June 12, 2009

"Hedge your bets"

Neither Taxing Nor Rationing CO2 Survives Cost Vs. Benefit Analysis

Somebody should tell Energy Secretary Steven Chu that commencement speakers are supposed to give new graduates good advice. His Harvard commencement address last Thursday laid out some pretty poor premises for addressing the challenge of climate change:

If the world continues on a business-as-usual path, the Intergovernmental Panel on Climate Change predicts that there is a 50-50 chance the temperature change will exceed five degrees by the end of this century. . . . A world 5 degrees warmer will be a very different place.

The change will be so rapid that many species, including us, will have a hard time adapting.

That sounds scary, but there are some problems with it.

One is that the Intergovernmental Panel on Climate Change (IPCC) wisely avoids asserting a "business as usual" path, because it recognizes the difficulty in projecting world economic and population growth over a century. Instead, it describes six "marker scenarios" for global development and provides probability distributions for projected warming under each.

Under no marker scenario does the IPCC project a 50-50 chance of more than 5 degrees Celsius warming by 2100. Expected warming by scenario ranges from a low of 1.80C to a high of 4C. A more realistic representation of the over-under bet from the IPCC's current assessment report is about 3C of warming by 2100.

A second is that, according to the IPCC, a global temperature increase of 4C should cost the world about 3% of economic output. So if we do not take measures to ameliorate global warming, the world should expect to be about 3% poorer than it otherwise would be sometime well after 2100.

Because we expect secular economic growth, this 22nd century world should still be far richer, even after warming damages, than our world is today. This doesn't quite comport with the rhetoric of global devastation.

Trying to avoid these potential future damages wouldn't be free. Yale professor William Nordhaus, arguably the world's pre-eminent authority on this trade-off, uses the probability distributions for potential impacts to estimate that the total expected net benefit of an optimally designed, implemented and enforced global carbon tax equals about 0.2% of the present value of future global economic consumption.

We won't get an optimal regime in the real world of domestic politics and geostrategic competition. The economic drag created by the deals necessary for such a global arrangement means that the expected benefits of global emissions mitigation would not cover expected costs.

The concrete political decision in front of us with respect to climate change is the proposed Waxman-Markey bill to ration U.S. greenhouse gas emissions. Not surprisingly, given the prior analysis, it is a terrible deal for American taxpayers.

Even using extremely favorable assumptions, the Environmental Protection Agency estimated that it will reduce the consumption of a typical U.S. household by about 0.8% by 2050. Standard climate models project that it will reduce temperatures on the order of 0.10C by 2100.

Give up about 1% of consumption in return for an operationally immeasurable reduction in warming? No thanks.

Advocates argue that the bill is part of a global drive for all countries to reduce emissions, and that the U.S. needs to "show leadership." Whenever one nation sacrifices economic growth in order to reduce emissions, the whole world can expect to benefit, because future temperature should decrease for the entire globe.

Every nation's incentive, therefore, is to free ride on others.

Even if we wanted a deal, our most obvious leverage with other emitting nations would be to offer to reduce our emissions if they reduce theirs. Giving up this leverage and hoping that our unilateral reductions would put moral pressure on those nice men who rule China is a poor negotiating strategy. More fundamentally, even the dreamed-of global deal would be unattractive for the reasons previously described.

We are then left with the rational concern that our current expected projections might dramatically underestimate the dangers we face. Warming could turn out to be worse than even the outer edge of current probability distributions for projected impacts.

Anything's possible. But coercively reorienting the entire energy sector of the U.S. economy because of this fear is to get lost in the world of single-issue advocates, and become myopic about risk.

Humanity will confront lots of other unquantifiable threats of at least comparable realism and severity over the upcoming centuries. In the face of massive uncertainty on multiple fronts, the best strategy is almost always to hedge your bets and keep your options open.

Wealth and technology are raw materials for options. A much more sensible strategy would emphasize technology rather than carbon taxes or rationing. The federal government should fund prediction, adaptation and geo-engineering capabilities that would provide us with the tools we would need to deal with any unanticipated future climate emergencies.


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