The Pitfalls in Pricing Carbon

The federal government's favoured vehicle for cutting greenhouse gas emissions is the introduction of a carbon price or a carbon tax on fossil energy.

These calculations are usually based on some notion of the social cost of greenhouse gas emissions to the atmosphere, currently the main driver of global warming (but natural feedback loops are catching up frighteningly fast). We use integrated assessment models, IAMs, to work out such things as economic risk and social costs of GHG emissions.

However Nicholas Stern, Baron Stern of Brentford to you, has written a paper suggesting current IAMs grossly understate the actual risks and costs and therefore mislead policy makers.

The Fifth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC), published in 2013 and 2014, provided a comprehensive overview of the literature on the costs of action and inaction. But the assessment understated the limitations of the research done so far. Essentially, it reported on a body of literature that had systematically and grossly underestimated the risks of unmanaged climate change. Furthermore, that literature had failed to capture the learning processes and economies of scale involved in radical structural and technical change, and the benefits of reducing fossil-fuel pollution, protecting biodiversity and forests, and so on.

The IPCC pointed out1 that estimates of losses resulting from a 2 °C increase in mean global temperature above pre-industrial levels ranged from 0.2% to 2% of global gross domestic product. It admitted that the global economic impacts are “difficult to estimate” and that attempts depend on a large number of “disputable” assumptions. Moreover, many estimates do not account for factors such as catastrophic changes and tipping points.

...Sadly, most IAMs struggle to incorporate the scale of the scientific risks, such as the thawing of permafrost, release of methane, and other potential tipping points. Furthermore, many of the largest potential impacts are omitted, such as widespread conflict as a result of large-scale human migration to escape the worst-affected areas.

...IAMs are also used to calculate the social cost of carbon (SCC). They attempt to model the incremental change in, or damage to, global economic output resulting from 1 tonne of anthropogenic carbon dioxide emissions or equivalent. These SCC estimates are used by policymakers in cost–benefit analyses of climate-change-mitigation policies.

Because the IAMs omit so many of the big risks, SCC estimates are often way too low. As a first step, the consequences being assessed should include the damages to human well-being and loss of life beyond simply reduced economic output. And the very large uncertainty, usually involving downward bias, in SCC estimates should always be made explicit.

As the IPCC acknowledged, published SCC estimates “lie between a few dollars and several hundreds of dollars”. These values often depend crucially on the 'discounting' used to translate future costs to current dollars. The high discount rates that predominate essentially assume that benefits to people in the future are much less important than benefits today.

...Most current models of climate-change impacts make two flawed assumptions: that people will be much wealthier in the future and that lives in the future are less important than lives now.

The former assumption ignores the great risks of severe damage and disruption to livelihoods from climate change. The latter assumption is 'discrimination by date of birth'. It is a value judgement that is rarely scrutinized, difficult to defend and in conflict with most moral codes.

Stern goes on to note that we also understate the benefits that society can realize from alternative energy technologies, usually because we have trouble visualizing the knock-on effects of scientific and technological breakthroughs.

Why does this matter? Easy. Our government wants to introduce a carbon price but it has to be a realistic carbon price, one that weighs all the factors from the downsides of continued fossil fuel use to the upside advantages of transitioning to alternative clean energy. Without that comprehensive approach we stand a very good chance of falling back on a token price that bears little resemblance to the cost/benefit equation and is more in line with a political number.