Blog Post

The economic debates behind COP21

What’s at stake: France will chair and host the 21st Conference of the Parties to the United Nations Framework Convention on Climate Change (COP21) at the end of the year. While the scientific community has reached a consensus that climate-warming trends are very likely due to human activities, the discussion about how to address is mired in huge political disagreements.

By: Date: November 23, 2015 Topic: Energy & Climate

Scientific consensus

John Cook et al. examined 11 944 abstracts of peer-reviewed scientific literature published between 1991–2011 on the topics ‘global climate change’ or ‘global warming’. Among abstracts expressing a position on anthropogenic global warming, 97.1% endorsed the consensus position that humans are causing global warming – a rare level of agreement in the world of science!

However, there is controversy about the validity of this result. Richard Tol pointed out that the paper did not meet basic academic standards, although the authors answered this criticism. The debate, more about academic rigor than about the fact that there is a consensus, is still ongoing (see here, here and Figure 1). In fact, Tol wrote:

“There is no doubt in my mind that the literature on climate change overwhelmingly supports the hypothesis that climate change is caused by humans. I have very little reason to doubt that the consensus is indeed correct.”

Figure1: Estimates of the consensus on anthropogenic global warming according to Cook et al. and other studies (Bray, Oreskes, Doran, Anderegg, Stenhouse, Verheggen) as a function of the sample size.

BEBR211115_1

Let us return to the political discussion. In 2009 the COP15 in Copenhagen did not result in a consensus. Parties did not adopt a successor of the Kyoto Protocol. Instead the Doha Conference (Qatar) in 2012 established a second commitment period of the Kyoto Protocol (2013-2020), which concerned only a number of industrialised countries. In December in Paris, the expected outcome is a new international agreement on climate change, applicable to all, to keep global warming below 2°C.

Legal form of the agreement

Ahead of the summit, countries have agreed to publicly outline which post-2020 climate actions they intend to take under a new international agreement. Many of these stated intentions (known as Intended Nationally Determined Contributions, or INDCs) demonstrate a tendency to free riding – leading to a true tragedy of the commons. The solution, as 2009 Economic Nobel Prize Elinor Ostrom documented, always involves reciprocity and trust: “I will commit myself to follow the set of rules we have devised in all instances except dire emergencies if the rest of those affected make a similar commitment and act accordingly.”

Recently US Secretary of State John Kerry announced that the Paris deal will not be legally binding treaty. François Hollande restated, as the European Commission did earlier, and as it had been agreed during the G7 summit, that those commitments should be binding. Robert Stavins and Nicholas Stern argue that those lengthy discussions on the form of a legal agreement are “futile” or “a serious mistake”, because of the extremely limited chances of political viability. (Any binding agreement would need approval from a hostile US senate, which must ratify all treaties). They argue that additional efforts should be invested in the content of the agreement instead.

Feasibility of 2°C

There are only few elements of the discussion where parties are close to a consensus. The 2°C ceiling is one of them, but according to the IEA’s recent publication, the actual pledges made by countries will be more consistent with an increase limited to around 2.7°C.

The Intergovernmental Panel for Climate Change (IPCC) is a multi-disciplinary group of scientists which provides scientific evidence on climate change to the COP officials. Oliver Geden and others argue that 2°C is essentially impossible within the IPCC’s models, as they rely on currently unproven technologies. The IPCC models that are able to hit the 2°C target rely on ‘negative emissions’ – the removal of greenhouse gases from the atmosphere during the second half of the century. This could probably only be achieved through carbon capture and storage technologies, which are still in their infancy.

Pricing Carbon

Carbon pricing is one of the key policies that economists call for, as effective carbon pricing is both welfare-maximising and cost-effective. The roots of the idea go back to 1920, when Arthur Cecil Pigou identified the possibility of “uncompensated or uncharged effects [due to] the consumption of things other than the one directly affected.” He advised states to encourage (or discourage accordingly) those divergences: “The most obvious forms which these encouragements and restraints may assume are, of course, those of bounties and taxes.

Those divergences are also known in the market failure literature as externalities. What Pigou was proposing was late reframed later as a Pigouvian tax, a tax on goods that produce such externalities.

In the climate discussion, the negative externalities faced are greenhouse gas emissions. In 2006, at the initiative of Gregory Mankiw, the Pigou Club advocated higher Pigouvian taxes. It included a long list of economists, such as William Nordhaus, Paul Krugman, Ken Rogoff, Robert Samuelson and Joseph Stiglitz.

Pigou’s analysis was accepted until 1960. In his Nobel prize-winning paper “The Problem of Social Cost” Ronald Coase argued that, if the people affected by the externality and the people creating it can easily get together and bargain, taxes and subsidies may be unnecessary. In practice, as Coase himself noted, the assumption of low/near-zero transaction costs is often not satisfied and poorly defined property rights can prevent Coasian bargaining.

In the climate debate, Cap-and-Trade systems take up Coase’s ideas by providing a market to owners of carbon emission permits. To counter the major flaw in his theory regarding the problem of initial allocation of permits, recent literature advises permit auctions.

However, even if economists agree on the necessity of pricing such externalities, there is no consensus about the appropriate tools. Policymakers debate a wide range of options, but Christian Gollier and Jean Tirole say that either cap-and-trade or carbon taxes should be policymakers’ preferred weapon. More political figures agree: Christine Lagarde and Jim Yong Kim made a joint statement in favour of carbon taxes, emissions-trading and the removal of inefficient subsidies.

Cost-benefit-analysis

The standard tool economists use to assess policies is cost-benefit analysis. The positive and negative consequences of a policy are estimated and added together as discounted sum – effects further in the future are assigned a lower weighting. If the benefits prevail, the policy is socially preferable.

Martin Weitzman, an economist at Harvard University, and Gernot Wagner, lead senior economist at the Environmental Defense Fund, argue that the expected loss to society through catastrophic climate change is so large that it cannot be reliably estimated. A cost-benefit analysis cannot be applied here, as even slightly reducing a near-infinite loss is near-infinitely beneficial.

Other economists, including William Nordhaus of Yale University, have examined the technical limits of Mr Weitzman’s argument. Rheinberger and Treich argue that “as the interpretation of infinity in economic climate models is essentially a debate about how to deal with the threat of extinction, Mr Weitzman’s argument depends heavily on a judgement about the value of life”.

The second problem raised by economists is the choice in the discount rate applied when weighting future consequences in the cost-benefit analysis. How much should we value improved climate outcomes in more distant futures? In 2006 the Stern Review on the Economics of Climate Change was released and has been the most widely known and discussed report of its kind. However, it has often been criticised for its use of an unusually small discount rate of approximately 1.4%.

An intense debate emerged at the end of the nineties  (Figure 2) about whether it is socially efficient to use a discount rate for the distant future that is different from the one used to discount cash flows occurring within the next few years. Much of this controversy is now resolved, as a 2012 all-star publication by 13 authors (Arrow, Cropper, Gollier, Groom, Heal, Newell, Nordhaus, Pindyck, Pizer, Portney, Sterner, Tol and Weitzman) converged on one mathematical formula for estimating the discount over long horizons. But the authors still hold differing opinions on how the parameters should be determined.

Those oppositions revisit a long-standing debate about the “descriptive” versus “prescriptive” approach to discounting—the former approach arguing that discount rates should reflect observed behaviour in markets, and the latter that ethical considerations should be used to set the utility rate of discount and the elasticity of marginal utility of consumption.

Figure 2: Histogram of individual estimates of the discount rate among 2160 PhD-level economists

BEBR211115_2

Source: Weitzman, M.L., (1998), Gamma discounting, American Economic Review, 91, 260-271.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

The United States-Mexico-Canada free trade agreement (USMCA)

While final ratification of the USMCA (also known as Nafta 2.0) is pending, we review economists’ assessment of the agreement.

By: Silvia Merler Topic: Global Economics & Governance Date: October 22, 2018
Read article More on this topic More by this author

Blog Post

The 2018 Nobel Prize: Growth and the environment

The 2018 Nobel Prize in Economic Sciences has been awarded jointly to William Nordhaus and Paul Romer for integrating respectively climate change and technological innovation into long-run macroeconomic analysis. We review how economists reacted to the announcement.

By: Silvia Merler Topic: Energy & Climate Date: October 15, 2018
Read article Download PDF More on this topic More by this author

External Publication

The impact of global decarbonisation policies and technological improvements on oil and gas producing countries in the Middle East and North Africa

Simone Tagliapietra contributed to the IEMED Mediterranean Yearbook 2018 with a chapter on the impact of decarbonisation policies on oil and gas producing countries in the MENA region.

By: Simone Tagliapietra Topic: Energy & Climate Date: October 3, 2018
Read article More on this topic More by this author

Blog Post

Inequality in China

After amply discussing income inequality in Europe and the US, economists are now looking at the magnitude, implications and possible remedies for this phenomenon in the context of the Chinese economy.

By: Silvia Merler Topic: Global Economics & Governance Date: September 24, 2018
Read article More on this topic More by this author

Blog Post

Reforming the EU fiscal framework

Researchers have often highlighted the problematic nature of the currently very complex EU fiscal framework. Here we review economists’ views on how it should be changed.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: September 17, 2018
Read article More on this topic More by this author

Blog Post

Lehman Brothers: 10 Years After

Ten years after the bankruptcy that shook the world, we review economists’ take on the lessons learned from the global financial crisis.

By: Silvia Merler Topic: Finance & Financial Regulation Date: September 10, 2018
Read article More on this topic More by this author

Blog Post

Monetary policy and superstar firms

The yearly Jackson Hole gathering of central bankers has focused this year on the topic of changing market structure, the rise of superstar firms, and the implications of the way they compete for central banks.

By: Silvia Merler Topic: Global Economics & Governance Date: September 4, 2018
Read about event

Past Event

Past Event

Bruegel Annual Meetings 2018

The 2018 Annual Meetings will be held on 3-4 September and will feature sessions on European and global economic governance, as well as finance, energy and innovation.

Speakers: Maria Åsenius, Richard E. Baldwin, Carl Bildt, Barbara Botos, Maria Demertzis, Benjamin Denis, Lowri Evans, Mariya Gabriel, Svend E. Hougaard Jensen, Joanne Kellermann, Jörg Kukies, Emmanuel Lagarrigue, Philippe Lespinard, Rachel Lomax, Dominique Moïsi, Jean Pierre Mustier, Ana Palacio, Jean Pisani-Ferry, Lucrezia Reichlin, Norbert Röttgen, André Sapir, Johan Van Overtveldt, Martin Sandbu, Margrethe Vestager, Reinhilde Veugelers, Nicolas Véron, Thomas Wieser, Guntram B. Wolff and Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Brussels Comic Strip Museum, Rue des Sables 20, 1000 Brussels Date: September 3, 2018
Read article More on this topic More by this author

Blog Post

The Turkish Crisis

Financial markets have been very nervous about Turkey for the past few weeks. We review economists’ opinions about the economic, political and geopolitical risks and opportunities of this situation.

By: Silvia Merler Topic: Global Economics & Governance Date: August 27, 2018
Read article Download PDF

External Publication

Export and patent specialization in low carbon technologies

The low-carbon technology sector is going through a period of disruptive innovation and strongly increased investment, which is likely to continue. Global investment in new renewable power is the largest area of electricity spending. The political momentum to combat climate change was reinforced in the Paris Agreement, when almost every country in the world agreed to aim for carbon neutrality in the second half of the century.

By: Robert Kalcik and Georg Zachmann Topic: Energy & Climate, Innovation & Competition Policy Date: August 7, 2018
Read article More on this topic More by this author

Blog Post

Italy's "Dignity Decree"

The new Italian government pushed through its first legislative act including elements of labour market reform. Presented as an overturn of the previous government’s “Jobs Act”, the estimated effects of the decree are controversial. We review Italian economists’ view on the matter.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: July 23, 2018
Read article More on this topic More by this author

Blog Post

Economy of Intangibles

Economists have been discussing the implications of the rise of the intangible economy in relation to the secular stagnation hypothesis, and looking more generally into the policy implications it has for taxation. We review some recent contributions.

By: Silvia Merler Topic: Finance & Financial Regulation Date: July 16, 2018
Load more posts