With first Houston, then several Caribbean islands and Florida suffering dreadful flooding and destruction from Hurricanes Harvey and Irma, many are questioning whether more should be spent on flood prevention and reducing greenhouse gas emissions. Economists would normally argue that such questions are answered by conducting a cost–benefit analysis.
However, even if the size of the costs and benefits of such policies could be measured, this would not be enough to give the answer. Whether such spending is justified would depend on the social rate of discount. But what the rate should be in cost-benefit analyses is a highly contested issue, especially when the benefits occur a long time in the future.
I you ask the question today, ‘should more have been spent on flood prevention in Houston and Miami?’, the answer would almost certainly be yes, even if the decision had to have been taken many years ago, given the time it takes to plan and construct such defences. But if you asked people, say, 15 years ago whether such expenditure should be undertaken, many would have said no, given that the protection would be provided quite a long time in the future. Also many people back then would doubt that the defences would be necessary and many would not be planning to live there indefinitely.
This is the familiar problem of people valuing costs and benefits in the future less than costs and benefits occurring today. To account for this, costs and benefits in the future are discounted by an annual rate to reduce them to a present value.
But with costs and benefits occurring a long time in the future, especially from measures to reduce carbon emissions, the present value is very sensitive to the rate of discount chosen. But choosing the rate of discount is fraught with difficulties.
Some argue that a social rate of discount should be similar to long-term market rates. But market rates reflect only the current generation’s private preferences. They do not reflect the costs and benefits to future generations. A social rate of discount that did take their interests into account would be much lower and could even be argued to be zero – or negative with a growing population.
Against this, however, has to be set the possibility that future generations will be richer than the current one and will therefore value a dollar (or any other currency) less than today’s generation.
However, it is also likely, if the trend of recent decades is to continue, that economic growth will be largely confined to the rich and that the poor will be little better off, if at all. And it is the poor who often suffer the most from natural disasters. Just look, for example, at the much higher personal devastation suffered from hurricane Irma by the poor on many Caribbean islands compared with those in comparatively wealthy Florida.
A low or zero discount rate would make many environmental projects socially profitable, even though they would not be with a higher rate. The choice of rate is thus crucial to the welfare of future generations who are likely to bear the brunt of climate change.
But just how should the social rate of discount be chosen? The following two articles explore the issue.
How Much Is the Future Worth? Slate, Will Oremus (1/9/17)
Climate changes the debate: The impact of demographics on long-term discount rates Vox, Eli P Fenichel, Matthew Kotchen and Ethan T Addicott (20/8/17)
- What is meant by the social rate of discount?
- Why does the choice of a lower rate of social discount imply a more aggressive climate policy?
- How is the distribution of the benefits and costs of measures to reduce carbon emissions between rich and poor relevant in choosing the social rate of discount of such measures?
- How is the distribution of the benefits of such measures between current and future generations relevant in choosing the rate?
- How is uncertainty about the magnitude of the costs and benefits relevant in choosing the rate?
- What is the difference between Stern’s and Nordhaus’ analyses of the choice of social discount rate?
- Explain and discuss the ‘mortality-based approach’ to estimating social discount rates.
- What are the arguments ‘for economists analysing climate change through the lens of minimising risk, rather than maximizing utility’?
Is slower economic growth a cost of cutting greenhouse gas emissions? Apparently not – at least according to two studies: one by DIW Econ, a German institute for economic research, and the other, earlier this year, by the International Energy Association (see reports below).
The IEA study found that, despite global GDP having grown by 6.4% in 2014, global emissions remained flat. The DIW Econ study found that from 2004 to 2014, OECD countries as a whole grew by 16% while cutting fossil fuel consumption by 6% and greenhouse gas emissions by 6.4%.
But what does this mean? If growth accelerated, what would happen to greenhouse gas emissions? Would they begin to rise again? Probably.
The point is that various developments, largely independent of economic growth have been reducing the greenhouse gas emissions/GDP ratio. These developments include: technological advances in energy generation; the switch to alternative fuels in many countries, thanks, in large part to lower renewable energy costs; increased energy efficiency by consumers; and a continuing move from energy-intensive manufacturing to less energy-intensive services.
So if governments forced more radical cuts in greenhouse gases, would this reduce the rate of economic growth or have no effect? For a given level of technological advancement, the initial effect would probably be a reduction in economic growth. But to the extent that this encouraged further investment in renewables and energy saving, it might even stimulate economic growth over the longer term, especially if it helped to bring lower energy prices.
A big problem in decoupling economic growth from fossil fuel usage is that developing countries, which are taking a growing share of world manufacturing, are more heavily dependent on coal than most developed countries. But even here there seems to be some hope. China, the biggest manufacturer in the developing world, is rapidly increasing its use of renewables. As the IEA press release states:
In China, 2014 saw greater generation of electricity from renewable sources, such as hydropower, solar and wind, and less burning of coal.
If the world is to tackle global warming by making significant cuts in greenhouse gases, there must be a way for developing countries to continue growing while making less use of fossil fuels.
Cutting greenhouse gas emissions won’t slow global economic growth — report The Guardian, Bruce Watson (26/9/15)
Turning point: Decoupling Greenhouse Gas Emissions from Economic Growth DIW Econ, Lars Handrich, Claudia Kemfert, Anselm Mattes, Ferdinand Pavel, Thure Traber (September 2015)
World Energy Outlook Special Report 2015: Energy and Climate Change International Energy Agency (June 2015)
- What are the possible causal relationships between cutting greenhouse gas emissions and the rate of economic growth?
- What incentive mechanisms can governments or other agencies adopt to encourage reductions in greenhouse gas emissions without reducing economic growth?
- Can a cap and trade system, such as the European Emissions Trading Scheme help to achieve a given level of emissions reduction at minimum cost to economic growth? Explain.
- How might the developed world support developing countries in moving to a low carbon technology?
- What factors lie behind the falling costs of renewable energy? Are these the same factors that lie behind the falling cost of oil?
- What political problems might hinder the greater production of renewable energy?
- How might an economist set about determining a socially optimal amount of fossil fuel production? What conceptual and philosophical problems might there be in agreeing what is meant by a social optimum?
The Governor of California, Jerry Brown, has issued an executive order to cut greenhouse gas emissions 40% from 1990 levels by 2030 (a 44% cut on 2012 levels). This matches the target set by the EU. It is tougher than that of the US administration, which has set a target of reducing emissions in the range of 26 to 28 percent below 2005 levels by 2025.
The former Governor of California, Arnold Schwarzenegger, had previously set a target of reducing emissions 80% below 1990 levels by 2050. Brown’s new target can be seen as an interim step toward meeting that longer-term goal.
There are several means by which it is planned to meet the Californian targets. These include:
a focus on zero- and near-zero technologies for moving freight, continued investment in renewables including solar roofs and distributed generation, greater use of low-carbon fuels including electricity and hydrogen, stronger efforts to reduce emissions of short-lived climate pollutants (methane, black carbon and fluorinated gases), and further efforts to create liveable, walkable communities and expansion of mass transit and other alternatives to travelling by car.
Some of these will be achieved through legislation, after consultations with various stakeholders. But a crucial element in driving down emissions is the California’s carbon trading scheme. This is a cap-and-trade system, similar to the EU’s Emissions Trading Scheme.
The cap-and-trade rules came into effect on January 1, 2013 and apply to large electric power plants and large industrial plants. In 2015, they will extend to fuel distributors (including distributors of heating and transportation fuels). At that stage, the program will encompass around 360 businesses throughout California and nearly 85 percent of the state’s total greenhouse gas emissions.
Under a cap-and-trade system, companies must hold enough emission allowances to cover their emissions, and are free to buy and sell allowances on the open market. California held its first auction of greenhouse gas allowances on November 14, 2012. This marked the beginning of the first greenhouse gas cap-and-trade program in the United States since the group of nine Northeastern states in the Regional Greenhouse Gas Initiative (RGGI), a greenhouse gas cap-and-trade program for power plants, held its first auction in 2008.
Since January 2014, the Californian cap-and-trade scheme has been linked to that of Quebec in Canada and discussions are under way to link it with Ontario too. Also California is working with other west-coast states/provinces, Oregon, Washington and British Columbia, to develop a co-ordinated approach to greenhouse gas reductions
To achieve sufficient reductions in emissions, it is not enough merely to have a cap-and-trade system which, through trading, encourages an efficient reduction in emissions. It is important to set the cap tight enough to achieve the targeted reductions and to ensure that the cap is enforced.
In California, emissions allowances are distributed by a mix of free allocation and quarterly auctions. Free allocations account for around 90% of the allocations, but this percentage will decrease over time. The total allowances will decline (i.e. the cap will be tightened) by 3% per year from 2015 to 2020.
At present the system applies to electric power plants, industrial plants and fuel distributors that emit, or are responsible for emissions of, 25,000 metric tons of carbon dioxide equivalent (CO2e) per year or more. The greenhouse gases covered are the six covered by the Kyoto Protocol ((CO2, CH4, N2O, HFCs, PFCs, SF6), plus NF3 and other fluoridated greenhouse gases.
California governor orders aggressive greenhouse gas cuts by 2030 Reuters. Rory Carroll (29/4/15)
California’s greenhouse gas emission targets are getting tougher Los Angeles Times, Chris Megerian and Michael Finnegan (29/4/15)
Jerry Brown sets aggressive California climate goal The Desert Sun, Sammy Roth (29/4/15)
California’s Brown Seeks Nation-Leading Greenhouse Gas Cuts Bloomberg, Michael B Marois (29/4/15)
California sets tough new targets to cut emissions BBC News, (29/4/15)
California’s New Greenhouse Gas Emissions Target Puts Obama’s To Shame New Republic, Rebecca Leber (29/4/15)
Governor Brown Announces New Statewide Climate Pollution Limit in 2030 Switchboard, Alex Jackson (29/4/15)
Cap-and-trade comes to Orego Watchdog, Chana Cox (29/4/15)
Cap and trade explained: What Ontario’s shift on emissions will mean The Globe and Mail, Adrian Morrow (13/4/15)
California’s Forests Have Become Climate Polluters Climate Central, John Upton (29/4/15)
States Can Learn from Each Other On Carbon Pricing The Energy Collective, Kyle Aarons (28/4/15)
Governor Brown Establishes Most Ambitious Greenhouse Gas Reduction Target in North America Office of Edmund G. Brown Jr. (29/4/15)
Frequently Asked Questions about Executive Order B-30-15: 2030 Carbon Target and Adaptation California Environmental Protection Agency: Air Resources Board (29/4/15)
Californian cap-and-trade scheme
Cap-and-Trade Program California Environmental Protection Agency: Air Resources Board (29/4/15)
California Cap and Trade Center for Climate and Energy Solutions (January 2014)
- Explain how a system of cap-and-trade, such as the Californian system and the ETS in the EU, works.
- Why does a cap-and-trade system lead to an efficient level of emissions reduction?
- How can a joint system, such as that between California and Quebec, work? Is it important to achieve the same percentage pollution reduction in both countries?
- What are countries coming to the United Nations Climate Change conference in Paris in November 2015 required to have communicated in advance?
- How might game theory be relevant to the negotiations in Paris? Are the pre-requirements on countries a good idea to tackle some of the ‘gaming’ problems that could occur?
- Why is a cap-and-trade system insufficient to tackle climate change? What other measures are required?