Market Forces

This guest blog was co-authored with Thomas Sterner

And then there were three. As of January 1^st, 2018, Ontario has joined California and Québec, linking their respective carbon markets. In a post-Paris world of bottom-up climate policy, linking of climate policy matters. It provides a concrete step forward on the Paris Declaration on Carbon Pricing in the Americas. It shows that, while the U.S. federal government is dismantling much-needed climate protections, states, together with Canadian provinces, are moving forward. Linking, if done right, can be a powerful enabler of greater ambition. It also raises important questions.

To be clear, there are real advantages to linking carbon markets: Linking of climate policies is a political affirmation of joint goals and a signal to others to move toward concerted carbon policies. It also shows the real advantages of market-based environmental policies. Bigger markets also afford greater cost-savings opportunities.

The textbook illustration of such savings is instructive. Take two jurisdictions, the high-cost abatement area (“H”) and the low-cost abatement area (“L”), with vastly different marginal costs (MC) of abatement. The total costs of abatement, the respective shaded areas in this graph, will be vastly different, too:

Now consider the idealized linked market. Total abatement (ΣX) will remain the same. The difference? Prices equilibrate across markets, with P_L now equal to P_H, lowering the total cost of achieving the same tons of carbon dioxide-equivalent (CO₂e) abated.

Abatement costs clearly matter. The lower the costs of achieving the same goal, the better. All else equal, the two jurisdictions can now afford to abate more at the same cost.

Will all else indeed be equal?

It is clear the world needs to do a lot more to stabilize greenhouse-gas concentrations. That means quickly getting net emissions of carbon dioxide going into the atmosphere to zero.

There, too, the simple textbook case can be instructive. Linking implies sending money from country H to country L to pay for the cheaper abatement. This raises important questions of baselines, accounting, and transparency. Moreover, lower abatement costs are not the only objective of climate policies. Direct support for the deployment of new, cleaner technologies often tops the list. Given the political economy of reducing greenhouse-gas emissions in the first place, there are many competing domestic objectives and indeed real tradeoffs that need attention.

The big question then is what linkage does to the overall level of policy ambition. Lower costs imply the potential for more ambitious policies. That is clearly good but the devil is in the details. It is important to assure that coordination and collaboration among different jurisdictions really do raise the level of ambition, as the Paris Declaration pledges.

It is also clear that climate policy overall ought to have a balance of bottom-up and top-down policies. Linkage is one potentially important element in that equation. The ultimate measure, however, is tons of greenhouse gases abated from the atmosphere.

This post was co-authored by Aurora Barone

In the face of havoc wrought by recent storms and hurricanes, Moody’s Investors Services, Inc. has declared that state and local bondholders must account for climate change or face downgrades. It is the first of the three major credit rating agencies to incorporate climate change risks into its ratings assessment, a move that may incentivize policymakers to make smarter, long-term investments in resilience efforts like stormwater systems or flood management programs.

Bond rating agencies like Moody’s help investors determine the risk of companies and governments defaulting on repayments. Revenue, debt levels, and financial management are all common measures of creditworthiness.

States at high risk–mainly on the coast–including Texas, Florida, Georgia and Mississippi, will have to account for how they are preparing for the adverse effects of climate change, including the effects of storms and floods, which are predicted to become more frequent and intense as temperatures climb.

In its report to its clients, Moody’s outlined parameters that it will use to assess the “exposure and overall susceptibility of U.S. states to the physical effects of climate change.” Some of these parameters include reviewing an area’s economic, institutional, fiscal strengths, and susceptibility to event risk – all of which will influence the borrower’s ability to repay debt. Coastal risks, like rising sea levels and flooding, and an increase in the frequency of extreme weather events, like tornadoes, wildfires, and storms, are just a few of the indicators that will be incorporated into the rating.

This wasn’t always the case. Take New Jersey’s Ocean County, for example. In 2012, Hurricane Sandy devastated Seaside Heights, destroying local businesses and oceanfront properties. Yet, last summer, Ocean County sold $31 million in bonds maturing over 20 years – bonds which received a perfect triple-A rating from both Moody’s and S&P Global Ratings. In 2016, major bond companies issued triple-A ratings for long-term bonds to Hilton Head and Virginia Beach, despite the U.S. Navy’s warnings that the latter faced severe threats from climate change. A recent World Bank study calculated future urban losses that many coastal cities may face because of climate change; Miami, New York, New Orleans, and Boston ranked highest in overall risk.  In March 2016, Moody’s and S&P gave top ratings to bonds issued by Boston of $150 million maturing over 20 years, evidently not accounting for any associated climate risks.

In Moody’s new effort to incorporate the risk of climate change into its ratings, it is trying to account for “immediate and observable impacts on an issuer’s infrastructure, economy and revenue base, and environment” as well as economic challenges that may result, such as “smaller crop yields, infrastructure damage, higher energy demands, and escalated recovery costs”.

The hope: in facing the threat of a rating downgrade and more expensive debt, local governments should move to implement major adaptation and resilience projects as a way to entice investors, and of course, to plan for the effects of climate change.

This post was co-authored with Beia Spiller

Since 2000, major flood and hurricane disasters have cost the nation $499.5 billion – that’s more than double what floods cost us from 1980 to 1999 – and doesn’t even reflect damages from Hurricanes Harvey, Irma, or Maria. You’d think that at a time when our nation faces greater threats from extreme weather, reducing the economic and social costs of flood disasters would be a top priority.

Instead, President Trump rescinded a requirement that federal agencies take future flood risks into greater consideration for federal projects in or affecting floodplains, setting us up for future fiscal disaster. Given the number and size of this year’s hurricanes, and the devastation they have wrought to millions of Americans, it’s clear that we aren’t doing enough to reduce the costs of these disasters. Yet, President Trump’s action, if uncorrected, will increase the costs to our country. Instead of rolling back common-sense rules meant to protect taxpayers, Congress and the administration should be ensuring that our federal investments can better withstand the impacts of flooding.

Where and how we build helps us better cope with disasters and saves money

The two best ways to minimize flood damage losses are: building outside of floodplains and building structures capable of coping with flooding. Federal agencies should be held accountable for implementing these proven best practices.

According to the Department of Homeland Security (DHS), benefits of implementing stronger building codes for natural hazards include savings from lowered insurance rates, increased property values, and reduced losses during floods. When building codes offer enhanced protection against the threats of flood-related disasters, communities recover faster and reduce the fiscal pressure on governments responding to damages.

Furthermore, designing for resiliency can be cost-effective. According to one study evaluating the effectiveness of flood building codes, constructing new buildings to withstand floods by increasing their elevation usually costs less than 1% of the total building cost for each foot they are raised. And, given the risks of flooding over time, these investments were found to pay for themselves in as little as one or two years for those areas with the highest risk of flooding. It’s noteworthy that buildings constructed after Andrew, following the more rigorous codes, withstood Irma.

In light of this, it is ironic that the most hurricane-prone state in the country could retreat from its renowned building code system given that Florida Governor Rick Scott signed into law changes to state’s system that had been adopted after Hurricane Andrew. The changes include reducing inspections and the frequency of code updates, and allowing for fewer votes from the state’s Building Commission to make further code revisions. The latter is seen by many as an opportunity for the Commission, which is dominated by contractors and construction firms, to further weaken the codes that have been seen as some of the best in the country.

From 1978-2016, FEMA paid out more than $59 trillion (in 2016 dollars) for losses associated with significant floods, with 76% of those payments occurring after 2004. Importantly, the average paid loss increased by almost 2.5 times since 1978 (even after accounting for inflation). These moves toward lowered building codes and standards will only ensure more and more costly FEMA payouts, with taxpayers footing the bill. In the long run, these actions are ultimately at odds with administrations preaching fiscal conservatism.

Investing now to save in the future

Instead of taking such unnecessary risks, cities and states should adopt more stringent risk-informed building codes and zoning, so we can start building now for a more reliable, sustainable and resilient infrastructure. Similarly, the administration should enhance flood resilience standards for federal investments, including those made as part of disaster recovery, to reduce the costs of flooding today and in the future. Doing so will improve long-term protection of human health and welfare. If we build smarter now, communities, taxpayers and nature will reap rewards in the future.

This blog was co-authored with Gernot Wagner

The Trump administration’s proposed federal budget for fiscal year 2017 slashes the Environmental Protection Agency’s (EPA) budget by 31 percent, targeting an entity that already operates with one of the smallest budgets in the government – of every 10 dollars the federal government spends, EPA only gets 2 cents.

But absolute numbers aren’t the right metric. The big question is what the public (President Trump’s employer) gets for its investment. And using that metric, the EPA generates the biggest benefits of any agency, bar none.

Between 2005 and 2015, EPA regulations produced on average $9 in benefits for every $1 spent towards compliance. These benefits include: keeping Americans safe from dirty air, water, and dangerous chemicals – all of which can cause increased hospitalizations, missed work days, premature death, and birth defects. While numerous agencies across the federal government provide vital, lifesaving services, as well, EPA has the best benefits-to-costs ratio of any U.S. agency, according to the Office of Management and Budget (OMB), which produces an annual report tallying the benefits and the costs of major federal rules for every U.S. agency.

Total numbers are even more staggering: over those ten years, EPA is responsible for $376 billion in social benefits after subtracting the costs incurred by its regulations. That’s an order of magnitude higher than any other U.S. agency.

The message is clear: EPA provides large benefits at a bargain. In fact, while a high benefit-to-cost ratio is good, the goal isn’t to maximize the ratio. The goal is to maximize net benefits to society. EPA has been extremely successful at doing exactly that. Now is not the time to walk back that kind of progress.