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Can we afford the future? The economics of a warming world Frank Ackerman SEI-US Can we afford the future? The economics of a warming world Frank Ackerman SEI-US and Tufts/GDAE November 30, 2007

The latest evidence (IPCC, 2007) The world is getting hotter Sea levels are rising The latest evidence (IPCC, 2007) The world is getting hotter Sea levels are rising Snow cover is decreasing (Northern Hemisphere, March -April)

Temperature change (relative to 1980 -99) 2020 -2029 B 1 A 1 B A Temperature change (relative to 1980 -99) 2020 -2029 B 1 A 1 B A 2 2090 -2099

Climate policy: two excuses for inaction • Fake science Ø Temperature extremes have softened Climate policy: two excuses for inaction • Fake science Ø Temperature extremes have softened … the frequency of hurricanes has been diminishing. . . since 1940, weather satellites, tree ring data, and corrected thermometer readings all agree that climate has not warmed -- even though CO 2 levels rose. (Fred Singer) • Conventional economics Ø …efficient or “optimal” economic policies to slow climate change involve modest rates of emission reduction in the near term… The optimal rate of emissions reduction is 14 percent in 2015, 25 percent in 2050, and 43 percent in 2100. (William Nordhaus, 2007) Ø We should tax CO 2 at the economically correct level of about two dollars per ton (Bjorn Lomborg, 2007)

Many styles of denial Many styles of denial

What will you wear to the apocalypse? What will you wear to the apocalypse?

Three ideas about climate economics 1. Our descendents are important 2. Uncertainty is inescapable Three ideas about climate economics 1. Our descendents are important 2. Uncertainty is inescapable 3. Some costs are better than others

Discounting the future (at 3% interest or discount rate) years from now compound interest Discounting the future (at 3% interest or discount rate) years from now compound interest 0 $100 1 $103 2 $106 10 $134 50 present value $438 100 $1, 922 200 $5. 20 $36, 936 XT = (1+r)T X 0 $0. 27 $100 X 0 = X T / (1+r)T Bigger r means compound interest grows faster – and present value shrinks faster!

Why do discount rates matter? • A higher discount rate makes it harder to Why do discount rates matter? • A higher discount rate makes it harder to “see” future costs Ø How much should we do to prevent $1000 of damages 100 or 200 years from now? • Present value of $1000 in 2107 Ø At 1. 5%: $226 Ø At 3%: $52 Ø At 6%: $3 • Present value of $1000 in 2207 Ø At 1. 5%: Ø At 3%: Ø At 6%: $51 $3 $0. 01 • Economic analysis supports active climate policy with 1. 5% discount rate – but not with 6% !

A future we’ll never know A future we’ll never know

Choosing a discount rate • Market interest rates? Ø Appropriate for short/medium-term private investments Choosing a discount rate • Market interest rates? Ø Appropriate for short/medium-term private investments Ø Need not apply to long-term public policy • Will future generations be richer and need less help? Ø If they are poorer, will they need more help? • Pure impatience: if all generations are equally wealthy, should we discount the future? Ø Is your granddaughter less valuable than your daughter, because she will be born a generation later? Ø If both are equally valuable, the “pure impatience” component of discounting should be zero

Three ideas about climate economics 1. Our descendents are important 2. Uncertainty is inescapable Three ideas about climate economics 1. Our descendents are important 2. Uncertainty is inescapable 3. Some costs are better than others

Things that won’t happen (soon) Things that won’t happen (soon)

Worst case or average? • Economic analysis is based on average forecasts Ø Sea Worst case or average? • Economic analysis is based on average forecasts Ø Sea level rise: without catastrophic loss of ice sheets, less than 1 meter forecast for this century (IPCC 2007) Ø Poses problems for low-lying areas (Bangladesh, Miami, …) • The greatest fears about climate change are often based on worst-case possibilities Ø Complete loss of the Greenland (or West Antarctic) ice sheet would cause 7 meters of sea level rise Ø Catastrophic impacts on most coastal cities, communities • Will the Greenland ice sheet melt? Ø Ø Complete melting is unlikely in this century But it becomes less unlikely as temperatures rise Average: no problem this century Worst case: increasing cause for worry

Why buy insurance? • People care a lot about unlikely “worst cases” Ø How Why buy insurance? • People care a lot about unlikely “worst cases” Ø How much time do you leave to get to the airport? Ø Airport security is all about worst case possibilities • Insurance is not based on average outcomes Ø Probability that you will have a residential fire next year is much less than 1% Ø Probability that healthy young parents will die next year is much less than 1% Ø But we buy fire insurance and life insurance! • Probability of enough warming to guarantee loss of Greenland ice sheet is much greater than 1% Ø Should we buy life insurance for the planet?

“Fat tail” uncertainty • What is the likely effect of a doubling of CO “Fat tail” uncertainty • What is the likely effect of a doubling of CO 2? • Blue curve: normal distribution probability Normal ØApplies when uncertainty is well understood from extensive evidence • Red curve: “Student’s t” ØApplies when uncertainty is inferred from limited data, as with climate change • “Fat tail” uncertainty Student’s t ØExtreme values are much more likely with red curve than with blue • New economic theory (Martin Weitzman, Harvard): Ø“Fat tail” uncertainty dominates climate analysis Ø Average effect (peak of curve) is less important Expected temperature change (or climate sensitivity parameter)

Three ideas about climate economics 1. Our descendents are important 2. Uncertainty is inescapable Three ideas about climate economics 1. Our descendents are important 2. Uncertainty is inescapable 3. Some costs are better than others

Two meanings of “costs” • Economic models of climate change are based on cost-benefit Two meanings of “costs” • Economic models of climate change are based on cost-benefit analysis Ø Benefits must exceed costs in order to endorse a policy • Numerous problems with methodology Ø Benefits not meaningfully measured in dollars (value of a human life, extinction of a species, etc. ) • See Ackerman and Heinzerling, Priceless • One more problem: what do we mean by “costs”? Ø Pure physical losses (storm damages) Ø Investment in different industries than we had planned on

Which costs are larger? • Hurricane Katrina: $135 billion property damage (more than half Which costs are larger? • Hurricane Katrina: $135 billion property damage (more than half uninsured) • Cost of prevention Ø Dutch seawalls are twice as high as New Orleans levees Ø Cost is a small fraction (10% ? ) of the Katrina damages • Difference in kinds of costs Ø Building higher levees creates jobs Ø Letting storms destroy property does not • Renewable energy, efficiency, conservation will create new industries, technologies, jobs Ø Not the same industries we would otherwise have chosen to create Ø Is this a “cost”?

Costs exceed benefits Benefits exceed costs Costs exceed benefits Benefits exceed costs

Conclusion: a new climate economics • The future matters Ø Your granddaughter’s life is Conclusion: a new climate economics • The future matters Ø Your granddaughter’s life is an important one Ø The discount rate should be low (1. 5% or less) Ø Future benefits are worth spending money on today • Uncertainty is decisive Ø Climate policy is insurance against low-probability (but not impossible) catastrophic events Ø Certainty will not be achieved until it is too late • Some costs are well worth paying Ø We are “forced” to invent new industries, technologies, and job opportunities in energy efficiency, renewable energy, and related technologies • Get it right, and your grandchildren will thank you for leaving them a liveable world

Download from www. gdae. org/Florida. Climate. html Contact Liz. Stanton@tufts. edu Frank. Ackerman@tufts. edu Download from www. gdae. org/Florida. Climate. html Contact Liz. [email protected] edu Frank. [email protected] edu