Transcript Institutional design

Time horizon, uncertainty
and cost benefit analysis.
Long run discount rate for
environmental goods.
Cost benefit analysis
The cost of Kyoto :
the verdict of models.
ITA
400
ROEFR
350
UK
FIN
300
Ca
rb
on
val
ue
in
U
S$
95
/
tC
SWE
NLD
DNK
ESP
250
200
150
100
DEU
50
0
0%
10%
20%
30%
Carbon emissions reductions (in
%)
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Why models ?
• Sectoral effects (électricityé).
• effect on final demande: econometrics of price effects.…
• General interactions.
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Which models ?
• sectoral.aggregate.
• Computable general equilibrium.macroéconomics.
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The double dividend controversy.
40%
The benefits of climate policies
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The difficulties
• Many chapters
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Agriculture, extreme weather events
Bio-diversity, health, quality of climate.
Flooding, large scale migrations..
• Difference across regions
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Northern areas and vulnerable, (southern) places.
• Differences according to the range of
temperature
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1 to 3 degrees : agriculture in northern areas.
Above high reductions of general fertility.
Uncertainty has to be faced.
The benefits of climate policies
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The solutions of the Stern review.
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A comprehensive qualitative coverage of the
phenomena.
A long run probabilistic assessment
A synthetical money assessment
• Damages = (T/2,5) power g, g=1,5 to 3
• Probabilistic assesment : high climate scenario,
markets and non market impacts, 95th percentile 35per
cent of global GDP in 2200.
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The presentation of numbers.
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Equivalent GDP loss.
Skips partly the discount rate issue.
The discount rate in the Stern
Review.
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The issue :
• How should one unit of consumption for the present
generation be valued in comparison of the same unit for the
present generation.
• If perfect altruism the answer depends upon the elasticity of
marginal utility (xU``/U`) or relative risk aversion.
• Pure rate of time preference.
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Example :
• Isoelastic utility function
• U= [1/(1-  ’]t=0infini{(exp(-  t))[U(xt)](1 - ’)}
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The solution of the Stern review
• Elasticity close to one (Log utility…)
• Does not kill the future.
• Underestimate risk aversion….
Questions on long run discount
rates for environmental goods.
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Discounting « kills » the distant future.
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10 per cent discount rate :120 in 50 years, 14000 in 100 years
7 per cent, discount rate : < 30 in 50 years, 860 in 100 years,
5 per cent discount rate : 130 in 100 years, 17 000 in 200 years,
2 per cent discount rate : 2,7 in 50 years, 7,3, in 100 years, 52 in
200 years.
Is standard discounting appropriate for long run decisions ?
Argument 1 : « ecological intuition »
• Discounting=selfishness of existing generations, ethically
unacceptable
• Destroys our common natural patrimony, for second rate
interests.
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Argument 2 : « economic reason »
• Cost benefit analysis provides the weights for decisions about
public versus private goods.
• Cost benefit analysis rightly stresses that it is useless to
sacrifice present generations to future and much wealthier
generations.
How to reconcile economic and
ecological intuition ?
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Ingredient 1 Environmental goods and the long run.
• They differ from
 private goods : out put cannot be continually expanded.
 non renewable resources : not destroyed by cautious use.
• in the long run, their relative scarcity (/ private goods)
increases.
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Ingredient 2 Uncert. lowers long run discount rate.
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Argument : valuation by generation 0 of 1 euro given to
generation T : exp(-Rt)
If uncertainty : R or r, R>r
• (1/2) exp(-Rt) + (1/2)exp(-rT) =
• exp(-rT) [(1/2)+(1/2)exp((-R+r)T)]=
• exp(-r ’(T)T),
• r ’(T) tends to r when T tends to infinity
Weitzman (2000), AER
How to reconcile CB analysis and
economic intuition.
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Ingredient 3 : Substitutability :
• If private and environmental goods were perfectly
substitutable, then, no reason to treat them differently in Cost
Benefit analysis.:
• If they are strict compléments
Min{x,y}
 Private output increases, the environmental good level
does not.
 After a while, increasing the welfare of a wealthier future
generation relies on improving environmental quality.
 Discount rate for private good : + 
 Discount rate for environmental good : almost zero.
Ingredient 4 : « ethical » considerations.
• Pure rate of time preference close to zero
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• > probability of the planet’s survival ?
A formal model
RG « Calcul économique et Développement durable », Revue Economique,
2004,
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2 goods :
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aggregate consumption good : quantity.
« environnemental quality »
Utility function :
• Formulation.
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v(xt ,yt) ={[xt((- 1)/  ) + yt(( -1)/  ) ] ( /( -1))}
V(xt ,yt) =[1/(1-  ’)][v(xt ,yt)](1 - ’)
• Comment.
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y/x decreases of 1/100, the willingness to pay increases of
(1/)
pour 100
Iso-élastic cardinal utilty for generation t,
Constant relative risk aversion ’.
Uncertainty :
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On the long run elasticity of substitution between private and
environnemental good, 
A formal model
RG « Calcul économique et Développement durable », Revue Economique,
2004,
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2 goods :
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aggregate consumption good : quantity.
« environnemental quality »
Note :
•  only parameter, summary statistics of much information
•  ’ different possible interprétations.
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Social welfare
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U= [1/(1-  ’]t=0infini{(exp(-  t))[v(xt ,yt)](1 - ’)}
Remarks
Index t associated to generation
Utilitarian.
When __0, « ethical » viewpoint.
Cost Benfit analysis at the margin
• A « reform » viewpoint.
• Combines the four previous ingredients.
Results
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« Canonical » Ecological Cost benefit Analysis
• Generation 0 evaluates an investment (at 0), generating an
improvement of the environmental quality for generation t
• The value of the improvement is measured with the marginal
willingness to pay of generation 0 : « canonical procedure »
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Proposition A :
• If the probability of « ecological strangling » in the long
run is null.
• Standard discount rate : Min (g’)+ 
• ethical « canonical » ecological long run discount rate :
• lim T  (T) = g[ ’-(1/  )]
• Min{g}[Min{’}-1/{Min  } :
• (1) (1,4 - 0.9) = 0,5 pour cent !
Results
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« Canonical » Ecological Cost benefit Analysis
• Generation 0 evaluates an investment (at 0), generating an
improvement of the environmental quality for generation t
• The value of the improvement is measured with the marginal
willingness to pay of generation 0 : « canonical procedure ».
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Proposition B :
• If the probability of « ecological strangling » in the long run is
non zero.
• The ethical long run discount rate for private goods : Min{g/
}
• The ethical « canonical » ecological long run discount
rate is zero.
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Lessons :
• Substitutability is essential …
• and uncertain..
Irreversibility and option value.
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Irreversibility of the greenhous effect.
• Irreversibility of concentrations
• Climate irreversibility.
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Cost benefit analysis : the value of preserving options.
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A stylised argument. :
To morow cost, value C, prob. (½), 0, prob. (1/2)
action allow to avoid it cost a,
Information will arrive : C or 0
Willingness to pay to keep the option ? : (1/2)(C-a)>0
Possibly (1/2)C-a<0,
More generally….
Some references.
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Aldy, J.E., P. R. Orszag and J. E. Stiglitz, ''(2001) ''Climate
Change: An Agenda for Global Collective Action'', Prepared for the
conference on ``The Timing of Climate Change Policies'', Pew
Center on Global Climate Change, October.
Bradford, D.F. (2001), « Improving on Kyoto: A No Cap but Trade
Approach to Greenhouse Gas control » Princeton University.
Chakrovorty U, Magné B. and Moreaux M, (2003) « Energy
resource substitution and carbon concentration targets with non
stationary needs'', Leerna 31, Université de Toulouse.
Cooper, R., (1998), ''Toward a real global warming treaty'', Foreign
Affairs, vol. 77 no 2, March-April
C
Carraro C.(1999) ''The Structure of International Agreements on
Climate Change''in C. Carraro C. (ed), International Environmental
Agreements on Climate Change, Kluwer Academic Publishers,
Dordrecht, NL
Chandler L and Tulkens H. (2005) « Stability issues and climate
related dynamic externalities »38p
Some references.
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Freixas X, Guesnerie R, et Tirole J. (1985) « Planning under
incomplete information and the ratchet effect », Review of
Economic Studies, LII, 173-191..
Guesnerie R. (2003) « Les enjeux économiques de l'effet de
serre » in «Kyoto et l‘économie de l'effet de serre », sous la
direction de R. Guesnerie, La Documentation Française, Paris.
Guesnerie R. ( 2004) « Calcul Economique et Développement
Durable », Revue Economique, p.363-382.
Guesnerie R. (2005) ''Assessing Rational Expectations :2''Eductive'' stability in economics », MIT Press, 453 P.
Guesnerie R. (2006) The design post Kyoto climate schemes : an
introductory analytical assesment ».
Ha-Duong M, Grubb M et. Hourcade J.C, (1997) ''Influence of
socio--economic inertia and uncertainty on optimal CO2-emissions
abatment'', Nature, Vol. 390.
Newell, R.G. and W.A. Pizer, (2000), « Regulating Stock
Externalities Under Uncertainty », Discussion Paper 99-10,
Resources for the Future, Washington DC, February.
Some references.
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Nordhaus, W.D, (2002), ''After Kyoto: Alternative Mechanisms to
Control Global Warming'', Paper prepared for the meetings of the
American Economic Association and the Association
of.IEA/SLT(2002)28
Philibert, C. (2000). ``How could emissions trading benefit
developing countries.'' Energy Policy , volume 28, no 13.
Philibert, C., and J. Pershing. (2001). ``Des objectifs climatiques
pour tous les pays : les options.'' Revue de l‘Energie 524.
Pizer, W.A., (2001), ''Combining Price and Quantity Control to
Mitigate Global Climate Change'', Journal of Public Economics,
85,(3), 409-434.
Rieu J.(2002) ''Politiques nationales de lutte contre le changement
climatique et réglementation de la concurrence : le cas de la
fiscalité », mimeo.
Weitzman, M. L., (1974) ''Prices vs. Quantities'', Review of
Economic Studies, vol.41, October.
Weitzman, M. L., (2000),AER