Can Countries Cut Carbon Emissions Without Hurting Economic Growth?

In the September 21st issue of the Wall Street Journal, the editors pose the following question: can countries cut carbon emissions without hurting economic growth? In his introductory essay, Michael Totty frames the issues as follows:

“There’s little doubt: Cutting greenhouse gases will be costly. But that leads to two big questions. First, how costly? And second, can nations afford it? As policy makers around the world take action to avoid a predicted climate catastrophe, the debate is turning to the costs of reducing carbon-dioxide emissions. Energy-efficiency measures are often pricey, and alternative energy sources are more expensive than the fossil fuels they replace. A steep price on carbon emissions will ripple through the economy. Does that mean a serious effort to tackle global warming is incompatible with economic growth? Or can we make significant cuts in greenhouse-gas emissions without causing serious damage to the economy?

We put the question to a pair of experts. Robert Stavins, a professor of business and government at Harvard University and director of Harvard’s environmental economics program, says the answer to the second question is yes: Making the necessary cuts need cause little more than a blip in world-wide growth if smart policies are used.

Steven Hayward, a fellow at the American Enterprise Institute for Public Policy Research, says no: Energy use — and the carbon dioxide it emits — is so central to the world’s economy that major cuts can’t be made without significant damage.

Of course, the answers can depend in large part on how “significant cuts” and “serious damage” are defined. Many scientists, the European Parliament and the Waxman-Markey climate legislation approved by the U.S. House of Representatives have set a goal of cutting carbon emissions about 80% by 2050, so that was picked as constituting significant cuts.

As the accompanying essays show, such a definition leaves plenty of room for disagreement.”

I encourage you to read the entire Journal Report on Environment in the Wall Street Journal (there’s an excellent Q&A on carbon offsets by Bob Curran) and to check out my affirmative response, “Yes: The Transition Can be Gradual — and Affordable,” as well as Steven Hayward’s well-articulated negative response, “No: Alternatives are Simply Too Expensive.”

Understandably, the editors wanted to highlight differences between us in order to develop a concise and clear debate. I find it interesting, however, that in an audio interview/debate at the Wall Street Journal web site (Podcast: Crafting a Global Policy), which was by nature more free-wheeling and less limited by space constraints, there is a remarkable amount of agreement between Mr. Hayward and me on a number of key issues.

For now, in today’s post — liberated from space constraints — I want to expand a bit on my WSJ essay, in which I responded, yes, the transition can be gradual and affordable.

Can the nations of the world meaningfully address the threat of global climate change without inflicting unjustifiable damage to their economies? The answer that has emerged with increasing clarity is a resounding “yes.”

Although “The Day After Tomorrow,” the 2004 disaster epic about the greenhouse effect’s apocalyptic consequences, had less scientific basis than “The Wizard of Oz,” scientific reality is disturbing enough. Man-made emissions of greenhouse gases — including carbon dioxide (CO2) from the combustion of fossil fuels — are very likely to change the earth’s climate in ways that most people will regret. World energy trends are unsustainable — environmentally, economically, and socially.

The global recession has slowed emissions growth, but the world is on a path to more than double global atmospheric greenhouse gas (GHG) concentrations to 1,000 parts per million (ppm) in CO2-equivalent terms by the end of the century, resulting in an average global temperature increase of 6 degrees Centigrade. But increased temperatures — which might well be welcome in some places — are only part of the story.

The most important consequences of climate change will be changes in precipitation (causing, for example, 75 to 250 million people in Africa to be exposed to increased water stress due to climate change by 2020, with rain-fed agriculture yields falling by as much as 50%), disappearance of glaciers throughout the world (and decreased snowpack in areas ranging from the western United States to Asia), droughts in mid to low latitudes (with severe effects in Australia), decreased productivity of cereal crops (at lower latitudes, especially in tropical regions), increased sea level, loss of islands and 30% of global coastal wetlands, increased flooding (in all parts of the world, but greatest in Asia), greater storm frequency and intensity (both typhoons and hurricanes), risk of massive species extinction (20 to 30% of all species, including massive coral mortality), and significant spread of infectious disease. On the other hand, climate change will also bring some health benefits to temperate areas, such as fewer deaths from cold exposure. But such benefits will be greatly outweighed by negative health effects of rising temperatures (cardo-respiratory, diarrhoeal, and infectious diseases, and increased morbidity and mortality from heat waves, floods, and droughts), especially in developing countries.

These impacts will have severe economic, social, and political consequences for countries worldwide, ranging from malnutrition and mass migration (hundreds of millions of people displaced) to national security threats. Bottom-line, comprehensive estimates of economic impacts of unrestrained climate change vary, with most falling in the range of 2 to 5% of world GDP per year by the middle of the century. The best estimates of marginal damages of emissions (again, by mid-century) are in the range of $100 to $175 per ton of CO2 (in today’s dollars).

The world is already experiencing the adverse effects of increasing concentrations of GHGs in the atmosphere, with concentrations already about 60% above pre-industrial levels, greatly exceeding the natural range over the past 600,000 years. Just one example: the Greenland ice sheet has been losing mass at a rate of 179 billion tons per year since 2003.

To have a coin toss’s 50-50 chance of keeping temperature increases below 2 degrees Centigrade — the level at which the worst consequences of climate change can be avoided — it will be necessary to stabilize atmospheric concentrations at 450 ppm. (Even this would result in significant sea-level rise, species loss, and increased frequency of extreme weather, according to the U.N. Intergovernmental Panel on Climate Change.) Consistent with the 450 ppm goal is a long-range target of cutting U.S. emissions 80% below 2005 levels by 2050, which happens to be the target of legislation passed earlier this year by the U.S. House of Representatives, H.R. 2454, the so-called Waxman-Markey bill.

Now, to the heart of the WSJ question: will a serious effort to tackle global warming is incompatible with economic growth? My response was and is that the nations of the world do not have to wreck their economies to avert the crisis. If appropriate and intelligent policies are employed, the job can be done at reasonable and acceptable cost.

Critics argue that the Waxman-Markey legislation — to cut U.S. emissions 80% below 2005 levels by 2050 — will mean big, disruptive changes to our infrastructure and untold economic damage. But they make a couple of basic errors. For one thing, they seem to think we’d have to replace the entire infrastructure quickly, paying trillions of dollars to shift to cleaner power. They also seem to assume that we have to choose between much more expensive energy and no energy at all.

The move to greener power doesn’t have to be completed immediately, and it doesn’t have to be painful. The right transition plan will increase consumers’ bills gradually and modestly, and allow companies to make gradual, well-timed moves.

How would this work? One way is via a combination of national and multinational cap-and-trade systems. Companies around the world would be issued rights by their governments to produce carbon, which they could buy and sell on an open market. If they wanted to produce more carbon, they could buy another company’s rights. If they produced less carbon than they needed, they could sell their extra rights. What’s more, companies could earn more rights by creating appropriate “offsets” that mitigated their carbon use, such as planting forests. Nations could add carbon taxes to the mix.

The effect would be to send price signals through the market — making use of less carbon-intensive fuels more cost-competitive, providing incentives for energy efficiency and stimulating climate-friendly technological change, such as methods of capturing and storing carbon, as well as safe nuclear power.

[NUKES_STAVIN]

Julian Puckett

Robert Stavins

More Efficient

True, in the short term changing the energy mix will come at some cost, but this will hardly stop economic growth. As economies have grown and matured, they have become more adept at squeezing more economic activity out of each unit of energy they generate and consume. Consider this: From 1990 to 2007, while world emissions rose 38%, world economic growth soared 75% — emissions per unit of economic activity fell by more than 20%.

Critics argue we can’t possibly increase efficiency enough to hit the 80% goal. In a very limited sense, that’s true. Efficiency improvements alone, like the ones that propelled us forward in the past, won’t get us where we need to go by 2050. But this plan doesn’t rely solely on boosting efficiency. It brings together a host of other changes, such as moving toward greener power sources. What’s more, making gradual changes means we don’t have to scrap still-productive power plants, but rather begin to move new investment in the right direction.

As for how much this will cost, the best economic analyses — including studies from the U.S. Congressional Budget Office and the U.S. Energy Information Administration — say such a policy in the U.S. could cost considerably less than 1% of gross domestic product per year in the long term, or up to $175 per household in 2020. (As the Obama administration is fond of saying, that’s about the cost of one postage stamp per household per day.)

In the end, we would be delaying 2050’s expected economic output by no more than a few months. And bear in mind that previous environmental actions, such as attacking smog-forming air pollution and cutting acid rain, have consistently turned out to be much cheaper than predicted.

The best economic experts have validated the wisdom of adopting climate policies: from Yale’s William Nordhaus, who has supported moderate carbon taxes to cut emissions as an “insurance policy” against the most serious consequences of climate change, to MIT’s Richard Schmalensee and Columbia’s Glenn Hubbard, who have endorsed the climate policy recommendations of the bipartisan National Commission on Energy Policy, to Harvard’s Martin Weitzman, who has argued for much more aggressive policies because of the risk of particularly catastrophic outcomes. And a diverse set of CEOs, including the heads of some of the largest U.S. corporations, acting as part of the U.S. Climate Action Partnership, have called on the government “to quickly enact strong national legislation to require significant reductions of greenhouse gas emissions.”

Critics are wary of raising energy prices, arguing that no nations have grown wealthy with expensive power. But historically, it is the scarcity and cost of energy that have prompted technological changes as well as the use of new forms of power. What’s more, critics challenge the price estimates the experts have set out. They say that the predictions depend on extensive — and unrealistic — cooperation among nations. In particular, they say, developing nations won’t sign onto plans for curbing emissions, for fear of losing their economic momentum.

Indeed, we do need a sensible international arrangement in place to achieve low costs, and the economic pain will be much greater if we don’t set up an international carbon market. But it can be done. Many nations have already initiated such emissions-control policies. And the world can be brought together in a meaningful, long-term arrangement that is scientifically sound, economically rational and politically pragmatic.

Road to Cooperation

Because the benefits of any single nation taking action to address global climate change are spread worldwide, unlike the costs, it may never be in the self-interest of a single country to take unilateral action. This is the nature of a global commons problem. For this reason, international cooperation is required; this is the point of climate negotiations among some 190 countries, which will continue in Copenhagen this December. It is also the motivation for the U.S. administration’s Major Economies Forum, which brings together the 17 largest economies, accounting for 80% of GHG emissions.

Europe has already put significant climate policy in place, and Australia, New Zealand, and Japan are moving to have their policies in place within a year. But without evidence of serious action by the U.S., there will be no meaningful future international agreement, and certainly not one that includes the key, rapidly-growing developing countries — Brazil, China, India, Indonesia, Mexico, South Africa, and South Korea. U.S. policy developments can and should move in parallel with international negotiations.

Understandably, developing countries have a very different perspective than the currently industrialized world regarding climate policy. After all, the vast majority of the accumulated stock of man-made greenhouse gases in the atmosphere is due to economic activity in the richer countries over the past century and more. But the share of global emissions attributable to developing countries is significant and growing rapidly. China surpassed the United States as the world’s largest CO2 emitter in 2006. And developing countries are likely to account for more than half of global emissions by the year 2020, if not before. China, Korea, and others are beginning to take action.

Most important, all of the key countries of the world can be brought together in a meaningful and pragmatic arrangement. Such a post-Kyoto international agreement can expand the scope of action to include key developing countries, but with targets linked via an appropriate formula with economic growth, so that emissions can be reduced around the world, while emissions (and job) leakage from the industrialized to the developing world is avoided, and economic growth continues in all parts of the world.

Reducing Costs

The longer we put off serious action, the more aggressive our future efforts will need to be, as greenhouse gases and carbon-spewing capital assets continue to accumulate. Plants built today will determine emissions for a generation. In the steel sector — where plant lifetimes typically exceed 25 years — more than half of all plants in the world are now less than 10 years old. The picture is similar in the cement industry, as well as more broadly throughout the economy. For every year of delay before moving to a sustainable emissions path, the global cost of taking necessary actions increases by hundreds of billions of dollars.

Critics argue that we can afford to wait because the world of tomorrow will be wealthier and better able to absorb the costs. But acting sooner, such as by adopting the emission caps proposed in the U.S. House legislation, will lower the ultimate costs of achieving the target, because there will be more time allowed for gradual transition — which is what keeps costs down. Perhaps most important, the costs of failing to take action — the damages of climate change — would be substantially greater.

Getting serious about climate change won’t be free, and it won’t be easy. But if state-of-the-science predictions about the consequences of continued delay are correct, the time has come for sensible and meaningful action.

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Too Good to be True?

Global climate change is a serious environmental threat, and sound public policies are needed to address it effectively and sensibly.

There is now significant interest and activity within both the U.S. Administration and the U.S. Congress to develop a meaningful national climate policy in this country.  (If you’re interested, please see some of my previous posts:  “Opportunity for a Defining Moment” (February 6, 2009); “The Wonderful Politics of Cap-and-Trade:  A Closer Look at Waxman-Markey” (May 27, 2009); “Worried About International Competitiveness?  Another Look at the Waxman-Markey Cap-and-Trade Proposal” (June 18, 2009); “National Climate Change Policy:  A Quick Look Back at Waxman-Markey and the Road Ahead” (June 29, 2009).  For a more detailed account, see my Hamilton Project paper, A U.S. Cap-and-Trade System to Address Global Climate Change.)

And as we move toward the international negotiations to take place in December of this year in Copenhagen, it is important to keep in mind the global commons nature of the problem, and hence the necessity of designing and implementing an international policy architecture that is scientifically sound, economically rational, and politically pragmatic.

Back in the U.S., with domestic action delayed in the Senate, several states and regions in the United States have moved ahead with their own policies and plans.  Key among these is California’s Global Warming Solutions Act of 2006, intended to return the state’s greenhouse gas (GHG) emissions in 2020 to their 1990 level.  In 2006, three studies were released indicating that California can meet its 2020 target at no net economic cost.  That is not a typographical error.  The studies found not simply that the costs will be low, but that the costs will be zero, or even negative!  That is, the studies found that California’s ambitious target can be achieved through measures whose direct costs would be outweighed by offsetting savings they create, making them economically beneficial even without considering the emission reductions they may achieve.  Not just a free lunch, but a lunch we are paid to eat!

Given the substantial emission reductions that will be required to meet California’s 2020 target, these findings are ­- to put it mildly – surprising, and they differ dramatically from the vast majority of economic analyses of the cost of reducing GHG emissions.  As a result, I was asked by the Electric Power Research Institute – along with my colleagues, Judson Jaffe and Todd Schatzki of Analysis Group – to evaluate the three California studies.

In a report titled, “Too Good To Be True?  An Examination of Three Economic Assessments of California Climate Change Policy,” we found that although some limited opportunities may exist for no-cost emission reductions, the studies substantially underestimated the cost of meeting California’s 2020 target — by omitting important components of the costs of emission reduction efforts, and by overestimating offsetting savings some of those efforts yield through improved energy efficiency.  In some cases, the studies focused on the costs of particular actions to reduce emissions, but failed to consider the effectiveness and costs of policies that would be necessary to bring about those actions.  Just a few of the flaws we identified lead to underestimation of annual costs on the order of billions of dollars.  Sadly, the studies therefore did not and do not offer reliable estimates of the cost of meeting California’s 2020 target.

This episode is a reminder of a period when similar studies were performed by the U.S. Department of Energy at the time of the Kyoto Protocol negotiations.  Like the California studies, the DOE (Interlaboratory Work Group) studies in the late 1990s suggested that substantial emission reductions could be achieved at no cost.  Those studies were terribly flawed, which was what led to their faulty conclusions.  I had thought that such arguments about massive “free lunches” in the energy efficiency and climate domain had long since been laid to rest.  The debates in California (and some of the rhetoric in Washington) prove otherwise.

While the Global Warming Solutions Act of 2006 sets an emissions target, critical policy design decisions remain to be made that will fundamentally affect the cost of the policy.  For example, policymakers must determine the emission sources that will be regulated to meet those targets, and the policy instruments that will be employed.  The California studies do not directly address the cost implications of these and other policy design decisions, and their overly optimistic findings may leave policymakers with an inadequate appreciation of the stakes associated with the decisions that lie ahead.

On the positive side, a careful evaluation of the California studies highlights some important policy design lessons that apply regardless of the extent to which no-cost emission reduction opportunities really exist.  Policies should be designed to account for uncertainty regarding emission reduction costs, much of which will not be resolved before policies must be enacted.  Also, consideration of the market failures that lead to excessive GHG emissions makes clear that to reduce emissions cost-effectively, policymakers should employ a market-based policy (such as cap-and-trade) as the core policy instrument.

The fact that the three California studies so egregiously underestimated the costs of achieving the goals of the Global Warming Solutions Act should not be taken as indicating that the Act itself is necessarily without merit.  As I have discussed in previous posts, that judgment must rest – from an economic perspective – on an honest and rigorous comparison of the Act’s real benefits and real costs.

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Is Benefit-Cost Analysis Helpful for Environmental Regulation?

With the locus of action on Federal climate policy moving this week from the House of Representatives to the Senate, this is a convenient moment to step back from the political fray and reflect on some fundamental questions about U.S. environmental policy.

One such question is whether economic analysis – in particular, the comparison of the benefits and costs of proposed policies – plays a truly useful role in Washington, or is it little more than a distraction of attention from more important perspectives on public policy, or – worst of all – is it counter-productive, even antithetical, to the development, assessment, and implementation of sound policy in the environmental, resource, and energy realms.   With an exceptionally talented group of thinkers – including scientists, lawyers, and economists – now in key environmental and energy policy positions at the White House, the Environmental Protection Agency, the Department of Energy, and the Department of the Treasury, this question about the usefulness of benefit-cost analysis is of particular importance.

For many years, there have been calls from some quarters for greater reliance on the use of economic analysis in the development and evaluation of environmental regulations.  As I have noted in previous posts on this blog, most economists would argue that economic efficiency — measured as the difference between benefits and costs — ought to be one of the key criteria for evaluating proposed regulations.  (See:  “The Myths of Market Prices and Efficiency,” March 3, 2009; “What Baseball Can Teach Policymakers,” April 20, 2009; “Does Economic Analysis Shortchange the Future?” April 27, 2009)  Because society has limited resources to spend on regulation, such analysis can help illuminate the trade-offs involved in making different kinds of social investments.  In this sense, it would seem irresponsible not to conduct such analyses, since they can inform decisions about how scarce resources can be put to the greatest social good.

In principle, benefit-cost analysis can also help answer questions of how much regulation is enough.  From an efficiency standpoint, the answer to this question is simple — regulate until the incremental benefits from regulation are just offset by the incremental costs.  In practice, however, the problem is much more difficult, in large part because of inherent problems in measuring marginal benefits and costs.  In addition, concerns about fairness and process may be very important economic and non-economic factors.  Regulatory policies inevitably involve winners and losers, even when aggregate benefits exceed aggregate costs.

Over the years, policy makers have sent mixed signals regarding the use of benefit-cost analysis in policy evaluation.  Congress has passed several statutes to protect health, safety, and the environment that effectively preclude the consideration of benefits and costs in the development of certain regulations, even though other statutes actually require the use of benefit-cost analysis.  At the same time, Presidents Carter, Reagan, Bush, Clinton, and Bush all put in place formal processes for reviewing economic implications of major environmental, health, and safety regulations. Apparently the Executive Branch, charged with designing and implementing regulations, has seen a greater need than the Congress to develop a yardstick against which regulatory proposals can be assessed.  Benefit-cost analysis has been the yardstick of choice

It was in this context that ten years ago a group of economists from across the political spectrum jointly authored an article in Science magazine, asking whether there is role for benefit-cost analysis in environmental, health, and safety regulation.  That diverse group consisted of Kenneth Arrow, Maureen Cropper, George Eads, Robert Hahn, Lester Lave, Roger Noll, Paul Portney, Milton Russell, Richard Schmalensee, Kerry Smith, and myself.  That article and its findings are particularly timely, with President Obama considering putting in place a new Executive Order on Regulatory Review.

In the article, we suggested that benefit-cost analysis has a potentially important role to play in helping inform regulatory decision making, though it should not be the sole basis for such decision making.  We offered eight principles.

First, benefit-cost analysis can be useful for comparing the favorable and unfavorable effects of policies, because it can help decision makers better understand the implications of decisions by identifying and, where appropriate, quantifying the favorable and unfavorable consequences of a proposed policy change.  But, in some cases, there is too much uncertainty to use benefit-cost analysis to conclude that the benefits of a decision will exceed or fall short of its costs.

Second, decision makers should not be precluded from considering the economic costs and benefits of different policies in the development of regulations.  Removing statutory prohibitions on the balancing of benefits and costs can help promote more efficient and effective regulation.

Third, benefit-cost analysis should be required for all major regulatory decisions. The scale of a benefit-cost analysis should depend on both the stakes involved and the likelihood that the resulting information will affect the ultimate decision.

Fourth, although agencies should be required to conduct benefit-cost analyses for major decisions, and to explain why they have selected actions for which reliable evidence indicates that expected benefits are significantly less than expected costs, those agencies should not be bound by strict benefit-cost tests.  Factors other than aggregate economic benefits and costs may be important.

Fifth, benefits and costs of proposed policies should be quantified wherever possible.  But not all impacts can be quantified, let alone monetized.  Therefore, care should be taken to assure that quantitative factors do not dominate important qualitative factors in decision making.  If an agency wishes to introduce a “margin of safety” into a decision, it should do so explicitly.

Sixth, the more external review that regulatory analyses receive, the better they are likely to be.  Retrospective assessments should be carried out periodically.

Seventh, a consistent set of economic assumptions should be used in calculating benefits and costs.  Key variables include the social discount rate, the value of reducing risks of premature death and accidents, and the values associated with other improvements in health.

Eighth, while benefit-cost analysis focuses primarily on the overall relationship between benefits and costs, a good analysis will also identify important distributional consequences for important subgroups of the population.

From these eight principles, we concluded that benefit-cost analysis can play an important role in legislative and regulatory policy debates on protecting and improving the natural environment, health, and safety.  Although formal benefit-cost analysis should not be viewed as either necessary or sufficient for designing sensible public policy, it can provide an exceptionally useful framework for consistently organizing disparate information, and in this way, it can greatly improve the process and hence the outcome of policy analysis.

If properly done, benefit-cost analysis can be of great help to agencies participating in the development of environmental regulations, and it can likewise be useful in evaluating agency decision making and in shaping new laws (which brings us full-circle to the climate legislation that will be developed in the U.S. Senate over the weeks and months ahead, and which I hope to discuss in future posts).

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