Why climate policy is good economic policy

More than 200 world leaders met over the last few days at the United Nations’ Annual Climate Change Conference in Bonn to discuss how to fill in the details of individual countries’ pledges of the Paris agreement. And while the United States has clearly ceded its leadership role to China, Germany, France, Canada and others, there are clear signs that adopting an ambitious climate policy is smart for long-term economic prosperity.

Economists across the political spectrum agree that the market alone will not solve climate change, because carbon pollution is still largely unpriced. From an ideal point of view, the optimal climate policy would be a global carbon price. If an appropriate and sufficiently robust global carbon price existed, with clear declining limits on pollution, no other climate policy would be needed.

Unfortunately, such a carbon policy does not currently exist. So, in the absence of such a global pricing regime, what kind of climate policy is cost-effective?   Each individual climate policy can be judged on its merits, and most typically show large economic gains, as the benefits of avoiding climate change far outweigh the costs.

Ambitious climate policy passes a benefit-cost test by using the Social Cost of Carbon

To understand the benefit of climate policy, we first need a sense on the magnitude of the climate damages that can be avoided. The current economic consensus view quantifies the social cost of carbon – that is the damage from emitting one ton of CO2 – at $42 per metric ton of CO2 emissions in 2007 U.S. Dollars based on work by the U.S. Government’s Interagency Working Group on Social Cost of Greenhouse Gases.

And while estimating the full range of climate damages is a daunting task, new research indicates economists are getting much better at it. Recent empirical studies have started to expand and strengthen the quantification of climate damages based on improved statistical techniques. A recent study in Nature, for example, finds that a lack of climate policy would reduce average income by 23% by 2100. These empirical estimates indicate that the true social cost of carbon is a multiple of the estimates based on the integrated climate-economy models that the Interagency Working Group still relies on. Which is what leading researchers suspected all along.

But what about the cost of climate policy? For many, the potential cost of enacting ambitious climate policy has become a powerful argument against taking any sort of action. So how can we tell if enacting climate policy is cost-effective? A first pass is to subject individual climate policy proposals to benefit-cost analyses that weigh the cost of the specific policy against the avoided climate damages using the social cost of carbon. For example, if the climate mitigation component of a renewable energy proposal costs less than the social cost of carbon, then the policy is good economics.

On the flip side, failing to pass a benefit-cost test does not necessarily imply that a policy is not cost-effective. The social cost of carbon still only captures some of the damages, and future revisions will in all likelihood correct it upwards. Additionally, a policy might lead to important co-benefits beyond climate policy such as reductions in criteria pollutants that have negative effects on human health and the environment.

The Clean Power Plan can serve as a good example to illustrate the argument.  Using benefit-cost analysis based on the social cost of carbon, the EPA determined that the Clean Power Plan is a worthwhile investment, with net gains totaling billions of dollars. This is the case even when ignoring any non-climate co-benefits, and when using the lower consensus estimate for the social cost of carbon. Relying instead on the newly available climate impact estimates adds several billion dollars to the net benefits.

Climate policy can go hand in hand with economic prosperity

Moreover, the evidence suggests that – contrary to what some claim – we can implement climate policy while growing the economy. While there can be small adjustment costs, climate policy also leads to lead to new opportunities and innovation. Patenting in clean technologies, for instance, is as vibrant as in biotech, translating into additional growth benefits for the economy as a whole.

Uncertainty makes acting now even more compelling

While there is uncertainty as to just how much CO2 levels in the atmosphere will rise, we know it will be more than ever before encountered by modern humans. And, we already know the economic impacts will be bad. The devastation from hurricanes Harvey, Irma and Maria—made worse by the impacts of a warming climate—will cost communities, taxpayers and insurance companies billions.

But things could turn out much worse. Theoretically, catastrophic climate damages could be so high as to dominate any benefit-cost analysis. This as of yet unpriced uncertainty is a compelling reason to act, not to wait. How to quantify uncertainty with precision is still at the frontier of climate economics. A recent working paper at the NBER calibrates a climate-economy model to financial risk attitudes. The authors find that taking the uncertainty in climate impacts seriously will increase the social cost of carbon even more.

Uncertainty taken seriously means ambitious climate policy today. At least that's what unites groups on both ends of the political spectrum, from progressive environmentalists to Nobel-prize winning Chicago economists.

 The economic case for ambitious climate action is clear. With the right policies, the benefits of avoiding climate change far outweigh the costs. And in the absence of a price on carbon, the only question is: what are the right climate policy instruments? As EDF has long argued, political debates in climate policy must not be over the if, but the how.

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