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Policy Responses to Global Warming under Uncertainty

This is a paper I prepared for my discussions with Des Moore at a meeting of the Economic Society of Australia, Victorian Branch.

1. Introduction

I wish to discuss three aspects of climate change policy. First, I discuss the background science and the role of uncertainty in that science. A distinction is raised between the role of the explicit scientific uncertainty that forms such an important part of the work of the Intergovernmental Panel on Climate change (IPCC) and the contrived uncertainty that is being promoted by those I will call climate change delusionists. Second, I analyse the broad economics of climate change with an emphasis on the impact of risk and uncertainty on our understanding of climate change economics. Third, I provide a critical appraisal of Australian climate change policy. A final section provides concluding remarks.

2. Climate science, uncertainty and delusionism

Scientific consensus. Modern climate science developed in the early nineteenth century from observations by Horace Saussure in the 1760s about how actual greenhouses trap the sun’s heat. In the early nineteenth century it was suggested that components of the atmosphere trapped heat energy analogously to way a greenhouse did so. These ideas were developed by famous scientists and mathematicians of the day including Fourier, Tyndall and others. In important work around 1895, Arrhenius linked the heating effect of the atmosphere to the logarithm of its CO2 concentration. Subsequent work identified other so-called greenhouse gases while branches of science, such as atmospheric physics, provided a theoretical basis for understanding the global warming issue in terms of the vibration rates of certain gas molecules in the atmosphere (IPPC, 2007, 103-106).

The predictions of this theoretical work are supported by the weight of evidence. It is now certain that warming is occurring and, with very high probability, the warming that has occurred since pre-industrial times is due to the accumulation in the atmosphere of anthropogenic greenhouse gas emissions (GGEs). These emissions are primarily linked to the burning of carbon-based fossil fuels such as coal and oil but also to modern agriculture and land clearing activities.

The consensus of scientific opinion suggests that the doubling of CO2 concentrations in the earth’s atmosphere over pre-industrial concentrations will, ignoring slower feedbacks, bring about approximate expected mean global surface temperature increase of about 30C – the Charney sensitivity. This increase will be more intense in the earth’s Polar Regions and there will be substantial regional variations.

CO2 concentrations have grown from 280 parts per million (ppm) in pre-industrial times to 379 ppm in 2005. Growth rates in global emissions over the last two years have been distorted, in a temporary and inessential way, by the effects of the global financial crisis on the demand for carbon-based fuels but, projecting smoothed emission growth trends, and ignoring the impact of active global mitigation program, a doubling of GGE concentrations should occur in less than 40 years.

Science and uncertainty. Much information has been accumulated about the process by which climate change is occurring. The degree of certainty regarding the anthropogenic warming hypothesis has strengthened although, paradoxically, the range of temperature forecasts remains substantial. The range of forecasts in the third and fourth IPCC Assessment reports has not narrowed so that it is clear that the increased knowledge has heightened awareness of the uncertainties as much as the certainties.

For example, the Charney temperature sensitivities are now known to reflect only a narrow range of short-run simple climatic drivers. These sensitivities assume that land surface, ice sheet and atmospheric compositions in terms of chemistry and aerosol composition remain the same. Longer run sensitivity measures such as Hansen’s long-term sensitivity (the Earth System sensitivity or ESS) allow these factors to vary to vary and feed-back to help determine climate (Hansen et al., 2008). The ESS suggests that global mean surface temperatures will rise 6oC with a doubling of CO2 concentrations over hundreds of years rather than a few decades. Decisions to include specific feedback effects in a sensitivity measure are based on the timescale and complexity of the feedback process. Slow feedbacks have been excluded until recently as have complex feedbacks due to changed ozone/aerosol concentrations. In principle measures, such as the ESS, can be deduced from paleoclimatic records but such estimates need accurate data on global temperatures as well as the various forcings that operated during these periods. This information is difficult to obtain.

Science does not have perfect information about how climate sensitivities vary with time horizon and the various forcings. For example, some feedbacks drive higher sensitivities and aerosol cleanup may ‘unmask’ greater heating. Ice sheet melting as a consequence of warming creates stronger long-run heating responses through reduced albedo (heat reflection) effects.

A fear by many is that the current climatic situation is deteriorating. That 11 of the 12 years over the interval 1995-2006 were among 12 warmest since 1850 highlights concerns about the sensitivity assessment (IPCC, 2007, p. 5).

 It is worth emphasizing that modern science has made no attempt to conceal its knowledge uncertainties. The IPCC Assessment reports focus on uncertainty with, for example, extensive discussion of the problematic role of clouds, aerosols, Antarctic sea ice and so on as climate drivers. Indeed, in The Physical Science Basis Report (IPCC, 2007, p. 81-91) there are 43 key uncertainties listed in relation to natural/human climate drivers, 6 on global projections, 2 on sea level changes and 3 on regional forecasts. None of these issues are minutiae. It is wrong to portray the IPCC institution as comprising propagandist, greenies since their reports include informed scientific views addressing uncertainty.

Delusionism. The key question some sections of the media and politically right wing groups seek to make prominent is whether the entire science of climate change is wrong. The science would be wrong if it were not the case that human beings are significantly altering the world’s climate – if the anthropogenic global warming hypothesis (AGWH) was false.

This question of the believability of the science was examined in the Garnaut Review. Ross Garnaut in a recent speech (Garnaut, 2009) where he commented on his earlier work argued:

“The Review accepted the views of mainstream science ‘on a balance of probabilities’. There is a chance that it is wrong. But it is just a chance. To heed instead the views of the small minority of genuine sceptics in the relevant scientific communities would be to hide from reality. It would be imprudent beyond the normal limits of human irrationality.”

This seems indisputable. It is sensible to act on the presumption that the mainstream science is correct and extremely imprudent to suppose otherwise.

Oreskes (2009) confirmed Garnaut’s presumption that almost all climate scientists support the AGWH in a bibliographic survey which found no explicit rejections of the hypothesis in the published scientific literature. In a recent study Doran and Zimmerman (2009) found overwhelming support for the AGWH with 75 out of 79 climatologists affirming belief in this hypothesis. Quoting Doran and Zimmerman (2009):

“It seems that the debate on the authenticity of global warming and the role played by human activity is largely nonexistent among those who understand the nuances and scientific basis of long-term climate processes. The challenge, rather, appears to be how to effectively communicate this fact to policy makers and to a public that continues to mistakenly perceive debate among scientists”.

Doubts about AGWH do not reflect the state of science although there is a mistaken public perception that there is a substantial scientific debate. It is worthwhile trying to understand how this false perception has developed.

The politics of climate change was driven decisively by a paper of Revelle and Suess (1957) which argued that global heating on the basis of anthropogenic CO2 emissions was a significant policy concern. Human use of fossil fuels amounted to a “large scale geophysical experiment”. Through to the early 1990s there emerged a consensus of international political opinion that led to the 1992 Climate Convention and to an ongoing role for the IPCC.

From the late 1980s however organised groups emerged who denied AGWH and who sought to force a public debate on whether AGWH was believable. This group comprise a tiny group of respectable sceptical scientists, a larger group who manufacture delusions on many topics for a living and a still larger group of conservatives who accept ideologically convenient delusions. These groups interact to a considerable extent and I label them collectively as the delusionists. This well-funded group have worked to create and disseminate uncertainty, ignorance and confusion on climate change issues. They have been extraordinarily successful with much of the political right in Australia and almost all in the US being seduced and deluded into thinking the climate change problem is illusory. In Australia most National Party MPs, many in the Liberal Party and a few in the Labor Party endorse delusionism.

It is important that the delusionist groups be revealed for what they are namely as an influential political movement which rejects mainstream science. In the US these groups centre on the George C. Marshall Institute and the Heartland Institute. In the past these groups have suggested that passive smoking may not cause health damages, that CFCs in the atmosphere caused the hole in the ozone layer hole, and that SO2 caused acid rain. None of these claims stand up to scrutiny. Furthermore it is a matter of public record that these groups have in the past received funding from Exxon-Mobil while their officials (e.g. Fred Singer, Frederick Seitz) have worked for the tobacco companies.

Australian delusionism draws heavily on US and UK delusionism. An important Australian offshoot is the Lavoisier Group. This group has enjoyed success in influencing public opinion beyond its due.

A major activity of delusionist groups is to create the false impression of a substantive debate in climate science whereas, as Oreskes (2007), Doran and Zimmerman (2009) show, there is none. The false inference that there is a substantive debate is further twisted to suggest that the case for activist climate policies is somehow weakened by the existence of such a debate. The implication that the falsely identified doubt implies no case for policy is a further foolish conclusion in several senses but importantly since, with correctly specified uncertainty, things might be ‘worse’ not ‘better’ than expected as is discussed further below intensifying the case for activist policy.

An alarming feature of delusionist activity is the repetition of discredited or heavily criticised viewpoints. An example is the repeated reputed claim that global warming stopped in the 10 years after 1998. This was rejected using evidence collated during the preparation of the Garnaut Review and by statisticians and climate scientists on numerous occasions since then. The claim is still repeated mostly without any reference to the contrary claims by eminently qualified statisticians and climatologists (Breusch and Vahid, 2008; Fawcett and Jones, 2008) that argue emphatically that the claim is false.

Delusionism is fostered In Australia by spurious press balance ideas according to which any view no matter how far-fetched has a right to equal treatment in the public domain. Academics, such as the geologist Professor Ian Plimer, promote delusionism in Australia through books such as Heaven and Earth which categorically deny AGWH. Plimer has never published a refereed scientific paper in the field of climate science and much of the analysis in this book is inconsistent with the carefully argued science.

As an economist it is not my right or role to comment on the veracity of mainstream science. Indeed I generally refuse to debate the mainstream science of climate and believe that economists whose policy preferences are defended by rejecting science have lost their bearings. I do however read the science and am familiar with the arguments peddled by delusionists. Rebuttals to these arguments are simple to find in the scientific literature (e.g. IPCC, 2007). But there is no more reason to question the validity of science than to take seriously the crank monetary theories that are sometimes pushed by physicists .

3. Climate change economics

Climate change economics seeks to determine the economic impacts of unmitigated climate change and the costs of mitigating and/or adapting to it at the global level or the level of an individual project such as, for example, a forest planting. Given these estimates the case for policy reverts to a cost-benefit analysis based on opportunity costs. What are the costs of pursuing active climate policy compared to the costs of not doing so?

Inputs into this endeavour include information from science-based models that link the emission of greenhouse gases to climate changes and to the damage functions that suggest the costs that will be inflicted by such temperature changes. There is also a need to forecast the human responses, such as climatic adaptations and the induced innovations that will be associated with climatic changes. This is an ambitious task.

Cost benefit analysis. There are problems of valuing the damages climate change will inflict on societies and, with demand and technology uncertainties, the costs of policies designed to offset such damages. But even apart from such valuation issues the complexity of climate policy analysis is driven by its formal character as an instance of cost-benefit analysis (CBA). The ingredients of this CBA involve several types of irreversibility coupled with learning processes, nonlinear responses and threshold effects all thrown together in an intrinsically dynamic setting where uncertainty is an ingredient. These CBA tasks can be analysed in what economists call a ‘real options’ setting (see Pindyck, 2006). There are distinctive features of such problems.

Analysts are highly uncertain about the extent of likely climate change, of associated costs and hence of the viability of various technological fixes such as carbon capture and storage (CCS). They have information about these issues but can expect to learn more as the future unfolds. Thus information about climate evolution and valuations are stochastic processes. These learning dynamics supplement the uncertain intrinsic dynamics associated with the accumulation of the stock GGE pollutants in the atmosphere.

There are also potential sunk cost irreversibilities and non-linearities associated with threshold effects. First, there are sunk cost irreversibilities associated with investment designed to address climate change effects that will involve irretrievable waste should business-as-usual climate change costs prove less costly than forecast. These irreversibilities motivate policy-makers to delay and de-intensify policy responses until better information becomes available. These irreversibilities are partially offset by the increasing costs of abatement that can arise with delays in responding. For example, incurring the incremental costs of expanding electricity supplies using carbon-friendly technologies are lower than replacing pre-existing carbon intensive technologies with those that are carbon friendly. Delay therefore locks in emissions-intensive infrastructure which constrains future abilities to mitigate. This is especially true for developing countries where incremental costs of energy capacity are much lower than replacement costs (Tony Blair, 2009).

There are also irreversibilities associated with potential threshold effects that give rise to catastrophic outcomes. With respect to biodiversity conservation, climate change induced species extinctions are irreversible costs while steadily worsening climate change generally might induce non-linear cost responses if ice sheets or the Arctic permafrost melts. Provided that policy actions can address these concerns the prospect of such phenomena motivate policy-makers to seek prompt and intense responses.

The differing sunk cost and environmental irreversibilities tug policy analysis in opposite directions. The sunk cost irreversibilities encouraging delay in order to learn while the prospects of catastrophic irreversibilities motivating decisive action now. Pindyck (2006) has sought via numerical simulations to find out which effects dominate – his emphasis is on sunk cost effects – but as he has no real world data his arguments are somewhat unpersuasive. Some qualitative insights can however be drawn.

Any policy measure which reduces possible sunk costs increases the case for immediate, decisive action. For example sunk cost irreversibilities are lower if investments provide ‘no regrets’ benefits as payoffs even should climate change be less damaging than expected. Clean power technologies provide useful local environmental benefits while enhanced biodiversity conservation programs provide valuable spill-over benefits in promoting agricultural sustainability even should they prove to be based on overly pessimistic climate assumptions. Simply put less of the ‘sunk costs’ in these situations are now sunk.

Reducing the prospects of catastrophic damages on the other hand delivers increased policy-maker flexibility by putting less weight on feared outcomes. Geo-engineering carbon clean-up options even if it comes at high cost or costly captive breeding programs to limit climate induced species extinctions provide backstop technologies that give policy-makers extra time to learn about prospects and implications of severe climate change.

As a general theoretical paradigm policy-makers should think of climate change issues using this ‘real options’ perspective. This amounts to using CBA under conditions of risk where irreversibility interacts with structural and learning dynamics. It means that it will be inappropriate to account for uncertainty by replacing random variables by their expected values since the effects of waiting-to-learn and of delay must be accounted for.

Discounting. What weight should be placed on current people’s welfare relative to the welfare of our children and on that of future generations? Should market or intergenerational equity-based discount rates be used in valuing future costs and benefits? This is a matter of practical importance. Climate economists like Stern (2007) use a discount rate of 1.4 per cent which values a dollar of benefits to be received in 32 years at 73 cents while Nordhaus (2008) prefers 3 per cent putting a current valuation on the same dollar of 38 cents.

It is important to understand that a 3 per cent choice has major intra-generational implications. This choice puts a weight on my 11 year old son’s welfare in 32 years of 0.38 which is less than I think is appropriate. Hence a 3 per cent discount rate is too high for me given my intra-generational objectives. I am more comfortable with low Stern-type discount rates because I wish to provide a sound environmental future for my children.

The choice of discount rate is an uncertain issue but the convexity of the discount factor in the discount rate meaqns that, if an expected rate is to be used, it should be ‘small’ (Pindyck, 2007). Thus suppose the expected present value of a $100 benefit to be received 100 years from now is to be determined but that the discount rate is either 0 or 10 per cent each with probability ½. At the expected value of the discount rate, 5 per cent, $100 has a present value less than $1. But the expected present value is ½($100) + ½($0) = $50 and the discount rate applied to a $100 benefit to be received in 100 years that yields a present value of $50 is 0.7 per cent. Thus even though the expected value of the discount rate is 5 per cent, uncertainty over its value implies an effective discount rate of less than 1 per cent.

Risky damages. Furthermore environmental damages themselves are certainly convex in future temperatures – they increase with higher temperatures at an increasing rate. Therefore supose the IPCC forecast of a 3oC increase in global mean surface temperature is associated with moderate economic damage equivalent, for example, to 5-10 per cent of GDP depending on how environmental damages are to be assessed. If the IPCC forecast is a mean forecast it can be interpreted as a forecast of 2oC with 50 per cent probability and 4oC with 50 per cent probability, or with greater uncertainty, as a forecast of 0oC with 50 per cent probability and 6oC with 50 per cent probability. With no warming there are no damages but with an equal probability of warming of 60C there would be catastrophic costs and certainly something to be avoided. More uncertainty implies a stronger case for decisive climate change policy action.

This issue can be looked at in a different way. Suppose there are various possible future climate states contingent on current climate policies but one state where catastrophic costs (for example, melting of the Greenland ice sheet and hence drastic sea level rises) occur with non-negligible probability. Then rational policy makers should act to avoid that state irrespective of discount rates or even strategic concerns in relation to the policies of other countries. The prospect of preventable catastrophes at non-negligible probabilities favour unilateralism and prompt policy action in relation to climate change (Clarke and Reed, 2006).

Knightian uncertainty. These probabilistic insights are ‘as if’ implications since, for the most part information about probabilities is not provided by climate science. Insights can however be sought in settings with pure Knightian uncertainty with ‘unknown unknowns’.

One approach attempted here is the use of classical decision rules not involving use of probability information (Clarke, 2008). For example the Precautionary Principle (PP) can be understood as an attempt to avoid severe costs by advocating policy actions to avoid the worst possible outcomes. This can be interpreted as a version of the classical Minimax Principle which seeks actions which minimise the worst that can occur. This plausible-sounding heuristic is however unhelpful unless the policy-maker can be certain that costly policy, once it needs to be undertaken, will not fail. Unless this is so the most costly outcome is that a costly policy is undertaken incurring a policy cost but that it fails so that a climate change cost arises. From this perspective PP would provide the counterintuitive instruction to always remain policy inactive.

An alternative approach that does underlies much modern policy thinking and which does lend a conditional support for policy activism is the Minimax Regret heuristic. Here policy interventions are taken if unmitigated climate change occurs involving possibly substantial costs which could have been avoided at much lower current cost, thus potentially creating a a source of regret. This heuristic provides a probability-free insurance heuristic that many of us doubtless use in everyday life. Inexpensive policy will now be undertaken if it addresses concerns that might have vast cost if left unaddressed but if climate change proves not to be as serious as thought the opportunity losses are low. This case for policy disappears if policy costs are only ‘somewhat’ less than the costs avoided without policy but, as is argued below, empirical evidence from various perspectives confirms that policy costs are much lower than possible costs of not taking action.

Finally, there are heuristic reasons for responding to policy uncertainty by both diversifying the choice of policy options and by retaining, as an option, the facility to introduce, perhaps expensive, backup options. In various climate policy settings various policy approaches should be employed without a telescopic committed focus on a particular approach. Where possible a portfolio of policies should be explored and policy choice should be adaptive and sensitive to the unexpected. Backstop insurance options should be researched and retained as longer term options should current policy fail. For example, if mitigation options should fail to be effective, geo-engineering approaches involving, for example, the direct removal of CO2 from the atmosphere can provide a backstop technology as insurance against disaster. Hansen et al. (2008) conjecture that, at $200/tC, CO2 can be directly removed from the atmosphere. The cost of removing 50 ppm of CO2 globally would be ~$20 trillion. Such policies can be unilaterally developed and implemented by a wealthy superpower without the ‘free-rider’ issues that thwart more conventional mitigation strategies that rely on international cooperation.

With respect to biodiversity conservation proposals to strengthen existing reserves by expanding their size in isolation might be pursued to minimise the risks arising from unsought species migrations. Other strategies that should also be independently considered might involve almost the opposite strategy of linking up existing reserves to facilitate sought migrations (see Dunlop and Brown, 2008). If these strategies jointly appear likely to fail backstops include captive breeding programs.

On secondary energy technologies there are substantial uncertainties on the commercial potential of low CO2 technology options and fourth generation nuclear power. There are, for example, specific issues of the economic viability of CCS technologies which would not seem to be economic at carbon prices much less than $60US/ton. At this stage a portfolio of technologies should be researched (renewable, nuclear) with a focus on CCS.

Focusing on CCS alone and on renewable technologies such as solar and wind is imprudent given the imperatives Australia will face to dramatically cut its GGEs by 2050. The possibility of a major shift toward nuclear fuels should be entertained. Nuclear fuels have potential economic advantages over coal, gas and wind technologies once environmental costs are accounted for and nuclear power involves negligible carbon emissions. In 2004 France generated slightly less than 80 per cent of its electricity using nuclear power and emitted about 9.3 tonnes of CO2 per head in 2003. Australia that year emitted 26.1 tonnes of CO2 per capita (figures from the UN’s Globalis websites). Suppose the world agrees to reduce its aggregate carbon emissions from 50 mega-tonnes now to less than 20 mega-tonnes by 2050 to avoid more than 2oC of warming. This is 2.2 tonnes per person in 2050 with an estimated population then of 9.1 billion. To achieve this France would need to cut its GGE emissions to less than one quarter of current levels. Australia however would need to cut its emissions to about one twelfth of their current levels!

Despite the uncertainties concerning various particular aspects of climate change economics there is an economic consensus on these issues that parallels the consensus in climate science. Most economists agree, for example, that while some countries benefit most lose with limited climate change. All lose with substantial change because positive effects on agriculture then disappear (Stern, 2006, p. 62).

In addition, even with substantial uncertainties there is a presumption that the cost of active policy is low relative to cost of doing nothing. As evidence note that the Stern Review (2007) estimate the cost of stabilising at 500-550 ppm at ≈ 1 per cent of world GDP whereas the costs of not addressing climate change are 20 per cent of GDP. The IPPC (2007b) estimate the 2030 costs of stabilising at from 445-535 ppm at less than 3 per cent of GDP with growth of GDP reduced by less than 0.12 per cent. Nordhaus (2008) targets lower levels of cutback than does Stern (and Nordhaus is very critical of Stern) but nevertheless estimates optimal costs of abatement at only 0.1 per cent of discounted world income. Finally, Weitzman (2009) has focused on possible catastrophic costs of not abating. Gradually ramping up climate change policies over the next 200 years creates significant global catastrophic risks and huge costs. There is a 5 per cent probability of a mean global surface temperature increase of greater than 10oC and a 1 per cent probability of an increase of greater than 20oC.

Taken together these studies employ distinct modelling strategies but a consensus is that mitigation costs are low relative to the costs of not addressing climate change.

While this is a basis for optimism, GGEs have grown by 70 per cent from 1970-2004. Most growth has come from the global electricity sector (145 per cent) (IPCC, 2007). Global energy intensities – energy consumption per unit output – have decreased but not by enough to avoid being by the effects of income and population growth. GGE mitigation policies have not yet worked to stall emissions growth. Moreover, policies as they currently stand will fail. From 2000-2030 GGEs will grow strongly with three quarters coming from developing countries. There is no basis for complacency.

4. Australian climate change policy

Australia will be impacted on heavily by unmitigated climate change because it is a ‘fringe climate’ society. Australia has high gross per capita emissions but is a ‘small’ country in terms of aggregate GGE emissions. Globally the US and China provide 50 per cent of total GGEs, another 15 countries provide a further 30 per cent and another 158 provide 20 per cent (Baumart, 2005). Therefore, in aggregate, small countries are important polluters. In addition, for a viable global climate change response post-Kyoto, poor and developing countries must begin to mitigate emissions in the medium term. Australia should not provide negative moral suasion by refusing to accept its share of the international policy response (Clarke, 2009).

Australia’s policy position can be exposited in terms mitigation and adaptation policies as well as by its attitude toward forthcoming international climate change agreements.

Mitigation. Governments can employ various policy instruments to encourage GGE cuts. They can, for example, prescribe energy consumption or energy production targets. However economic instruments, which rely on price changes to induce changes in emission behaviour, have advantages over prescriptive targets. Pricing GGEs generates broad supply and demand responses to climate problems that reflect both energy prices and the costs of altering emission behaviour. Prescriptive target setting is a more expensive policy because regulators cannot identify the costs different agents face in meeting these policies.

There is a debate about the case for using a GGE tax or a national emission trading scheme (ETS) based on targeted aggregate emissions. There are costs and benefits with each approach although choosing either policy is a decisive advance over choosing neither. For the most part choice between these policies is an issue of second-order importance. Setting carbon prices by imposing a tax means, with uncertain markets, that the extent of mitigation will be uncertain which is unattractive if a particular level of emission cuts is sought. Setting emission quotas using an ETS will leave carbon prices buffeted by market conditions creating price uncertainty and futures markets in carbon quota sales. With an ETS carbon prices will show significant month-to-month variations that make investment planning in firms more difficult although, longer-term, carbon prices that fall during periods of recession and which increase during booms provide an automatic macroeconomic economic stabiliser. The claim that carbon taxes make it difficult for interest group bargaining to secure exemptions is unproven – it is as easy to argue for a tax break as a free emissions permit. If either tax revenues or revenues from auctioned quotas are used to cut other more distorting taxes then further double dividend advantages may accrue.

An advantage of a global ETS is that improved opportunities to trade permits mean lower mitigation costs: costs are estimated to fall by 20 per cent (Tony Blair, 2009).

Since the Australian carbon pollution reduction scheme (CPRS) is an ETS this is the focus here. It will be phased in with unlimited permits at $10/tCO2 from 2011/12 with full permit auctioning from 2012/13 at what is expected to be around $29/tCO2. This will yield revenues of about $13b in 2012/13 which will be returned to households ($5b), fuel excise offsets ($2.2b), trade-exposed firms ($3.6b) and to electricity generators ($0.8b) (DCL, 2009). Caps will be pre-announced for first few years but subsequent caps will depend on 2020 targets that will be determined once the rest-of-the-world announces its cutbacks.

The structure of the CPRS is production-based with some free quotas allocated to trade exposed firms and generators of non-traded secondary energy and with income compensations for electricity consumers that make consumers respond only to the pure substitution effects of electricity price changes. Indeed electricity prices will rise about 25 per cent in 2012/13 with consumers being income-compensated for the higher prices.

There will be significant longer-term impacts of the CPRS on coal which is both Australia’s main source of electrical energy and Australia’s biggest export. There are strong effects on brown coal generators although 93 per cent of such capacity will still be in place by 2020 (Garnaut, 2007, p 491). There is the potential for substitution by nuclear power and renewables although there is limited engineering capacity to introduce nuclear technology – there is, for example, no school of nuclear engineering at any Australian university. Considering a mix of alternative energy sources ex ante makes sense given that the alternatives have cost advantage at differing carbon prices and interest rates. As Garnaut stresses there are significant potential payoffs to developing ‘clean coal’ (CCS) in cutting our own emissions and in securing valuable export markets. At present CCS is a technically feasible technology but its commercial potential remains unclear.

The CPRS is a useful start at providing a comprehensive demand management policy although it can be improved.

The scheme as it stands is production-based but its free quota distributions give it a partial consumption basis. A better scheme would begin with a CPRS based on consumption so carbon-intensive exports were exempted from the need to comply with emissions quotas and with all carbon-intensive imports from countries, which do not impose comparable carbon emission controls on a production basis, being subject to a border tax. Such BTAs are probably not inconsistent with the rules of the GATT (Tamiotti et al., 2009) since they operate essentially as a consumption tax. Such a scheme would resemble the longer-term ETS proposed in the US by the Waxman-Markey Bill. The consumption base provides incentives for other countries to tax their exports on a production basis and longer-term, when enough do so, Australia too can switch to a production-based tax without either exemptions for exports or border taxes on imports.

Consistent with this position there should be no free carbon permits to Australian electricity producers. Exporters which use electricity as an input would be eligible for rebates.

In addition, it has been pointed out that voluntary action to reduce GGE emissions will in the ineffectual since the effect of such actions will be to reduce the carbon price. This can be most easily addressed by buying ‘saved’ allowances back, by reducing emission caps or by more elaborate schemes such as the CEEM’s Additional Action Reserves (Betz, 2009).

The policy of assigning firms free carbon quotas has the undesirable consequence that such quotas must be used to be effective. It would be better to make such quotas tradeable and to then use the revenues to fund energy-saving adjustments.

Finally, there is probably no need for explicit renewable targets – and inefficiencies might stem from setting such targets – if the 2020 carbon price is around $50/tonne. Markets will then efficiently determine the viability of non-carbon based energy technologies with such a carbon price.

If markets worked perfectly then setting the correct carbon price will be all that is needed. However various market imperfections exist related to the supply of information for consumers and producers and for developing and transferring new energy-saving and carbon friendly technologies. These create a case for public support by providing information and by explicit subsidies. Such support will make the CPRS more effective.

Adaptation. Australia can pursue a timely, successful agreement to replace the Kyoto Protocol but would be foolish to assume that such an agreement will be either prompt or entirely successful. Plausibly the world can expect 1.8-2oC warming over pre-industrial temperatures from existing GGE concentrations so there is a case for policies which seek an adaptation to climate change in agriculture, industry, urban settlements and in the conservation of Australia’s biodiversity resources.

Adaptation investments are not subject to the ‘public goods’ market failure issues associated with mitigating climate change although, if mitigation is undersupplied globally, private incentives to adapt to many aspects of climate change are enhanced on the basis of private self-interest. Conversely, incentives to mitigate are reduced when active adaptation policies are in place but, if only adaptation policies are pursued globally, nations are engaged in a race toward collective disaster.

With respect to adaptation there is therefore greater potential to rely on market-driven responses and on policy responses which seek to encourage market-driven responses. In agriculture, for example, it has been widely observed that farmers are skilful at adapting to the vagaries of climate. Indeed their livelihood often depends on the capacity to make such adaptations. Provided that climate change is not proceeding too quickly, that prices for current outputs are not deteriorating too rapidly and that farmers can revise their production plans quickly enough farmers can make market-based adaptations that will come close to optimising their welfare. The only role for public policy is to provide climate information and to expand the range of technological options farmers have as they experience climate change (Clarke, 2009c). Public good market failures mean these informational investments as well as R&D need to be a focus. Of course policies which reduce the need to adapt – such as ‘exceptional circumstances’ drought relief – need to be either redesigned, or as the Productivity Commission (2009) has suggested, abolished.

Urban sector adaptations involve planning water and waste water infrastructure expansions and transport network designs need to be configured so climate change is either factored into the expansion decision or options are left to expand eventual capacity at low cost. . There is also a role for public planning with respect to disaster preparedness concerns.

Many other issues can also be market-driven again on the basis of campaigns to increase private sector awareness of the implications of climate change. Building roof colour, use of insulation and house location choice in relation to sea level change threats are decisions best kept private on the basis of, perhaps, publicly-boosted information about climate change consequences and such things as opportunities for improved energy efficiencies.

Adaptation policies cannot always be primarily private. There are no markets for the supply of biodiversity in Australia so that market-based solutions will not work here. There is a need to manage the national reserve system while promoting conservation and corridors on private land (Clarke, 2007). With respect to enhanced conservational investments there are significant ‘no regrets’ benefits even if climate change proves less extensive than expected.

Policies helping the global response. Australia ratified the Kyoto Protocol on the 3 December 2007. This sent a good ‘moral suasion’ message about Australia’s climate change policy intentions even if it had limited immediate effect and, even though the force of the Protocol will expire in 2012. In 2012 a new co-operative international agreement needs to be signed and the Australian Government has pledged a series of unconditional and conditional GGE reductions for an initial meeting to determine such an agreement in Copenhagen in November/December 2009. Australia offers a low level unconditional GGE target and higher conditional targets that match the offerings of other countries.

Australian Government plan commits to match a comprehensive agreement in Copenhagen. If there is no agreement in Copenhagen then Australia offers an unconditional 5 per cent cut over 2000 GGE levels by 2020. If other countries target a 510-540 ppm GGE target by 2050 then Australia offer a conditional 15 per cent cut over 2000 levels by 2020. Finally if other countries agree to target a 450 ppm agreement then Australia will offer a conditional 25 per cent cut over 2000 levels by 2020 with up to 5 per cent by deforestation credits.

The mix of conditional and unconditional targets is reasonable though the Green movement in Australia argued that still more ambitious targets of 330 ppm or lower should have been pursued. This is not sensible if targeting such low GGE levels limits the potential for achieving any collective agreement at all. It seems more sensible to target emission cuts that are plausibly achievable now and to seek tighter cuts in the future.

To enhance the prospect of gaining cooperation from developing countries Australia should agree to a common emissions entitlement per person by 2050 as suggested in the Garnaut Review.

5. Final remarks.

Economists should base their policy views on the mainstream science of climate change. This science accounts makes explicit a range of significant uncertainties and involves primarily belief in the view that human beings are significantly impacting on the global climate. To avoid taking policy action on the basis of the implausible views of a handful of practicing scientists who do not endorse this primary view would be folly.

The core economics of climate change policy amount to comparing the opportunity costs of taking policy actions with the costs of not taking action. This is an ambitious field because there are significant issues of uncertainty, the setting is intrinsically dynamic and there are important non-linearities and irreversibilities. Conceptually the way to proceed is to use cost benefit analysis which correctly accounts for uncertainty when there are significant irreversibilities.

Australian policy has made a credible start to initiating climate change adaptations and mitigations locally and has a reasonable stance toward international negotiations. Ultimately Australia needs a more comprehensive and integrated energy use plan that will provide a closed loop approach to commercialising non carbon polluting secondary energy technologies. As the Garnaut Review makes clear, Australia gains enormously with CCS technology development and transfer so this is a sound R&D focus. Another sensible focus is agriculture which is a significant contributor to GGE emissions but also carbon sequestration synergies with sustainable agriculture.

Over the coming decades Australia and other countries need to think about pursuing stricter GGE targets with eventual aim of restoring pre-industrial GGE levels. This will eliminate longer-term impacts of GGE emissions on climate.

References.

K. A. Baumert, T. Herzog & J. Pershing, Navigating the Numbers: Greenhouse Gas Data and International Climate Policy, World Resources Institute, 2005.

T. Breusch & F. Vahid, ‘Global Temperature Trends’, College of Business and Economics, Working Paper No. 495, Australian National University, April 2008.

R. Betz, ‘The Concept of the Additional Action Reserve’, Centre for Energy and Environmental Markets, University of New South Wales, Sydney, June, 2009. http://www.ceem.unsw.edu.au/content/userDocs/AdditionalActionReserve.pdf.

H. Clarke, ‘Agricultural adaptations to climate change: Roles for planning and for markets’, mimeographed, 2008.

H. Clarke, ‘Classical Decision Rules and the Economics of Climate Change’, Australian Journal of Agricultural and Resource Economics, 52, 2008, 487-504.

H. Clarke, ‘Conserving Biodiversity in the Face of Climate Change’, Agenda, 14, 2, 2007, 157-170. Reprinted in P.S. Ranade (ed) Climate Change and Biodiversity: Perspectives and Mitigation Strategies, ICFAI University Press, Hyderabad, India, 2008, 190-209.

H. Clarke, ‘Strategic Issues in Global Climate Change Policy’, Australian Journal of Agricultural and Resource Economics, forthcoming 2009a.

H. Clarke, ‘Carbon Leakages, Free Riders and International Climate Change Agreements’, mimeographed, September, 2009b.

H. Clarke & W. Reed, ‘Consumption/Pollution Tradeoffs in an Environment Vulnerable to Pollution-Related Catastrophic Collapse’, in M. Hoel (ed) Recent Developments in Environmental Economics, Critical Writings in Economics, Elgar Reference, 2006, 497-516.

Department of Climate Change, Revised Fiscal Impact of the Carbon Pollution Reduction Scheme (CPRS), Fact Sheet, Department of Climate Change, Canberra, May, 2009.

P. Doran & M. Zimmerman, ‘Examining the Scientific Consensus on Climate Change’, Eos, 20, January 2009.

M. Dunlop & P. Brown, Implications of climate change for Australia’s National Reserve System: A Preliminary Assessment. Report to the Department of Climate Change, 2008.

R. Fawcett and D. Jones, ‘Waiting for Global Warming’, National Climate Centre, Australian Bureau of Meteorology, mimeographed, April, 2008.

R. Garnaut, The Garnaut Climate Change Review, Final Report, Cambridge University Press, Cambridge, 2008.

R. Garnaut, ‘One Year After the Garnaut Climate Change Review’, Speech reported at the East Asia Forum Blog, September 21, 2009. Accessed at:

http://www.eastasiaforum.org/2009/09/21/one-year-after-the-garnaut-climate-change-review/

J. Hansen, M. Sato, P. Kharecha, D. Beerling, R. Berner, V. Masson-Delmotte, M. Pagani , M. Raymo, D. L. Royer & J. C. Zachos, ‘Target Atmospheric CO2: Where Should Humanity Aim?’, Open Atmosheric Science Journal, 2, 2008, 217-231.

IPPC, 2007: Climate Change 2007, Mitigation of Climate Change. Contribution of Working Group III to the Fourth assessment Report of the Intergovernmental Panel on Climate Change, Cambridge University Press, Cambridge, UK and New York, NY, USA, 2007.

IPPC, 2007: Climate Change 2007: The Physical Science Basis. Contribution of Working Group 1 to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change, Cambridge University Press, Cambridge, UK and New York, NY, USA, 2007.

N. Oreskes, ‘The Scientific Consensus on Climate Change: How Do We Know We’re Not Wrong?’ in J. DiMento & P. Doughman, Climate Change, MIT Press, Cambridge, MA, 2007.

R. Pindyck, ‘Uncertainty In Environmental Economics’, National Bureau of Economic Research, Working Paper, 12752, December 2006.

I. Plimer, Heaven and Earth- Global Warming: The Missing Science, Neilsen Bookscan May 2, 2009.

Productivity Commission, Government Drought Support, Productivity Commission Inquiry Report, February 2009.

N. Stern, The Economics of Climate Change: The Stern Review, Cambridge University Press, Cambridge, 2007.

L. Tamiotti, R. Teh, V. Kulaçoğlu, A. Olhoff, B. Simmons, V. Kulaçoğlu, H. Abaza, Trade and Climate Change WTO-UNEP Report, World Trade Organisation, 2009.

The Climate Group, Breaking the Climate Deadlock: The Economic Benefits of Collaborative Climate Action, Office of Tony Blair, September 2009.

W. Nordhaus, A Question of Balance, Yale University Press, New Haven, 2008.

M. Weitzman, ‘On Modeling and Interpreting the Economics of Catastrophic Climate Change’, Review of Economics and Statistics, 91, February, 2009, 1-19. (2098)

2 comments to Policy Responses to Global Warming under Uncertainty

  • derrida derider

    I expect you won hands down. I’ve never been much impressed with Mr Moore’s acumen, and even less with his respect for awkward facts. I reckon there are rightwing thinktank denizens who are much more worth engaging with.

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