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EMF WP 12.7: Cost-Benefit Analysis and Climate Change

The accumulation of greenhouse gases in the atmosphere raises the possibility of rising global mean surface temperature over the next couple of centuries. Proposed policy responses to global warming have generally been framed in terms of limits on emissions of greenhouse gases, especially CO2. Most such proposals seem to be quite arbitrary in character, e.g. limit CO2 emissions to 80 percent of 1990 levels. The very arbitrariness of such proposals raises the question: what is the best path of emissions over time?

It is not possible to determine an optimal emissions path without considering both the costs and the benefits associated with reductions in CO2 emissions. The costs of reducing emissions have received a considerable amount of attention from policy analysts; many of their analyses are represented in this Energy Modeling Forum study. However, much less attention has been paid to estimating the benefits of emission reduction (or equivalently, the avoided warming cost).

Nordhaus (1990) has attempted to synthesize available information regarding the cost to the U.S. of a three degree Celsius increase in mean surface temperature. Based on this work, Nordhaus concludes that measurable costs of warming are in the neighborhood of one-quarter of one percent of GDP. However, there are important possible costs of warming that are excluded from this total, for lack of any information regarding their magnitude. These include damage to any unmanaged natural systems including loss of ecosystems and species, and losses in the amenity values of everyday life. Nordhaus offers a guess that including these omitted costs and considering the world as a whole, the total cost could be one or two percent of the global income.

While Nordhaus’s estimate is a useful starting point, important questions remain: What are the costs associated with a five, six, or eight degree rise in temperature? Does it matter whether temperature rise occurs overnight or over two centuries? These are exceedingly difficult questions to answer, but they need to be answered if CO2 emission limits are to be based on a balance between the costs and benefits of emission reductions.

Obviously, we cannot begin to resolve these questions here. What we can do, however, is offer some insight into the possible character of emission limits or carbon taxes, if these limits or taxes are determined from a balancing of costs and benefits; in addition, we can offer some insight into what the benefits of emission reduction might have to be in order for the kinds of polices now being discussed to be at least roughly correct, taking account of both costs and benefits.