Transcript Economics of Global Climate Change: Market Response to

Economics of Global (and
Domestic) Climate Change
Sabina Shaikh
University of Chicago
Climate Change: Biological and Social Implications
Summer Teachers Institute
June 24, 2008
Introduction and Outline
1.
Economics of Pollution Control
2.
Economics of Global Climate Policy
3.
Leveling the Playing Field: Pricing Carbon
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4.
Demand and Supply Responses
Energy Efficiency as “low-hanging fruit”
Uncertainties and Some Recommendations
Fun Economic Concepts for Today!
Externalities, Moral Hazard, Prisoner’s Dilemma
Discount Rates, Principal Agent Problems
Economics of Pollution Control
Markets and Government Intervention
 Externalities as Market Failure

The Private Cost of production or consumption
does not reflect the Social or True Cost
 The difference is the “external cost” or a negative
externality.
 Example: Driving is “too cheap”
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 Pollution,
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Congestion, Accidents
In this case, government intervention solves a
market failure. What kind of intervention is
‘efficient’?
Economics of Pollution Control
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Command and Control
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Market-Based Instruments: Permits and Taxes
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Marginal Costs and Marginal Benefits
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One more unit…
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With Pollution Controls, the polluter’s choice compares the
marginal cost of pollution abatement Vs. the price of
polluting.
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The price of pollution is the permit price or the tax.
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Each polluter is comparing their marginal cost of abatement
to this same price. They stop abating where the marginal
cost of abatement just equals the price of pollution.
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By equating the marginal costs of pollution abatement, no
one entity can reduce pollution cheaper than another.
Global Climate Change
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The Kyoto Protocol
Ratification: Nations representing 55% of
world’s emissions
 Average reduction 5% below 1990 levels by
2012.
 U.S. not participating, Australia signed 2007.
 The Role of Developing Countries
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Kyoto Protocol and Flexibility Mechanisms
Flexibility of Kyoto
1. Carbon Sinks and Sequestration
2. Emissions Trading
3. Joint Implementation
4. Clean Development Mechanism
Kyoto Protocol
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The “Inverted U”
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Issues: Types of Pollutants, Globalization,
Outsourced Pollution
Kyoto Protocol
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The Clean Development Mechanism
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Cuts costs of emissions reductions for developed countries
Encourages pollution control in developing countries
Generated $59B in total investment but value of new
projects halved next year, zero by 2010 (Economist 2008)
Concerns: Moral Hazard
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“Additionality”
 Projects must bring about new emissions reductions
 Reduces incentives to voluntarily reduce emissions or use
new cleaner technology.
 Why spend money when someone else will do it?
 CDM rules modified to address this issue but questions
remain for future.
Future of Global Climate Policy
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Developing Countries
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So, what happens now?
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Growth Rate in CO2 emissions
China is now the world’s leader in CO2 emissions
But, Cumulative Emissions and Per-Capita Emissions
Countries (Cities, Companies, etc.) do not want to act alone.
Free Riders: Individual Costs and Shared Benefits
Game Theory: Prisoner’s Dilemma?
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Everyone waiting on someone else to act.
Those who do not sign on will free ride.
But, if most countries sign on, they can agree to sanction
those who do not (Liebrich 2008)
Domestic Climate Policy
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Examples of Domestic Policy

Lieberman/Warner, Regional, States, Cities
Setting Carbon Prices
 In theory, Cap and Trade and Carbon
Taxes are equivalent
 Upstream on Carbon Content
 Downstream on Emissions
 Uncertainty
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Carbon Pricing: Cap and Trade Vs. Carbon Taxes
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Advantages of Cap and Trade
Potential Concerns of Cap and Trade and Solutions
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“The chief political virtue of cap-and-trade is it’s complexity.”
Washington Post, June 08
“..cap and trade systems are complicated and conveniently opaque.” The
Economist, June 07
Moral Hazard: Additionality
Allocating Allowances: Free or Auctioned?
Price Uncertainty
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Economic Shocks
Lack of Innovation
Safety Valve
Fixed Emissions
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Adjust for Business Cycles
Banking
Carbon Taxes
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Direct Examples: B.C.
Advantages of Carbon Taxes
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Upstream: Easier, more Efficient
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CBO, May 2008: Carbon Tax five times more effective than
an inflexible Cap and Trade program.
Fewer Administrative Costs
Price Certainty
Less Volatility allows for Long-Term Investment, R & D
 Allow Emissions to Vary with Economic Conditions
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Revenue Neutrality: Tax Swap, Distribution of Income
Concerns about Carbon Taxes:
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Quantity Uncertainty: Cumulative CO2 and Threshold
Support: Political Palatability
Loss of CDM?
Inefficient Use of Revenues
Relative Efficiency of Policies
CBO, February 2008
Carbon Prices
Regardless of Policy, a carbon price levels the
playing field
 Supply Response
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Demand Response
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Elasticity: Increased Price of Fossil-Fuel Based
Inputs leads to Substitution
Elasticity: As Price of Energy/Fuel goes up, the
Amount Consumed Goes Down
How to Reduce Carbon Emissions?
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Choose cheapest option?
Supply Response
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Fixing Coal
Clean Coal, Carbon
Capture, FutureGen?
Renewable Energy: Wind,
Solar, Nuclear?
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Renewables projected to
double by 2030 (EIA)
Petroleum, coal and natural
gas will decrease from 85%
in 2006 to 83% in 2030.
Increasing Domestic Oil
Supply
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ANWR, Tar Sands,
Strategic Reserve, Ethanol
Carbon price of at least $30 makes
wind and coal carbon capture viable
Demand Response: Energy Efficiency
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Global energy demand is increasing. Increased supply
is not enough.
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Buildings account for about 40% of the U.S. GHG
emissions, 70% in cities
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Buildings represent half of U.S. energy consumption
and 70% of electricity use
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McKinsey Report (2008)
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Energy Efficiency in Buildings is the lowest cost (cost-saving)
way to abate GHG emissions.
Low-Cost energy efficiency improvements in buildings could
offset 85% of projected increase in energy demand by 2030.
Energy efficiency investments with average rates of return of
17% could return $900 billion in annual energy cost savings
by 2020.
Improving global energy productivity could provide half of
abatement recommended by IPCC.
Market Barriers to Energy Efficiency
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Do higher energy prices lead to energy
efficiency investments?
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Potential Barriers
1.
2.
3.
4.
High Discount Rates
Principal-Agent Problems
Hidden Costs of Substitutes
Information and Transactions Costs
1. High Discount Rates
Upfront Costs – Future Returns
 Rates of Return
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High Rates of Return Required: 25-300%?
 Uncertainty from Future Legislation
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Individual, Business/Utility, Legislator
Levels
2. Principal Agent Problems
Employer—Employee Relationship
 Incentives and End Users
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Developers, Builders
 Landlord, Tenant
 Demand for Green?
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Other Incentives: Utility Companies Decoupling
3. Hidden Costs of Substitutes
Perfect Substitutability?
 Sacrificing Quality or Convenience
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Lightbulbs: Incandescent, CFL
 Bottled Vs Tap Water
 Hybrid Cars
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4. Information and Transactions Costs
Too Little Information
 Too Much Information
 “Greenwashing”, “Green Noise”
 Inertia
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Uncertainties and Some
Recommendations
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Future of Global Agreements: Address Additionality, Free
Riders
Cap Vs Tax? Address concerns of either.
Carbon Prices are a Significant Step but Technology
Improvements Needed
“Europe’s carbon-trading system has not shown much capacity
to generate large-scale research nor to develop, demonstrate
and deploy breakthrough technologies.” Sachs (2008)
Energy Efficiency
 Financing
 Reconciling & Decoupling
 Availability of Viable Substitutes
 Evaluation of Outcomes for Consistency of Information
Portfolio of Demand Response and Supply Side Options