Climate Policies: A Burden, or a Gain?

• Author: Brechet, Thierry

1. INTRODUCTION

   That climate policies are costly is evident and therefore often creates major fears in industry. Understandably so: actions of mitigation of GHG emissions require considerable resources hence entail high costs. Actors of industrial life consider this as a burden for our economies. Is it a bearable one?

   To appreciate that, consider the alternative, i.e. no action, and its cost: no action means our economies incurring damages, possibly considerable (see IPCC (2007), which will also be a burden. There are two categories of costs, one caused by climate change (damages incurred), the other caused by climate policy (mitigation costs) which in any sensible cost-benefit analysis of abatement policies have to be considered jointly. However, the amounts of each of the two terms in the sum vary depending upon what the policies are. In fact, they are substitutes: indeed, the more mitigation and adaptation actions, the less damages will be incurred, and the less of the former, the more of the latter. The reverse also holds: severe adverse climate impacts provide strong incentives for emission abatement. This naturally follows from realizing that policies aim at avoiding damages. In that perspective, avoiding damages appears to be the benefit that accompanies climate policies. And if that benefit appears to be larger than the mitigation and adaptation cost (the "direct" cost, for short), such policies can be deemed economically sound. Actually, costs and benefits are the two sides of a same coin.

   This reasoning brings climate policies naturally in the realm of benefit-cost analysis, a well-established instrument of decision-making in the public sector. In this paper, we wish first to simply illustrate the "direct" cost component of various policies (Section 2), then to confront them with the benefits generated, that is, the damage cost avoided (Section 3) and draw (in Section 4) preliminary conclusions on the policies' respective justification. The purpose here is mostly to offer the reader information on the orders of magnitude as provided by published advanced models, thereby avoiding to enter into the details of these.

   In climate affairs, there is however an additional dimension to the benefit side just identified. In the way it is invoked above, the benefit-cost criterion makes no reference to the multinational component of the issue. When the problem that requires action is of exclusively national nature, benefits as well as costs are those that accrue to the country and these only determine the decision. Transposing benefit-cost analysis to enlighten decision-making on issues with international impacts cannot simply consist in an addition of national benefits and costs of domestically chosen strategies. In a multi-national context, there is often--and certainly in the climate change case--a superadditive aspect to the possible joint actions by the countries, in the sense that together they can (i) do more than the sum of their alternative individualistic policies, and (ii) generate a larger joint benefit than the sum of their benefits when acting individualistically.

   Therefore, the sheer domestic benefit-cost criterion is not a sufficient incentive to induce the synergies needed to achieve efficiency at the world level. Additional and specific motivations of some sort for adopting non-individualistic policies are called for. What can they consist of? In Section 5 we advocate for and illustrate the role of inter-country transfers to go beyond the standard framework of selfish national benefit-cost analysis to implement an efficient international climate agreement.

2. WHAT IS THE COST OF A CLIMATE POLICY?

   2.1 The Policy's Direct Cost as a Burden for the Economy

   A comprehensive and interesting synthesis of the direct cost approach is provided in the survey by Edenhofer et al. (2010). This survey covers four major numerical simulation models that are widely used in policy discussions, namely: MERGE (Kypreos and Bahn, 2003), REMIND-R (Leimbach et al., 2010), POLES-ETSAP (European Commission, 1996) and TIMER (Bouwman et al. 2006). All models project how the economy may evolve spontaneously in the future (about a century), and then examine how a couple of discretionary climate policies affect the estimated evolution of the GDPs, both national and at the world level. The policies considered are expressed in terms of global caps either on emission levels, or on carbon concentration in the atmosphere, or still on average temperature increase. These caps are introduced as exogenous constraints in the models, which for the rest are optimal growth models.

   As to how the burden is measured, in the MERGE and REMIND models the cost is measured as discounted cumulative GDP losses up to 2100 relative to some baseline, and it is expressed in percent of the baseline GDP over the same period. The POLES and TIMER models report instead the increase in abatement costs relative to the baseline, also expressed in percent of GDP. For all models the discount rate is 3 percent a year and net present values are calculated with 2000 as the base year. The results are reported in figure 7 in Edenhofer et al. (2010, page 31).

   Edenhofer et al. (2010) focus on three policies. All of them are expressed in terms of alternative caps on global GHG concentration in 2100, respectively of 400, 450 and 550 ppm C[O.sub.2]-eq. Two key conclusions emerge from this model comparison. First, the direct costs of the policies considered are small: the 550 ppm cap entails a 0.8% cumulated loss of world GDP in 2100, the 400 ppm cap a 2.5% loss. Second, despite differences in the orders of magnitude, all models agree on the qualitative message that policy costs are limited. (1)

   2.2 The Policy's Genuine Cost

   In case of "no policy", what is the burden? Is there at all a cost for the economy? What we have described above as "direct" costs are absent, since no action entailing them--mitigation or adaptation--is taken in that case. Unfortunately, this is only one side of the coin, as other costs are involved. Indeed, global warming has powerful physical impacts on earth such as storms, coastal erosion, sea level rise and droughts. These in turn entail damages that are materialized in losses of economic goods, properties and assets, let alone human lives. These damages are sheer destructions of parts of the economy, and they are maximal in case of no action. Clearly there is a cost of doing nothing.

   But policies, if rational, aim at reducing damages. Therefore, the genuine cost to society of any climate policy is to be thought of as a number which is net of the damage costs the policy allows one to avoid--in other words, it is the number obtained by subtracting the value of the avoided damages from the burden of the direct cost described above. If negative, this genuine cost is obviously a net benefit, implying that the policy is justified according to the standards of benefitcost analysis.

   It is important to note at this point that for any country the benefits as well as the costs are not to be considered in isolation: their magnitude also depends on the policies implemented abroad, be they the result of international agreements or not. This extension of the reasoning will be the topic of Section 5.

3. EVALUATING TWO POLICIES IN TERMS OF THEIR GENUINE COST

   The most striking example of a statement on climate change made recently in the spirit of benefit-cost analysis is the Stern Review (Stern, 2007). Using an integrated assessment model (henceforth IAM) of the world economy, namely the PAGE model, the Review estimates that, for the policies it defines, benefits in terms of value of damages avoided would range between 5 and 20 percent of world GDP every year and for ever, whereas mitigation costs to achieve this damage avoidance would amount to about 1 to 2% of world GDP, every year and for ever. We propose to apply the same reasoning to two among the policy choices studied in Edenhofer et al. (2010), namely the 650 and 550 ppm caps, and check whether or not they pass the benefit-cost criterion. We do this by using our own IAM, namely CWS (for CLIMNEG World Simulation) (2), so as to see whether a result such as Stern's can be obtained by means of this alternative measurement tool. (3)

   The CWS model is close the original RICE model by Nordhaus and Yang (1996) or its variations as in Eyckmans and Tulkens (2003), Yang (2008) and Brechet et al. (2012). In the model, the world is split into 18 regions or countries. An essential characteristic of an IAM is the endogenous feedback between the economy and the climate. Decision variables are capital accumulation (to sustain economic growth) and GHGs emission abatement (to control climate change). CWS can also be seen as a general equilibrium model in the sense that all the dimensions of the economy are endogenous, in particular capital accumulation. The model consists of an optimal control problem in which investment in physical capital and abatement efforts are the control variables and temperature change is the state variable. The objective function to be maximized is the intertemporal welfare expressed as the discounted green consumption (Z), i.e. gross output (Y, driven by capital accumulation and population growth) net of investment in capital (I), emission abatement costs (C) and climate damages (D, driven by GHGs concentration and temperature change), so that we have Z...