In July, the UN Secretary-General Ban Ki-moon said climate change was a real threat to international peace and security urging developed countries to lead concerted efforts to mitigate and adapt to its detrimental effects, with emerging economies shouldering their fair share of the responsibility, when he spoke to the journalists after a Security Council meeting. Climate scientists have warned the world that our addiction to fossil fuels is triggering a global warming catastrophe that could end up costing the Earth dearly.
Bibliography
Significant reductions in anthropogenic greenhouse gas output are expected of rational people and governments worldwide, but the latest emissions figures appear to prove the problem is exacerbating. Are they telling us there is limited appeal in taking short-term costly action to counteract a long-term threat - particularly one by its nature being hard to calibrate? Convincing businesses to take necessary action to combat economic activity-driven climate change does require an economic argument. The matter at issue here is how we price the world’s climate and the disasters which are induced by global warming.
Durban climate change summit has just extended the Kyoto Protocol supposed to expire in 2012 to 2017. As the international community is racing against time to explore, if not negotiate on, Kyoto II, attempts to fill a policy vacuum are putting climate economics under the spotlight. The hottest area of the discipline over the past two decades, climate economics is an amalgamation of environmental economics, energy economics, development economics and economics of international relations. The economics of climate change is increasingly recognised by academies worldwide and has created its distinctive theories, methodologies and scopes of research. Some cross-sectional work includes Stern Review on the Economics of Climate Change (2006), the IPCC Fourth Assessment Report (by Working Group III in 2007), and Garnaut Climate Change Review (2011).
The blind spots of traditional economics
While scientific knowledge in this area has gained a great leap forward, corresponding transformation in economics has rather been sluggish. Most economics theories are designed to address issues relatively short term or national. Even international economics sometimes fails to cope with trans-boundary issues. Given that it is difficult for economists to accurately forecast one year ahead, 100 years is out of the question. Nevertheless, climate economics must take into consideration a plethora of uncertainties – scientific and political – over a dauntingly long timescales.
Sir Nicholas Stern, the author of “The Stern Review” (to be featured in later paragraphs), in a lecture to the Oxford Institute for Economic Policy in 2006, outlined some of the complexities of establishing economic solutions to climate change. He said “[Addressing climate change] is an international collective action problem… The simple standard theory of externality is useful but not a fundamental answer to the problem.” In the meantime, Dieter Helm, an economics fellow at New College, Oxford, suggested that “The usual economists’ toolbox looks puny against the scale of this challenge.” Drawing on the experience of the unemployment of the 1930s that required the reinvention of much of macroeconomics, he believes that climate change needs new thinking too. (Daneshkhu & Harvey, 2006)
An example of “new thinking” is environmental goods like clean air, water and a stable climate which are rarely considered in standard economic analyses. In order for environmental goods to be valued and included in economists’ equations, the United Nations have been promoting the concept of “natural capital”. Just less than half a year ago, the National Ecosystem Assessment (NEA) 2011 concluded that the nature, including parks, lakes, forests and wildlife, is worth billions of pounds to the UK, an average of £300 per person per year. Thus, if we damage our natural capital, we not only undermine our ecosystem – life support systems, but also the economic basis for the present and future generations. In fact, targeted investments in preserving or developing natural capital can deliver a high rate of returns.
The birth of climate economics – Two opposing views
Since early 1990s, economists have begun a lengthy debate on the practicality of adopting advance measures to avert climate change and; made a comparison between the economic cost of reducing greenhouse gas emissions and that of climate change. The debate is dichotomised into two representational yet opposing camps. One is the mainstream view, ‘actionists’, who believe anthropogenic global warming be undeniable and the world should take measures against the crisis. Another one is ‘sceptics’, represented by Danish statistician Bjørn Lomborg, who also believe anthropogenic global warming be factually true, but taking measures against climate change is neither of exigency nor necessity. In this article, we will focus on the views of actionists.
By differential values, conceptions, political stances and cultural traditions, ‘actionist’ is further sub-divided into ‘active’ and ‘passive’ ones. The pioneer of ‘active actionists’ is Sir Nicholas Stern, the former Economic Advisor to the Prime Minister the World Bank’s Chief Economist; whereas that of ‘passive actionists’ Professor William D. Nordhaus of Yale University and Martin L. Weitzman of Harvard University. The ‘active’ and ‘passive’ actionists differ mainly on the ultimate target of emissions reduction, the targets of individual phases and the route to reducing emissions.
The ‘active actionists’
Commissioned by Gordon Brown, the then Chancellor of Exchequer, in October 2006, Sir Nicholas Stern released “The Stern Review”, which carries weight internationally and forms a part of the basis for UN discussions on the future of Kyoto Protocol. Sir Nicholas took a global view of the economic risks and possible benefits of climate change and; assessed the potential of economic instruments to address them. His report demonstrates the scientificity, reliability and urgency of keeping the global temperature rise to within 2°C in the long term as what the European Union has advocated. On adaptation and mitigation measures, Sir Nicholas conducted a profound evaluation on the cost of action tackling climate change and the loss associated with business-as-usual; and derived an important conclusion that the world can avoid huge costs of global warming in the future at a relatively low cost at present. The report, thus, attempts to answer the question that whether we can be green and grow. (Stern, 2006)
Following this report, Sir Nicholas has elaborated his views in a series of articles. He recommends that greenhouse gas concentrations should be stabilised at a level ranging between 450 and 550 parts per million (ppm) CO2e where 550 ppm CO2e is the limit. “A concentration in the region of 550 ppm CO2e is clearly itself a fairly dangerous place to be and the danger posed by even higher concentrations looks unambiguously unacceptable.” He went on further by criticising Nordhaus’s argument that stabilisation levels around 650 ppm CO2e or even higher are more preferable or even optimal of “involving a real possibility of devastating climate changes”. (Stern, The Economics of Climate Change, 2008) Sir Nicholas estimates the annual costs of stabilisation at 500-550 ppm CO2e from now onwards to be around 1% of the world’s GDP by 2050 – a level that is significant and manageable. But if the world takes measures 30 years later, the costs of emissions reduction will substantially increase to 4% of the GDP.
In April 2008, Sir Nicholas published another article entitled “Key Elements of a Global Deal on Climate Change”. A comprehensive article, it contains a set of proposals for post-2012 international institutional architecture dealing with the impacts of climate change. He adheres to the basic principles of international institutions which he has been advocating, i.e. effectiveness, efficiency and equity. By “effectiveness”, it refers to a deal that must lead to cuts in emissions on the scale required to mitigate climate change; “Efficiency” a deal that must be implemented in the most cost-effective way, with mitigation being undertaken at the minimal cost; and “Equity” a deal that considers shared responsibility between rich and poor countries. On reduction targets, Sir Nicholas converts all the targets which he has previously suggested into emissions targets per capita on the basis of the contraction and convergence (C&C) model. (Stern, Key Elements of a Global Deal on Climate Change, 2008)
Other than Sir Nicholas Stern, ‘active actionists’ also includes a number of well-known economists such as Joseph Stiglitz (USA), Lester Brown (USA) and Ross Garnaut (Australia), etc. Along with the release of the Fourth Assessment Report by the IPCC, the field of economics has heard a voice which supports adopting tough and significant emissions-reducing measures absorbed into the mainstream gradually.
The ‘passive actionists’
Nordhaus leads the camp of ‘passive actionists’ who claim that the world should assume a ‘go-it-slow strategy’ to address climate change. He estimates the loss of the world’s GDP associated with global warming to be as minimal as 3% (revised upwards from 1% earlier on) by 2100 and rising to 8% by 2200. (Nordhaus, 2007) In his book entitled “A Question of Balance: Weighing the Options on Global Warming Policies” (2008), armed with cost-benefit analyses, Nordhaus proposed a ‘climate policy ramp’ in which climate policies involve modest rates of emissions reductions in the near term, followed by sharp reductions in the medium and long term in order to achieve the ultimate target of limiting greenhouse gas concentrations to the level of 700 ppm. In his view, therefore, emissions reduction is not an urgent action.
One of the reasons which significantly differentiates Nordhaus’s and Stern’s conclusions is ‘discount rate’. In the context of climate change, ‘discount rate’ refers to the value of welfare of future generations expressed in terms of that of the present generation. “A zero discount rate means that all generations into the indefinite future are treated the same; a positive discount rate means that the welfare of future generations is reduced or ‘discounted’ compared with nearer generations.” (Nordhaus, Critical Assumptions in the Stern Review on Climate Change, 2007) For example, if the discount rate is 10%, the ‘present value’ of a disaster affecting human being 50 years from now will be less than 1% of future cost.
Stern lets discount rate of the welfare of future generations be 1.4% per annum while Nordhaus 6% p.a. Owing to the welfare of future generations relative to that of the present being valued at a lower rate and his assumption that future generations will be much wealthier than the present one, Nordhaus argues against sharp emissions reduction and large-scale investment today for climate change adaptation and mitigation. His view has been condemned by Stern as “morally unforgivable”.
Compared with Stern who recommends simultaneous implementation of all-encompassing emissions reduction policies, Nordhaus is the most active advocate of ‘carbon tax’. After evaluating quantity-oriented mechanism (e.g. the cap-and-trade system and emissions reduction systems in the Kyoto Protocol) and price-oriented control mechanism like Pigovian taxes, Nordhaus concludes that price-type approaches are more feasible and efficient. Lower emissions reduction targets set, Nordhaus suggests a carbon levy of US$30-50 per tonne, which will increase to US$85 by the middle of the century. There is huge difference from US$300 per tonne suggested by Sir Nicholas Stern.
Market forces to combat climate change
Be there always proponents of market forces, rather than government intervention, to tackle climate change. Jonathan Köhler, an economist in Cambridge, indicated that it was not necessary for everyone to sign up to an international agreement as market forces would do some work. At some point there would be gigantic markets out there and major export opportunities for low-carbon production technologies. Denmark, for instance, captured a large slice of the wind turbines market through its early investment in that sector.
The impact of technological change on lowering the cost of renewable energy sources should be taken into account when climate policies are formulated. Economic models which consider this factor do suggest that the cost of switching over to a low-carbon energy environment is not as high as what some investors have perceived when it is compared with that of investment in energy systems needed anyway. Not clear is how quickly this would happen. (Daneshkhu & Harvey, 2006) For example, the three flagship renewable energy policies – Feed-in Tariff, Renewable Heat Incentive and Green Deal – introduced by the British Government are seeking to answer this question.
Europe-America divide
In a sense, the difference between Stern and Nordhaus is actually reflective of the divide between Europe and America on combating climate change as demonstrated in the UN’s climate-change summits for years. Generally, Europeans are concerned about global warming that undermines the mild climate in Europe. That is why both academics and politicians tend to favour tougher measures to tackle climate change. By contrast, Americans enjoy a vast territory with larger environmental carrying capacity. Added to this is Americans traditionally getting used to luxurious and extravagant lifestyle. The context here cannot concern the American people and academics as much as their counterparts in Europe about climate change, particularly before the IPCC Fourth Assessment Report was released and President Obama (who is a democrat) came into power.
Obama’s posture on climate change is well demonstrated in his speech to the UN General Assembly in September this year, which actually echoed the comment by UN Secretary-General, Ban Ki-moon. Having covered one issue near and dear to his heart – climate change, President Obama said, “To preserve our planet, we must not put off the action that a changing climate demands…Together, we must work to transform the energy that powers are economies, and support others as they move down that path. That is what our commitment to the next generation demands.”
On action against climate change, Europe basically stresses on the adoption of both regulatory and market instruments whereas America more on market instruments, especially their preference to carbon tax. This was still true until the financial crisis in 2008 and Barack Obama coming into power in 2009 when the situation has become more complicated. Since then, Climate change is given more emphasis by Americans. Even a famous economics Nobel laureate, Kenneth J. Arrow, who had been sceptical about Stern Review “believes that Stern’s fundamental conclusion is justified: we are much better off reducing CO2 emissions substantially than risking the consequences of failing to act.” (Arrow, 2007)
Scope of studies in climate economics
As aforementioned, climate economics spans across a number of areas in the field. In theory, there are four pillars of studies in climate economics:
- Low-carbon economy – Theories and assessment methodologies of low-carbon economy, low-carbon urban planning, low-carbon business parks development and green built environment and assessment and planning of low-carbon community, etc.
- Socio-economics of climate change mitigation – Assessment of impacts of climate change mitigation to the economy, assessment and design of global greenhouse gas emissions reduction systems, energy and climate change policy research, etc.
- Socio-economics of climate change adaptation – Climate change impact and vulnerability assessment, socio-economic analysis of adaptation and adaptive policy management, etc.
- Theories and methodologies of meteorological economics – Climate disaster impact and risk assessment, economic assessment of meteorological services, risk management system and policy research, etc.
Traditionally, the policy instruments available to governments do not go beyond carbon tax, limits on emissions and incentives to encourage the development of clean-fuel technologies. With more systemic researches into the economics of climate change, it is very likely that more innovative, viable market-based solutions, favoured by most economists, will materialise. For example, thanks to the early researches in academia, carbon trading (as in EU Emissions Trading Scheme) and auctioning of long-term carbon contracts are becoming common alternatives to subsidising a particular clean technology in recent years.
Developed by the World Bank, carbon contracts auctioning is a scheme where the government would auction carbon contracts for the supply of emission reductions over a long period of time, say 20-30 years. The primary advantage for governments is that they are not obliged to evaluate industry claims about which technology is more cost-effective. Nor would they be obliged to promote a politically unpopular choice such as nuclear technology before sceptical voters.
Nonetheless, what bedevils climate economists’ attempts to provide an authoritative analysis of the economic impact of climate change; and hence the policy instruments necessary to address the potential crisis is the high level of scientific uncertainty which pervades the subject. In spite of the scientific evidence having confirmed that human activities are affecting the climate, many important questions remain unanswered. For instance, while there has been an increase in no. of warm days and a decrease in cold nights in Australia, the possible impact on future weather events would not be evident for decades because of natural variability, suggested by the scientists in a key review prepared for the IPCC last month.
Conclusion
Climate economics emerges from the defects of traditional economics in analysing the crisis of climate change that was completely unknown to the world hundreds of years ago. People who advocate scientism are increasingly sceptical about the capability of economics in tackling climate change because there are definitely poignant and irreconcilable contradictions between growth and mitigation. Perhaps limited by the vision of classical economics, mainstream economics obsessed with infinite GDP growth disables itself to recognise the fact of global environmental depletion. In the near future, climate economics will even become a new integrative and strategic discipline that involves the environment, technology, economics, politics, and law, etc. There is beyond doubt a very long way to go before it becomes an established one.
Bibliography
1. Arrow, K. J. (2007, December 10). The Case for Mitigating Greenhouse Gas Emissions. The Economists' Voice .
2. Daneshkhu, S., & Harvey, F. (2006, February 3). Will it cost the earth? How economists are pricing the ravages of climate change. Financial Times .
3. Nordhaus, W. D. (2007, July 13). Critical Assumptions in the Stern Review on Climate Change. Science , pp. 201-202.
4. Nordhaus, W. D. (2007). The Challenge of Global Warming: Economic Models and Environmental Policy. New Haven, Connecticut: Yale University.
5. Stern, N. (2008). Key Elements of a Global Deal on Climate Change. London: London School of Economics & Political Science.
6. Stern, N. (2006). Stern Review on the Economics of Climate Change. London: HM Treasury.
7. Stern, N. (2008). The Economics of Climate Change. American Economic Review , 98 (2), 1-37.
To read more chapters, look out for my book - Green Economics & Climate Change - http://www.amazon.co.uk/Economics-Climate-Change-Institute-Handbook/dp/1907543104/ref=sr_1_6?ie=UTF8&qid=1324409027&sr=8-6
Email me at winstonkm.mark@googlemail.com
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