Greenhouse Gases: The Cost Of Cutting Back
As delegates from the world's nations prepare to negotiate a treaty on global warming in Kyoto starting Dec. 1, the debate over what to do might itself generate enough hot air to raise Earth's temperature. On one side are the auto, coal, and oil industries. They argue that a proposal to cut U.S. emissions of carbon dioxide and other gases back to 1990 levels over the next 13 years will devastate the economy. To prove it, they brandish sophisticated economic models showing the policy would slash gross domestic product in 2010 by as much as 2.5%. It would also raise gas prices by 50 cents per gallon, send the trade deficit soaring, "and throw a record-shattering number of American families out of work," warns Cecil Roberts, president of the United Mine Workers.
Ridiculous, say environmentalists and companies selling fuel-efficient technologies. They say energy-efficient technologies and alternative fuel sources--from fuel cells to photovoltaic panels to wind power--are already out there, waiting to be used. "It's a myth that the costs of action are high," says Joseph Romm, assistant secretary for energy efficiency at the U.S. Energy Dept. Indeed, a new study from Worldwatch Institute concludes the reverse: that greenhouse gas reduction will boost the global economy by spurring innovation. Amory Lovins, director of the Colorado-based Rocky Mountain Institute, an environmental think tank, agrees. "The bottom line is that reducing energy use is a competitive advantage," he argues.
Who's right? It's exceedingly difficult to know. Past predictions of the cost of environmental protection have often been far off the mark, and the same could be true here. "If there were a single answer it would have floated to the top by now," says Craig E. Ebert, senior vice-president of Virginia-based consultants ICF Kaiser International Inc. Economists admit that their models fall far short of simulating something as complex as the U.S. economy--they have a hard enough time predicting next year's GDP. And the assumptions modelers make are crucial. Carnegie Mellon University economist Hadi Dowlatabadi finds that changing a few assumptions can make the predicted costs of slashing CO2 emissions vary by a factor of 20.
If economists can't pin down the costs, how does the world arrive at a rational climate policy? Some economists have a clever solution. Dowlatabadi and Peter J. Wilcoxen of the University of Texas at Austin suggest that policymakers stop focusing on cutting emissions to a specific level, as the Clinton Administration and many delegates to Kyoto advocate. Instead, governments should increase the price of oil, gas, and coal just enough to encourage a shift to lower CO2 emissions without causing widespread dislocations. A carbon tax or emissions-trading program (where companies buy and sell rights to emit greenhouse gases) that limits costs to $10 to $15 per metric ton of carbon emitted might do the trick. That's equivalent to about a 10% to 15% rise in the wholesale price of energy, explains Yale economist William D. Nordhaus.
Such modestly higher prices for energy would accomplish two things. Companies and consumers would have an economic incentive to cut emissions. And the economy's response would help resolve the huge debate over the cost of climate policies. Once it's clear how much a given boost in energy prices does reduce greenhouse gas emissions, it would be possible to fine-tune the price later to hit any desired emissions target.
But the talk at Kyoto will likely be on emissions limits. The European nations want a rollback of emissions in 2010 to well below 1990 levels--and are busy bashing the U.S. for not signing on. But the U.S. is resisting deeper cuts--and will point the finger at rapidly developing countries such as China, which haven't agreed to sign on. Some fear the Kyoto talks will fail utterly, as nations blame each other for scuttling the proposed targets. Others hope there will be progress on such key issues as targets and timetables for cuts, along with a plan for the developing world.
The talks in Kyoto might get further, though, if politicians and consumers better understood the following sources of disparity in the cost claims.
Most economic models try to mimic the entire economy from the top down. As individuals react to changes in the price of a key commodity like energy, the model's equations calculate the impact on the overall economy. Such models, however, can be unreliable.
Clinton Administration economists used one prominent macroeconomic model to conclude that stabilizing greenhouse gas emissions at 1990 levels by 2010 would raise the price of a metric ton of carbon by $100--doubling the wholesale price of energy. Another use of the same model, done for industry groups by the consulting firm WEFA Inc., put the increase at $200 per metric ton.
Can either figure be believed? The problem is that macroeconomic models become less accurate as they look further ahead, in part because behaviors can change in unexpected ways. That's one reason the St. Louis-based modeling firm Macroeconomic Advisers turned down requests to model climate policies. "We couldn't possibly run something like this through and come up with anything meaningful," says chairman Joel Prakken. Even WEFA Senior Vice-President Mary H. Novak, who insists her group's forecasts are valid, admits that "if you look at all the estimates over the last 30 years, we really miscalculated prices."
Another problem is that estimates of costs vary dramatically depending on the underlying assumptions.
One key issue is what the models assume about tax policies. Most economists agree that market-based measures such as a carbon tax or an emissions-trading program would be more efficient--and cheaper--than so-called command-and-control regulations that simply order emissions be cut to a certain level. World Resources Institute economist Robert Repetto argues that there are further gains to be had from recycling the revenues from a carbon tax or emissions permit auction back into the economy in a way that spurs investment. That would boost the economy at the same time it prevented damage from climate change. But such a fundamental shift in the tax code is hardly a given. "We don't have the political will," says Massachusetts Institute of Technology economist Richard Schmalensee.
Then there's the question of benefits. The WEFA model and others that predict high costs do not include benefits that might emerge from slowing greenhouse gas emissions. Environmentalists believe curbing global warming will prevent droughts, flooding, and the spread of disease. Reducing fossil fuel use should also slash pollution. Throw in those benefits, and the net cost of a climate policy plummets. "Yet in the models, the benefits have been arbitrarily set to zero," complains Repetto. "If that's the right number, then what the hell are we doing?"
Perhaps the biggest controversy concerns the pace of technological change. Yet another type of model looks at the economy from the bottom up, asking what new energy-efficient technologies are cost-effective at today's and tomorrow's prices. How fast can they be adopted? And what would be the impact on CO2 emissions?
A new study from the Energy Dept. concludes that the potential impact of innovative new approaches could be enormous. High-mileage cars already nearing production could slash U.S. carbon emissions by a total of 87 million metric tons per year by 2010--20% of the way toward stabilizing emissions at 1990 levels. More efficient buildings could cut 59 million more metric tons per year. Advances in electric generation--such as converting coal plants to natural gas--could cut 136 million metric tons more. Some of these make sense even at today's prices, and others need only a modest boost in the price of energy, the study says. "Any company or business or building can reduce emissions by 20% to 25% now--and cut its costs," asserts the Energy Dept.'s Romm.
Romm says the top-down economic models ignore innovation--they assume that a given boost in energy prices will stimulate the same increase in energy efficiency as past price rises did. "But technology is what makes the future not like the past," explains Romm.
Modelers retort that claims of a technological "magic bullet" are hopelessly rosy. A bedrock assumption of economics is that markets are efficient. Any better and cheaper strategies and technologies should have already been adopted. If they haven't, "that means the technologies are more expensive to commercialize than people think or they're just lousy technologies," says WEFA's Novak.
The fact that neither economics nor technology can pinpoint the cost of climate policies may seem like a fatal blow to developing a rational approach. But there is a solution.
Most participants in the debate agree on two points. First, if the world wants to reduce global warming risks, it must send a clear economic signal now. President Clinton's plan preaches new technology and voluntary reductions--but it doesn't call for economic measures, like a scheme to trade emission permits, until 2008.
The second point of consensus: Any greenhouse gas reduction plan should rely on market-based mechanisms. Economists generally agree that a carbon tax or an auction of emissions permits will stimulate innovative ideas at far lower cost than any other approach. The idea is to let the market "choose" the best technological solutions.
The crucial issue, then, is where to set the price of emitting a metric ton of carbon. Raising that to $200 per metric ton to stabilize emissions at 1990 levels is a political nonstarter. "We should do something modest, like $10 per metric ton," says Yale's Nordhaus, which would add only 0.25% to the cost of living. "That would get people to think about substitutes."
In other words, the best tack may be to decide what price we're willing to pay, not pick a target for emissions reduction. One approach would be a carbon tax. But Australian economist Warwick J. McKibbin and Texas' Wilcoxen have a clever, less intrusive scheme. It would use a permit-trading scheme with a built-in safety valve. Companies and industries would buy and sell emissions permits. But if the cost of emissions reduction went too high, companies could buy permits instead from their governments for a set price, say $10 or $15.
Environmentalists generally dislike the idea because it doesn't commit governments to specific levels of emissions cuts. But once such a policy is in place, the world would be able to measure its effectiveness in both cutting emissions and reducing global warming. Then governments could decide to ratchet the cost up or down as required. In a world where economics can't provide the answers we need, the response of the economy itself might offer the ultimate solution to the problem of global warming.