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Assessing Economic Impacts of Greenhouse Gas Mitigation: Summary of a Workshop
of risk aversion. Since climate change is stochastic and not deterministic, a single discount rate may not be appropriate.
The other big value judgment, according to Zenghelis, is in pure rate of time preference—market rates of return are the consequence of individual agent relative decisions, which are not necessarily appropriate to apply in valuing effects on future generations. A more appropriate rate seems to be close to the risk-free treasury bill rate. Zenghelis also stated that the non-marginality of climate change is also significant—there is no option for countries to put money in the bank and, instead of investing early in abatement, take it out hundreds of years from now to buy off the consequences, some of which are irreversible. Investors could be locked-in to backing high-carbon pathways and potentially facing catastrophes. The bottom line is that strategies that slowly ramp up may involve taking large, potentially irreversible risks.
Nordhaus explained that we know that addressing climate change is a global public good and that it involves millions of firms, thousands of different governments, and billions of people, all of which have to face realistic market prices. He also reiterated that new technologies and products need to be created by people in firms, and thus will be competing in the marketplace. Thus, he contends that analysts have to deal with the issue of at least a market rate of return as a benchmark for current policy, because investments in mitigation will be competing with other investments in other areas. He said that an important question for consideration is whether investments in mitigation are truly risk-free investments. Richard Newell remarked that Martin Weitzman discussed in his research how the combination of market- and non-market-based costs might lean toward a risk-free rate of return. In Nordhaus’s own analysis, returns on investments in mitigation correlated positively with returns in general, indicating that a full-risk discount is appropriate. This area needs more research before decisions can be made on taking a risk-free versus full-risk discounting approach. Ultimately, Nordhaus concluded, the discounting argument can be a red herring—a real challenge seems to be improving analysis of the impacts of the lower-probability outcomes.
Importance of International Participation
Building on participants’ earlier comments about the need for global participation in mitigation efforts, Bill Nordhaus described the cost of non-participation and its centrality to mitigation policy. Models have shown that the penalty cost function is enormous—top-down models indicate a larger penalty than bottom-up models do, but all show substantial cost penalties as participation drops below 100 percent. He explained that this was intuitive to economists but that he was surprised by the enormity of the importance of participation. He concluded that to be economically efficient, mitigation approaches need to be universal and harmonized across sectors and countries. Rick Bradley also pointed out that policymakers at the international level are looking for guidance on designing a phase-in strategy to eventually engage all countries in GHG reductions. Bill Cline stated that the prospective future damage from global warming warrants aggressive abatement action, and there is a solid economic case for a goal of 50 percent reductions by 2050. An important caveat is that although reaching the goal requires participation, the distribution of emissions is sufficiently concentrated that engaging countries like Brazil, China, India, and Russia will go a long way toward achieving that goal.