THE ECONOMICS OF GLOBAL WARMING: Not to Act at All, to Act Now or Later. (Ahmed M. Hussen, July 2007)

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1 THE ECONOMICS OF GLOBAL WARMING: Not to Act at All, to Act Now or Later (Ahmed M. Hussen, July 2007) I. INTRODUCTION: Preliminary Facts about Climate Change and the Science behind it Serious international discussion on global warming did not start until the singing of the Framework Convention on Climate Change at the Earth Summit in Rio de Janeiro in It was not, however, until five years later that the first United Nations conference to enact a binding international agreement to control the emissions of greenhouse gases was held in Kyoto, Japan the Kyoto Protocol. This environmental conference clearly indicated that climate change or in this particular instance global warming (see Box 1, next page) is a very serious problem and the world community has to take concrete steps to reduce the emissions of greenhouse gases (GHGs). The final agreement reached under the Kyoto Protocol decreed an average of 5.2 percent cut in greenhouse gas emissions from 1990 levels by the year Furthermore, the emissions cut will be forthcoming entirely from the developed nations. The main message of the Kyoto Protocol agreement has been that doing nothing about global warming is not an option if the present generation of humanity is to avoid passing-on a world to future generations that is going to be hostile and incompatible to pursuing a normal and productive life as we know it today. For the sake of clarifying some conceptual ambiguities right from the onset, it will be helpful to begin with a formal definition of climate change and a brief description of an organization that has contributed a great deal to the scientific understanding of the causes and consequences of global warming; namely, the Intergovernmental Panel on Climate Change (IPCC). Climate Change: refers to any change (cooling or warming) in climate overtime, whether due to natural variability or as a result of human activity (IPCC Report, 2007). For example, there is now ample scientific evidence that the Earth has been in a warming trend since approximately The estimate of the actual increase in global average surface temperature ranges from 0.5 to 0.8 degree Centigrade. However, it is important to note that the Earth has gone through several warming and cooling trends during its long history of existence. For example, even over the past 1150 years, the Earth has already experienced one warming and one cooling period. During the period 850 AD to 1350 AD the Earth s atmosphere experienced sharp and pronounced warming with an average surface temperature increase in as much as 2.5 degrees Celsius. There was also a cooling period, historically known as The Little Ice Age that occurred between 1550 and 1850 (Wikipedia, 2007). However, what is new and somewhat disturbing about the recent global warming trend is the fact it is caused largely by human activities. How do we know this? The answer to this question requires an understanding of the vital role played by the Intergovernmental Panel on Climate Change (IPCC). 1

2 BOX 1 The Greenhouse Gas Effect: Global Warming Nearly half of the solar energy that approaches the planet Earth is reflected or absorbed by gases and aerosols in the atmosphere, with the greatest amount, approximately 22 percent, being intercepted by the white tops of clouds. The remaining solar radiation, most of which is in the form of infrared or visible light waves, passes through the atmosphere to the surface of the planet. There it is either reflected off light surfaces such as snow and ice, or absorbed by land, water or vegetation. Much of this energy that is absorbed by the Earth is reradiated out from the planet toward outer space in the form of longer-wave infrared rays. A portion of this escaping energy is absorbed by certain gases found in the atmosphere, in particular carbon dioxide (CO 2 ), methane (CH 4 ) and nitrous oxide (NO). In the process, heat is released that warms the lower atmosphere. These substances that are so critical to the Earth s climate account for only about 0.03 percent of atmosphere gases. Water vapor, which occurs in concentrations of from 0 to 4 percent of the atmosphere, also intercepts outgoing infrared radiation. This process has become known as the greenhouse effect, because as with the glass walls of a greenhouse, the atmosphere allows solar energy to pass inwards while blocking its escape, thus keeping the space within it warm compared to outside conditions. Thus, it is the so-called greenhouse gases (GHGs) CO 2, CH 4 and NO along with water vapor that account for the Earth s moderate climate. Much larger amount of CO 2 in the atmosphere of Venus explains its intensely hot climate, while the frigid conditions of Mars are attributed to lesser concentration of GHGs (Fisher 1990). IPCC was created in 1988 by the World Metrological Organization (WMO) and the United Nations Environmental Programme (UNEP). The role of IPCC has been to assess periodically the state of climate science as a basis for informed policy action (IPCC, December 2004). These assessments were done on the basis of expert s peerreviewed and published scientific literature. So far, since 1990, IPCC has completed four major assessment reports with an interval of approximately five years. The latest IPCC report was released in April In these reports, IPCC has been able to affirm with increasing confidence that the cause for global warming has been the anthropogenic emissions of greenhouse gases, most notably carbon dioxide (Naomi Oreskes, 2004). In fact, in its latest report, IPCC has gone as far as attaching a probability figure of 90 percent that the cause for global warming is the emissions of heat trapping GHGs arising primarily from human activities. Furthermore, it is observed that over two third of the CO 2 built-up in the atmosphere has occurred since World War II paralleling the era of incredible global economic expansion (see Box 2 next page) However, the existence of a scientific consensus on the anthropogenic sources for climate change should not imply that we now know all we need to know about climate change and its consequences. Many details about climate interactions are still not well understood, and there are ample grounds for continued research to provide a better basis for understanding climate dynamics (Naomi Oreskes, 2004). What this means is that, 2

3 BOX 2 The Root Cause of Global Warming: Biophysical Limits to Economic Growth A case could be made that the root cause for global warming is the rampant growth of a fossil fuel based human economy without due regards to ecological limits. To make this point evident, let us look at the following facts and events: The global output of goods and services grew from just under $5 trillion in 1950 to more than $47.8 trillion in 2006, an expansion of nearly ten fold (IMF, 2006). According to a most recent IMF report (September 2006), the global economy grew at a rate of 4.9 percent during Furthermore, this report forecast that this rapid expansion would continue in 2006 and beyond. Even if the world economy is to grow at 4 percent per year the global GDP would double within approximately seventeen years. In recent years, the economies of the two most populous nations in the world, China and India, have been growing at an alarming rate between 8 to 10 percent annually. If this rate of annual growth is to be sustained even for a decade, the economy of these two countries will be more than doubled. Since 1950, the world population has increased by 150 percent (from 2.5 to 6.2 billions). Next year alone nearly 90 million people will be added to the world population. According to a recent comprehensive study on global warming commissioned by the British government, the Stern Review (2006), the current stock of greenhouse gases in the atmosphere is about 430 parts per million (ppm) CO 2 equivalent compared with only 260 ppm before the Industrial Revolution. Increased use of fossil fuels has been the primary source for this marked change in the atmospheric concentration of carbon dioxide. Furthermore, if nothing is done, in view of continued economic growth and fossil fuel reserves, the stock of greenhouse gases in the atmosphere is projected to reach double pre-industrial levels by 2050, that is, 550 ppm CO 2 equivalent (Stern Review, 2006). The unfortunate reality is that while the economy continues to expand, the ecosystem in which it depends does not there is only one EARTH. What this has created is an increasingly stressful relationship between the human economy and the natural ecosystem. A case could be made, therefore, that rising global temperature or what is popularly known as global warming is just one of the most serious and visible symptoms of a fossil fuel based economy that is outgrowing the natural ecosystems. while we know that increased concentration of GHGs in the atmosphere has contributed to recent global warming, there still remain a great deal of uncertainty on the nature, severity, time horizon, and regional impacts of future warming trend. For example, it is widely expected, under current conditions, by 2050, the greenhouse gas emissions will be twice the level recorded before the Industrial Revolution (The Stern Review, 2006). 3

4 Even if this projection of greenhouse gas emissions is taken as a fact, it is still difficult to know what this heightened level of emissions means in terms of the actual increase of the average global surface temperature. Currently, the estimates for the average global surface temperature within the next 50 years (i.e., by about 2050) range from 1 to 3.5 degree centigrade (Cline, 2004). In addition, it is difficult to predict the regional impacts of average global surface temperature changes of the above nature. As will be evident in the next section, in many respects, uncertainties about the actual increases in surface temperatures and their associated regional impacts are factors that have contributed to the disputes among economists who have been conducting academic studies on the economic, human health and environmental impacts of global warming. It is also important to note that these uncertainties get magnified when economic impact assessments of global warming are extended further in time (100, 200 and more years). II. THE ECONOMICS OF GLOBAL WARMING: Basic Theoretical Concepts and Framework of Analysis A. Framework of Analysis: From a purely standard economic perspective, concern for climate change is a resource allocation problem. It deals with how much reduction in current consumption society is willing to sacrifice today to mitigate environmental damages arising from global temperature increases in the future. More specifically, at any given point in time, society, at any level, is confronted with rationing its scarce resources (land, labor, capital, etc) to satisfy competing ends. Thus, if a society decides to use more of its resources to invest on projects intended to avoid future environmental damages (slow global warming), it means less resources will be available to produce goods and services for current consumption (such as cars, housing, apparels, furniture settings, public recreational facilities, etc.) Viewed this way, the economics of global warming starts with the recognition of the trade-off that exists between two social costs; namely, greenhouse damage cost (the costs of not reducing greenhouse gas emissions beyond the current level maintaining the status quo) and greenhouse abatement costs (the costs of cutting the level of greenhouse gas emissions beyond the current level in order to slow future global warming). The trade-off between these two costs is quite apparent since a higher abatement cost (i.e., a reduction in greenhouse gas emissions) would be expected to cause lower damage cost, and a lower abatement cost would have the opposite effect. Once the trade-off between greenhouse damage and abatement costs is clearly recognized, a standard cost-benefit analysis dictates that a rational decision regarding climate change would warrant that a dollar spent on projects to slow global warming today (i.e., abatement cost) must be justified by a dollar or more benefit that are expected to be realized from avoiding future economic, human health, environmental and 4

5 ecological damages (i.e., damage cost). This simple decision rule can be presented in abbreviated form as follow: $1 (a.c.t.) must bring at least $1 (a.f.d.) where (a.c.t.) represents abatement cost today and (a.f.d.) conveys avoided future damage. Once the economic framework of analysis and the decision rule for investment on projects intended to slow global warming is clearly understood, in the next two subsections attempts will be made to discuss the nature and key determining factors of greenhouse abatement and damage cost functions. B. The Greenhouse Damage Costs The greenhouse damage costs arise from the fact that, if no action is taken today, global warming, despite the scientific uncertainties, is predicted to inflict significant economic, human health and ecological damages. Damage costs, therefore, represent the estimated dollar values of all these expected damages. These damages could be physically manifested in various forms, such as flooded cities, diminished food production, loss of biodiversity, land lost to oceans, increased storm damages, increased human morbidity and mortality arising from heat stress and the expansion of the range of tropical diseases, and so on. These are, therefore, the costs of doing nothing to slow global warming. They measure the costs to the economy, human health and the natural environment at some future time due to higher level atmospheric concentration of GHGs. It is also important to recognize that while these costs arise from the side-effects of activities undertaken by the present generation; future generations have no say in the matter directly. Hence, to use a well-known economic jargon, these are external costs imposed on future generations. The salient characteristics of the greenhouse damage cost function can be explained using Figure 1 (see next page). The horizontal axis represents concentration of GHGs in the atmosphere in parts per million (ppm) CO 2 equivalent. It is important to note that, as a group, greenhouse gases are stock pollutant because of the long life cycle these gases have once they enter the atmosphere, especially carbon dioxide. Carbon dioxide, the major component of the GHGs could stay into the environment for over a century (Cline, 1992). Hence, the damage function is not only affected by the current level of greenhouse gas emissions but also by the cumulative effect of past emissions extending over a long period of time. 5

6 Figure 1: Marginal Damage Cost MDC $ Major catastrophic and irreversible environmental damages & human death and displacement may occur. 0.5 to 0.8 C B A 1.5 to 4.0 C 280 ppm ce 420 ppm ce (ppm ce parts per million CO 2 equivalent) 550 ppm ce Stock of GHGs The vertical axis is the dollar value of the expected future damages arising from global warming. It is important to note, although this is outside the scope of this paper, the estimation of the monetary values of the damages from future global warming is an extremely difficult undertaking for a number of reasons. First, as discussed in the introductory section of this paper, future damages from global warming are clouded with uncertainty. Second, as discussed earlier, damage costs are externalities, hence, reliable market information on these costs are not readily available the case of market failure. Last but not least, damage costs are not easily quantifiable since they include intangible ecosystem services (such as the possible extinction of spices) that are impossible to capture in monetary terms. As one economist put it, the effort to quantify damage costs is the terra incognita of the social and economic impacts of climate change. 6

7 Despite the difficult practical issues involved in estimating damage costs (more on this later), as shown in Figure 1 above, it is theorized that the incremental (marginal) damage cost is an increasing function of the greenhouse gas concentration. The rationale for this argument comes from the simple fact that, other things equal, a higher concentration level of GHGs in the atmosphere will be accompanied by a larger increase in the average future global surface temperature (warming), hence, greater damage cost. For example, in Figure 1, by design, the first segment of damage cost curve represents the era between pre-industrial period and today. As discussed in the introductory section of this paper, the atmospheric concentration was 280 ppm during the pre-industrial era and 420 ppm today. During this period, the increase in the global average surface temperature is estimated to fall within the range of 0.5 to 0.8 degree Centigrade. On the other hand, as shown in Figure 1, by 2050 the atmospheric concentration of GHGs is expected to increase from the current level (420 ppm) to 550 ppm (Stern Review, 2006). During this interval period, the average global temperature is expected to increase between 1.5 and 3 degrees Centigrade. What is significant here is that while the increase in the atmospheric concentration between these two time intervals, from pre-industrial to present and from present to 2050, appears to be the same (about 130 ppm), the average surface global temperature increase associated in the years ahead is expected to be much higher than the past. This should not be surprising given what is already discussed about the cumulative effect of greenhouse gases. This phenomenon clearly explains why marginal damage cost is expected to increase at an increasing rate. Keep in mind, however, as discussed in the introductory section of this paper, prediction of future global temperature increase is often clouded with uncertain. As shown in Figure 1, it is postulated that a jump in the marginal damage cost curve would occur at 550 ppm level of atmospheric concentration of greenhouse gases. This is done to illustrate possible catastrophic and irreversible environmental damages (such as the destruction of a large portion of the Amazon Forest by fire and the associated loss of biodiversity) that may occur when a certain threshold of greenhouse gases concentration in the atmosphere is reached. This may possibly happen if the concentration of greenhouse gases reached to a level that precipitate an increase in the average global surface temperature between 4 and 6 degree Centigrade. Finally, it is important to note that because of the cumulative effect of greenhouse gases, we can never stop future global warming. However, programs designed to cut greenhouse gas emissions at the scale that is adequate enough to slow global warming could avert possible future major catastrophic and irreversible damages. To illustrate this point, in Figure 2 (see next page), the impact of a policy designed to mitigate global carbon emissions is displayed by a downward shift in the marginal damage cost curve. The new damage cost curve clearly indicates reduced costs at all levels of greenhouse gas emissions that must have resulted from the lower increase in global temperature (i.e., slower global warming) achieved due to the steps taken to cut greenhouse gas emissions. The important lesson here is this: although global warming cannot be stopped, measures can be taken to slow future warming trend and in so doing avoid major future 7

8 environmental catastrophes. This is, of course, the impetus for binding international agreement to cut the emissions of greenhouse gases, such as, the Kyoto Protocol. Figure 2: Possible Effect of GHGs Emissions Reduction on Future Global Warming Trend Important Lessons: MDC $ We can only slow but not stop global warming. We can, however, prevent irreversible ecological damages from occurring B 280 ppm ce 420 ppm ce A 550 ppm ce Stock of GHGs C. Greenhouse Abatement Costs Greenhouse abatement costs represent the social costs arising from the use of resources for projects that are intended to reduce greenhouse gas emissions. Costs of this nature may include: expenditures on carbon emission control devices, investments in energy conserving technologies; investments on the development of alternative energy sources; expenditures for raising coastal structures to prevent flooding; expenditures on research projects to develop drought-tolerant crops; investment in afforestation projects for expanded carbon sequestration capacity; and so on. 8

9 A helpful way to look at abatement costs is to view it as an investment by current generation to protect future environmental damages that clearly stands to benefit future generations. When abatement costs are viewed this way, they may raise ethical considerations of the following nature. First, why should the current generation be obligated to care for future generations, especially given that the impacts of global warming on the wellbeing of future generations remain uncertain? Second, why worry about future generations when their living standards (per capita GDP), based on the empirical evidence of the past two hundred years, is expected to be 3 to 4 times higher on the average than people living now (Taylor, 1998)? Third, investments to avoid future environmental damages often compete with current expenditure budget allocations to improve the conditions of today s poor. Given this, would it be fair to care for the environment that stands to benefit future generations, at the expense of today s poor? For example, increased investment to slow global warming by the developed nations may mean providing less money for international assistance to mitigate child malnutrition in parts of Africa, Asia and Latin America. Figure 3 is a graphic depiction of the abatement cost function. The horizontal axis shows the stock of greenhouse gases in percentages, and the 100 percent represents (where the marginal damage cost touches the horizontal axis of Figure 3) represents the current level of GHG stock (concentration) in the atmosphere. A move from the current Figure 3: Marginal Abatement Cost MAC Use of alternative energy fuels and transportation systems in a massive scale Minor changes in life style; enforcing existing industrial pollution regulations; planting trees; minor changes in transportation systems; etc. B A 0 80% 90% 100% Stock of GHGs 9

10 level towards the origin represents successive percentage reduction in greenhouse gas emissions from the current level. It is evident from Figure 3 that the abatement cost for each successive percentage reduction of greenhouse gas emissions is increasing at an increasing rate. The reason for this is that successive reduction in greenhouse gases requires the use or implementation of more sophisticated and expensive technologies. For example, as indicated in Figure 3, the first 10 percent reduction in greenhouse gas emissions may require no more than minor changes in life style (such as the use of more energy efficient light bulbs, stricter enforcement of existing industrial pollution regulations, planting trees, and minor changes in the way we transport people (such as car pooling) and commodities (such as the use of trains instead of tracks). On the other hand, the second 10 percent reduction in greenhouse gases may require the development and use of alternative energy fuels (such as ethanol) and the provision of public transportation systems in a massive scale. Clearly, the above discussion is done without considering the possibilities for advances in greenhouse gas emissions abatement technologies. This is an important issue since technological advances of this nature would precipitate a downward shift of the entire curve in Figure 3, therefore, a lower abatement cost for each percentage reduction in greenhouse gas emissions. As will be evident shortly, it is in anticipation of this kind of cost reduction, arising from advances in emissions abatement technology, that some economists continue to support a guarded (or wait and see) approach to any public policy measure that tend to advocate for a sizeable reduction in greenhouse gas emissions in the near term (Taylor, 1998). What has been discussed so far is the anatomy (structure) of two important cost functions, damage and abatement costs, economists use to perform cost-benefit analysis relevant to global warming. Since the early 1990s, with various assumed conditions about these two cost functions, economists have been conducting empirical studies that allowed them to offer policy recommendations relevant to global warming the amount of cut annually on greenhouse gas emissions needed in order to slow global warming. The analyses in these studies were done large simulation models and a framework of standard cost benefit analysis. Based on the salient characteristics of the major findings and the resulting policy implications, the economic studies that have been conducted on global warming over the past two decades can be grouped into the following three major categories: 1. The business as usual approach which advocates for the status quo over the next 15 to 25 years. 2. The gradualist approach which recommends for a modest actions in the reduction of GHGs emissions in the near term and to be followed by sharp reductions in the medium and long term. 3. The precautionary approach which favors an aggressive programs of international abatement of GHGs in the near term. The next section, therefore, explores the key arguments presents by these three groups. 10

11 III. ALTERNATIVE EMPERICAL STUDIES ON GLOBAL STUDIES AND THEIR POLICY IMPLICATIONS: Not to Act at All to Act Now or Later A. The Business as Usual Approach (BAU) The proponents of this approach are economists from conservative school of economic thought; big businesses that heavily depends on fossil fuels; and conservative Washington Think Tanks, such as the Cato Institutes, etc. Thus, the empirical studies under this general category are conducted by economists and public and private institutions who vigorously and openly attempt to rescue existing industries; principally the energy sectors, from the potentially adverse economic effects of public policies intended to significantly curtail carbon emissions. Such studies have focused on estimating the effects of abatement costs (the current investment expenditure to reduce greenhouse gas emissions) on the economy with the use of energy-economic simulation model. The problem is simply viewed as analyzing the impacts of using alternative energy resources (wind, solar, bio-fuels, etc.) on the economy if used as substitutes for fossil fuels. This economic approach is actually a cost-effective rather than cost-benefit analysis since it does not at all consider the avoided damage costs (the benefits) from the policy measures taken to slow global warming. The view taken here is that the world should respond to global warming provided it is not too costly to society in terms of its impact on near term economic activities. In these empirical studies, therefore, damage costs (costs largely borne to future generations) are hardly considered. Thus, they singularly focus on the current national and global economic loss (in terms of GDP) due to mandatory reduction of carbon emissions. For example, a representative study carried out by proponents of the BAU approach suggested that because of the cost of switching to alternative fuels, a 10 percent reduction below the 1990 emissions levels could cost the United States up to 3 percent of its gross domestic product (Taylor, 1998). A similar outcome was expected to hold for the global economy as a whole. The implication being that these kinds of policy measures, if implemented, would have profound effects on for near term economic growth in the United States and else where in the world. Clearly, the United States continued reluctance to sign the Kyoto Protocol (a reduction of greenhouse gas emissions by 7 percent below the 1990 level by the year 2012) is partly based on studies of this nature. In general, therefore, proponents of the BAU approach argue that any policy measure that requires abatement costs that causes substantial reduction in current global economic growth will be hard to justify for the following reasons. 11

12 First, the science of global warming is far too uncertain to justify mandatory reduction of carbon emissions at a level that would significantly affect near and long-term global economic growth. Second, climate change is likely to produce a combination of gains and losses with no strong presumption of substantial net economic damages. For example, several studies suggest that greenhouse warming will lower yields in agriculture (Shushan). This impact is, however, offset by the fertilization effect of higher levels of CO 2. This is how Professor Robert O. Mendelsohn of the Yale School of Forestry and Environmental Studies, expressed this viewpoint, Countries in the polar region are likely to receive large benefits from warming, countries in the mid-latitudes will at first benefit and only begin to be harmed if temperature rises above 2.5 degree Centigrade. Only countries in the tropical and subtropical regions are likely to be harmed immediately by warming and be subject to the magnitude of impacts first thought likely. Summing these regional impacts across the globe implies that warming benefits and damages will likely offset each other until warming passes 2.5 degree Centigrade and even then it will be far smaller on net than originally thought. Third, even if the anticipated damages of global warming occur, it would be cheaper to wait as long as a quarter of a century before instituting any CO 2 reductions because, in all likelihood, safer alternative energy technology will be less expensive in the future than at present time (Taylor, 1998). Furthermore, a study by Wigley and his associates (Nature, 2006) suggested that waiting more than 20 years before taking action to limit anthropogenic greenhouse gas emissions would result only about a 0.2 degree Celsius temperature increase spread out over a 100 year period. In other wards, by waiting, society is far more likely to minimize regrets. Fourth, although an extreme position, some proponents of the BAU approach simply deny the scientific evidence that global warming is caused by anthropogenic emissions of GHGs (Sheehan, Adler). This claim was defended, as mentioned in the introductory section of this paper, by pointing out that the history of our planet clearly indicates that the Earth s atmosphere has gone through periodical warming and cooling periods independent of human actions. The implications of this kind of argument is that there is nothing that can be done about global warming since it is a factor outside human control blame nature! Thus, given all the above arguments, what seems to emerge is a very guarded and often business as usual policy recommendation intended to avoid costly expenditures on the development and implementation of alternative energy technologies to reduce anthropogenic greenhouse gas emissions. It is important to note that this conclusion is reached with no consideration of damage costs. 12

13 B. The Gradualist Approach to Global Warming Concerns: The economic analyses in this situation are different from the business as usual approach, discussed above, in two important ways. First, proponents of the gradualist approach do not intentionally attempt to discredit or distort what appears to be the scientific consensus on global warming. Second, at least in principle, they accept that cost-benefit analysis intended to evaluate the desirability of proposed projects or policy actions to slow climate change should explicitly consider both the damage and abatement costs. Once a decision is made to include damage costs in the cost-benefit calculus of global warming, the major challenge becomes finding reliable methods to estimate these costs. This is because such an endeavor involves the estimations of several anticipated economic impacts of climate change and, as discussed earlier, chief among them are: agricultural losses from heat stress and draught, losses from sea level rise, increased demand for space cooling, losses from runoff in water basins, increased urban pollution associated with warmer weather, increased incidence of mortality with heat stress, loss in amenity values of everyday life and leisure, increased hurricane and forest damages, loss in biological diversity, and deterioration in environmental quality. Of course, as discussed earlier, not all of these costs are easily quantifiable. Furthermore, the fact damage costs are externalities make market information, even if it exists, unreliable. However, despite these apparent difficulties, several estimates of damage costs exist and as would be expected they differ widely, by a factor of two to three. In general, the economic analyses that characterize the gradualist approach to global warming base their modeling on estimates of damage costs with the following underlying assumptions concerning future warming trends, economic conditions, and time horizons: First, 50 years from now all emissions and concentrations of greenhouse gases will plateau; and the climate impacts of industrial activities will stabilize. Second, the impacts (damages) of global warming on the economy, human health and the natural ecosystems will be limited to the next 100 years. That is, by 2100, the global average temperature will attain a steady state equilibrium and as such will start to have neutral effect on the economy and the environment. Furthermore, no consideration is given to the likelihood that, in the long run, an irreversible catastrophic environmental damage could occur if policy responses to global warming concerns are found to be inadequate due to either timing or scale. Third, when the steady-state equilibrium is achieved (100 years from now) the median global surface temperature would increase by 2.5 degree Celsius; and it would be highly unlikely that it will exceed 3 degree Celsius. Fourth, a discount rate of 3 percent is used to perform cost-benefit analysis. This is the rate at which the present value of future environmental damage costs is assessed. This assumption is not to be taken lightly since the effect of a high discount rate is to 13

14 reduce (compress) benefits or costs coming in distant future. In the case of global warming, significant portions of the damage costs occur in distant future (50, 100, 200 years from now). If the discount rate is high, the value of these projected damage costs will be considerably reduced. This factor alone could be sufficient enough to cause the rejection of investment projects intended to abate GHG emissions on the basis of cost-benefit analysis. As we shall see soon, this is one fundamental issue that differentiates the gradualist from the precautionary approach to global warming. Based on the above set of assumptions and using a simulation model known as the Dynamic Integrated Model of Climate and the Economy (DICE), several academic studies (1991, 1992, 1996, 2006) were conducted by Professor Nordhaus, a Yale economist noted for his pioneering works on the economic consequences of global warming. The most representative outcome of the economic studies performed by Nordhuas and his associates has been: First, the net damage costs from a 3 degrees warming by 2100 will be approximately 1 to 2 percent of global GDP. The word net refers here that both the positive and negative effects of global warming are considered in calculating damage cost at a global level. Thus, the loss in some parts of the world (such as the continent of Africa) is compensated fully or in part by the gains realized in some other parts of the globe (such as Greenland, Siberia, etc.) Second, abatement costs were shown to vary considerably depending on the level of emissions reduction sought: About 10% of GHG emissions can be reduced at extremely low cost. (Area A in Figure 3, page 9, may be assumed to demonstrate such an outcome.) However, above this level, the incremental (marginal) cost of greenhouse gas emissions reduction raises sharply. (Area B in Figure 3, page 9, may be assumed to represent this scenario.) Thus, in light of these sharply rising marginal (therefore, total) abatement cost estimates and given that the estimate of the net damage cost is not that high (only 1 to 2 percent of global GDP), the conclusion reached by Nordhaus and his associates was to recommend only a modest reduction in greenhouse gas emissions--around 10 percent in the near term (or by about 2015). Nordhaus and his associates also look favorably on the idea of a gradual tightening of greenhouse gas emissions through increased carbon taxes as the scientific evidence for increased future global warming becomes more evident According to the proponents of the gradualist approach to global warming, therefore, to go beyond a modest cut in GHGs emissions suggests a very pessimistic assessment of damages, and this will be unnecessary given in the long-run, global warming is unlikely to be so catastrophic to the extent of reducing world income sharply below today s levels. Furthermore, it was argued that if drastic cut in emissions is to be 14

15 recommended, where would the necessary reductions in near term consumption come from? From today s poor! If so, to reduce current consumption sharply in order to prevent a decline in the wellbeing of future generations would hardly seem equitable or ethically defensible, especially given that future generations are expected to be much richer than today (Nordhaus, 2007). The gradualist s are aware of the criticisms often voiced by various environmental groups for recommending modest and incremental policy measures to slow global warming. Nordhaus, the leading gradualist, responded to these critics by echoing his sentiment this way: while the findings of such mainstream economic assessments may not satisfy the most ardent environmentalists, if followed, they would go far beyond current global emissions reductions and would be a good first step on a journey of many miles. (Nordhaus, 2007). Of course, this seemingly conciliatory remark by Nordhaus would not stop other economists from constructing models that support drastic cuts in carbon emissions in the near term. This will be the subject matter that will be pursued next. C. The Precautionary Approach to Global Warming Concerns Some economists spearheaded by William Cline of the Institute for International Economics have questioned the validity of the conclusions (policy recommendations) reached by economic studies of the gradualist school to global warming concerns. Cline who has won several prestigious awards for his numerous academic studies on the economic consequences of global warming argued that, first, valid policy decisions cannot be made about global warming without taking into account the very-long term implications of the phenomenon over a horizon of three centuries, up to This is warranted because the greenhouse effect is cumulative and long lasting. That is, the effect of a ton of carbon emitted today will be felt in 200 or more years from now. Secondly, to account for the risk of irreversible consequences of global warming on distant generations, Cline argued for using a very low discount rate, 1 instead of 3 percent. Recently, the Stern Review on the Economics of Climate Change, a major study on global warming commissioned by the British government, used an approach remarkably similar to Cline. The Review, like Cline, weighed the very long term impacts of global warming heavily by extending the analysis of damage costs up to The discount rate used by the Review was even lower than Cline s, only 0.1 percent. In both Cline and the Review studies it was argued that when damage cost assessment is extended to 2300 (instead of the usual 2100), it is conceivable that temperatures could rise as high as 5 to 6 degrees Celsius far higher than the 2 or 3 degree Celsius range usually considered by Nordhaus and most other mainstream economists. As a result of this, the risk of future damages would be much worse than expected and probably catastrophic, that is, some of the damages could be irreversible. 15

16 Cline in one of his earlier studies (1991), using a simulation model very much similar to Nordhaus s DICE but modified to reflect his own assumption, recommended a 50 percent reduction from baseline (i.e., the 1990 level of global carbon emission) by 2015, 71 percent cut by 2050, 82 percent reduction by 2100, and a 90 percent reduction by According to Cline these are the kind of cuts needed to stabilize the carbon emission of the atmosphere by In terms of the carbon taxes needed to achieve this end, using the DICE 99CL model, Cline estimated the optimal carbon tax to be about $200 per ton in 2015 which is much higher than Nordhaus s recommendation of carbon tax per ton of $17 by 2005 and $84 by 2050 (Cline, 2004). The findings of the Stern Review (2006) on the expected impacts of global warming on the economy, human health and the natural environment are even more ominous than Cline s. The Review estimated the total cost over the next two centuries of climate change associated under BAU emissions involves impacts and risk that are equivalent to an average reduction in global per-capita consumption of at least 5%, now and forever. This is without including the impacts on the environment, human health, and the negative feedback of the cumulative impacts of GHGs concentration on the atmosphere, and the unequal burden of global warming to poor nations. Putting these additional factors together would increase the total cost of BAU climate change to the equivalent of around a 20% reduction in consumption per head, now and into the future. In light of this, the Review recommends strong mitigation (abatement) policy without delay and to view mitigation as a highly productive investment. It is important to point out that critics of the Review have been quick to note that the difference between the results of this study and others (including Cline) was largely due to the very low discount factor used by the Review (Varian, Desgupta). The risk of considering an almost zero (to be exact, 0.1 percent) discount rate is the possibility that action of this nature may hinder important technological advances in the near term (Desgupta). Of course, the implication here is that this will have adverse effect not only to the present but also future generations. Despite this criticism, the main message that proponents of the precautionary approach to global warming is that when cost-benefit analysis is conducted from a very long-term perspective, a more aggressive GHGs emissions abatement program is justified. This should be the case since failure to take strong action in the near term may have the potential for irreversible consequences or for sever limits on the options for future generations. Furthermore, such actions should be taken even if there is as yet no incontrovertible scientific proof that serious consequences will ensue. In other word, the justification for aggressive international actions to slow global warming should be based not only on the basis of traditional cost-benefit analysis but also on the precautionary principle of resource management where uncertainty cannot be used as an excuse for inactions. 16

17 IV. Concluding Remarks One could argue that the starting point for the international debate on what to do about global warming goes as far back as 1972 at the first United Nations conference on the environment held in Stockholm, Sweden. One important agreement that emerged out of this conference was the need for more reliable scientific information on global warming. The recognition of this need ultimately led to the establishment of the Intergovernmental Panel on Climate Change (IPCC) in By early 1990s, progress in the science of global warming appeared to have facilitated the pioneering works of William Cline and William Nordhaus on the economics of global warming. Global warming confronts economists with new and daunting challenges. First, global warming is an externality on a global scale the atmosphere as a global commons. In this respect, economic analysis of global warming is confronted with the biggest case of market failure. Second, the problem involves long-run economic analysis looking as far ahead into the future as 50, 100, 200 or even more years. Third, a serious economic analysis of global warming has to consider risk and uncertainty explicitly. In addition, the economic analysis needs to incorporate non-marginal changes since irreversible outcomes could not be ruled out. Last but not least, consideration of intergenerational equity, hence, decision on discount rate, is unavoidable. Despite these challenges, as is evident from the discussion in this paper, there has been significant advance in the development of analytical models for the assessment of the economic impacts of global warming. Unfortunately, these positive developments in methodology and analytical models have not lead to consensus opinions on the specific policy measures to be taken to slow global warming. The recommended cut in greenhouse gas emissions varies from doing nothing because of the fear of what a cut in GHGs may do to the economy today or in the near future to taking aggressive action now to avoid irreversible and catastrophic impacts on future generations. This should hardly be surprising, given that economic impact assessments of global warming rely on scientific information that are subject to dispute, and that economic impact assessments of this nature involve consideration of normative issues that require making subjective judgments, principal among them being how much caring should present generation provide to posterity. After Thought: So far, I have discussed the various positions mainstream economists have taken on what specific action(s) to take to slow down global warming. I would like to end this paper with a discussion of a particular unorthodox economic perspective on global warming. I do this partly because this perspective embraces fresh ideas and implications to public policy measures relevant to global warming that are seldom addressed (or simply ignored) by mainstream economists. 17

18 The fundamental issue here is the approaches mainstream economists have chosen to take to address large scale environmental concerns which include global warming. Mainstream economists seem to hold a strong belief with the notion that society can always find technical solutions to all environmental problems. In addition, modern economists seem to take that continued economic growth (as measured by per capita GDP) for granted; an economic event that will be with us to perpetuity. For example, in all the three economic impact assessments on global warming discussed in this paper, it was assumed that each succeeding generations will be materially richer than its predecessors. The fact that there may be biophysical limits to both technological and economic growth has yet to be registered in the psychology of modern economic practitioners. For this reason, it is not in the mind set of mainstream economists to consider alternative paths to economic growth (development) as a possible remedy to major environmental problems, a case in point global warming. It will be an unorthodox economic position, therefore, to suggest that the resolutions to modern large scale environmental problems, among others, require: (i) fundamental changes in human relationships with nature, and (ii) the recognition that a biophysical limit to economic growth is a real possibility. A prominent economist who saw the environmental problems of the 21 st Century through this novel perspective was the late Kenneth Boulding. In his classic article the Economics of the Coming Spaceship Earth (1966), Kenneth Boulding forcefully articulated the nature of the new environmental era and the necessity for an alternative path to economic development in this manner. He started by reminding us that our past is characterized by a frontier mentality, i.e., the strongly held belief that there is always a new place to discover when things got too difficult, either by reason of the deterioration of the natural environment or a deterioration of the social structure in places where people happened to live (p. 297). The Earth, therefore, is viewed as an open system or unlimited plane. Boulding uses the metaphor the cowboy economy to describe the economic system that is compatible with this scenario of resource availability. In this scenario, where resource availability is taken for granted, both consumption and production are regarded as good things. Accordingly, nature is recklessly exploited with little or no concern. Moreover, the success of an economy is measured by the amount of matter and energy used to produce the desired goods and services, without regard to depletion or pollution. Thus, according to Boulding, reckless exploitation of nature, which is symbolic of cowboy-like behavior, characterized our past. However, Boulding views the future quite differently. Specifically, he alerts us to the fact that we are now in a transition from the open to the closed Earth. We were able to fully realize this only recently when we entered into the space age and vividly observed that the Earth is a finite sphere. Thus, the Earth has become a single spaceship, without unlimited reservoirs of anything, either for extraction or for pollution. (p. 303) 18

19 This new reality has significant economic implications. The economy of the future, the spaceman economy, requires economic principles that are different from those of the open Earth of the past. In the spaceman economy, matter and energy are indeed to be regarded as something to be minimized rather than maximized. Hence, the essential measure of the success of the economy is not production and consumption, but the nature, extent, quality, and complexity of the total physical outputs and stock of capital, and the state of the human bodies and minds included in the system. (p. 304). With this in mind, Boulding s messages are quite clear. First and foremost, for all practical purposes the Earth is a closed ecological sphere. When the human population was small and its technological capabilities were not overpowering, viewing the Earth as unlimited plane might have been, if not correct then certainly understandable and permissible. However, current human conditions with respect to population, technology, and habit of consumption and production warrant a fresh look at our social values and economic systems. We need to espouse social values and build economic systems that reinforce the idea that in a material sense more in not necessarily better. While this call for a materially sustainable economy appears to be more relevant now than 40 years ago, are there signs that the world community is finally taking Boulding s message seriously? If I limit my responses only to the on-going worldwide initiatives to slow global warming, my answer to this question would be both YES and NO. On the positive side, there have been several recent encouraging steps that have been taken by countries, business enterprises, and individuals with significant political and financial influence that appear to be quite consistent with Boulding s call for energy conservation and for the dematerialization and decarbonization of the production processes of our industrial society as a way of responding to the growing concern of global warming. For example, on September 27, 2006, the State of California, the sixth largest economy in the world, passed a legally enforceable legislative act known as the Global Warming Solutions Act. This Act caps California s greenhouse gas emissions at 1990 levels by On March 8, 2007, another landmark decision was made by the European Unions (EU) countries. These countries agreed on a legally binding 20 percent GHG emissions cut by They also agreed that 20 percent of their energy consumption will come from alternative fuel energies (not fossil fuels) by On the business front, there are several companies worldwide who are now taking major steps in producing environmentally friendly products. A prime example of this is a leading United States office carpet producing company, Interface. For over two decades, this company with its Headquarters in Atlanta, Georgia, has been demonstrating to the world that a business enterprise can remain strong and profitable while continuously striving to minimize its utilization of energy and the dematerialization of its production process in a major way. Another example is 19

20 the leading Japanese car manufacturer, Toyota. Toyota has demonstrated that building a product that is durable and taking a lead in the production of energy saving cars pays handsomely. We are starting to observe that many private individuals and government leaders with significant influence are starting to voice about their commitment to do something about global warming. A prime example of this would be former Vice President of United States Al Gore who is mounting a serious and effective publicity campaign (more like a crusade) worldwide to spread the awareness of the long term dangers associated with being complacent about global warming. Lastly, there are also several recent developments that indicate the proponents of BAU approach on global warming are losing ground. Even the Bush administration (that still refuses to sign the Kyoto Protocol agreement on the basis of its exclusion of China and India) is pushing hard for the development of alternative energy resources, in particular, bio-fuel (ethanol), as a means of reducing carbon emissions. On the negative side, China and India the two most populous countries in the world continue to march ahead at full speed to catch-up with the material progress of the Western world. In recent years, the economies of these two countries have been growing at an annual rate that ranged between 8 and 10 percent. This growth rate implies a doubling of the GDP for these two countries in less than a decade. While these are significant economic achievements for China and India, the implication of this economic success stories to global warming hardly needs explanation given that: (i) over 25 percent of the world population resides in these two countries, and (ii) these two countries use relatively inefficient industrial production technologies from the standpoint of their fossil fuel consumption (Lorenz and Wagner). Despite this, India and China continue to refuse to take actions to limit their growing greenhouse gas emissions. They reason that they are in very early stage of industrialization and that the rich countries of the world (the West) should take the lead in curbing greenhouse gas emissions (Yardely). Of course, it will be unwise and unfair to put the blame only on China and India alone. In general, the world community remains rather complacent and as such reluctant to take legally binding actions to cut greenhouse gas emissions. What else could explain that 80 percent of the countries who have already signed the Kyoto Protocol agreement are actually taking no concrete measures intended to slow global warming. Of course, this is without even considering the continued refusal of the United States (by far the major contributor to global greenhouse gas emissions) to sign the Kyoto Protocol. In the final analysis, it is paramount to recognize that climate change is global in its causes and consequences; and binding international collective action will be needed to implement an effective, efficient and equitable response on the scale that is required (The Review, 2006). Given this, at least in principle, no country that claims to be a member of the United Nations should attempt to find an excuse to do nothing about global warming, however small the contribution might be. At the same time, it is also fair to expect that 20