Climate change is often portrayed as the greatest problem of the 21st century. Politicians are promising deep cuts in greenhouse gas emissions and will try to codify them in Copenhagen in December. A substantial amount of money has already been spent on climate policy, and much more will be spent if current ambitions are realised. The EU has promised a transfer of €100 billion per year from rich to poor countries. The new EU climate directive will easily cost the same amount again. Are such sums justified?
We worry about climate change because of its impacts. The benefits of climate policy are the impacts that would be avoided. Nordhaus (1991) was the first to estimate the effect of global warming on welfare. Fankhauser (1995) provided the first regional breakdown of impacts.
The impacts of climate change are uncertain and diverse. The impacts are uncertain because climate change will take place in the future. We cannot accurately predict emissions. We do not fully understand all mechanisms in the climate system, so we do not know how temperature and rainfall will change – but they will change. We have limited knowledge on the effects of climate change, and these effects will be on a future society that will be radically different from today’s. The impacts of climate change, and thus the benefits of climate policy, are very uncertain.
The impacts of climate change are also diverse. Low-lying coasts are vulnerable to sea-level rise while mountain areas may see a decline in skiing. The very old and the very young suffer disproportionally from heat stress. Rich people can afford air conditioning, and poor people cannot. And there are benefits too. The Baltic coast may become a prime tourist attraction. The costs of heating homes in winter would fall. Fewer people would die of cold-related diseases.
If we want to compare the different impacts of climate change to each other and compare the impacts of climate change to the costs of greenhouse gas emission reduction, we need to express the impacts of climate change in money. This is a difficult and controversial, but necessary step. I survey the literature on this in a recent article (Tol 2009).
There are a number of robust results, illustrated by Figure 1. Climate change has both negative and positive impacts. Positive impacts dominate in the short term. This is irrelevant, because we cannot affect the course of climate change in the short term. Impacts in the short term are sunk benefits. Negative impacts dominate in the longer term. We can influence climate change then. Emission abatement reduces the negative impacts of climate change, but leaves the positive impacts as they are. Abatement reduces damages. This is a benefit. There is thus an economic case for greenhouse gas emission reduction. You do not need to be a bleeding heart ecologist to favour climate policy. Cold economic calculus calls for action too.
Figure 1. The 14 estimates of the global economic impact of climate change, expressed as the welfare-equivalent income loss (dots), a suggested impact function (inner line) and its 95% confidence interval (outer lines).
Assessing the magnitude of climate change
At the same time, estimates of the impacts of climate change do not support the often-dramatic language of the media. Estimates suggest that the overall impact of a century of climate change is equivalent to losing up to 2% of income. The impact of a century of climate change is of the same size as a year of economic growth. In the worst case, impacts may be ten times as large. Still, a deep recession wreaks as much havoc in a year as climate change would do in a century. Climate change is therefore not the biggest problem of humankind.
Climate change implies more malaria and diarrhoea, and this may have killed 100,000 children already in 2009. Poverty also brings malaria and diarrhoea, and this killed 1,000,000 children or more in the same year. Climate change may not even be the biggest environmental problem. The WHO reckons that air pollution kills over 1,000,000 per year in India and China. But although climate change is not the biggest problem, it is still a problem. It will need to be solved.
Climate change primarily affects poor people in faraway places. Poor people often live in hot places. They are more exposed and cannot afford to protect themselves against the vagaries of the weather. This means that climate policy is not for our benefit, nor for the benefit of our children and grandchildren. Climate policy is for the benefit of the children and grandchildren of people in distant countries (Schelling 2000). We have a moral obligation, however, to avoid harming others or to compensate them if we do.
We should also wonder what is in their best interest. Emission abatement would slow the spread of malaria. A malaria vaccine would eradicate the disease. Climate change may cut food production in Africa by one-third. If African farmers would use the latest farming methods, food production would increase ten-fold. Climate policy should therefore not come at the expense of development policy. But it does. A growing share of development aid is spent on climate change (Michaelowa et al. 2007).
Some of the impacts of climate change are really impacts of poverty in disguise. If we leave these aside, there is still plenty to worry about climate change. And there are many things that we do not know or understand. The effect on biodiversity is one such area. We know climate change will have widespread negative effects, but we don’t know how bad it will be. We know that the negative impacts of a gradual warming in the 21st century would be modest, but there has been no serious study of the impacts of more rapid warming or of the impacts in the very long term. If emissions continue unabated, climate change after 2100 could well be much more dramatic than anything foreseen for this century. Nor do we know much about the indirect effects of climate change. Tropical countries tend to grow slower than economies in the temperate zone. If climate is a contributing factor to the inability to develop, as some scholars suspect, then the impacts of climate change are much larger than current estimates suggest. But we simply do not know.
Uncertainty justifies more stringent abatement. The impacts of climate change are very uncertain. What we do know suggests that climate change is a real problem. There is no reason to believe that climate change will dramatically improve welfare. There is good reason to believe that there is an unknown (hopefully small) probability that climate change will wreck the livelihood of many people. Uncertainty is therefore a reason to increase the ambition of emission abatement (Weitzman 2009).
The price of carbon
The social cost of carbon is a measure of seriousness of climate change. It shows how much damage is done by emitting one tonne of carbon. This is useful because even the most ambitious government plans only tinker at the margin of the climate problem. Money would be wasted if climate policy costs more, per tonne, than the social cost of carbon.
Almost 300 estimates of the social cost of carbon have been published. Figure 2 shows an estimate of the probability density function for different rates of pure time preference. A higher discount rate leads to a lower, less uncertain social cost of carbon. Estimates with independent quality control tend to be lower, and the same is true for more recent estimates. The overwhelming majority of estimates are positive. That is, climate change does harm. Reducing emissions improves welfare.
Figure 2. The probability density function of the social cost of carbon for three alternative rates of pure time preference
This means that greenhouse gas emissions should be taxed or otherwise regulated. At the moment, only the EU has such regulation in place, and it covers only about one-third of emissions. Europe is right to extend its current policy, and other countries should follow suit.
There are four important assumptions in the estimate of the social cost of carbon. How serious is climate change? How much do we care about remote probabilities? How much do we care about people in distant lands? How much do we care about the far future? There is therefore a strong ethical component to any assessment of climate policy. If you do not care about what could happen to someone faraway in the future, then climate change is not a concern. Following the ethical preferences as revealed by insurance, charity, and savings, the recommended price of carbon is €3.5/tCO2.
The current price of CO2 emission permits in Europe is €14/tCO2. That is, the EU is paying four times as much as it should. As a rate of pure time preference of 1% would justify a carbon price of €16/tCO2, European climate policy may also reveal an increased concern about the future. This may be, but the logical implication is that the EU should then also start to invest much more in education and pensions.
In sum, these results call for a measured policy of greenhouse gas emission reduction. There is reason to believe that European climate policy is overly ambitious. Climate policy outside Europe is surely not ambitious enough.
Fankhauser, S. (1995), Valuing Climate Change - The Economics of the Greenhouse, 1 edn, EarthScan, London.
Michaelowa, A. and K. Michaelowa (2007), 'Climate or Development: Is ODA Diverted from its Original Purpose?', Climatic Change, 84, 5-21.
Nordhaus, W.D. (1991), 'To Slow or Not to Slow: The Economics of the Greenhouse Effect', Economic Journal, 101, (444), 920-937.
Schelling, T.C. (2000), 'Intergenerational and International Discounting', Risk Analysis, 20, (6), 833-837.
Tol, R.S.J. (2009), 'The Economic Effects of Climate Change', Journal of Economic Perspectives, 23, (2), 29-51.
Weitzman, M.L. (2009), 'On Modelling and Interpreting the Economics of Catastrophic Climate Change', Review of Economics and Statistics, 91, (1), 1-19.