the prices which
clear cap and trade permit markets can be volatile. Volatility has
certainly been the hallmark of the sulfur permit markets in the United
States and the nascent carbon markets of the European Union. This
Committee's proposed legislation has responded to threat of
incapacitating volatility by proposing ``safety valve'' limits on the
price of permits. Others have argued that volatility can be diminished
by appropriate banking provisions. The fundamental problem with either
solution, however, is that appropriate climate policy requires a clear
signal that carbon will always be more expensive next year than it is
today. Even a modest amount of volatility can obscure that signal.
On other hand, a tax, increasing at the rate of interest, would
produce a persistent and predictable increase in the cost of using
carbon that would inspire cost-reducing innovation and fuel switching
in the transportation, building, and energy supply sectors of our
economy.\1\
---------------------------------------------------------------------------
\1\ The tax should increase, in real terms, at the real rate of
interest. If expressed in nominal terms, then it should increase at the
nominal rate of interest.
---------------------------------------------------------------------------
If carbon were taxed at the point it entered an economy (a couple
thousand sources for the United States as opposed to millions of end-
users), then it would be dispersed appropriately throughout the economy
with relative prices of thousands of goods changing in proportion to
the underlying carbon intensities.
Moreover, a carbon tax would generate revenue. The $15 per tonne of
carbon dioxide tax noted above would, for example, generate something
like $90 billion in tax revenue in the United States in 2007 if it were
paid on every tonne of carbon embodied in every unit of fossil fuel
consumed. This is revenue that could be used to offset the regressive
nature of the carbon tax itself, by underwriting tax credits for
citizens with taxable incomes below a specified level. Revenue could
even be used to fund research into alternative energy sources.
A carbon tax would not, of course, provide any incentive to
sequester carbon, but that can also be accomplished by appropriate use
of some of the tax revenue. It should be possible to use some of the
revenue to ``buy back'' carbon that was removed from the end of the
effluent stream at a price that equals the tax applied at the
beginning. Doing so would mean that the marginal cost of bringing in
the last tonne would equal the marginal cost of taking it out--an
efficiency criterion that ``closes the loop''. Interestingly, a $25-30
per tonne of carbon dioxide has been identified as the level for which
current sequestration technologies might become economically efficient.
Bringing these technologies up to scale would take more than a decade,
of course, and large investment would be based on the same type of
present value calculation outlined above. It follows that the same tax
trajectory that starts at $15 per tonne in 2007 and reaches the $30
threshold around 2021 would also serve well in this context.
Question 2. The Stern Review has received criticism from The
Economist, the Copenhagen Consensus headed by Bjorn Lomborg, as well as
other economists for either putting too much of the emphasis of climate
change abatement on rich Western nations and not enough focus on the
developing world. How would you respond to that assertion?
Answer. The developing world must and will do its part, but it need
not take the lead in 2007. Leadership has to be provided by the
developed world, in general, and by the United States, in particular.
The ideas outlined above would not do much harm over the near term,
would improve our own energy security, and would show the world that we
are willing to accept our leadership responsibilities. They will not
solve the climate problem, though, unless they are accompanied by
negotiations with and investments in developing countries designed to
(1) promote improved capacities to adapt and to mitigate and (2) allow
an effective ``leap-frogging'' of carbon-intensive technologies that
characterized economic activity at the end of the last century.
It should be noted in passing that Bjorn Lomborg's criticism of the
Stern Review stopped with his concern that the damage estimates were
inflated. He expressed admiration for the assessment of the underlying
science and assessment of climate risk (just as he did when he
commented on the Working Group 1 report to the Fourth Assessment of the
Intergovernmental Panel on Climate Change (IPCC) released in Paris last
month). My argument before you was that this science was the basis for
a case for near-term climate policy and that a least cost approach to
such a policy would involve starting immediately. His concerns,
therefore, do not apply to points outlined above or in my testimony.
Question 3. It is my understanding that the basic premise of the
Stern Review is that our international response should act similarly to
an insurance policy--pay some now to avoid big problems later.
Considering that its recommendations usrge spending 1% of global GDP to
prevent climate change, how would nations be forced to comply?
Answer. This question is beyond my expertise, and I have made it a
practice not to respond to questions about which I am no more expert
than the next person.
I have, though, used the insurance metaphor in trying to motivate
the need for modest near-term policy. In those statements, the
``insurance'' purchased by near-term climate policy is not against the
risk of climate change, per se; rather it is against the risk of costly
adjustments in policy sometime in the medium term future and against
the chance of rendering a policy target infeasible that might turn out
to be critical. In a paper that I published in Science in 2004
(attached to this response), the near policy that minimized expected
adjustment cost in Nordhaus's DICE model across 5 possible temperature
targets that would be identified in 2035 (one of which was deciding
that no restriction at all is required on greenhouse gas emissions) for
a current distribution of climate sensitivity turned out to be $10 per
tonne of carbon dioxide.
Question 4. Who would control the collection and allocation of
funds to combat climate change under the Stern Review model?
Answer. To my knowledge, the Stern Review model does not presume
any specific allocation mechanism; and if it does, the validity of its
fundamental conclusion that there is an economic reason for near-term
climate policy is independent of that mechanism. Of course, I think
that the Stern Review is right for the wrong reasons, but allocation
mechanisms are not part of my reasons for concern.
Question 5. One figure that is often quoted by some critical of the
Stern Review is the ``social cost'' of carbon dioxide. Under the Stern
Review, that comes to $85 dollars a tonne (of carbon dioxide) while the
Yale economist William Nordhaus has determined that cost to be $2.50
per tonne. Why is there such a large difference in these approaches?
Answer. As noted in my answer to the second question from Senator
Domenici, Figure 1 below displays the range of more than 100 estimates
currently available in the published literature. I note above that the
Stern estimate ($85 per tonne of carbon dioxide or $310 per tonne of
carbon) is an outlier on the high side, especially when compared with
peer reviewed estimates. The Nordhaus estimate ($2.50 per tonne of
carbon dioxide or $9 per tonne of carbon) is much lower, but not as low
as some (older estimates).
Why the disparity? The choice of discount rate and the
incorporation of equity weights are extremely important, and both lie
within the purview of decision-makers. High discount rates sustain low
estimates because future damages become insignificant. Conversely, low
discount rates produce high estimates because future damages are
important. Meanwhile, strong equity weighting across the globe support
high estimates because poor developing countries are most vulnerable.
Conversely, weak or no equity weighting can produce low estimates
because poor developing countries do not factor heavily in the overall
calculation.
It turns out, however, that several scientific parameters that
decision-makers cannot choose are even more important in explaining the
variability depicted in Figure 1.* Indeed, climate sensitivity (i.e.,
the increase in global mean temperature that would result from a
doubling of greenhouse gas concentrations from pre-industrial levels)
is the largest source of variation. It is possible to derive high
estimates for the social cost of carbon even if you assume low discount
rates and almost no equity weighting. All that is required is the
assumption that the climate sensitivity lies at the high range of the
latest range of estimates. Andronova and Schlesinger (2001), for
example, find that the historical record could easily be explained with
climate sensitivities as high as 8 or 9 degrees Centigrade (even though
the TAR reported an upper bound of 5.5 degrees).
---------------------------------------------------------------------------
* Graphic has been retained in committee files.
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How could one get an estimate below Nordhaus's? By assuming a high
discount rate (decision-maker choice), low damages over the medium term
(and even some benefits in the short term--the result of effective,
timely and pervasive adaptation in developed and developing countries),
and a low climate sensitivity (Mother Nature's choice, and she hasn't
told us yet that this is so).
Question 6. When conducting economic analysis of the future impacts
on climate change, what type of prognostications are usually given for
hurricanes and other unforeseen weather disasters?
Answer. The answer here depends on the type of analysis. If it is a
detailed impact analysis at a specific location over a specific period
of time, then sea level rise is a driving force for climate stress.
Exposure is magnified by coastal storms, and sensitivity depends on
development patterns. Vulnerability analyses try to account for
possible adaptations (good ones like set-back rules and bad ones like
the withdrawal of properly priced insurance coverage). In these
analyses, probabilistic representations of storm frequency and
intensity are usually employed. With the current state of scientific
debate, increases in either are usually included in sensitivity
analyses around baselines that assume no change. It is important to
note, however, that coastal storms become more threatening as seas rise
regardless of whether or not climate change is influencing their
likelihoods or intensities; a 10 foot storm surge is automatically an
11 foot surge after 1 foot of sea level rise.
Large integrated assessment like PAGE2002 (employed by the Stern
Review author team) or RICE (William Nordhaus's regional model) include
far less detail because they use aggregate measures of damage. There,
unforeseen weather events are treated stochastically, and damages
include estimates of what people would be willing to pay to have the
risk eliminated--an economic construction of the sort employed by Stern
in the calculation of equivalent per capita consumption.