Market Forces

New Climate-Economic Thinking

By Gernot Wagner / Bio / Published: April 27, 2015

By Gernot Wagner and Martin L. Weitzman

Each ton of carbon dioxide emitted into the atmosphere today causes about $40 worth of damages. So at least says standard economic thinking.

A lot goes into calculating that number. You might call it the mother of all benefit-cost analyses. It’s bean-counting on a global scale, extending out decades and centuries. And it’s a process that requires assumptions every step along the way.

The resulting $40 figure should be taken for what it is: the central case presented by the U.S. Government Interagency Working Group on Social Cost of Carbon when using its preferred 3% discount rate for all future climate damages. But it is by no means the full story.

Choose a different discount rate, get a different number. Yale economist Bill Nordhaus uses a discount rate of slightly above 4%. His resulting price is closer to $20 per ton of carbon dioxide. The Stern Review on the Economics of Climate Change uses 1.4%. The resulting price per ton is over $80.

And the discount rate is not the only assumption that makes this kind of a difference. In Climate Shock, we present the latest thinking on why and how we should worry about the right price for each ton of carbon dioxide, and other greenhouse gases, emitted into the atmosphere. There are so many uncertainties at every step—from economic projections to emissions, from emissions to concentrations, from concentrations to temperatures, and back to economics in form of climate damages—that pointing to one single, final number is false precision, misleading, or worse.

Of course, that does not mean that we shouldn’t attempt to make this calculation in the first place. The alternative to calculating the cost of carbon is to use a big fat zero in government benefit-cost calculations. That’s clearly wrong.

Most everything we know about what goes into calculating the $40 figure leads us to believe that $40 is the lower bound for sensible policy action. Most everything we know that is left out would push the number higher still, perhaps much higher.

It’s not over ’til the fat tail zings

As just one example, zero in on the link between carbon concentrations in the atmosphere and eventual temperature outcomes. We know that increasing concentrations will not decrease global temperatures. Thank you, high school chemistry and physics. The lower bound for the temperature impact when carbon concentrations in the atmosphere double can be cut off at zero.

In fact, we are pretty sure it can be cut off at 1°C or above. Global average temperatures have already warmed by over 0.8°C, and we haven’t even doubled carbon concentrations from preindustrial levels. Moreover, the temperature increases in this calculation should happen ‘eventually’—over decades and centuries. Not now.

What’s even more worrying is the upper tail of that temperature distribution. There’s no similarly definitive cut-off for the worst-case scenario. In fact, our own calculations (based on an International Energy Agency (IEA) scenario that greenhouse gas concentrations will end up around 700 parts per million) suggest a greater-than-10% chance of eventual global average warming of 6°C or above.

Focus on the bottom row in this table. If you do, you are already ahead of others, most of whom focus on averages, here depicted as “median Δ°C” (eventual changes in global average surface temperatures). The median is what we would expect to exceed half the time, given particular greenhouse gas concentrations in the atmosphere. And it’s bad enough.

But what really puts the “shock” into Climate Shock is the rapid increase in probabilities of eventual temperatures exceeding 6°C, the bottom row. While average temperatures go up steadily with rising concentrations, the chance of true extremes rises rapidly:

That 6°C is an Earth-as-we-know-it-altering temperature increase. Think of it as a planetary fever. Normal body temperatures hover around 37°C. Anything above 38°C and you have a fever. Anything above 40°C is life-threatening.

Global average warming of 3°C wouldn’t be unprecedented for the planet as a whole, in all of it geological history. For human society, it would be. And that’s where we are heading at the moment—on average, already assuming some ‘new policies’ to come into play that aren’t currently on the books.

It’s the high-probability averages rather than low-probability extremes that drive the original $40 figure. Our table links greenhouse gas concentrations to worryingly high probability estimates for temperatures eventually exceeding 6°C, an outcome that clearly would be catastrophic for human society as we know it.

Instead of focusing on averages then, climate ought to be seen as a risk management problem. Some greenhouse gas concentration thresholds should simply not be crossed. The risks are too high.

This kind of focus on temperature extremes is far from accepted wisdom. We argue it ought to be.

Gernot Wagner and Martin L. Weitzman are co-authors of Climate Shock (Princeton University Press, 2015). First published by The Institute for New Economic Thinking.

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“Naomi Klein wants to stick it to the man. I want to stick it to CO2.″

By Gernot Wagner / Bio / Published: March 30, 2015

By Jonathan Derbyshire, Prospect Magazine‘s The world of ideas.

Why is it so difficult to get people to worry about climate change? After all, the science is pretty unambiguous—pace the climate change “deniers”. Part of the problem, according to a new book, “Climate Shock,” by the economists Gernot Wagner and Martin L Weitzman, is that while what we know about global warming is bad enough, there are “unknown risks that may yet dwarf all else.”

Wagner, who is lead senior economist at the Environmental Defense Fund in the United States, visited London a couple of weeks ago. I caught up with him while he was here and talked to him about the difficulties of mobilising public opinion around the threats and challenges of climate change.

GW: The big problem, frankly, is speaking the truth and talking about what scientists actually know and what they don’t know, which in many ways is even scarier. Saying the latest science out loud is [often taken to be] akin to catastrophising. That’s the big conundrum: on the one hand, “climate shock” shouldn’t be all that shocking—we’ve known this for quite a while. The problem is finding a way to state the scientific facts in a way that does not turn people off immediately.

JD: So it’s partly a public relations or political challenge then?

It’s more than that. Political, certainly. But it’s also a science communications challenge.

You mentioned scientific uncertainty just now. The book is, among other things, an attempt to deal with the challenge of climate change and the policymaking challenges from an economic perspective. But it’s also, it seems to me, a work of epistemology, almost—it’s a reflection on uncertainty and the implications that uncertainty has for policymaking.

Most books are written about what we know. This book is about what we don’t know. We clearly know enough to act. We’ve known enough to act for years, decades. Now, the more we find out, the more apparent it gets that what we don’t know is in fact potentially much, more worse. Choose you favourite analogy here—Nassim Nicholas Taleb’s “black swans,” Donald Rumsfeld’s “unknown unknowns”. That’s what it’s all about. The things we don’t know will most likely be the things that bite us in the back.

This is one of the things that makes climate change a public policy challenge unlike any other.

Climate change is uniquely long-term. It is uniquely global. It is uniquely irreversible and uniquely uncertain. You could probably identify other policy issues that combine two of those four factors, but none that I know of combines all four like climate change [does].

Continue reading in Prospect Magazine.

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Climate Shock in under 90 seconds

By Gernot Wagner / Bio / Published: March 11, 2015

Think of the atmosphere as a giant bathtub. There’s a faucet—emissions from human activity—and a drain—the planet’s ability to absorb that pollution. For most of human civilization and hundreds of thousands of years before, the inflow and the outflow were in relative balance. Then humans started burning coal and turned on the faucet far beyond what the drain could handle. The levels of carbon in the atmosphere began to rise to levels last seen in the Pliocene, over three million years ago.

What to do? That’s the question John Sterman, an MIT professor, asked two hundred graduate students. More specifically, he asked what to do to stabilize concentrations of carbon dioxide in the atmosphere close to present levels. How far do we need to go in turning off the faucet in order to stabilize concentrations? Here’s what not to do: stabilizing the flow of carbon into the atmosphere today won’t stabilize the carbon already there at close to present levels. You’re still adding carbon. Just because the inflow remains steady year after year, doesn’t mean the amount already in the tub doesn’t go up. Inflow and outflow need to be in balance, and that won’t happen at current levels of carbon dioxide in the tub (currently at 400 ppm) unless the inflow goes down by a lot.

That seems like an obvious point. It also seems to get lost on the average MIT graduate student, and these students aren’t exactly ‘average’. Still, over 80 percent of them in Sterman’s study seem to confuse the faucet with the tub. They confuse stabilizing the inflow with stabilizing the level.

Watch this video to avoid making the same mistake:

Excerpted from Climate Shock.

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Stick It To Carbon, Not The Man.

By Gernot Wagner / Bio / Published: March 2, 2015

Editor’s note: The following is excerpted from Climate Shock (2015) by Gernot Wagner, Lead Senior Economist, Environmental Defense Fund, and Martin L. Weitzman, Professor of Economics, Harvard University. Published here with permission from Princeton University Press.

Two quick questions:

Do you think climate change is an urgent problem?

Do you think getting the world off fossil fuels is difficult?

If you answered “Yes” to both of these questions, welcome. You’ll nod along, occasionally even cheer, while reading on. You’ll feel reaffirmed.

You are also in the minority. The vast majority of people answer “Yes” to one or the other question, but not both.

If you answered “Yes” only to the first question, you probably think of yourself as a committed environmentalist. You may think climate change is the issue facing society. It’s bad. It’s worse than most of us think. It’s hitting home already, and it will strike us with full force. We should be pulling out all the stops: solar panels, bike lanes, the whole lot.

You’re right, in part. Climate change is an urgent problem. But you’re fooling yourself if you think getting off fossil fuels will be simple. It will be one of the most difficult challenges modern civilization has ever faced, and it will require the most sustained, well-managed, globally cooperative effort the human species has ever mounted.

If you answered “Yes” only to the second question, chances are you don’t think climate change is the defining problem of our generation. That doesn’t necessarily mean you’re a “skeptic” or “denier” of the underlying scientific evidence; you may still think global warming is worthy of our attention. But realism dictates that we can’t stop life as we know it to mitigate a problem that’ll take decades or centuries to show its full force. Look, some people are suffering right now because of lack of energy. And whatever the United States, Europe or other high emitters do to rein in their energy consumption will be nullified by China, India and the rest catching up with the rich world’s standard of living. You know there are trade-offs. You also know that solar panels and bike lanes alone won’t do.

You, too, are right, but none of that makes climate change any less of a problem. The long lead time for solutions and the complex global web of players are precisely why we must act decisively, today. Read More »

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We need a climate insurance policy – now

By Gernot Wagner / Bio / Published: February 18, 2015

Q&A with Karin Rives first published on EDF Voices.

Before climate change gets so bad that we may be forced to “geoengineer” ourselves out of catastrophe, a new book—Climate Shock—suggests that we reframe the problem altogether.

Gernot Wagner, a lead senior economist at Environmental Defense Fund and co-author of the book, says we ought to look at climate change as a risk management problem and treat it as such. I had a chat with Gernot about the book he will release next week together with Martin L. Weitzman, a professor of economics at Harvard University.

Karin Rives: Many books have already been published on climate change. What’s new or different about Climate Shock?

Most everyone focuses on what we know about climate change. Our book is about what we don’t know.

Call it Nassim Nicholas Taleb’s “Black Swan,” or the Rumsfeldian “unknown unknowns”—a state of complete and dangerous uncertainty and unpredictability. Call it what you want, but it’s that tail that may yet wag us in the end.

What we know is bad. What we don’t know is potentially much worse. Climate, in the end, is a risk management issue. Just like homeowners take out insurance against fires and flooding, society needs insurance against climate change.

KR: So what do we know?

Last time the planet experienced as much carbon in its atmosphere as there is now, sea levels where up to 66 feet higher than they are today. Camels lived in Canada. That was more than 3 million years ago. The geological clock read “Pliocene.”

We certainly know enough to take reasoned action today. And almost everything we don’t know points in one and only one direction: that action is all the more urgent.

KR: Why do we need to read this book now?

The time to buy our insurance policy is now—while we still can. And I’m speaking both metaphorically and literally.

Insurance here, of course, is to avoid dumping carbon into the atmosphere. We pay to have our trash picked up instead of just dumping it for free onto our streets. We similarly need to pay to avoid dumping carbon into our atmosphere.

That’s not free, but it’s still relatively cheap to do—and much cheaper than experiencing the consequences of unchecked global warming.

KR: What should be my three most important takeaways from your book?

Scream, cope, and profit.

We need to get the right policies in place, and soon. That’s “scream.” Then there’s some global warming we can no longer avoid—and that we are already experiencing. Let’s prepare ourselves better for that.

“Profit” is, of course, what you would expect two economists to say, dollar signs in their eyes and all. All that starts with smart investment decisions. Green, clean, and lean isn’t just got for the planet. It’s also the right financial choice and we need to ensure that it is much more so going forward.

The main takeaway, in the end, is that this isn’t some artificial battle between capitalism and the climate. It’s not about sticking it to the man. It’s about sticking it to carbon.

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Reconsidering the Rebound Effect

By Gernot Wagner / Bio / Published: November 20, 2014

By Kenneth Gillingham, David Rapson, and Gernot Wagner.

The rebound effect from improving energy efficiency has been widely discussed—from the pages of the New York Times and New Yorker to the halls of policy and to a voluminous academic literature. It’s been known for over a century and, on the surface, is simple to understand. Buy a more fuel-efficient car, drive more. Invent a more efficient bulb, use more light. If efficiency improves, the price of energy services will drop, inducing increased demand for those services. Consumers will respond, producers will respond, and markets will re-equilibrate. All of these responses can lead to reductions in the energy savings expected from improved energy efficiency. And so some question the overall value of energy efficiency, by arguing that it will only lead to more energy use—a case often called “backfire.”

In a new RFF discussion paper, “The Rebound Effect and Energy Efficiency Policy” we review the literature on the rebound effect, classify the different types, and highlight the need for careful distinction between causal links—which are indeed worthy of the “rebound” label—and mere correlations, which are not. We find, in fact, that measures to improve efficiency, despite potential rebound effects—are likely to improve welfare, generally.

Among the key questions about the rebound effect are a) whether the net benefits of energy efficiency increases are positive (for a costless improvement, the answer is almost certainly “yes”), and b) whether the increase in demand for energy services uses so much additional energy that it leads to greater, rather than less, demand for energy itself (the answer is almost certainly “no”).

Our findings are clear: while it is possible for rebound effects to be large in some settings, there is no reliable evidence supporting rebound effects so large that improving energy efficiency leads to more energy use. Backfire is theoretically possible, but even the theoretical predictions rely on channels that are either a) second-order in magnitude (and thus unlikely to overwhelm primary effects), or b) lacking in empirical evidence of their existence and magnitude. Globally, we have little reason to worry about backfire. While there is much uncertainty about the size of the so-called “macroeconomic rebound” (how re-equilibration of markets and such hypothesized effects as induced innovation from the energy efficiency improvement may lead to a rebound), we consider a plausible upper bound of the total effect to be in the range of 60 percent (that is, 60 percent of the potential energy savings will be lost to rebound), with most studies pointing to a smaller effect.

Regardless of its size, we find that the rebound effect is very likely to be welfare-improving. In fact, in the extreme, energy efficiency improvements that come about from innovations or otherwise have no cost are unequivocally welfare-enhancing. If the improvements come with costs, such as air pollution from more driving or more expensive technology, those need to be weighed against the energy savings, emissions savings, and welfare benefits from the policy.

In short, undue emphasis on backfire is a mere distraction. Or as we put it in a recent letter to the editor of the New York Times: energy efficiency improvements such as “LEDs alone won’t solve global warming or global poverty, but they are a step in the right direction for both.”

Published on Common Resources. The RFF Discussion Paper is here: “The Rebound Effect and Energy Efficiency Policy.”

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