Climate risks and carbon prices: Revising the social cost of carbon

Acke man, F ank; S an on, Elizabe h A. Wo king Pape Clima e isks and ca bon p ices: Re ising he social cos o ca bon Economics Discussion Pape s, No. 2011-40 P o ided in Coope a ion wi h: Kiel Ins i u e o he Wo ld Economy – Leibniz Cen e o Resea ch on Global Economic Challenges Sugges ed Ci a ion: Acke man, F ank; S an on, Elizabe h A. (2011) : Clima e isks and ca bon p ices: Re ising he social cos o ca bon, Economics Discussion Pape s, No. 2011-40, Kiel Ins i u e o he Wo ld Economy (I W), Kiel This Ve sion is a ailable a : h ps://hdl.handle.ne /10419/49935 S anda d-Nu zungsbedingungen: Die Dokumen e au EconS o dü en zu eigenen wissenscha lichen Zwecken und zum P i a geb auch gespeiche und kopie we den. Sie dü en die Dokumen e nich ü ö en liche ode komme zielle Zwecke e iel äl igen, ö en lich auss ellen, ö en lich zugänglich machen, e eiben ode ande wei ig nu zen. So e n die Ve asse die Dokumen e un e Open-Con en -Lizenzen (insbesonde e CC-Lizenzen) zu Ve ügung ges ell haben soll en, gel en abweichend on diesen Nu zungsbedingungen die in de do genann en Lizenz gewäh en Nu zungs ech e. Te ms o use: Documen s in EconS o may be sa ed and copied o you pe sonal and schola ly pu poses. You a e no o copy documen s o public o comme cial pu poses, o exhibi he documen s publicly, o make hem publicly a ailable on he in e ne , o o dis ibu e o o he wise use he documen s in public. I he documen s ha e been made a ailable unde an Open Con en Licence (especially C ea i e Commons Licences), you may exe cise u he usage igh s as speci ied in he indica ed licence. h p://c ea i ecommons.o g/licenses/by-nc/2.0/de/deed.en Clima e Risks and Ca bon P ices: Re ising he Social Cos o Ca bon F ank Acke man and Elizabe h A. S an on S ockholm En i onmen Ins i u e – U.S. Cen e , Some ille Abs ac The social cos o ca bon – o ma ginal damage caused by an addi ional on o ca bon dioxide emissions – has been es ima ed by a U.S. go e nmen wo king g oup a $21 in 2010. Tha calcula ion, howe e , omi s many o he bigges isks associa ed wi h clima e change, and downplays he impac o ou cu en emissions on u u e gene a ions. Ou eanalysis explo es he e ec s o unce ain y abou clima e sensi i i y, he shape o he damage unc ion, and he discoun a e. We show ha he social cos o ca bon is unce ain ac oss a b oad ange, and could be much highe han $21. In ou wo s case, i could be almos $900 in 2010, ising o $1,500 in 2050. The mos ambi ious scena ios o elimina ing ca bon dioxide emissions as apidly as echnologically easible ( eaching ze o o nega i e ne global emissions by he end o his cen u y) equi e spending up o $150 o $500 pe on o educ ions in ca bon dioxide emissions by 2050. Using a easonable se o al e na i e assump ions, he e o e, he damages om a on o ca bon dioxide emissions in 2050 could exceed he cos o educing emissions a he maximum echnically easible a e. Once his is he case, he exac alue o he social cos o ca bon loses impo ance: he clea policy p esc ip ion is o educe emissions a apidly as possible, and cos -e ec i eness analysis o e s be e insigh s o clima e policy han cos -bene i analysis. Pape submi ed o he special issue The Social Cos o Ca bon JEL Q54, Q58 Keywo ds Social cos o ca bon; cos -bene i analysis; clima e policy; clima e economics Co espondence F ank Acke man, S ockholm En i onmen Ins i u e – U.S. Cen e , 44 Teele A e., Some ille, MA 02144, USA; e-mail: ank.ack[email p o ec ed]. Discussion Pape No. 2011-40 | Sep embe 23, 2011 | h p://www.economics-ejou nal.o g/economics/discussionpape s/2011-40 © Au ho (s) 2011. Licensed unde a C ea i e Commons License - A ibu ion-NonComme cial 2.0 Ge many 2 1. In oduc ion Wi h he U.S. En i onmen al P o ec ion Agency’s ecen his o ic s ep owa d egula ion o g eenhouse gas emissions, cos -bene i analyses o p oposed Ame ican egula ions can now include an es ima e o damages done by g eenhouse gas emissions – o con e sely, he bene i s o educing hose emissions. I is, howe e , a e y small s ep: he “social cos o ca bon” (SCC), i.e. he damage pe on o ca bon dioxide, is es ima ed a $21 o 2010 (In e agency Wo king G oup 2010).1 Equi alen o $0.21 pe gallon o gasoline,2 such a low cos is di icul o econcile wi h he belie ha i is u gen o ake ac ion o add ess se ious clima e isks.3 The analysis by he ede al In e agency Wo king G oup is signi ican o i s ole in se ing U.S. clima e policy. I is also no ewo hy as a a e ins ance whe e economic heo ies and analyses ha e been newly in oduced in o he public policy deba e.4 Thus i is impo an o examine he uses o clima e economics in he Wo king G oup analysis, pa icula ly he ea men o he c ucial unce ain ies ha cha ac e ize he ield. This pape p esen s an examina ion and e- analysis o he SCC, inding ha ou majo unce ain ies in he economics o clima e change could imply much la ge es ima es. In each case, he Wo king G oup has chosen he op ion ha minimizes es ima es o clima e isks and damages. We begin wi h a discussion o he choice o models and scena ios o he SCC calcula ion. Ou e-analysis elies on DICE, one o he models used by he In e agency Wo king G oup ha p oduced he $21 es ima e; we use he Wo king G oup’s modi ied e sion o DICE, and he same i e scena ios on which hey based hei calcula ions. We hen in oduce ou majo a eas o unce ain ies ha a ec he calcula ion: he sensi i i y o he clima e o g eenhouse gases; he le el o damages expec ed a low empe a u es; he le el o damages expec ed a high empe a u es; and he discoun a e. We ecalcula e he SCC based on combina ions o high and low al e na i es o each o hese ac o s, yielding an a ay o 16 possible alues, bo h o 2010 and o 2050. Some o he esul an alues o he SCC a e ex emely high; he highes ones exceed $800 pe on in 2010 and $1,500 in 2050. In con as , a e iew o scena ios ha each ze o o nega i e ne global emissions wi hin his cen u y inds ha hey o en imply ca bon p ices, and ma ginal aba emen cos s, o $150 o $500 pe on o CO2 by 2050. Se e al o ou al e na i e SCC alues a e well abo e his ange. 1 All dolla igu es in his a icle a e in cons an 2007 U.S. dolla s. 2 Acco ding o he U.S. En i onmen al P o ec ion Agency, he e a e 8.8 kg o CO2 emissions om a gallon o gasoline, implying ha 114 gallons o gasoline yield one me ic on o emissions ( he s anda d uni o analysis o emissions); 103 gallons yield one sho on o emissions (see h p://www.epa.go /oms/clima e/420 05001.h m, accessed Ap il 22, 2011). Thus a use ul ule o humb is ha $1 pe on o CO2 is equi alen o oughly $0.01 pe gallon o gasoline. The es ima e in he ex o $0.21 pe gallon is o e ed solely o he sake o compa ison; he e a e no exis ing o p oposed ede al egula ions ha would add a ca bon cha ge o he p ice paid o gasoline. 3 On he u gency o ac ion, see IPCC (2007). On he implica ions o low SCC alues, see Acke man and S an on (2010). 4 I is new only o U.S. policy; o he coun ies, no ably he Uni ed Kingdom, a e se e al yea s ahead o he Uni ed S a es in his espec . The U.S. policy p ocess is un o una ely pa ochial, howe e , so ha he in oduc ion o clima e economics in o policy analysis is p esen ed wi h almos no e e ence o o he coun ies’ expe ience. 3 We conclude wi h a discussion o he meaning o e y high SCC es ima es. Once he SCC exceeds he cos o b inging ne emissions o ze o, i s exac alue becomes less impo an ; i he SCC we e wice as la ge, i would ha e he same policy implica ions. A such high SCC alues, cos -bene i analysis o indi idual policies p o ides no use ul in o ma ion; wha is needed ins ead is a cos -e ec i eness analysis o he leas -cos , mos e icien pa hway o each ze o o nega i e ne emissions. 2. Choice o models The In e agency Wo king G oup used h ee well-known models o clima e economics: DICE, PAGE, and FUND. They an each o he models on he same i e scena ios, and a e aged he esul s. Unde hei “cen al case” o p e e ed assump ions, he alue o he SCC, a e aged ac oss he i e scena ios, was $28 in DICE, $30 in PAGE, and $6 in FUND, o a h ee-model a e age o $21. Ou e-analysis uses only he DICE model. I is p obably he bes -known and mos widely used clima e economics model, and i is he easies o modi y o ou pu poses. Mo eo e , i s es ima e is he closes o he Wo king G oup’s h ee-model a e age. As sugges ed by he Wo king G oup’s cen al case esul s, i is likely ha FUND would ha e p oduced lowe es ima es han hose epo ed below, while PAGE would ha e p oduced highe es ima es. Rega ding he la e , PAGE has an explici ea men o po en ial clima e ca as ophes, using a Mon e Ca lo analysis ha allows a ia ion in he size o ca as ophes, he empe a u e h eshold a which hey become possible, and he likelihood o ca as ophe once he h eshold has been passed. DICE, in con as , includes he ce ain y-equi alen o expec ed alue o ca as ophe in i s damage unc ion. As a esul , PAGE es ima es a highe SCC han DICE a lowe discoun a es o highe clima e sensi i i y.5 Ou analysis includes bo h lowe discoun a es and highe clima e sensi i i y, so ou SCC es ima es would ha e been highe i we had used PAGE. 3. Choice o scena ios The Wo king G oup analysis ejec s, wi h li le discussion, he widely used In e go e nmen al Panel on Clima e Change (IPCC) clima e scena ios, and ins ead uses scena ios om ou o he models: he business-as-usual scena ios om IMAGE, MERGE, MESSAGE, and MiniCAM, and a 550 ppm s abiliza ion scena io. The s anges aspec o his choice is he inclusion o he 550 ppm scena io. Does i imply a guess ha unde business-as-usual condi ions, he e is a 20-pe cen chance ha he wo ld will each ag eemen on s abiliza ion a ha le el? No explana ion is o e ed. Mo eo e , he 550 ppm scena io is no e en a single, in e nally consis en scena io; a he , i s GDP, popula ion, and emissions ajec o ies a e a e ages o he alues in he 550 ppm scena ios om he o he ou models (see In e agency Wo king G oup 2010, p.16). None heless, inclusion o he 550 ppm scena io makes li le di e ence in p ac ice. Excluding i would cause only a $1 inc ease o he $21 SCC es ima e om DICE, FUND, and PAGE, o he 5 A lowe discoun a e inc eases he impo ance o e en s a he in he u u e, when empe a u es a e highe and ca as ophes a e mo e likely. Highe clima e sensi i i y makes highe empe a u es and inc eased isks o ca as ophe occu soone . Fo hese easons, PAGE es ima es a la ge SCC han DICE a a 2.5% discoun a e, and a 95 h pe cen ile clima e sensi i i y; see In e agency Wo king G oup on Social Cos o Ca bon (2010), Table 3. 4 $28 es ima e om DICE alone. Fo he SCC es ima es in ou analysis, p esen ed below, exclusion o he 550 ppm scena io would cause an a e age inc ease o 1 pe cen ; no indi idual es ima e would change by mo e han 15 pe cen in ei he di ec ion. Thus we ha e e ained he 550 ppm scena io in ou calcula ions, o inc ease compa abili y wi h he Wo king G oup esul s. The ou business-as-usual scena ios used by he Wo king G oup we e adop ed om an Ene gy Modeling Fo um (EMF) exe cise which compa ed en models; no hing is said abou why hese ou we e selec ed om among he en EMF models. The mo e amilia IPCC scena ios a e dismissed in a single sen ence, on g ounds o hei age and he unexplained asse ion ha hey now appea o be ex eme ou lie s in some a iables. Fo hose who a e no amilia wi h EMF, i may be help ul o con as he selec ed EMF scena ios wi h s anda d IPCC SRES scena ios.6 Figu es 1 and 2 compa e he cumula i e ca bon dioxide emissions and cu en me hane emissions om he ou EMF scena ios and h ee IPCC scena ios, A2, B2, and B1.7 As Figu e 1 shows, ca bon dioxide emissions in he ou EMF scena ios (solid lines) a e close o he B1 and B2 scena ios o he i s hal o his cen u y, sp eading ou o oughly span he in e al om A2 o B2 by 2100. Figu e 1: Compa ing EMF and IPCC CO2 emission scena ios Sou ce: See ex . Fo me hane emissions, Figu e 2 shows ha h ee o he ou EMF scena ios s a ou well below he le el o he B1 and B2 scena ios; by 2100, all ou a e oughly a o below he le el o B2. 6 IPCC scena io da a a e om h p://s es.ciesin.o g/ inal_da a.h ml , downloaded Ma ch 1, 2011. EMF scena io da a a e om h p://em .s an o d.edu/e en s/em _b ie ing_on_clima e_policy_scena ios_us_domes ic_and_in e na ional_policy_a chi ec u es , downloaded Feb ua y 15, 2011. 7 Figu e 1 p esen s cumula i e emissions because CO2 pe sis s in he a mosphe e o long pe iods o ime; Figu e 2 p esen s cu en emissions because me hane is emo ed om he a mosphe e much mo e quickly. 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100 CO2 : cumula i e G since 2000 MERGE MiniCAM IMAGE MESSAGE A2 B2 B1 5 Thus he emissions ajec o ies o he EMF scena ios a e b oadly wi hin, bu owa d he lowe end o , he spec um o IPCC scena ios, pe haps closes o B2. Figu e 2: Compa ing EMF and IPCC CH4 emission scena ios Sou ce: See ex . All else being equal, lowe emissions imply lowe damages, and he e o e a lowe es ima e o he SCC. Use o an IPCC scena io in which emissions g ow mo e apidly, such as A2, would likely ha e led o highe alues o he SCC. Rela i e o IPCC scena ios, he EMF emission ajec o ies a e pa icula ly low in he i s hal o his cen u y; his is o g ea es impo ance a high discoun a es, which weigh he ea lie yea s mo e hea ily. Fo he sake o compa abili y wi h he Wo king G oup esul s, we ha e adop ed he same i e scena ios in ou analysis o unce ain ies. No e ha his is a conse a i e choice o scena ios, as well as models; epe i ion o ou analysis wi h he PAGE model and highe -emission IPCC scena ios would lead o la ge SCC alues. Kopp and Mignone (2011) p o ide a mo e de ailed e alua ion o he Wo king G oup’s emission scena ios as pa o a discussion o he ull se o assump ions used in he Wo king G oup’s analysis. 4. Fou unce ain ies This sec ion explo es ou majo unce ain ies ha a ec he SCC calcula ion: he alue o he clima e sensi i i y pa ame e ; he le el o clima e damages expec ed a low empe a u es; he le el o damages a high empe a u es; and he discoun a e. The nex sec ion p esen s mul iple es ima es o he SCC, based on al e na i es o each o hese unce ain ies. 4.1. Clima e sensi i i y The clima e sensi i i y pa ame e is he long- e m empe a u e inc ease expec ed om a doubling o he concen a ion o ca bon dioxide in he a mosphe e. This c ucial pa ame e , which measu es he pace o global wa ming, emains unce ain, and he e a e easons o belie e ha signi ican unce ain y abou clima e sensi i i y is inescapable (Roe and Bake 2007). 250 300 350 400 450 500 550 600 650 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100 M CH 4 emissions MERGE MiniCAM IMAGE MESSAGE A2 B2 B1 6 On his opic, he Wo king G oup analysis is imp essi ely ho ough. They discuss he scien i ic e idence on likely alues o clima e sensi i i y, and adop a p obabili y dis ibu ion which assumes a wo- hi ds p obabili y ha clima e sensi i i y is be ween 2.0oC and 4.5oC. The minimum is ze o and he maximum is 10oC; he dis ibu ion has a median o 3.0oC and a 95 h pe cen ile o 7.14oC. They hen pe o m a Mon e Ca lo analysis, epea edly selec ing a clima e sensi i i y alue om his p obabili y dis ibu ion and unning he model wi h ha alue; he inal SCC es ima e is he a e age esul om hese uns.8 The Wo king G oup epo s, bu does no emphasize, he 95 h pe cen ile esul s as a measu e o he po en ial impac o unce ain y abou clima e sensi i i y. Resul s o DICE, and o he h ee- model a e age used by he Wo king G oup, a e p esen ed in Table 1. Table 1: SCC es ima es, 2010 and 2050, 3% discoun a e Sou ce: In e agency Wo king G oup (2010). We ollow he Wo king G oup in epo ing esul s o bo h a e age and 95 h pe cen ile clima e sensi i i y, in each o he a ia ions desc ibed below. In p ac ice, hese esul s may co espond o clima e sensi i i y somewha below 3.0oC and 7.1oC, espec i ely, since ac ual clima e sensi i i y in DICE (and se e al o he in eg a ed assessmen models) is lowe han he epo ed alues. DICE uses a de aul clima e sensi i i y o 3.0oC, bu ac ually esponds o a doubling o a mosphe ic ca bon dioxide wi h a long- un empe a u e inc ease o 2.77oC ( an Vuu en e al. 2011). 4.2. Damage unc ion es ima es Like clima e sensi i i y, he ela ionship be ween empe a u e inc eases and economic damage is unce ain. The Wo king G oup says li le abou he es ima es o economic damages om clima e change, excep o call o addi ional esea ch. Implici ly, i adop s wi hou ques ion he app oach aken by each model. Kopp e al. (2011) modi y he Wo king G oup’s e sion o he DICE model by including unce ain y in he damage unc ion and a ying he le el o isk a e sion in he discoun a e. We ake a simple app oach: he damage unc ion emains a ce ain y equi alen , bu we explo e al e na i e unc ional o ms and pa ame e alues. DICE assumes ha as empe a u es ise, an inc easing ac ion o ou pu is los o clima e damages. We will use D o damages as a ac ion o he GDP ha would be p oduced in he 8 In PAGE and FUND, he e a e o he Mon e Ca lo a iables ha a e d awn om p obabili y dis ibu ions o each un; in DICE, as used by he Wo king G oup, clima e sensi i i y is he only Mon e Ca lo a iable. Emissions yea Clima e sensi i i y DICE 3-Model A e age 2010 A e age $28 $21 2010 95 h pe cen ile $56 $65 2050 A e age $64 $45 2050 95 h pe cen ile $123 $136 7 absence o clima e change; R = 1 – D o he ne ou pu a io, o ou pu ne o clima e damages as a ac ion o ou pu in he absence o clima e change; and T o global a e age empe a u e inc ease in oC abo e 1900. The DICE damage unc ion is: (1) 𝑅𝑅=1 1+.00284 𝑇𝑇2 O equi alen ly, (2) 𝑅𝑅=1 1+�𝑇𝑇18.8 ��2 The DICE ne ou pu a io can be iewed as combining wo sepa a e es ima es: i s , o low empe a u es, William No dhaus, he c ea o o DICE, es ima es ha damages a e 1.8 pe cen o ou pu a 2.5oC (No dhaus 2007); second, a high empe a u es, i is assumed by de aul ha he quad a ic ela ionship o damages o empe a u e in (1) o (2) con inues o apply. Sepa a e esea ch add esses he low- empe a u e and high- empe a u e es ima es, sugges ing al e na i es o each. The DICE low- empe a u e damage es ima e is based on an e alua ion o se e al ca ego ies o clima e damages a 2.5oC (No dhaus 2008; No dhaus and Boye 2000). In a e iew and c i ique o he No dhaus es ima es as applied o he Uni ed S a es, Michael Hanemann de elops al e na i e es ima es o damages a 2.5oC, which a e, in o al, almos exac ly ou imes he No dhaus alue (Hanemann 2008). I he same ela ionship applies wo ldwide, hen a easonable al e na i e a low empe a u es is o keep he o m o equa ion (1) o (2), bu ecalib a e damages o 7.1 pe cen o ou pu a 2.5oC. This yields he equa ion: (3) 𝑅𝑅=1 1+�𝑇𝑇9.1 ��2 Nei he he No dhaus no he Hanemann 2.5oC es ima e p o ides a basis o p ojec ing damages a much highe empe a u es.9 I has become con en ional o ex apola e he same quad a ic ela ionship o highe empe a u es, bu he e is no economic o scien i ic basis o ha con en ion. The ex apola ion implies ha damages g ow a a leisu ely pace, especially in he No dhaus e sion: om equa ions (2) and (3), i is easy o see ha hal o wo ld ou pu is no los o clima e damages un il empe a u es each18.8oC acco ding o DICE, o 9.1oC in he Hanemann a ian . In a discussion o damage unc ions and ca as ophic isks, Ma in Wei zman a gues ha e en i he No dhaus es ima e is app op ia e o low- empe a u e damages, he inc easingly ominous scien i ic e idence abou clima e isks implies much g ea e losses a highe empe a u es (Wei zman 2010). He sugges s ha damages should be modeled a 50 pe cen o ou pu a 6oC and 99 pe cen a 12oC as be e ep esen a ions o he cu en unde s anding o clima e isks; he la e empe a u e can be aken as ep esen ing he end o mode n economic li e, i no human li e in gene al. In suppo o his disas ous p ojec ion o 12oC o wa ming, Wei zman ci es ecen esea ch showing ha a ha empe a u e, a eas whe e hal he wo ld’s popula ion now 9 No dhaus p esen s some nume ical es ima es o damages a 6oC, sugges ing hey a e be ween 8 pe cen and 11 pe cen o ou pu (No dhaus 2007); hese es ima es a e no well documen ed, and do no appea o be used in he calib a ion o DICE. 8 li es would expe ience condi ions, a leas once a yea , ha human physiology canno ole a e – esul ing in dea h om hea s oke wi hin a ew hou s (She wood and Hube 2010). Wei zman c ea es a damage unc ion ha ma ches he DICE es ima e a low empe a u es, bu ises o his sugges ed alues a 6oC and 12oC. He modi ies (2) by adding a highe powe o T o he denomina o :10 (4) 𝑅𝑅=1 1+�𝑇𝑇20.2 ��2 +�𝑇𝑇6.08 ��6.76 When T is small, he quad a ic e m in (4) is mo e impo an , p o iding a close ma ch o he o iginal DICE damage unc ion; when T is la ge, he highe -powe e m is mo e impo an , allowing he damage unc ion o ma ch Wei zman’s alues o highe empe a u es. The same me hod can be applied o he Hanemann low- empe a u e es ima e in (3); calib a ing o Hanemann’s alue a 2.5oC, and Wei zman’s alues a 6oC and 12oC, we ob ain: (5) 𝑅𝑅=1 1+�𝑇𝑇9.2 ��2 +�𝑇𝑇6.47 ��7.41 Equa ions (2), (3), (4), and (5) inco po a e all combina ions o wo low- empe a u e al e na i es (No dhaus and Hanemann), and wo high- empe a u e al e na i es (No dhaus and Wei zman). Using hei ini ials, hese can be labeled as he N-N, H-N, N-W, and H-W damages unc ions, espec i ely. They a e displayed in Figu e 3 ( he g aph p esen s damages as a sha e o GDP, i.e. 1 - R), wi h la ge do s indica ing he poin s used o calib a ion. Below 3oC, he low- empe a u e al e na i es a e dominan , and he high- empe a u e al e na i es make no isible di e ence; a 6oC and abo e, he high- empe a u e al e na i es de e mine he shape o he damage unc ion. In pa icula , he wo damage unc ions wi h he Wei zman high- empe a u e assump ion a e nea ly iden ical abo e 6oC.11 10 This equa ion ollows Wei zman’s me hod bu di e s sligh ly om his nume ical es ima es. He appea s o ha e aken he DICE coe icien in (1) o be .00239 a he han .002839. Ou equa ions (4) and (5) we e i ed o minimize he sum o squa ed de ia ions om he No dhaus and Hanemann damage es ima es, espec i ely, a 2.5oC, and he Wei zman poin es ima es a 6oC and 12oC. 11 A small anomaly is ha be ween 6oC and 12oC he N-W damage unc ion, despi e i s lowe low- empe a u e damages, is sligh ly highe han H-W; he gap is g ea es a 6.9oC, whe e N-W damages a e 3.8 pe cen abo e H-W. 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