Thursday, July 19, 2007

Kenneth Arrow and Thomas Schelling on Climate Change

The latest issue of The Economists' Voice is out, with two articles on the economics of climate change by Nobel Prize-winning economists.

The first is an excellent primer on climate change by Kenneth Arrow: Global Climate Change: A Challenge to Policy. I'd really recommend reading it as a backgrounder to the issue:

Two factors deserve emphasis, factors that differentiate global climate change from other environmental problems. First, emissions of CO2 and other trace gases are almost irreversible; more precisely, their residence time in the atmosphere is measured in centuries. Most environmental insults are mitigated promptly or in fairly short order when the source is cleaned up, as with water pollution, acid rain, or sulfur dioxide emissions. Here, reducing emissions today is very valuable to humanity in the distant future.

Second, the scale of the externality is truly global; greenhouse gases travel around the world in a few days. This means that the nation-state and its subsidiaries, the
typical loci for internalization of externalities, are limited in their remedial ability.

The detail in the article is on the issue of discounting future costs, which is central to the findings in the Stern Report on The Economics of Climate Change that susbstantial immediate action on climate change is likely to be much cheaper over the long-term than inaction. Discounting is something I need to cover in a future Oikos 101 column, but for now I'll just observe that Stern has been criticised for using a zero rate of pure social time preference - which is consistent with the idea of inter-generational equity but inconsistent with observations by economists of how people actually behave.

Arrow conducts a sensitivity analysis, plugging different social time preference rates into Stern's figures, and finds that using a higher social time preference rate doesn't change the fundamental finding of the Stern Report, that action will cost less than inaction.

Thomas Schelling discusses what uncertainty surrounding climate change implies for policy responses and makes some sensible observations in Climate Change: The Uncertainties, the Certainties, and What They Imply About Action:

In some public discourse, and in sentiments emanating from the Bush Administration, it appears to be accepted that uncertainty regarding global warming is a legitimate basis for postponement of any action until more is known. The action to be postponed is usually identified as “costly.” (Little attention is paid to actions that have been identified as of little or no serious cost.) It is interesting that this idea that costly actions are unwarranted if the dangers are uncertain is almost unique to climate. In other areas of policy, such as terrorism, nuclear proliferation, inflation, or vaccination, some “insurance” principle seems to prevail: if there is a sufficient likelihood of sufficient damage we take some measured anticipatory action.

At the opposite extreme is the notion, often called the “precautionary principle” now popular in the European Union, that until something is guaranteed safe it must be indefinitely postponed despite substantial expected benefits. Genetically modified foods and feedstuffs are current targets. (One critic has expressed it as, “never do anything for the first time.”) In this country the principle says that until a drug has proven absolutely safe it must be deferred indefinitely.

Neither of the two extreme principles—do nothing until we are absolutely sure it’s safe; do nothing until we are absolutely sure the alternative is dangerous—makes
economic sense, or any other kind. Weigh the costs, the benefits, and the probabilities as best all three are known, and don’t be obsessed with either extreme tail of the distribution.

Monday, July 16, 2007

Exposing the hidden costs of pollution

An article in today’s Sydney Morning Herald, which questions whether the Australian states could undermine national action on climate change, illustrates just why a broad-based national emissions trading scheme would be effective.

Environment groups said the Opposition Leader, Kevin Rudd, needed to explain how he would curb rising greenhouse gas emissions at a time when Queensland and NSW were dramatically boosting coal exports and several states were approving big road and power projects that would increase climate change pollution…

The NSW Treasurer [Michael Costa] favours building a new coal-fired power plant to meet the state's energy needs, in contrast to other proposals for more gas-fired generation or energy efficiency and demand management.

New coal-fired power stations would make it difficult for a federal Labor government to reach its target of cutting emissions by 60 per cent by 2050, said the Australian Conservation Foundation campaigner Tony Mohr.

"The really interesting question to ask Kevin Rudd would be if Costa approves a new coal-fired power plant, what will he do about it?" Mr Mohr said. "How is he going to deal with the parochialism of the states?

The power of an emissions trading scheme or carbon tax is that it imposes the same price on greenhouse pollution from any source in any state, so questions like these become irrelevant. Both major parties have now committed to a national emissions trading scheme.

With a trading scheme, the federal government sets a cap on total emissions from all sources and issues permits for that amount. Emitting without a permit is prohibited so total emissions don’t exceed the cap. If you don’t have enough permits for the pollution you wish to create, you need to buy them from someone else. They can only sell them if they’ve taken action to reduce their emissions so that they have surplus permits.

Under an emissions trading scheme, if NSW wants to approve a coal-fired power station, so what? For the station to be allowed to operate, the operator will need to buy enough permits to cover its emissions. It can buy them only if someone else reduces their emissions and so has surplus permits. The total level of emissions is therefore unchanged.

It will no longer be up to the NSW Government to decide whether a new coal-fired power plant, more gas-fired generation or energy efficiency and demand management is the best way to meet the state's energy needs: all those methods will compete side by side on the basis of bang for your cost-of-pollution-adjusted buck.

So what is a parochial state government that wants to encourage coal-fired power production to do? Well it can offer breaks from state taxes and planning restrictions, but that’s not a good look. Importantly, it can’t exempt power stations from emissions trading, because it’s a scheme administered by the federal government. If it really wants to encourage the power station, it will have to agree to buy the permits for it. (Scarily, they’ve already started doing this).

And this is one thing I love about a national emissions trading scheme: it puts a price on pollution for everyone to see. State governments place costs on their citizens every time they exempt a large development from laws that apply to everyone else, but those costs are hidden. Voters don’t notice the cost of a government exemption, but you can bet they’ll notice when their taxes are used to buy permits for a large and profitable energy company.

When we put a price on polluting, we bring hidden costs into the open.

Tuesday, July 03, 2007

Live Earth concert this Saturday

Only 4 sleeps to go until the Live Earth concerts around the world - in New York, London, Johannesburg, Rio de Janeiro, Shanghai, Tokyo, Sydney and Hamburg on 7/7/07 - this Saturday!

By the way, I have a couple of spare tickets to the Sydney concert, so email me at ozelaw [at] yahoo [dot] com [dot] au if you missed out.

Check out the Sydney concert website for lots of good material about the concert and the cause.