The Real Cost of Climate Policy

Jon AndaThis post is by Jon A. Anda, President of the Environmental Markets Network at Environmental Defense. A version of this post was published in the Financial Times on December 4, 2007.

A November 28 column by John Kay in the Financial Times, "Climate Change: the (Groucho) Marxist approach", starts with a quote from Groucho Marx: "Why should I do anything for posterity? What has posterity ever done for me?" Groucho’s position may be morally indefensible, Kay says, but "[t]he problem of weighting the present and the future equally is that there is a lot of future." From an economic standpoint, valuing future people equally would require unrealistically great sacrifices by those living today.

There’s a problem with this argument. It’s based on a rather totalitarian belief in net present value (NPV) as the means to evaluate policy – a simple calculation of the benefits of action (the cost of doing nothing) minus the costs of action. If a 5 percent discount rate applied to base-case cost and damage estimates yields a negative NPV for policy, does that mean we reject it?

Let’s put aside for a moment that our data is very incomplete. If the distribution of outcomes were more normally distributed, then perhaps yes, we could base our policy on a simple NPV analysis. But climate feedback loops drive a damage risk curve that’s more log normal than normal, with a long, fat tail.

Accounting for this significant risk of catastrophic damage requires more rigorous analysis. If we take no action now, these potentially dire consequences will be irreversible. There is an option value associated with having the flexibility to respond to new information in the future. Therefore reducing carbon emissions today can create positive option value even when NPV is negative.

Climate damage is happening sooner than scientists predicted. The future generations Professor Kay refers to are likely already born. We owe them the best possible analytics for a decision of this magnitude.

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  1. rkcannon
    Posted December 14, 2007 at 7:09 pm | Permalink

    Could it be that the climate “damage” happening sooner that scientists predicted is because man is not causing it? It should not be happening so fast if man IS the cause. Our increase in CO2 is gradual. Therfore the cause is something else, and NOT CO2, and this is also shown in ice core samples- the temp goes up then the CO2 rises. And in the melting ice they are seeing FROZEN TREES! Did you know the water level was once hundreds of feet higher???

    The real concern is the water pollution, mercury in air from coal burning, fluoride in water poisoning the environment, pesticides and other chemicals building up in people, etc etc. This will kill us off long before global warming from natural causes. This is smokescreen to hide what is really important!

  2. Posted December 17, 2007 at 4:08 pm | Permalink

    Climate change is happening faster than predicted because of what’s called “feedbacks” that accelerate warming. For example, when ice melts off the North Pole, the Earth is less reflective (dark Earth doesn’t reflect like white ice) and warming accelerates. We are working on a post about climate feedbacks that will be posted before too long.

    For the rest of it, see my previous answer to you.

  3. timgo
    Posted June 4, 2008 at 11:32 am | Permalink

    The quote from the Financial Times is quite astonishing. Is it a joke?

  4. Posted June 4, 2008 at 5:31 pm | Permalink

    The quote sounds a little strange from a lay standpoint, I agree. It comes from the economists’ practice of quantifying things we usually think about in a qualitative way. They put numbers to everything. No joke here.