Economics of global warming

Economics of global warming

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Definitions


In this article, the phrase “climate change
Climate change
Climate change is a significant and lasting change in the statistical distribution of weather patterns over periods ranging from decades to millions of years. It may be a change in average weather conditions or the distribution of events around that average...

” is used to describe a change in the climate, measured in terms of its statistical properties, e.g., the global mean
Mean
In statistics, mean has two related meanings:* the arithmetic mean .* the expected value of a random variable, which is also called the population mean....

 surface temperature
Temperature
Temperature is a physical property of matter that quantitatively expresses the common notions of hot and cold. Objects of low temperature are cold, while various degrees of higher temperatures are referred to as warm or hot...

. In this context, “climate
Climate
Climate encompasses the statistics of temperature, humidity, atmospheric pressure, wind, rainfall, atmospheric particle count and other meteorological elemental measurements in a given region over long periods...

” is taken to mean the average weather. Climate can change over period of time ranging from months to thousands or millions of years. The classical time period is 30 years, as defined by the World Meteorological Organization
World Meteorological Organization
The World Meteorological Organization is an intergovernmental organization with a membership of 189 Member States and Territories. It originated from the International Meteorological Organization , which was founded in 1873...

. The climate change referred to may be due to natural causes, e.g., changes in the sun's output, or due to human activities, e.g., changing the composition of the atmosphere. Any human-induced changes in climate will occur against the “background” of natural climatic variations (see attribution of recent climate change
Attribution of recent climate change
Attribution of recent climate change is the effort to scientifically ascertain mechanisms responsible for recent changes observed in the Earth's climate...

 for more information).

In this article, the phrase “global warming” refers to the change in the Earth's global average surface temperature. Measurements show a global temperature increase of 1.4 °F (0.78 °C) between the years 1900 and 2005. Global warming is closely associated with a broad spectrum of other climate changes, such as increases in the frequency of intense rainfall, decreases in snow
Snow
Snow is a form of precipitation within the Earth's atmosphere in the form of crystalline water ice, consisting of a multitude of snowflakes that fall from clouds. Since snow is composed of small ice particles, it is a granular material. It has an open and therefore soft structure, unless packed by...

 cover and sea ice
Sea ice
Sea ice is largely formed from seawater that freezes. Because the oceans consist of saltwater, this occurs below the freezing point of pure water, at about -1.8 °C ....

, more frequent and intense heat wave
Heat wave
A heat wave is a prolonged period of excessively hot weather, which may be accompanied by high humidity. There is no universal definition of a heat wave; the term is relative to the usual weather in the area...

s, rising sea level
Current sea level rise
Current sea level rise potentially impacts human populations and the wider natural environment . Global average sea level rose at an average rate of around 1.8 mm per year over 1961 to 2003 and at an average rate of about 3.1 mm per year from 1993 to 2003...

s, and widespread ocean acidification
Ocean acidification
Ocean acidification is the name given to the ongoing decrease in the pH and increase in acidity of the Earth's oceans, caused by the uptake of anthropogenic carbon dioxide from the atmosphere....

.

Climate change science



This section describes the science of climate change in relation to economics (Munasinghe et al., 1995:39-41):
  • Greenhouse gases:
    • These gases have been linked with current climate change and may result in further climate change in the future (e.g., see US NRC, 2001). Greenhouse gas
      Greenhouse gas
      A greenhouse gas is a gas in an atmosphere that absorbs and emits radiation within the thermal infrared range. This process is the fundamental cause of the greenhouse effect. The primary greenhouse gases in the Earth's atmosphere are water vapor, carbon dioxide, methane, nitrous oxide, and ozone...

      es (GHGs) are stock pollutants, and not flow pollutants. This means that it is the concentration of GHGs in the atmosphere that is important in determining climate change impacts, rather than the flow of GHGs into the atmosphere.
    • The stocks of different GHGs in the atmosphere depreciate at various rates, e.g., the atmospheric lifetime of carbon dioxide
      Carbon dioxide
      Carbon dioxide is a naturally occurring chemical compound composed of two oxygen atoms covalently bonded to a single carbon atom...

       is over 100 years. If the atmospheric lifetime of the GHG is a year or longer, then the winds have time to spread the gas throughout the lower atmosphere, and its absorption of terrestrial infrared
      Infrared
      Infrared light is electromagnetic radiation with a wavelength longer than that of visible light, measured from the nominal edge of visible red light at 0.74 micrometres , and extending conventionally to 300 µm...

       radiation occurs at all latitudes and longitudes (US NRC, 2001:10). It is the flows from all the GHG sources of all nations that contribute to the stock of long-lived GHGs in the atmosphere.
  • Inertia: The emissions of GHGs in any one year represent a relatively small fraction of the total global stock, meaning that the system as a whole has great inertia. If emissions were to be reduced to zero, it would take decades to centuries for stock levels to decline significantly. The time required for stocks to depreciate depends on the physical process of GHG removal. The stocks of GHGs with relatively short atmospheric lifetimes, such as methane
    Methane
    Methane is a chemical compound with the chemical formula . It is the simplest alkane, the principal component of natural gas, and probably the most abundant organic compound on earth. The relative abundance of methane makes it an attractive fuel...

    , depreciate more quickly than the stocks of GHGs with longer atmospheric lifetimes, e.g., HFCs.
  • Impact data: Predictions of the physical impacts of climate change are based on the work of climate scientists. Only once (or if) further climate change occurs, will the true social and economic impacts of climate change be known. (Note: The preceding sentence is from 1995. Climate change is acknowledged by mainstream science to exist, to be continuing and to be highly likely to be largely caused by human activity)

Scenarios


Socioeconomic scenarios
Scenario analysis
Scenario analysis is a process of analyzing possible future events by considering alternative possible outcomes . Thus, the scenario analysis, which is a main method of projections, does not try to show one exact picture of the future. Instead, it presents consciously several alternative future...

 are used by analysts to make projections of future GHG emissions and to assess future vulnerability to climate change (Carter et al., 2001:151). Producing scenarios requires estimates of future population levels, economic activity, the structure of governance, social values, and patterns of technological change. Economic and energy modelling (such as via the World3
World3
The World3 model was a computer simulation of interactions between population, industrial growth, food production and limits in the ecosystems of the Earth. It was originally produced and used by a Club of Rome study that produced the model and the book The Limits to Growth...

 or the POLES
Prospective Outlook on Long-term Energy Systems
Prospective Outlook on Long-term Energy Systems is a world simulation model for the energy sector that runs on the Vensim software...

 models) can be used to analyse and quantify the effects of such drivers.

Emissions scenarios

One type of emissions scenario is called a "global future" scenario. These scenarios can be thought of as stories of possible futures. They allow the description of factors that are difficult to quantify, such as governance, social structures, and institutions. Morita et al. (2001:137-142) assessed the literature
Scientific literature
Scientific literature comprises scientific publications that report original empirical and theoretical work in the natural and social sciences, and within a scientific field is often abbreviated as the literature. Academic publishing is the process of placing the results of one's research into the...

 on global futures scenarios. They found considerable variety among scenarios, ranging from variants of sustainable development, to the collapse of social, economic, and environmental systems.

No strong patterns were found in the relationship between economic activity and GHG emissions. Economic growth was found to be compatible with increasing or decreasing GHG emissions. In the latter case, emissions growth is mediated by increased energy efficiency, shifts to non-fossil energy sources, and/or shifts to a post-industrial (service-based) economy.

Factors affecting emissions growth
  • Development trends: In producing scenarios, an important consideration is how social and economic development will progress in developing countries (Fisher et al., 2007:176). If, for example, developing countries were to follow a development pathway similar to the current industrialized countries, it could lead to a very large increase in emissions.
  • GHG emissions and economic growth: Emissions do not only depend on the growth rate of the economy. Other factors are listed below:
    • Structural changes in the production system.
    • Technological patterns in sectors such as energy.
    • Geographical distribution of human settlements and urban structures. This affects, for example, transportation requirements.
    • Consumption patterns: e.g., housing patterns, leisure activities, etc.
    • Trade patterns: the degree of protectionism
      Protectionism
      Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...

       and the creation of regional trading blocks
      Trade bloc
      A trade bloc is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, are reduced or eliminated among the participating states.-Description:...

       can affect availability to technology.

Trends and projections



Emissions


The Kaya identity
Kaya identity
The Kaya identity is an equation relating factors that determine the level of human impact on climate, in the form of emissions of the greenhouse gas carbon dioxide. It states that total emission level can be expressed as the product of four inputs: population, GDP per capita, energy use per unit...

 expresses the level of energy related CO2 emissions as the product of four indicators (Rogner et al., 2007, p. 107):
  • Carbon intensity. This is the CO2 emissions per unit of total primary energy supply (TPES)
  • Energy intensity. This is the TPES per unit of gross domestic product
    Gross domestic product
    Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....

     (GDP)
  • GDP per capita (GDP/cap)
  • Population
    Population
    A population is all the organisms that both belong to the same group or species and live in the same geographical area. The area that is used to define a sexual population is such that inter-breeding is possible between any pair within the area and more probable than cross-breeding with individuals...


GDP/capita growth (an aspect of economic development
Economic development
Economic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...

) and population growth
Population growth
Population growth is the change in a population over time, and can be quantified as the change in the number of individuals of any species in a population using "per unit time" for measurement....

 were the main drivers of the increase in global emissions during the last three decades of the 20th century. At the global scale, declining carbon and energy intensities have been unable to offset these effects, and consequently, carbon emissions have risen.

Equity and GHG emissions


There are a number of issues relating to equity and GHG emissions (equity
Equity (economics)
Equity is the concept or idea of fairness in economics, particularly as to taxation or welfare economics. More specifically it may refer to equal life chances regardless of identity, to provide all citizens with a basic minimum of income/goods/services or to increase funds and commitment for...

 is the concept of fairness in economics). For example, a persistent theme in the scientific literature is the explicit or implicit assignment of responsibility for global warming trends (Banuri et al., 2001 ; see also Banuri et al. (1996:91) for a discussion of this issue). Examples of emissions allocation include a country's annual emissions, national annual emissions divided by population (per capita emissions), and emissions per unit of income. Emissions may also be measured over longer time periods (historical or cumulative emissions) (Banuri et al., 1996:91). Some of these different types of measurement are described in greenhouse gas#Regional and national attribution of emissions. It is also possible to make estimates of who has contributed most to changes in global average temperature (i.e., global warming), but there are uncertainties in making such estimates. However, most estimates assessed by Banuri et al. (2001) suggested that developing countries might overtake developed countries in terms of the total contribution to global warming by the years 2060 to 2090. Developed countries' past contributions to climate change were in the process of economically developing to their current level of prosperity; developing countries are attempting to rise to this level, this being one cause of their increasing greenhouse gas emissions.

Another aspect of equity in regards to emissions is that of GHG scenarios. For example, the scenarios used in the Intergovernmental Panel on Climate Change's (IPCC) First Assessment Report
IPCC First Assessment Report
The Intergovernmental Panel on Climate Change first assessment report was completed in 1990, and served as the basis of the United Nations Framework Convention on Climate Change ....

 of 1990 were criticized for embodying what the critics considered highly inequitable assumptions, both in the reference scenario (i.e., a scenario which assumes no future efforts to curb emissions) and in the apportioning of emissions reductions in emissions abatement scenarios (Banuri et al., 1996:95). The IPCC's later "SRES
Special Report on Emissions Scenarios
The Special Report on Emissions Scenarios was prepared by the Intergovernmental Panel on Climate Change in 2000, based on data developed at the Earth Institute at Columbia University. The emissions scenarios described in the Report have been used to make projections of possible future climate...

" scenarios, published in 2000, explicitly explore scenarios with a narrowing income gap (convergence) between the developed and developing countries. Projections of convergence in the SRES scenarios have been criticized for lacking objectivity (Defra/HM Treasury, 2005; see also Tol (2005) for a discussion).

Emissions projections



Without additional policies to cut GHG emissions (including efforts to reduce deforestation
Deforestation
Deforestation is the removal of a forest or stand of trees where the land is thereafter converted to a nonforest use. Examples of deforestation include conversion of forestland to farms, ranches, or urban use....

), they are projected to increase between 25% and 90% by 2030 relative to their 2000 levels (Rogner et al., 2007:111). Two-thirds to three-quarters of the increase in CO2 emissions are projected to come from developing countries, although the average per capita CO2 emissions in developing country regions will remain substantially lower than those in developed country regions.

By 2100, projections range from a 40% reduction to an increase in emissions of 250% above their levels in 2000. Atmospheric concentrations of GHGs (see below) are unlikely to stabilize this century without major policy changes.

Concentrations


Rogner et al. (2007:102) reported that the then-current estimated total atmospheric concentration of long-lived GHGs was around 455 parts-per-million
Parts-per notation
In science and engineering, the parts-per notation is a set of pseudo units to describe small values of miscellaneous dimensionless quantities, e.g. mole fraction or mass fraction. Since these fractions are quantity-per-quantity measures, they are pure numbers with no associated units of measurement...

 (ppm) CO2-eq
Carbon dioxide equivalent
Carbon dioxide equivalent and Equivalent carbon dioxide are two related but distinct measures for describing how much global warming a given type and amount of greenhouse gas may cause, using the functionally equivalent amount or concentration of carbon dioxide as the reference.- Global warming...

 (range: 433-477 ppm CO2-eq). The effects of aerosol
Aerosol
Technically, an aerosol is a suspension of fine solid particles or liquid droplets in a gas. Examples are clouds, and air pollution such as smog and smoke. In general conversation, aerosol usually refers to an aerosol spray can or the output of such a can...

 and land-use change changes reduced the physical effect (the radiative forcing
Radiative forcing
In climate science, radiative forcing is generally defined as the change in net irradiance between different layers of the atmosphere. Typically, radiative forcing is quantified at the tropopause in units of watts per square meter. A positive forcing tends to warm the system, while a negative...

) of this to 311 to 435 ppm CO2-eq, with a central estimate of about 375 ppm CO2-eq.
  • SRES Projections: At the time they were developed, the range of global emissions projected across all forty of the SRES
    Special Report on Emissions Scenarios
    The Special Report on Emissions Scenarios was prepared by the Intergovernmental Panel on Climate Change in 2000, based on data developed at the Earth Institute at Columbia University. The emissions scenarios described in the Report have been used to make projections of possible future climate...

     scenarios covered the 5th% to 95th% percentile
    Percentile
    In statistics, a percentile is the value of a variable below which a certain percent of observations fall. For example, the 20th percentile is the value below which 20 percent of the observations may be found...

     range of the emission scenarios literature (Morita et al., 2001:146). The forty SRES scenarios are classified into six groups, with an illustrative scenario for each group. Under these six illustrative scenarios, the projected concentration of CO2 in the year 2100 ranges from 540 to 970 ppm (IPCC, 2001b:8). Uncertainties over aspects of climate science, such as the GHG removal process of carbon sinks, mean that the total projected concentration ranges from 490 to 1,260 ppm. This compares to a pre-industrial (taken as the year 1750) concentration of about 280 ppm, and a concentration of about 368 ppm in the year 2000.

Cost-benefit analysis


Standard cost-benefit analysis
Cost-benefit analysis
Cost–benefit analysis , sometimes called benefit–cost analysis , is a systematic process for calculating and comparing benefits and costs of a project for two purposes: to determine if it is a sound investment , to see how it compares with alternate projects...

 can be applied to the problem of climate change (Goldemberg et al., 1996:24,31-32). This requires (1) the valuation of costs and benefits using the willingness to pay
Willingness to pay
In economics, the willingness to pay is the maximum amount a person would be willing to pay, sacrifice or exchange in order to receive a good or to avoid something undesired, such as pollution...

 as a measure of value, and (2) a criterion for accepting or rejecting proposals:

(1) The valuation of costs and benefits of climate change is difficult because some climate change impacts are difficult to assign a value to, e.g., ecosystems and human health. It is also impossible to know the preferences of future generations, which affects the valuation of costs and benefits (DeCanio, 2007:4).

(2) The standard criterion is the compensation principle
Compensation principle
In welfare economics, the compensation principle refers to a decision rule used to select between pairs of alternative feasible social states. One of these states is the hypothetical point of departure...

. According to the compensation principle, so long as those benefitting from a particular project compensate the losers, and there is still something left over, then the result is an unambiguous gain in welfare. If there are no mechanisms allowing compensation to be paid, then it is necessary to assign weights to particular individuals.

One of the mechanisms for compensation is impossible for this problem: mitigation might benefit future generations at the expense of current generations, but there is no way that future generations can compensate current generations for the costs of mitigation (DeCanio, 2007:4). On the other hand, should future generations bear most of the costs of climate change, compensation to them would not be possible (Goldemberg et al., 1996:32). Another transfer for compensation exists between regions and populations. If, for example, some countries were to benefit from future climate change but others lose out, there is no guarantee that the winners would compensate the losers; similarly, if some countries were to benefit from reducing climate change but others lose out, there would likewise be no guarantee that the winners would compensate the losers.

Risk

In a cost-benefit analysis, an acceptable risk
Risk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...

 means that the benefits of a climate policy outweigh the costs of the policy (Halsnæs et al., 2007). The standard rule used by public and private decision makers is that a risk will be acceptable if the expected net
Net (economics)
In economics, net means after deductions. A related concept is gross, meaning before deductions.Nett is an alternative spelling used in British English.-Usage:...

 present value
Present value
Present value, also known as present discounted value, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk...

 is positive. The expected value is the mean of the distribution of expected outcomes (Goldemberg et al., 1996, p. 25). In other words, it is the average expected outcome for a particular decision. This criterion has been justified on the basis that:
  • a policy's benefits and costs have known probabilities
    Probability
    Probability is ordinarily used to describe an attitude of mind towards some proposition of whose truth we arenot certain. The proposition of interest is usually of the form "Will a specific event occur?" The attitude of mind is of the form "How certain are we that the event will occur?" The...

  • economic agents (people and organizations) can diversify their own risk through insurance
    Insurance
    In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...

     and other markets.


On the first point, probabilities for climate change are difficult to calculate. Also, some impacts, such as those on human health and biodiversity, are difficult to value. On the second point, it has been suggested that insurance could be bought against climate change risks. In practice, however, there are difficulties in implementing the necessary policies to diversify climate change risks.

Risk


One of the problems of climate change are the large uncertainties
Uncertainty
Uncertainty is a term used in subtly different ways in a number of fields, including physics, philosophy, statistics, economics, finance, insurance, psychology, sociology, engineering, and information science...

 over the potential impacts of climate change, and the costs and benefits of actions taken in response to climate change, e.g., in reducing GHG emissions (Toth et al., 2001, p. 608). Two related ways of thinking about the problem of climate change decision-making in the presence of uncertainty are iterative risk management
Climate risk management
Climate Risk Management is a term is used for a large and growing body of work, bridging the climate change adaptation, disaster management and development sectors, amongst many others.- Definition :...

 (Fisher et al., 2007; Yohe, 2010) and sequential decision making
Decision making
Decision making can be regarded as the mental processes resulting in the selection of a course of action among several alternative scenarios. Every decision making process produces a final choice. The output can be an action or an opinion of choice.- Overview :Human performance in decision terms...

 (Toth et al., 2001). Considerations in a risk-based approach might include, for example, the potential for low-probability, worst-case climate change impacts (Barker et al., 2007a).

An approach based on sequential decision making recognises that, over time, decisions related to climate change can be revised in the light of improved information
Information economics
Information economics or the economics of informationis a branch of microeconomic theory that studies how information affects an economy and economic decisions. Information has special characteristics. It is easy to create but hard to trust. It is easy to spread but hard to control. It...

 (Goldemberg et al., 1996, p. 26). This is particularly important with respect to climate change, due to the long-term nature of the problem. A near-term hedging
Hedge (finance)
A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...

 strategy concerned with reducing future climate impacts might favour stringent, near-term emissions reductions (Toth et al., 2001, pp. 612–613). Such an approach would allow for greater future flexibility with regard to a low stabilization target, e.g., 450 ppmv CO2. To put it differently, stringent near-term emissions abatement can be seen as having an option value in allowing for lower, long-term stabilization targets. This option may be lost if near-term emissions abatement is less stringent.

On the other hand, a view may be taken that points to the benefits of improved information over time. This may suggest an approach where near-term emissions abatement is more modest (Defra/HM Treasury, 2005). Another way of viewing the problem is to look at the potential irreversibility of future climate change impacts (e.g., damages to ecosystems) against the irreversibility of making investments in efforts to reduce emissions (Goldemberg et al., 1996, p. 26; see also Economics of climate change mitigation#Irreversible impacts and policy).

Resilient and adaptive strategies


CCSP (2009, p. 59) suggested two related decision-making management strategies that might be particularly appealing when faced with high uncertainty. The first were resilient strategies. This seeks to identify a range of possible future circumstances, and then choose approaches that work reasonably well across all the range. The second were adaptive strategies. The idea here is to choose strategies that can be improved as more is learned as the future progresses. CCSP (2009) contrasted these two approaches with the cost-benefit approach, which seeks to find an optimal strategy.

Portfolio theory


An example of a strategy that is based on risk is portfolio theory
Modern portfolio theory
Modern portfolio theory is a theory of investment which attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets...

. This suggests that a reasonable response to uncertainty is to have a wide portfolio of possible responses. In the case of climate change, mitigation can be viewed as an effort to reduce the chance of climate change impacts (Goldemberg et al., 1996, p. 24). Adaptation acts as insurance against the chance that unfavourable impacts occur. The risk associated with these impacts can also be spread. As part of a policy portfolio, climate research can help when making future decisions. Technology research can help to lower future costs.

Optimal choices and risk aversion


The optimal result of decision analysis depends on what criterion is chosen to define what "optimal" is (Arrow et al., 1996, pp. 62–63. See also the section on trade offs). In a decision analysis based on cost-benefit analysis, the optimal policy is evaluated in economic terms. The optimal result of cost-benefit analysis maximizes net benefits. Another type of decision analysis is cost-effectiveness analysis. This is similar to cost-benefit analysis, except that the assessed benefit, or policy target, is set outside of the analysis.

The actual choice of a criterion for deciding the optimal result of decision analysis is a subjective decision. The choice of criterion is made outside of the analysis. One of the influences on this choice on this is attitude to risk. Risk aversion
Risk aversion
Risk aversion is a concept in psychology, economics, and finance, based on the behavior of humans while exposed to uncertainty....

 describes how willing or unwilling someone is to take risks. Evidence indicates that most, but not all, individuals prefer certain outcomes to uncertain ones. Risk-averse individuals prefer decision criteria that reduce the chance of the worst possible outcome, while risk-seeking individuals prefer decision criteria that maximize the chance of the best possible outcome. In terms of returns on investment, if society as a whole is risk-averse, we might be willing to accept some investments with negative expected returns, e.g., in mitigation (Goldemberg et al., 1996, p. 24). Such investments may help to reduce the possibility of future climate damages or the costs of adaptation.

International insurance


Traditional insurance works by transferring risk to those better able or more willing to bear risk, and also by the pooling of risk (Goldemberg et al., 1996, p. 25). Since the risks of climate change are, to some extent, correlated, this reduces the effectiveness of pooling. However, there is reason to believe that different regions will be affected differently by climate change. This suggests that pooling might be effective. Since developing countries appear to be potentially most at risk from the effects of climate change, developed countries could provide insurance against these risks.

Authors have pointed to several reasons why commercial
Commerce
While business refers to the value-creating activities of an organization for profit, commerce means the whole system of an economy that constitutes an environment for business. The system includes legal, economic, political, social, cultural, and technological systems that are in operation in any...

 insurance markets cannot adequately cover risks associated with climate change (Arrow et al., 1996, p. 72). For example, there is no international market where individuals or countries can insure themselves against losses from climate change or related climate change policies.

Financial markets for risk

There are several options for how insurance could be used in responding to climate change (Arrow et al., 1996, p. 72). One response could be to have binding agreements between countries. Countries suffering greater-than-average climate-related losses would be assisted by those suffering less-than-average losses. This would be a type of mutual insurance contract. Another approach would be to trade "risk securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...

" among countries. These securities would amount to betting on particular climate outcomes.

These two approaches would allow for a more efficient distribution of climate change risks. They would also allow for different beliefs over future climate outcomes. For example, it has been suggested that these markets might provide an objective test of the honesty of a particular country's beliefs over climate change. Countries that honestly believe that climate change presents little risk would be more prone to hold securities against these risks.

Distribution of impacts


Climate change impacts can be measured as an economic cost (Smith et al., 2001, pp. 936–941). This is particularly well-suited to market impacts, that is impacts that are linked to market transactions and directly affect GDP. Monetary measures of non-market impacts, e.g., impacts on human health and ecosystem
Ecosystem
An ecosystem is a biological environment consisting of all the organisms living in a particular area, as well as all the nonliving , physical components of the environment with which the organisms interact, such as air, soil, water and sunlight....

s, are more difficult to calculate. Other difficulties with impact estimates are listed below:
  • Knowledge gaps: Calculating distributional impacts requires detailed geographical knowledge, but these are a major source of uncertainty in climate model
    Climate model
    Climate models use quantitative methods to simulate the interactions of the atmosphere, oceans, land surface, and ice. They are used for a variety of purposes from study of the dynamics of the climate system to projections of future climate...

    s.
  • Vulnerability: Compared with developed countries, there is a limited understanding of the potential market sector
    Market sector
    The term market sector is used in economics and finance to describe a set of businesses that are buying and selling such similar goods and services that they are in direct competition with each other...

     impacts of climate change in developing countries.
  • Adaptation: The future level of adaptive capacity in human and natural systems to climate change will affect how society will be impacted by climate change. Assessments may under- or overestimate adaptive capacity, leading to under- or overestimates of positive or negative impacts.
  • Socioeconomic trends: Future predictions of development affect estimates of future climate change impacts, and in some instances, different estimates of development trends lead to a reversal from a predicted positive, to a predicted negative, impact (and vice versa).


In a literature assessment, Smith et al. (2001, pp. 957–958) concluded, with medium confidence, that:
  • climate change would increase income inequalities between and within countries.
  • a small increase in global mean temperature (up to 2 °C, measured against 1990 levels) would result in net negative market sector impacts in many developing countries and net positive market sector impacts in many developed countries.

With high confidence, it was predicted that with a medium (2-3 °C) to high level of warming (greater than 3 °C), negative impacts would be exacerbated, and net positive impacts would start to decline and eventually turn negative.

Aggregate impacts


Aggregating impacts adds up the total impact of climate change across sectors and/or regions (IPCC, 2007a, p. 76). In producing aggregate impacts, there are a number of difficulties, such as predicting the ability of societies to adapt climate change, and estimating how future economic and social development will progress (Smith et al., 2001, p. 941). It is also necessary for the researcher to make subjective value judgements over the importance of impacts occurring in different economic sectors, in different regions, and at different times.

Smith et al. (2001, p. 958) assessed the literature on the aggregate impacts of climate change. With medium confidence, they concluded that a small increase in global average temperature (up to 2 °C, measured against 1990 levels) would result in an aggregate market sector impact of plus or minus a few percent of world GDP. Smith et al. (2001) found that for a small to medium (2-3 °C) global average temperature increase, some studies predicted small net positive market impacts. Most studies they assessed predicted net damages beyond a medium temperature increase, with further damages for greater (more than 3 °C) temperature rises.

Comparison with SRES projections

IPCC (2001, p. 74) compared their literature assessment of the aggregate market sector impacts of climate change against projections of future increases in global mean temperature. Temperature projections were based on the six illustrative SRES emissions scenarios. Projections for the year 2025 ranged from 0.4 to 1.1 °C. For 2050, projections ranged from 0.8 to 2.6 °C, and for 2100, 1.4 to 5.8 °C. These temperature projections correspond to atmospheric CO2 concentrations of 405-460 ppm for the year 2025, 445-640 ppm for 2050, and 540-970 ppm for 2100.

Adaptation and vulnerability


IPCC (2007a) defined adaptation (to climate change) as "[initiatives] and measures to reduce the vulnerability of natural and human systems against actual or expected climate change effects" (p. 76). Vulnerability (to climate change) was defined as "the degree to which a system is susceptible to, and unable to cope with, adverse effects of climate change, including climate variability and extremes" (p. 89).

Autonomous and planned adaptation


Autonomous adaptation are adaptations that are reactive to climatic stimuli, and are done as a matter of course without the intervention of a public agency. Planned adaptation can be reactive or anticipatory, i.e., undertaken before impacts are apparent. Some studies suggest that human systems have considerable capacity to adapt autonomously (Smit et al., 2001:890). Others point to constraints on autonomous adaptation, such as limited information and access to resources (p. 890). Smit et al. (2001:904) concluded that relying on autonomous adaptation to climate change would result in substantial ecological, social, and economic costs. In their view, these costs could largely be avoided with planned adaptation.

Costs and benefits


A literature assessment by Adger et al. (2007:719) concluded that there was a lack of comprehensive, global cost and benefit estimates for adaptation. Studies were noted that provided cost estimates of adaptation at regional level, e.g., for sea-level rise. A number of adaptation measures were identified as having high benefit-cost ratios.

Adaptive capacity


Adaptive capacity is the ability of a system to adjust to climate change. Smit et al. (2001:895-897) described the determinants of adaptive capacity:
  • Economic resources: Wealthier nations are better able to bear the costs of adaptation to climate change than poorer ones.
  • Technology: Lack of technology can impede adaptation.
  • Information and skills: Information and trained personnel are required to assess and implement successful adaptation options.
  • Social infrastructure
  • Institutions: Nations with well-developed social institutions
    Institutional economics
    Institutional economics focuses on understanding the role of the evolutionary process and the role of institutions in shaping economic behaviour. Its original focus lay in Thorstein Veblen's instinct-oriented dichotomy between technology on the one side and the "ceremonial" sphere of society on the...

     are believed to have greater adaptive capacity than those with less effective institutions, typically developing nations and economies in transition.
  • Equity: Some believe that adaptive capacity is greater where there are government institutions and arrangements in place that allow equitable access to resources.

Smit et al. (2001) concluded that:
  • countries with limited economic resources, low levels of technology, poor information and skills, poor infrastructure, unstable or weak institutions, and inequitable empowerment and access to resources have little adaptive capacity and are highly vulnerable to climate change (p. 879).
  • developed nations, broadly speaking, have greater adaptive capacity than developing regions or countries in economic transition (p. 897).

Enhancing adaptive capacity


Smit et al. (2001:905) concluded that enhanced adaptive capacity would reduce vulnerability to climate change. In their view, activities that enhance adaptive capacity are essentially equivalent to activities that promote sustainable development
Sustainable development
Sustainable development is a pattern of resource use, that aims to meet human needs while preserving the environment so that these needs can be met not only in the present, but also for generations to come...

. These activities include (p. 899):
  • improving access to resources
  • reducing poverty
    Poverty
    Poverty is the lack of a certain amount of material possessions or money. Absolute poverty or destitution is inability to afford basic human needs, which commonly includes clean and fresh water, nutrition, health care, education, clothing and shelter. About 1.7 billion people are estimated to live...

  • lowering inequities of resources and wealth among groups
  • improving education
    Education
    Education in its broadest, general sense is the means through which the aims and habits of a group of people lives on from one generation to the next. Generally, it occurs through any experience that has a formative effect on the way one thinks, feels, or acts...

     and information
  • improving infrastructure
  • improving institutional capacity and efficiency

Goklany (1995) concluded that promoting free trade - e.g., through the removal of international trade barriers - could enhance adaptive capacity and contribute to economic growth.

Regions


With high confidence, Smith et al. (2001:957-958) concluded that developing countries would tend to be more vulnerable to climate change than developed countries. Based on then-current development trends, Smith et al. (2001:940-941) predicted that few developing countries would have the capacity to efficiently adapt to climate change.
  • Africa: In a literature assessment, Boko et al. (2007:435) concluded, with high confidence, that Africa's major economic sectors had been vulnerable to observed climate variability. This vulnerability was judged to have contributed to Africa's weak adaptive capacity, resulting in Africa having high vulnerability to future climate change. It was thought likely that projected sea-level rise would increase the socio-economic vulnerability of African coastal cities.
  • Asia: Lal et al. (2001:536) reviewed the literature on adaptation and vulnerability. With medium confidence, they concluded that climate change would result in the degradation of permafrost
    Permafrost
    In geology, permafrost, cryotic soil or permafrost soil is soil at or below the freezing point of water for two or more years. Ice is not always present, as may be in the case of nonporous bedrock, but it frequently occurs and it may be in amounts exceeding the potential hydraulic saturation of...

     in boreal Asia
    Asia
    Asia is the world's largest and most populous continent, located primarily in the eastern and northern hemispheres. It covers 8.7% of the Earth's total surface area and with approximately 3.879 billion people, it hosts 60% of the world's current human population...

    , worsening the vulnerability of climate-dependent sectors, and affecting the region's economy.
  • Australia and New Zealand: Hennessy et al. (2007:509) reviewed the literature on adaptation and vulnerability. With high confidence, they concluded that in Australia
    Australia
    Australia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans. It is the world's sixth-largest country by total area...

     and New Zealand
    New Zealand
    New Zealand is an island country in the south-western Pacific Ocean comprising two main landmasses and numerous smaller islands. The country is situated some east of Australia across the Tasman Sea, and roughly south of the Pacific island nations of New Caledonia, Fiji, and Tonga...

    , most human systems had considerable adaptive capacity. With medium confidence, some Indigenous communities were judged to have low adaptive capacity.
  • Europe: In a literature assessment, Kundzewicz et al. (2001:643) concluded, with very high confidence, that the adaptation potential of socioeconomic systems in Europe
    Europe
    Europe is, by convention, one of the world's seven continents. Comprising the westernmost peninsula of Eurasia, Europe is generally 'divided' from Asia to its east by the watershed divides of the Ural and Caucasus Mountains, the Ural River, the Caspian and Black Seas, and the waterways connecting...

     was relatively high. This was attributed to Europe's high GNP, stable growth, stable population, and well-developed political, institutional, and technological support systems.
  • Latin America: In a literature assessment, Mata et al. (2001:697) concluded that the adaptive capacity of socioeconomic systems in Latin America
    Latin America
    Latin America is a region of the Americas where Romance languages  – particularly Spanish and Portuguese, and variably French – are primarily spoken. Latin America has an area of approximately 21,069,500 km² , almost 3.9% of the Earth's surface or 14.1% of its land surface area...

     was very low, particularly in regard to extreme weather events, and that the region's vulnerability was high.
  • Polar regions: Anisimov et al. (2001, pp. 804–805) concluded that:
    • within the Antarctic and Arctic, at localities where water was close to melting point, socioeconomic systems were particularly vulnerable to climate change.
    • the Arctic would be extremely vulnerable to climate change. Anisimov et al. (2001) predicted that there would be major ecological, sociological, and economic impacts in the region.
  • Small islands: Mimura et al. (2007, p. 689) concluded, with very high confidence, that small islands were particularly vulnerable to climate change. Partly this was attributed to their low adaptive capacity
    Adaptive capacity
    Adaptive capacity is the capacity of a system to adapt if the environment where the system exists is changing. It is applied to e.g., ecological systems and human social systems.As applied to ecological systems, the adaptive capacity is determined by :...

     and the high costs of adaptation in proportion to their GDP.

Systems and sectors

  • Coasts and low-lying areas: According to Nicholls et al. (2007, p. 336), societal vulnerability to climate change is largely dependent on development status. Developing countries lack the necessary financial resources to relocate those living in low-lying coastal zones, making them more vulnerable to climate change than developed countries. With high confidence, Nicholls et al. (2007, p. 317) concluded that on vulnerable coasts, the costs of adapting to climate change are lower than the potential damage costs.
  • Industry, settlements and society:
    • At the scale of a large nation or region, at least in most industrialized
      Industrialisation
      Industrialization is the process of social and economic change that transforms a human group from an agrarian society into an industrial one...

       economies, the economic value of sectors with low vulnerability to climate change greatly exceeds that of sectors with high vulnerability (Wilbanks et al., 2007, p. 366). Additionally, the capacity of a large, complex economy to absorb climate-related impacts, is often considerable. Consequently, estimates of the aggregate damages of climate change - ignoring possible abrupt climate change - are often rather small as a percentage of economic production. On the other hand, at smaller scales, e.g., for a small country, sectors and societies might be highly vulnerable to climate change. Potential climate change impacts might therefore amount to very severe damages.
    • Wilbanks et al. (2007, p. 359) concluded, with very high confidence, that vulnerability to climate change depends considerably on specific geographic, sectoral and social contexts. In their view, these vulnerabilities are not reliably estimated by large-scale aggregate modelling.

Mitigation


Mitigation of climate change involves actions that are designed to limit the amount of long-term climate change (Fisher et al., 2007:225). Mitigation may be achieved through the reduction of GHG emissions or through the enhancement of sinks that absorb GHGs, e.g., forests.

International public goods


The atmosphere is an international public good
Public good
In economics, a public good is a good that is non-rival and non-excludable. Non-rivalry means that consumption of the good by one individual does not reduce availability of the good for consumption by others; and non-excludability means that no one can be effectively excluded from using the good...

, and GHG emissions are an international externality
Externality
In economics, an externality is a cost or benefit, not transmitted through prices, incurred by a party who did not agree to the action causing the cost or benefit...

 (Goldemberg et al., 1996:21, 28, 43). A change in the quality of the atmosphere does not affect the welfare of all individuals equally. In other words, some individuals may benefit from climate change, while others may lose out. This uneven distribution of potential climate change impacts, plus the uneven distribution of emissions globally, make it difficult to secure a global agreement to reduce emissions (Halsnæs et al., 2007:127).

National


Both climate and non-climate policies can affect emissions growth. Non-climate policies that can affect emissions are listed below (Bashmakov et al., 2001:409-410):
  • Market-orientated reforms can have important impacts on energy use, energy efficiency, and therefore GHG emissions.
  • Price and subsidy policies: Many countries provide subsidies
    Subsidy
    A subsidy is an assistance paid to a business or economic sector. Most subsidies are made by the government to producers or distributors in an industry to prevent the decline of that industry or an increase in the prices of its products or simply to encourage it to hire more labor A subsidy (also...

     for activities that impact emissions, e.g., subsidies in the agriculture and energy
    Energy subsidies
    Energy subsidies are measures that keep prices for consumers below market levels or for producers above market levels, or reduce costs for consumers and producers...

     sectors, and indirect subsidies for transport.
  • Market liberalization: Restructuring of energy market
    Energy market
    Energy markets are those commodities markets that deal specifically with the trade and supply of energy. Energy market may refer to an electricity market, but can also refer to other sources of energy...

    s has occurred in several countries and regions. These policies have mainly been designed to increase competition in the market, but they can have a significant impact on emissions.


There are a number of policies that might be used to mitigate climate change, including (Bashmakov et al., 2001:412-422):
  • Regulatory
    Regulation
    Regulation is administrative legislation that constitutes or constrains rights and allocates responsibilities. It can be distinguished from primary legislation on the one hand and judge-made law on the other...

     standards, e.g., technology or performance standards.
  • Market-based instruments, such as emissions taxes and tradable permits.
  • Voluntary agreements between public agencies and industry.
  • Informational instruments, e.g., to increase public awareness of climate change.
  • Use of subsidies and financial incentives, e.g., feed-in tariff
    Feed-in Tariff
    A feed-in tariff is a policy mechanism designed to accelerate investment in renewable energy technologies. It achieves this by offering long-term contracts to renewable energy producers, typically based on the cost of generation of each technology...

    s for renewable energy (Gupta et al., 2007:762).
  • Removal of subsidies, e.g., for coal mining and burning (Barker et al., 2001:567-568).
  • Demand-side management, which aims to reduce energy demand through energy audits, product labelling, etc.

International

  • The Kyoto Protocol
    Kyoto Protocol
    The Kyoto Protocol is a protocol to the United Nations Framework Convention on Climate Change , aimed at fighting global warming...

     to the UNFCCC sets out legally binding emission reduction commitments for the "Annex B" countries (Verbruggen, 2007, p. 817). The Protocol defines three international policy instruments ("Flexibility Mechanisms") which can be used by the Annex B countries to meet their emission reduction commitments. According to Bashmakov et al. (2001:402), use of these instruments could significantly reduce the costs for Annex B countries in meeting their emission reduction commitments.
  • Other possible policies include internationally coordinated carbon tax
    Carbon tax
    A carbon tax is an environmental tax levied on the carbon content of fuels. It is a form of carbon pricing. Carbon is present in every hydrocarbon fuel and is released as carbon dioxide when they are burnt. In contrast, non-combustion energy sources—wind, sunlight, hydropower, and nuclear—do not...

    es and/or regulation (Bashmakov et al., 2001:430).

Finance


The International Energy Agency
International Energy Agency
The International Energy Agency is a Paris-based autonomous intergovernmental organization established in the framework of the Organisation for Economic Co-operation and Development in 1974 in the wake of the 1973 oil crisis...

 estimates that USD$197 billion is required by states in the developing world above and beyond the underlying investments needed by various sectors regardless of climate considerations, this is twice the amount promised by the developed world at the UN Framework Convention on Climate Change (UNFCCC) Cancún Agreements. Thus, a new method is being developed to help ensure that funding is available for climate change mitigation. This involves financial leveraging, whereby public financing is used to encourage private investment.

Cost estimates


According to a literature assessment by Barker et al. (2007b:622), mitigation cost estimates depend critically on the baseline (in this case, a reference scenario that the alternative scenario is compared with), the way costs are modelled, and assumptions about future government policy. Fisher et al. (2007) estimated macroeconomic costs in 2030 for multi-gas mitigation (reducing emissions of carbon dioxide and other GHGs, such as methane
Methane
Methane is a chemical compound with the chemical formula . It is the simplest alkane, the principal component of natural gas, and probably the most abundant organic compound on earth. The relative abundance of methane makes it an attractive fuel...

) as between a 3% decrease in global GDP to a small increase, relative to baseline. This was for an emissions pathway consistent with atmospheric stabilization of GHGs between 445 and 710 ppm CO2-eq. In 2050, the estimated costs for stabilization between 710 and 445 ppm CO2-eq ranged between a 1% gain to a 5.5% decrease in global GDP, relative to baseline. These cost estimates were supported by a moderate amount of evidence and much agreement in the literature (IPCC, 2007b:11,18).

Macroeconomic cost estimates made by Fisher et al. (2007:204) were mostly based on models that assumed transparent markets, no transaction costs, and perfect implementation of cost-effective policy measures across all regions throughout the 21st century. According to Fisher et al. (2007), relaxation of some or all these assumptions would lead to an appreciable increase in cost estimates. On the other hand, IPCC (2007b:8) noted that cost estimates could be reduced by allowing for accelerated technological learning, or the possible use of carbon tax/emission permit revenues to reform national tax systems.
  • Regional costs were estimated as possibly being significantly different from the global average. Regional costs were found to be largely dependent on the assumed stabilization level and baseline scenario.
  • Sectoral costs: In a literature assessment, Barker et al. (2001:563-564), predicted that the renewables
    Renewable energy
    Renewable energy is energy which comes from natural resources such as sunlight, wind, rain, tides, and geothermal heat, which are renewable . About 16% of global final energy consumption comes from renewables, with 10% coming from traditional biomass, which is mainly used for heating, and 3.4% from...

     sector could potentially benefit from mitigation. The coal
    Coal
    Coal is a combustible black or brownish-black sedimentary rock usually occurring in rock strata in layers or veins called coal beds or coal seams. The harder forms, such as anthracite coal, can be regarded as metamorphic rock because of later exposure to elevated temperature and pressure...

     (and possibly the oil
    Petroleum industry
    The petroleum industry includes the global processes of exploration, extraction, refining, transporting , and marketing petroleum products. The largest volume products of the industry are fuel oil and gasoline...

    ) industry was predicted to potentially lose substantial proportions of output relative to a baseline scenario, with energy-intensive sectors, such as heavy chemicals
    Chemical industry
    The chemical industry comprises the companies that produce industrial chemicals. Central to the modern world economy, it converts raw materials into more than 70,000 different products.-Products:...

    , facing higher costs.

Adaptation and mitigation


The distribution of benefits from adaptation and mitigation policies are different in terms of damages avoided (Toth et al., 2001:653). Adaptation activities mainly benefit those who implement them, while mitigation benefits others who may not have made mitigation investments. Mitigation can therefore be viewed as a global public good, while adaptation is either a private good
Private good
A private good is defined in economics as "an item that yields positive benefits to people” that is excludable, i.e. its owners can exercise private property rights, preventing those who have not paid for it from using the good or consuming its benefits; and rivalrous, i.e. consumption by one...

 in the case of autonomous adaptation, or a national or regional public good in the case of public sector policies.

Paying for an international public good


Economists generally agree on the following two principles (Goldemberg, et al.., 1996:29):
  • For the purposes of analysis, it is possible to separate equity from efficiency. This implies that all emitters, regardless of whether they are rich or poor, should pay the full social costs of their actions. From this perspective, corrective (Pigouvian) taxes should be applied uniformly (see carbon tax#Economic theory).
  • It is inappropriate to redress all equity issues through climate change policies. However, climate change itself should not aggravate existing inequalities between different regions.


Some early studies suggested that a uniform carbon tax would be a fair and efficient way of reducing emissions (Banuri et al., 1996, pp. 103–104). A carbon tax is a Pigouvian tax, and taxes fuels based on their carbon content (Hoeller and Wallin, 1991, p. 92). A literature assessment by Banuri et al. (1996:103-104) summarized criticisms of such a system:
  • A carbon tax would impose different burdens on countries due to existing differences in tax structures, resource endowments, and development.
  • Most observers argue that such a tax would not be fair because of differences in historical emissions and current wealth.
  • A uniform carbon tax would not be Pareto efficient unless lump sum transfers were made between countries. Pareto efficiency
    Pareto efficiency
    Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...

     requires that the carbon tax would not make any countries worse off than they would be without the tax (Chichilnisky and Heal, 1994, p. 445; Tol, 2001, p. 72). Also, at least one country would need to be better off.


An alternative approach to having a Pigouvian tax is one based on property rights. A practical example of this would be a system of emissions trading, which is essentially a privatization of the atmosphere (Hepburn, 2007). The idea of using property rights in response to an externality was put forward by Coase (1960). Coase's model of social cost assumes a situation of equal bargaining power among participants and equal costs of making the bargain (Toth et al.., 2001:668). Assigning property rights can be an efficient solution. This is based on the assumption that there are no bargaining/transaction costs involved in buying or selling these property rights, and that buyers and sellers have perfect information available when making their decisions.

If these assumptions are correct, efficiency is achieved regardless of how property rights are allocated. In the case of emissions trading, this suggests that equity and efficiency can be addressed separately: equity is taken care of in the allocation of emission permits, and efficiency is promoted by the market system. In reality, however, markets do not live up to the ideal conditions that are assumed in Coase's model, with the result that there may be trade-offs between efficiency and equity (Halsnæs et al., 2007).

Efficiency and equity


No scientific consensus exists on who should bear the burden of adaptation and mitigation costs (Goldemberg et al.., 1996:29). Several different arguments have been made over how to spread the costs and benefits of taxes or systems based on emissions trading.

One approach considers the problem from the perspective of who benefits most from the public good. This approach is sensitive to the fact that different preferences exist between different income classes. The public good is viewed in a similar way as a private good, where those who use the public good must pay for it. Some people will benefit more from the public good than others, thus creating inequalities in the absence of benefit taxes. A difficulty with public goods is determining who exactly benefits from the public good, although some estimates of the distribution of the costs and benefits of global warming have been made - see above. Additionally, this approach does not provide guidance as to how the surplus of benefits from climate policy should be shared.

A second approach has been suggested based on economics and the social welfare function
Social welfare function
In economics, a social welfare function is a real-valued function that ranks conceivable social states from lowest to highest. Inputs of the function include any variables considered to affect the economic welfare of a society...

. To calculate the social welfare function requires an aggregation of the impacts of climate change policies and climate change itself across all affected individuals. This calculation involves a number of complexities and controversial equity issues (Markandya et al., 2001:460). For example, the monetization of certain impacts on human health. There is also controversy over the issue of benefits affecting one individual offsetting negative impacts on another (Smith et al.., 2001:958). These issues to do with equity and aggregation cannot be fully resolved by economics (Banuri et al.., 1996:87).

On a utilitarian basis, which has traditionally been used in welfare economics, an argument can be made for richer countries taking on most of the burdens of mitigation (Halsnæs et al., 2007). However, another result is possible with a different modeling of impacts. If an approach is taken where the interests of poorer people have lower weighting, the result is that there is a much weaker argument in favour of mitigation action in rich countries. Valuing climate change impacts in poorer countries less than domestic climate change impacts (both in terms of policy and the impacts of climate change) would be consistent with observed spending in rich countries on foreign aid (Hepburn, 2005; Helm, 2008:229).

In terms of the social welfare function, the different results depend on the elasticity of marginal utility. A declining marginal utility of consumption means that a poor person is judged to benefit more from increases in consumption relative to a richer person. A constant marginal utility of consumption does not make this distinction, and leads to the result that richer countries should mitigate less.

A third approach looks at the problem from the perspective of who has contributed most to the problem. Because the industrialized countries have contributed more than two-thirds of the stock of human-induced GHGs in the atmosphere, this approach suggests that they should bear the largest share of the costs. This stock of emissions has been described as an "environmental debt" (Munasinghe et al., 1996, p. 167). In terms of efficiency, this view is not supported. This is because efficiency requires incentives to be forward-looking, and not retrospective (Goldemberg et al., 1996, p. 29). The question of historical responsibility is a matter of ethics
Ethics
Ethics, also known as moral philosophy, is a branch of philosophy that addresses questions about morality—that is, concepts such as good and evil, right and wrong, virtue and vice, justice and crime, etc.Major branches of ethics include:...

. Munasinghe et al. (1996, p. 167) suggested that developed countries could address the issue by making side-payments to developing countries.

Trade offs


It is often argued in the literature that there is a trade-off between adaptation and mitigation, in that the resources committed to one are not available for the other (Schneider et al., 2001:94). This is debatable in practice because the people who bear emission reduction costs or benefits are often different from those who pay or benefit from adaptation measures.

There is also a trade off in how much damage from climate change should be avoided. The assumption that it is always possible to trade off different outcomes is viewed as problematic by many people (Halsnæs et al., 2007). For example, a trade off might exist between economic growth and damages faced by indigenous
Indigenous peoples
Indigenous peoples are ethnic groups that are defined as indigenous according to one of the various definitions of the term, there is no universally accepted definition but most of which carry connotations of being the "original inhabitants" of a territory....

 culture
Culture
Culture is a term that has many different inter-related meanings. For example, in 1952, Alfred Kroeber and Clyde Kluckhohn compiled a list of 164 definitions of "culture" in Culture: A Critical Review of Concepts and Definitions...

s.

Some of the literature has pointed to difficulties in these kinds of assumptions. For instance, there may be aversion at any price towards losing particular species. It has also been suggested that low-probability, extreme outcomes are overweighted when making choices. This is related to climate change, since the possibility of future abrupt changes
Abrupt climate change
An abrupt climate change occurs when the climate system is forced to transition to a new state at a rate that is determined by the climate system itself, and which is more rapid than the rate of change of the external forcing...

 in the climate or the Earth system cannot be ruled out. For example, if the West Antarctic ice sheet
West Antarctic Ice Sheet
The West Antarctic Ice Sheet is the segment of the continental ice sheet that covers West Antarctica, the portion of Antarctica on the side of the Transantarctic Mountains which lies in the Western Hemisphere. The WAIS is classified as a marine-based ice sheet, meaning that its bed lies well...

 was to disintegrate, it could result in a sea level rise of 4–6 meters over several centuries.

Cost-benefit analysis

In a cost-benefit analysis, the trade offs between climate change impacts, adaptation, and mitigation are made explicit. Cost-benefit analyses of climate change are produced using integrated assessment models (IAMs), which incorporate aspects of the natural, social, and economic sciences.

In an IAM designed for cost-benefit analysis, the costs and benefits of impacts, adaptation and mitigation are converted into monetary estimates. Some view the monetization of costs and benefits as controversial (see Economic impacts of climate change#Aggregate impacts). The "optimal" levels of mitigation and adaptation are then resolved by comparing the marginal costs of action with the marginal benefits of avoided climate change damages (Toth et al., 2001:654). The decision over what "optimal" is depends on subjective value judgements made by the author of the study (Azar, 1998).

There are many uncertainties that affect cost-benefit analysis, for example, sector- and country-specific damage functions (Toth et al., 2001:654). Another example is with adaptation. The options and costs for adaptation are largely unknown, especially in developing countries.

Results


A common finding of cost-benefit analysis is that the optimum level of emissions reduction is modest in the near-term, with more stringent abatement in the longer-term (Stern, 2007:298; Heal, 2008:20; Barker, 2008). This approach might lead to a warming of more than 3 °C above the pre-industrial level (World Bank, 2010:8). In most models, benefits exceed costs for stabilization of GHGs leading to warming of 2.5 °C. No models suggest that the optimal policy is to do nothing, i.e., allow "business-as-usual" emissions.

Along the efficient emission path calculated by Nordhaus and Boyer (2000) (referred to by Fisher et al.., 2007), the long-run global average temperature after 500 years increases by 6.2 °C above the 1900 level. Nordhaus and Boyer (2000) stated their concern over the potentially large and uncertain impacts of such a large environmental change. It should be noted that the projected temperature in this IAM, like any other, is subject to scientific uncertainty (e.g., the relationship between concentrations of GHGs and global mean temperature, which is called the climate sensitivity
Climate sensitivity
Climate sensitivity is a measure of how responsive the temperature of the climate system is to a change in the radiative forcing. It is usually expressed as the temperature change associated with a doubling of the concentration of carbon dioxide in Earth's atmosphere.The equilibrium climate...

). Projections of future atmospheric concentrations based on emission pathways are also affected by scientific uncertainties, e.g., over how carbon sinks, such as forests, will be affected by future climate change. Klein et al. (2007) concluded that there were few high quality studies in this area, and placed low confidence in the results of cost-benefit analysis.

Hof et al. (2008) (referred to by World Bank, 2010:8) examined the sensitivity of the optimal climate target to assumptions about the time horizon, climate sensitivity, mitigation costs, likely damages, and discount rates. The optimal target was defined as the concentration that would result in the lowest reduction in the present value (i.e., discounted) of global consumption. A set of assumptions that included a relatively high climate sensitivity (i.e., a relatively large global temperature increase for a given increase in GHGs), high damages, a long time horizon, low discount rates (i.e., future consumption is valued relatively highly), and low mitigation costs, produced an optimum peak in the concentration of CO2e at 540 parts per million (ppm). Another set of assumptions that assumed a lower climate sensitivity (lower global temperature increase), lower damages, a shorter time horizon, and a higher discount rate (present consumption is valued relatively more highly), produced an optimum peaking at 750 ppm.

Strengths


In spite of various uncertainties or possible criticisms of cost-benefit analysis, it does have several strengths:
  • It offers an internally consistent and global comprehensive analysis of impacts (Smith et al., 2001:955).
  • Sensitivity analysis allows critical assumptions in the analysis to be changed. This can identify areas where the value of information is highest and where additional research might have the highest payoffs (Downing, et al., 2001:119).
  • As uncertainty is reduced, the integrated models used in producing cost-benefit analysis might become more realistic and useful.

Geoengineering


Geoengineering
Geoengineering
The concept of Geoengineering refers to the deliberate large-scale engineering and manipulation of the planetary environment to combat or counteract anthropogenic changes in atmospheric chemistry The Intergovernmental Panel on Climate Change concluded in 2007 that geoengineering options, such...

 are technological efforts to stabilize the climate system by direct intervention in the Earth-atmosphere-system's energy balance (Verbruggen, 2007, p. 815). The intent of geoengineering is to reduce the amount of global warming (the observed trend of increased global average temperature (NRC, 2008, p. 2)). IPCC (2007b:15) concluded that reliable cost estimates for geoengineering options had not been published. This finding was based on medium agreement in the literature and limited evidence.

Major reports considering economics of climate change


The Intergovernmental Panel on Climate Change
Intergovernmental Panel on Climate Change
The Intergovernmental Panel on Climate Change is a scientific intergovernmental body which provides comprehensive assessments of current scientific, technical and socio-economic information worldwide about the risk of climate change caused by human activity, its potential environmental and...

 (IPCC) has produced several reports where the economics literature on climate change is assessed. In 1995, the IPCC produced its second
IPCC Second Assessment Report
The Second Assessment Report of the Intergovernmental Panel on Climate Change , published in 1996, is an assessment of the then available scientific and socio-economic information on climate change...

 set of assessment reports on climate change. Working Group III of the IPCC produced a report on the "Economic and Social Dimensions of Climate Change." In the later third
IPCC Third Assessment Report
The IPCC Third Assessment Report, Climate Change 2001, is an assessment of available scientific and socio-economic information on climate change by the IPCC. The IPCC was established in 1988 by the United Nations Environment Programme and the UN's World Meteorological Organization ".....

 and fourth
IPCC Fourth Assessment Report
Climate Change 2007, the Fourth Assessment Report of the United Nations Intergovernmental Panel on Climate Change , is the fourth in a series of reports intended to assess scientific, technical and socio-economic information concerning climate change, its potential effects, and options for...

 IPCC assessments, published in 2001 and 2007 respectively, the assessment of the economics literature is divided across two reports produced by IPCC Working Groups II and III.

The Stern Review on the Economics of Climate Change
Stern Review
The Stern Review on the Economics of Climate Change is a 700-page report released for the British government on 30 October 2006 by economist Nicholas Stern, chair of the Grantham Research Institute on Climate Change and the Environment at the London School of Economics and also chair of the Centre...

 is a 700-page report released for the British government on October 30, 2006 by economist Nicholas Stern
Nicholas Stern
Nicholas Herbert Stern, Baron Stern of Brentford, Kt, FBA is a British economist and academic. He is IG Patel Professor of Economics and Government, Chair of the Grantham Research Institute on Climate Change and the Environment at the London School of Economics , and 2010 Professor of Collège de...

 chair of the Grantham Research Institute on Climate Change and the Environment
Grantham Research Institute on Climate Change and the Environment
The Grantham Research Institute on Climate Change and the Environment is a research centre at the London School of Economics and Political Science founded in May 2008...

 at the London School of Economics
London School of Economics
The London School of Economics and Political Science is a public research university specialised in the social sciences located in London, United Kingdom, and a constituent college of the federal University of London...

. The report discusses the effect of global warming
Global warming
Global warming refers to the rising average temperature of Earth's atmosphere and oceans and its projected continuation. In the last 100 years, Earth's average surface temperature increased by about with about two thirds of the increase occurring over just the last three decades...

 on the world economy.

The Garnaut Climate Change Review
Garnaut Climate Change Review
The Garnaut Climate Change Review was a study by Professor Ross Garnaut, commissioned by then Opposition Leader, Kevin Rudd and by the Australian State and Territory Governments on 30 April 2007...

 was a study by Professor Ross Garnaut
Ross Garnaut
Ross Gregory Garnaut AO is a Distinguished Professor of Economics at the Australian National University and both a Vice-Chancellor's Fellow and Professorial Fellow of Economics at The University of Melbourne....

, commissioned by then Opposition Leader, Kevin Rudd
Kevin Rudd
Kevin Michael Rudd is an Australian politician who was the 26th Prime Minister of Australia from 2007 to 2010. He has been Minister for Foreign Affairs since 2010...

 and by the Australia
Australia
Australia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans. It is the world's sixth-largest country by total area...

n State and Territory
States and territories of Australia
The Commonwealth of Australia is a union of six states and various territories. The Australian mainland is made up of five states and three territories, with the sixth state of Tasmania being made up of islands. In addition there are six island territories, known as external territories, and a...

 Governments on 30 April 2007. After his election on 24 November 2007 Prime Minister of Australia
Prime Minister of Australia
The Prime Minister of the Commonwealth of Australia is the highest minister of the Crown, leader of the Cabinet and Head of Her Majesty's Australian Government, holding office on commission from the Governor-General of Australia. The office of Prime Minister is, in practice, the most powerful...

 Kevin Rudd
Kevin Rudd
Kevin Michael Rudd is an Australian politician who was the 26th Prime Minister of Australia from 2007 to 2010. He has been Minister for Foreign Affairs since 2010...

 confirmed the participation of the Commonwealth Government
Government of Australia
The Commonwealth of Australia is a federal constitutional monarchy under a parliamentary democracy. The Commonwealth of Australia was formed in 1901 as a result of an agreement among six self-governing British colonies, which became the six states...

 in the Review.

See also

  • Carbon tax
    Carbon tax
    A carbon tax is an environmental tax levied on the carbon content of fuels. It is a form of carbon pricing. Carbon is present in every hydrocarbon fuel and is released as carbon dioxide when they are burnt. In contrast, non-combustion energy sources—wind, sunlight, hydropower, and nuclear—do not...

  • Carbon credit
    Carbon credit
    A carbon credit is a generic term for any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or the mass of another greenhouse gas with a carbon dioxide equivalent equivalent to one tonne of carbon dioxide....

  • Carbon finance
    Carbon finance
    Carbon finance is a new branch of Environmental finance. Carbon finance explores the financial implications of living in a carbon-constrained world, a world in which emissions of carbon dioxide and other greenhouse gases carry a price....

  • Emissions trading
    Emissions trading
    Emissions trading is a market-based approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants....

  • CDM Gold Standard
    CDM Gold Standard
    The Gold Standard is the world's only independent standard for creating high-quality emission reductions projects in the Clean Development Mechanism Joint Implementation and Voluntary Carbon Market. It was designed to ensure that carbon credits are not only real and verifiable but that they make...


  • Business action on climate change
    Business action on climate change
    Business action on climate change includes a range of activities relating to global warming, and to influencing political decisions on global-warming-related regulation, such as the Kyoto Protocol...

  • Politics of global warming
    Politics of global warming
    The politics of global warming have involved corporate lobbying, funding of special interest groups and public relations campaigns by the oil and coal industries which have affected policy decisions and legislation worldwide...


External links


Videos

  • Cournot Centre Conference on "The Economic Cost of Climate Change". Speakers: Masahiko Aoki (Stanford University
    Stanford University
    The Leland Stanford Junior University, commonly referred to as Stanford University or Stanford, is a private research university on an campus located near Palo Alto, California. It is situated in the northwestern Santa Clara Valley on the San Francisco Peninsula, approximately northwest of San...

    ), Michel Armatte (Centre A. Koyré), Jean-Pierre Dupuy (Stanford University), Olivier Godard (C.N.R.S.), Jean-Charles Hourcade (C.I.R.E.D.), Inge Kaul (Hertie School), Philippe Quirion (C.N.R.S.), Thomas Schelling
    Thomas Schelling
    Thomas Crombie Schelling is an American economist and professor of foreign affairs, national security, nuclear strategy, and arms control at the School of Public Policy at University of Maryland, College Park. He is also co-faculty at the New England Complex Systems Institute...

     (University of Maryland
    University of Maryland
    When the term "University of Maryland" is used without any qualification, it generally refers to the University of Maryland, College Park.University of Maryland may refer to the following:...

    ), Robert Solow
    Robert Solow
    Robert Merton Solow is an American economist particularly known for his work on the theory of economic growth that culminated in the exogenous growth model named after him...

     (MIT), Nicholas Stern
    Nicholas Stern
    Nicholas Herbert Stern, Baron Stern of Brentford, Kt, FBA is a British economist and academic. He is IG Patel Professor of Economics and Government, Chair of the Grantham Research Institute on Climate Change and the Environment at the London School of Economics , and 2010 Professor of Collège de...

     (London School of Economics
    London School of Economics
    The London School of Economics and Political Science is a public research university specialised in the social sciences located in London, United Kingdom, and a constituent college of the federal University of London...

    ), Thomas Sterner (University of Gothenburg), and Martin Weitzman
    Martin Weitzman
    Martin Lawrence "Marty" Weitzman is a well known-economist and a Professor of Economics at Harvard University. He is among the most influential economists in the world according to IDEAS/RePEc...

     (Harvard University
    Harvard University
    Harvard University is a private Ivy League university located in Cambridge, Massachusetts, United States, established in 1636 by the Massachusetts legislature. Harvard is the oldest institution of higher learning in the United States and the first corporation chartered in the country...

    ). Recorded in 2008.
  • "Climate Change and Disasters - Risk and Policy". A discussion based on the work of William Nordhaus
    William Nordhaus
    William Dawbney "Bill" Nordhaus is the Sterling Professor of Economics at Yale University. Nordhaus lives in New Haven, Connecticut, with his wife Barbara.-Career:...

    , Sterling Professor of Economics at Yale University
    Yale University
    Yale University is a private, Ivy League university located in New Haven, Connecticut, United States. Founded in 1701 in the Colony of Connecticut, the university is the third-oldest institution of higher education in the United States...

    . This discussion was held at the World Bank in 2008.
  • "Can We Afford the Future? The Economics of a Warming World". A lecture given by Frank Ackerman
    Frank Ackerman
    Frank Ackerman is an economist known for his work in environmental economics, particularly in the areas of climate change and development...

     at Boston University
    Boston University
    Boston University is a private research university located in Boston, Massachusetts. With more than 4,000 faculty members and more than 31,000 students, Boston University is one of the largest private universities in the United States and one of Boston's largest employers...

    , April 28, 2009.
  • "Negotiating a New International Climate Treaty". A talk given by Scott Barrett, Lenfest-Earth Institute Professor of Natural Resource Economics, School of International and Public Affairs, Columbia University
    Columbia University
    Columbia University in the City of New York is a private, Ivy League university in Manhattan, New York City. Columbia is the oldest institution of higher learning in the state of New York, the fifth oldest in the United States, and one of the country's nine Colonial Colleges founded before the...

    . October 8, 2009.