Optimal climate policy
Prof. Dr. Carsten Vogt
Bochum University of Applied Sciences
Summer term 2013
Optimal climate policy
• Weighing of costs and benefits from climate
policy
• Need for quantifying benefits and costs
• Moreover: we need to take into account the
timing of climate policy
– Abatement today is more costly than abating
emissions in the future (technical progress)
• In short: We need a model.
Optimal climate policy: DICE (Nordhaus)
• DICE: Dynamic Integrated model of the
Climate and the Economy
• Contains the important links between
economic activity and climate system
• Is a daynamic optimization model
• i.e. it allows for calculating the optimal
abatement path over time
DICE (2007): model architecture
Welfare
Population
Utility
carbon
abatement
emissions
Global
temperature
consumption
capital
output
damages
Labour force
DICE: Equations
• Welfare:
– Depends on:
• Utility from consumption
• Population size (the more people, the more suffer from
climate change)
– DICE: maximizes the sum of discounted utilities
• Obvious: core parameter of the model: discount rate
• Note: DICE approach is purely anthropocentric and
utilitarian
DICE: economic equations
• Utility:
– Depends on: per capita consumption
– Population size L
– Utility function is neoclassical (increasing and
concave in consumption
DICE: economic equations
• Capital rate of return:
– r: capital rate of return
– 𝜌: social rate of time preference
– 𝛼: elasticity of marginal utility
– g: annual growth rate of per capita consumption
DICE: economic equations
• Capital rate of return:
Important: assumptions about rho, alpha and g
determine r !
Note: r defines the discount rate on goods markets!
Thus: r gives the opportunity costs of climate policy.
DICE: sets r=4.1%
heavily influences current value of climate
damages!
DICE: economic equations
• Example: future damage due to climate
change 1 trillion €
– r=1%: Current value is 370 billions €
– R=4%: CV decreases to merely 20 billions!
What is the right number?
Society faces different choices:
We can invest in: Climate Policy
But also, e.g., in: capital accumulation
Investment into capital gives a rate of return of about
4% (long run rate of return on capital markets)
DICE: economic equations
• When is an investment in climate mitigation
economically justified?
• If it gives at least a return as high as capital investment!
• Climate investment has to cover at least the
opportunity costs.
• Otherwise, society could earn higher returns by
investing into capital formation, formation of human
capital etc…
• Note: This is an important question particularly for
developing and emerging countries!
DICE: economic equations
• Output:
• Standard neoclassical production function
• Showing decreasing returns to capital and labour
•  : Climate damage factor
• Climate damages:
•
•
Increasing in T
And convex.
DICE: economic equations
• Climate damages: what is contained?
• Based on data from 12 world regions (e.g. US, China,
Europe, Africa, Latin America …)
• Damages from decreased crop yields in agriculture
• Damages from sea level rise at coastal lines
• Increased morbidity
• Empirically estimated in order to give a best fit to the
damage data reported in the current literature
DICE: economic equations
• Abatement costs:
• Increasing and convex in emissions reduction
• Output: divides into consumption and
investment:
• Per capita consumption:
• Capital accumulation:
• Industrial emissions:
• Core parameter: carbon intensity 𝜎
DICE: geophysical equations
• Carbon cycle model:
• Describes exchanges of carbon between the
atmosphere, the upper and the lower layers of the
oceans
DICE: geophysical equations
• Radiative forcing:
• Describes total incoming energy captured in the
atmosphere
• Depends on: exogeneous amount of energy
• Depends also on: atmospheric concentration of carbon
in the atmosphere relative to its preindustrial level
• Temperature:
DICE: Results
• Four scenarios:
– Baseline: no abatement policy at all
– Intertemporal Optimum („Optimum“): Efficient
abatement suited to maximize social welfare
– 2 degrees: Policy (often advocated in the political
arena) aiming at stabilizing temperature increase
at 2°C
– „Stern“: Scenaio adopting a very low discount rate
(as has been used in the Stern-Review)