Worldly Philosopher: The Social Cost of Carbon as a Lower Bound for Policy
This week's Worldly Philosopher, Anthony Bonen, writes on economists' contribution to efforts to mitigate against climate change.
On Sunday, the IPCC Working Group Mitigation of Climate Change, released its latest report, and the news isn’t good. The report says (to no one’s surprise) that governments around the world have failed to act against climate change. The result has been rapid increases in greenhouse gas (GHG) atmospheric concentrations and rising temperatures around the world (see figure). The silver lining (silver sliver?) is that climate change mitigation is eminently affordable if – a big if – governments start to invest now.
It is time for economists to step up and help politicians take this supremely reasonable and moral action to invest. This can be done by improving economic models of climate change and, even more importantly, clearly communicating the limitations of our models.
The Financial Times reports that the costs of “an ambitious fight against climate change will reduce annualised economic growth by somewhere between 0.04 and 0.14 percentage points” versus a scenario of zero mitigation efforts. This compares to a welfare loss of between 0.2% and 2.0% of global GDP if average global temperatures rise by a further 2°C (IPCC, WGII SPM, p. 19). A finance degree is not necessary to decide between these two investment choices.
Yet, these two headline costs, -0.14% (maximum loss if mitigation) versus -0.2% (mininimum loss if no effort), are generated from extremely different data, which leaves the latter open to charges of, at best, uncertainty and, at worst, fantasy. The cost of investing in renewable energy, carbon capture and green transportation are based on real, observable markets and technologies. But the cost of unmitigated climate change? This comes from integrated assessment models’ estimates of the social cost of carbon (SCC).
The SCC metric is the net present value cost of an additional ton of CO2 emissions (tCO2). That is, how much welfare society stands to lose from a marginal increase in carbon emissions, translated into current U.S. dollars. Undoubtedly, there is an enormous degree of uncertainty regarding the nonlinear and variegated impacts of temperature increases on the environment, economy and society.
Although we don’t like to admit it, monetizing the cost of climate change involves a lot of guesswork. We already know that unabated climate change will bring devastating consequences for many peoples and communities around the world. So, are economists adding anything by putting a price tag on these impacts? Put another way: is it worthwhile for economists to compute the social cost of carbon?
I posed this question to IPCC lead author Michael Oppenheimer at last week’s SCEPA and Milano School-sponsored talk, “Extreme Weather and the Risks from Climate Change.” In a nutshell, his answer was, "Yes, but we have to do better."
On a practical level, American SCC estimates are indispensible, as all federal regulations require a cost-benefit analysis. For example, the Obama Administration’s 2010 fuel-efficiency standards were based on a central cost estimate of $19 per tonne of CO2. This U.S. Interagency estimate was the first coordinated effort to integrate a cost for carbon emissions into regulation. Before 2010, emissions cost was assumed to be zero ($0). (Last year’s US Interagency Update raised the central estimate to $37/tCO2 based on the updated SCC models.)
Furthermore, Oppenheimer pointed to a study by van den Bergh and Botzen in Nature, Climate Change that forcefully argues SCC estimates must be viewed as the lower-bound to risks posed by climate change. They note that from a SCC estimate of $41/tCO2 (the low meta-analysis average, see table) including premia for risk avoidance and low-probability/high-impact events (e.g., Hurricane Sandy, west coast drought) increases the SCC estimate to a $70--$213/tCO2 range! Clearly, if these figures were used in the IPCC reports, the lost GDP from climate change would be well above the annual loss of 2%.
Risk premia and “fat tails” are nothing new to economists. Integrating these complicating factors into our SCC models are crucial next steps that may well increase the uncertainty of these costs, but these technical advances are not going to overturn the central message – climate change is real, growing faster than previously thought, and we need investments and policy changes now to mitigate future risk and damages.
Most of us – myself included – will never be comfortable with the translation of human suffering into economic costs. But, so long as policymakers demand dollar figure analyses, we must produce something for the accountants. This is not an excuse for fabrication – quite the opposite. We must strive to improve the economic valuation of climate change so that the full societal costs are incorporated. To this end, heterodox and pluralistic economic approaches are especially useful since they can model complex systems without being captive to a narrow view of human welfare and well-being.
Even then we will invariably miss and omit many factors of global climate change. Thus, for any SCC estimate economists provide to legislators, it must be made clear that we are talking about the lowest, most conservative estimates of a radically uncertain and dangerous future. Maybe then the investment choice will be obvious even to politicians.