September 22, 2012 — andyextance

The financial benefits of reducing CO2 emissions, and avoiding the climate change they would bring, is at least 2.6 times larger than the US government estimates. And, according to Laurie Johnson of the Natural Resources Defense Council in Washington, DC, and Chris Hope at the University of Cambridge, UK, they could be much higher. Undervaluing the damages, which play a part in how the US government makes decisions about climate issues, borders on insanity, Laurie told me. “What we have to ask ourselves is what our children are going to think of us,” she said. “We’re being very self-destructive, but also deeply unethical. We’re not even trying to minimise how much worse it’s going to get. They’ll look back at all this science and how everything is changing, and see how we treated the damages so trivially and did so little.”

In 2010 some of the top departments in the US government got together to publish the first estimates of the money value of benefits from CO2 cuts. The benefits come from avoiding losses through damage caused by climate change. Called the social cost of carbon (SCC), this value is important because it affects rules on CO2 emissions, such as those from cars and power stations. Using three models that linked climate and economics, the government departments decided that the SCC was $21 per metric tonne of CO2*. Thanks to its importance for future climate rules, Laurie had watched the value being calculated closely – and was worried about what she saw.

“One of the models includes infectious disease damage estimates that are highly questionable,” she told me. “The models also estimate net gains from agriculture from now up to 2300 globally. By contrast the insurance industries appear to be estimating $25 billion dollars for crop losses in the US this year. That’s just one year for one country, and their calculation is for more than two hundred years, all countries. It also estimates a couple of billion in extreme weather damages globally over that period. Last year, in the US alone, there was over $50 billion dollars’ worth of extreme weather damage. Overall, it’s a very problematic estimate.” While the faults are plain, correcting any of these areas with more accurate values is a big problem itself. So Laurie and Chris looked at two other areas that they also felt had been worked out badly, but were simpler to tackle.

Miscounting discounting

The first was the “discount rate” the government had applied to work out the future value of damages. Discounting sees money today as more valuable than the same amount of money in the future, due to interest and economic growth. The discount rate can be thought of as how much interest money would earn. It can be used to compare the value of damages to the amount of money needed to prevent them. “Discount rates assume there’ll be more income in the future, so you cancel out damages against them to the extent that incomes increase,” Laurie explained. “Whatever damages we have imposed on people in the future, their income compensates them. They also assume that we prefer to have things now than later, but it doesn’t make sense across generations. It says you’re more important than people in the future.”

The original SCC values used three interest rates, 2.5, 3 and 5 per cent, which Chris and Laurie point out were too high. The $21 figure came from the 3 per cent ‘risk-free’ rate, which you might get from ‘a safe investment’ in the US government. “That’s viewing emission reduction investment as a way to maximise profit rather than minimise risk. Instead, you might consider this an insurance problem and say, ‘I don’t care if I don’t make a profit off of reducing emissions today because the planet could be destroyed if I don’t do this’. When people make insurance investments, they are accepting a negative return – that’s how insurance companies make money.” She adds that even the government’s own guidelines note economists say that for intergenerational problems like these discount rates should be 1-3 per cent.

Generation gap

The second area that Laurie and Chris were concerned about was the government’s assumption that damage has the same value wherever it happens. Poorer regions have far less income to cope with damages than wealthier regions. They are also set to get more of the damage, while having contributed the least to the problem. To take that into account, economists widely recommend using a method called equity weighting. This assigns a higher value to a dollar’s worth of damage occurring in a poor region than to one occurring in a wealthy one.

Recalculating SCC to fix the discount rate, as Laurie and Chris did in a research paper published in the Journal of Environmental Studies and Sciences last week, was relatively easy. That’s because it the discount rate is one of the basic settings that the models use. “It doesn’t take trying to figure out how you put an economic damage number on pain and suffering, all you do is change one number and run the model,” Laurie said. They used 1, 1.5 and 2 per cent constant discount rates, as well as two other methods where the discount rate started at 3 and 4 per cent and decreased over 300 years. These gave SCCs from $55-$266 per metric tonne of CO2. Two of three models the government used could also already do equity weighting, and including this also gave much higher SCC values.

While their work is just the start of tackling all the problems in the previous SCC estimate, Laurie and Chris worked out that their values could justify trying harder to reduce CO2 emissions. Laurie was surprised how effectively changing the discount rate alone supported renewable rather than fossil-fuel power station construction, and higher efficiency standards for electric motors. “It’s amazing, given how much is not in the model, that just changing this one parameter to treat generations equally can have that big an effect,” she said.

Laurie explains her work in much more detail in blog entries here and here.

*In 2011 worldwide CO2 emissions reached a record high of 31.6 billion tonnes.

Journal reference:

Laurie T. Johnson and Chris Hope (2012). The social cost of carbon in U.S. regulatory impact analyses: an introduction and critique Journal of Environmental Studies and Sciences DOI: 10.1007/s13412-012-0087-7