Wednesday, August 3, 2011

What is the economic impact of greenhouse gas emissions?

Discussing the topic of global warming is bound end any polite dinner conversation. It's like discussing politics at a's bound to get people really angry.

With that being said, check your ego before reading on, and only leave a comment if you've thoroughly digested everything below. I don't want to turn this into a 'he said, she said' or 'Red vs. Blue' dispute that I see in a lot of blogs (CNN for example).

What I'm about to say will probably annoy both the climate change alarmists and the climate change deniers. But those of you who have some training in economics (i.e. the science/skill/art of making a cost-benefit analysis under uncertainty) will find what I have to say to be pretty middle of road and boring.

1) Human emissions from the exhaust products of burning fossil fuels are causing an increase in the concentration of greenhouse gases: CO2, CH4 and CFC's.

2) You can prove that the increased concentrations are increasing the radiative forcing function on the Earth by looking at the the amount of IR radiation leaving the atmosphere at the frequencies where CO2, CH4 & CFCs absorb. There is plenty of satellite data showing there have been decreases in the amount of infrared light leaving the Earth at the frequencies where these gases absorbs. And the decrease in the amount of IR leaving at these frequencies is as expected from the rise in GHG concentrations. For example, see the link below:

3) Particulate emissions from coal power plants (in the 50's/60's in the US), and now in China, have a negative effect on the radiative forcing function. This is part of the reason why global temperatures have only slightly increased over the last decade, and actually decreased somewhat in the 50s.

4) There is still some amount of uncertainty in going from a change in the radiative forcing function and an increase in global temperatures. Models are getting better with time, and this uncertainty is decreasing with time as we collect more data and add more details to the global climate models.

5) The largest area of uncertain (as far as making public policy decisions) is the economic impact of increased temperatures. There needs to be a lot more work in this field. As I've mentioned before, it would be a good idea for an independent agency like RAND Corp or the US DOE to estimate the economic impact of increased temperatures. As of 2009, there have only been 14 studies that calculate the impact on global GDP as a function the Earth's mean global temperature. That's not a lot of studies, given the amount of money that has already gone into trying to solve what people assume is a problem, but without having actually done their homework to see if it really is a problem. I've plotted the data from the 14 studies below: (the data point can be found at the following site. Along with the much prettier graph made by Tol, which includes error bars.)

I haven't included the error bars on the data points because some of the studies give the estimated error and some don't. Check out the paper by Tol (2009) to get more information on the studies. You can see from the graph that the net impact on the globe is positive until a temperature rise of 2 degrees Celcius. The increase in temperature has a net positive effect on: a) preventing deaths in the winter, b) increasing access to resources in the Arctic, and c) increasing the agricultural crop yield due to CO2 fertilization. The positive attributes of these GHG gases outweigh the negatives (increased deaths in the summer, ocean acidification, and increased flooding) when the temperature increase is less than 2 deg C.

The problem of course is that the positive benefits of climate change show up mostly in countries that are already wealthy (such as Canada), but the initial damage is in areas that are already poor (small island nations and the tropics.) There is a real moral question of whether those countries that will gain from climate change should help those that will be directly impacted. I will leave that as an open question for you to ponder.

6) It is clear that once we get past 2 degrees Celsius, there will be a net negative impact on global GDP. There have not been any studies that estimate economic impact for temperature increases above 3 deg C, but the curve likely continues downward. (Probably pretty rapidly because some of the advantages of higher CO2 levels and temperatures go away quickly after 600 ppm or 3 deg C while the disadvantages continue to grow.)

7) Using a) the data above, b) the equation that relates an increase in CO2 concentrations with an increase in radiative forcing, c) the estimates of the climate sensitivity (i.e. the function between an increase in radiative forcing and a temperature increase), and d) setting the "pure rate of time preference" roughly equal to the rate of growth in the global GDP, then one can estimate the "net present value" of future economic damage from current emissions from fossil fuel power plants. We need to know the "pure rate of time preference" in order to tell us how much to weigh future damage from CO2 because, as shown above, there is no net damage until a temperature increase of at least 2 deg Celcius.

Note that the other way to do this is to calculate the societal rate of return on investment for building a power plant. Roughly speaking, there will be capital costs in year 1&2, net profit in years 3 through 30, and then economic damage from climate change in years above 50. The economic damage 50 years in the future will not significantly change the value of the rate of return on investment from the power plant. The IRR will still be ~10%/yr because (1.1)^-50 is a really small number, and (1.1)^-100 is even smaller. Future damage has virtually no effect on the net present value of the power plant because it's so far off in the future.

8) Using a "pure rate of time preference" of 3% (which is actually a little less than the actual growth rate of the global GDP and lower than the discount rate used by electricity generation regulators), one can calculate the social cost of emitting CO2 into the atmosphere today. This value is between $10 and $20 / ton CO2 in 2009 US dollars. To give you a feel for how large or small this number is, I calculated that if a typical coal power plant would have to pay this cost, then we would see an increase in the price of electricity by between 5% to 10%. Also for comparison, the cost of purchasing an emissions credit in the E.U. is currently around $20/ t CO2 in 2011 US dollars. This may or may not be coincidental. Over the next decade or two, having a CO2 tax or emission credit above $20 / t CO2 does not seem to be the socially optimal solution to global warming.

9) In the far future, the value of the social cost of carbon will likely increase because the emission of greenhouse gases will start immediately having an impact on the environment and on the economy. We will have to estimate the effect on global GDP for temperature increasing more than 3 deg Celsius in order to estimate further into the future

10) If the estimated social cost of greenhouse gas emissions is only between $10 and $20 / ton CO2 in 2009 US dollars, then we need to focus on only those power plant projects that can be economically viable (without subsidies or feed-in-tariffs or renewable energy credits) when the price of emitting CO2 is less than ~$20. Right now, it is a cheaper solution for us to tax existing power plants and use that money to help people who are adversely affected by climate change than it is for us to build new expensive power plants (such as wind turbines or home solar panels.) For example, the marginal costs per tCO2 avoided for building wind turbines or home solar panels is well over $100 / tCO2 avoided.

11) Yes, let me repeat this. There is more benefit in taxing existing power plants and using that money to help people adapt to climate change than it would be for us to replace existing power plants with wind turbines or home solar panels. (Honestly, it would be better for you to not build a solar panel on your home, invest the money that you would have spent on the solar panels into a money market account, and then in 50 years, give that money to families who need to adapt to a changing climate. That would be the wiser why to help people.)

12)  I'm not sure how else to say this:  climate change is a problem, but not a major problem in the near term (unless you happen to live in the Netherlands or Bangladesh.) It's also not that hard of a problem to solve in the near term. Global warming has a net positive effect on the global economy for temperature increases less than 2 deg C. A 3 deg C rise in temperature is only expected to decrease net global GDP by 3% (total...not yearly rate.) In the long run (in a century or so), it will definitely be a problem. But let's put this in perspective:
The recession of 2008 had a larger impact on global GDP than would an increase in the Earth's temperature by 3 deg C. Let me state this again, the oil price increase in 2008 (like the oil price shocks in the 1970's) had a greater impact on our global economy than will a rise in global temperature by 3 deg C.

13)  For those of you who really like solar and wind energy, do not ignore the points I've made above and quote the Stern Review's estimate in 2006 of >$100/tCO2 social cost. Be very careful reading the Stern Review on the Economics of Climate Change. They make a bad economic assumption on GDP growth rate and they cherry-pick from the studies of economic damage as a function of temperature. For example, they used a "pure rate of time preference" of 0.01%. (i.e. the Time Value of Money) This means that they assume that the global GDP will stagnant in the future. There is no evidence for this assumption. The global GDP has been increasing at a ~4%/yr rate over the last few decades.  And since they try to estimate damages over the next 200 years (even though the studies haven't estimated economic impact past 3 deg C), their use of a 0%/yr 'time rate of preference' means that future impact is weighted equally with today's benefits. This is completely absurd. No sane person weighs future profits equally with today's profits. Ignoring even the fact that global GDP is actually growing over 3%/yr, we are still a completely risk adverse society. We prefer $50 today rather than $60 tomorrow. We need to include a positive 'time rate of preference' for two reasons: a) we are growing and b) we are risk adverse. This 'time rate of preference' should be between 3%/yr (the global GDP growth rate) and 7%/yr (the typical discount rate for economic analysis that includes risk aversion.)

Even worse, the Stern Review guesses that there is a 10% probability that Homo sapiens will go extinct in the 21st century as a justification for the 0.01%/yr discount rate. Check out page 161 of the report if you think that I'm making this up. This is their quote: "So the probability of [humans] surviving beyond, say, 2106 is e-0.001*100, which is 90.5%."

This is an absurd statement and is borderline paranoia. You'd have to be crazy to think that there's a 10% probability that Homo sapiens will go extinct in the 21st century. Our society is growing and will continue to grow. We are nowhere near the limit of using all of the renewable or fossil fuels sources on our planet, let alone on other planets.

In Conclusion:
This is not a call to do nothing, nor is it a call to conserve 'energy'. This is a call to grab all of the low hanging fruit while we conduct more detailed studies of the estimated economic impacts of greenhouse gas emissions. Examples of low hanging fruit are: 1) Getting Germany and Switzerland to reverse their decisions to close existing nuclear power plants.  2) Installing CO2 capture and sequestration devices on all coal gasification power plants. 3) Eliminating the emissions of CFC's and other extreme greenhouse gases.

The problem I see right now is that we seem focused on the high hanging fruit before we tackle all of the low hanging fruit. Examples of the high hanging fruit are: 1) installing solar PV cells on people's homes. 2) Installing CO2 capture and sequestration devices on conventional coal combustion power plants. 3) On shore or Off shore wind turbines.  4) Anything that involves corn/cellulose/algae as a replacement for gasoline.

Let's focus on the low hanging fruit while we take the time to really understand the problem we face. We need to have patience and not freak out. (As Axel Rose says, "We all need just a little patience.") If we freak out and start being alarmist or nihilistic, we'll do more damage to ourselves than will the climate.

Go have a beer and get back to whatever you were working on before reading this post. There's already a lot of people out there who know how to grab the low hanging fruit I listed above. We don't need more people reinventing the wheel. We do need people to solve the major problems we do face: cancer, HIV/AIDS, automobile accidents, world hunger, cost effective recycling, lack of vitamins, arsenic in drinking water supplies around India, decreasing costs to space, etc...

The reason that this post might be boring to economists is that they've already been saying this for years: global warming is mild problem today and there are a lot more dire problems that need to be solved today. And if you haven't read Cool It by Bjorn Lomborg, I highly recommend it. As well, here's some links to interviews with him.

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