Can we afford the future?
The economics of a warming world
Frank Ackerman
U. N. Committee on Development Policy
November 20, 2007
The latest evidence (IPCC, 2007)
Temperature change (relative to 1980-99)
2020-2029
B1
A1B
A2
2090-2099
Climate policy: two excuses for inaction
• Fake science
 Temperature extremes have softened … the frequency of
hurricanes has been diminishing ... since 1940, weather
satellites, tree ring data, and corrected thermometer
readings all agree that climate has not warmed -- even
though CO2 levels rose. (Fred Singer)
• Conventional economics
 …efficient or “optimal” economic policies to slow climate
change involve modest rates of emission reduction in the
near term… The optimal rate of emissions reduction is 14
percent in 2015, 25 percent in 2050, and 43 percent in
2100.
(William Nordhaus, 2007)
 We should tax CO2 at the economically correct level of
about two dollars per ton (Bjorn Lomborg, 2007)
Many styles of denial
What will you wear to the apocalypse?
Three ideas about climate economics
1. Our descendents are important
2. Uncertainty is inescapable
3. Some costs are better than others
Discounting the future
(at 3% interest or discount rate)
years
from now
compound
interest
0
$100
1
$103
2
$106
10
$134
50
$438
100
$1,922
200
$36,936
XT = (1+r)T X0
present value
$5.20
$0.27
$100
$100
X0 = XT
/ (1+r)T
Bigger r means compound interest grows faster
– and present value shrinks faster!
Why do discount rates matter?
• Present value of $1000 in 2107
 At 1.5%: $226
 At 3%:
$52
 At 6%:
$3
• Present value of $1000 in 2207
 At 1.5%:
 At 3%:
 At 6%:
$51
$3
$0.01
• At a higher discount rate, it is harder for economics
to “see” future costs
 How much should we do to prevent $1000 of damages 100
or 200 years from now?
• Economic analysis supports active climate policy
with 1.5% discount rate – but not with 6% !
The future we’ll never know
Choosing a discount rate
• Market interest rates?
 Appropriate for short/medium-term private investments
 Need not apply to long-term public policy
• Will future generations be richer and need less help?
 If they are poorer, will they need more help?
• Pure impatience: if all generations are equally
wealthy, should we discount the future?
 Is your granddaughter less valuable than your daughter,
because she will be born a generation later?
 If both are equally valuable, the “pure impatience”
component of discounting should be zero
Three ideas about climate economics
1. Our descendents are important
2. Uncertainty is inescapable
3. Some costs are better than others
Things that won’t happen (soon)
Worst case or average?
• Economic analysis is based on average forecasts
• Fears about climate change are often based on
worst-case possibilities
• Will the Greenland ice sheet melt?
 Complete melting, causing sea level rise of 7 meters, is
unlikely in this century
 But it becomes more likely as temperatures rise
 Average: no problem this century
 Worst case: increasing cause for worry
• Other low-probability catastrophes: same issues
 West Antarctic ice sheet melting
 Abrupt release of methane from tundra or clathrates
 Thermohaline circulation failure in North Atlantic
Why buy insurance?
• People care a lot about unlikely “worst cases”
 How much time do you leave to get to the airport?
 Airport security is all about worst case possibilities
• Insurance is not based on average outcomes
 Probability that you will have a residential fire next year is
much less than 1%
 Probability that healthy young parents will die next year is
much less than 1%
 But we buy fire insurance and life insurance!
• Probability of enough warming to guarantee loss of
Greenland ice sheet is much greater than 1%
 Should we buy life insurance for the planet?
“Fat tail” uncertainty
• What temperature increase is likely
probability
from a doubling of CO2?
• Blue curve: normal distribution
Applies when uncertainty is well
understood from extensive evidence
Normal
• Red curve: “Student’s t”
Applies when uncertainty is
inferred from limited data – as is
necessarily true for climate change
Student’s t
• “Fat tail” uncertainty
Extreme values are much more
likely with red curve than with blue
• New economic theory (Martin
Weitzman, Harvard):
“Fat tail” uncertainty dominates
climate analysis
 Average effect (peak of curve) is
much less important
Expected temperature change
(or climate sensitivity parameter)
Three ideas about climate economics
1. Our descendents are important
2. Uncertainty is inescapable
3. Some costs are better than others
Two meanings of “costs”
• Economic models of climate change are based on
cost-benefit analysis
 Benefits must exceed costs in order to endorse a policy
• Numerous problems with methodology
 Benefits not meaningfully measured in dollars (value of a
human life, extinction of a species, etc.)
• See Ackerman and Heinzerling, Priceless
• One more problem: what do we mean by “costs”?
 Pure physical losses (storm damages)
 Investment in different industries than we had planned on
Which costs are larger?
• Hurricane Katrina: $135 billion property damage
(more than half uninsured)
• Cost of prevention
 Dutch seawalls are twice as high as New Orleans levees
 Cost is a small fraction (10% ?) of the Katrina damages
• Difference in kinds of costs
 Building higher levees creates jobs
 Letting storms destroy property does not
• Renewable energy, efficiency, conservation will
create new industries, technologies, jobs
 Not the same industries we would otherwise have chosen to
create
 Is this a “cost”?
Costs
exceed
benefits
Benefits
exceed
costs
Conclusion: a new climate economics
• The future matters
 Your granddaughter’s life is an important one
 The discount rate should be low (1.5% or less)
 Future benefits are worth spending money on today
• Uncertainty is decisive
 Climate policy is insurance against low-probability (but not
impossible) catastrophic events
 Certainty will not be achieved until it is too late
• Some costs are well worth paying
 We are “forced” to invent new industries, technologies, and
job opportunities in energy efficiency, renewable energy,
and related technologies
• Get it right, and your grandchildren will thank you for
leaving them a liveable world