The Economics of 1.5°C Climate Change

In October 2018 IPCC published a special report on the impacts of global warming of 1.5 °C above pre-industrial levels. This report has been widely publicized in media across the globe such as BBC News, Financial Times, EURACTIVE or the New York Times. The conclusion is that there is an urgent need for a quick action. One issue that economists in general would have with this report is whether or not it makes sense to stick to the 1.5°C target from a cost-benefit point of view. So what do we know?

Unfortunately, the IPCC special report says little about estimates for the costs and benefits of a 1.5°C warming. In the Summary for Policymakers we find that a 1.5°C warming tends to induce severe and wide-spread impacts/risks across various ecosystems (mostly unique and threatened systems and extreme weather events), but few numbers that give us an idea as to its quantification. The only information we have from the Summary for Policymakers is about some expected costs for the energy transition, and for some expected costs from climate impacts of a 1.5°C degree warming (Chapter 3, Box 3.6). However, there is no side-by-side comparison in an integrated framework.

Fortunately there is an article that has looked more closely at this:   “The economics of 1.5°C climate change” in the journal the Annual Review of Environment and Resources, written by Simon Dietz, Alex Bowen, Baran Doda, Ajay Gambhir and Rachel Warren. I had a quick Q&A with one of the authors, Simon Dietz, from ESRC Centre for Climate Change Economics and Policy and Grantham Research Institute on Climate Change and the Environment, London School of Economics and Political Science, who was very kind in responding to my questions.

Question: Simon, you just published the article “The economics of 1.5°C climate change” in the journal the Annual Review of Environment and Resources, together with your co-authors Alex Bowen, Baran Doda, Ajay Gambhir and Rachel Warren. What was your main motivation for writing this article?

Dietz: The 2015 Paris Agreement included, for the first time, the ambition of “pursuing efforts to limit the temperature increase to 1.5C above pre-industrial levels”. This has rightly stimulated interest in the feasibility of limiting warming to 1.5C, how much it would cost, what benefits it would provide, and what set of policies would best get us there. Perhaps surprisingly, not a lot has been written about these issues until very recently, mainly because 1.5C wasn’t a formal ambition of the international climate negotiating process until 2015. Our paper tries to answer these questions as far as possible. The timing was obviously also opportune, given IPCC published their Special Report on 1.5°C shortly afterwards.

Question: In the article you argue that it is not clear whether the 1.5°C target passes a cost-benefit analysis. One of the reasons is uncertainty about costs and benefits. What criterion then, in your opinion, did the IPCC use in order to suggest that the 1.5°C target is important for us to achieve (or what would be the equivalence in a standard economic CBA)?

Dietz: I’m not sure IPCC really tackled this issue head on. I think they see coming to a clear view of whether 1.5C is worth doing in terms of benefits/costs is beyond their remit, too close to being prescriptive. They also have bad memories of the politics of CBA from way back in the mid-1990s, when there was a controversy about the value of a statistical life and how, from an efficiency standpoint, it may be lower in lower-income countries. There was also some controversy about the treatment of economic benefit estimates in the 2013 Fifth Assessment Report. So, all in all, they clearly decided not to do CBA. Instead, IPCC has tended to summarise the benefits of avoided warming in terms of so-called “Reasons for Concern” (see the Special Report Summary for Policy-Makers P13). This is essentially multi-criteria analysis.

The main take-away message from the article is that the 1.5°C target can pass a cost-benefit analysis, but there is still high uncertainty surrounding economic costs and benefits, and as always the discount rate tends to matter. This is, unfortunately, a somewhat unsatisfactory answer from an economist’s point of view, as it implies that we are unable to give a clear policy answer in this case.

However, we can nevertheless conclude from this: Using a standard cost benefit analysis has large uncertainties, and therefore the 1.5°C target cannot easily be defended based on current integrated assessment models, or cost-benefit analysis, alone.

So what can we do? One reasonable option, of course, is to argue that it is precisely this uncertainty that requires the immediate action that a 1.5°C target calls for. Economists call this the precautionary principle approach. Intuitively, it means we prefer not to err on the wrong side and prefer to avoid bad surprises. Thus, if we believe that the current impact estimates forwarded by the IPCC for a 1.5°C target provide sufficient concern for climate action, then we also have to think of what this implies for policy.

Question: In the article you note that “[i]f global mitigation efforts are consistent with the current Paris pledges to 2030, then even a 5% annual rate of decarbonization post-2030 would provide less than a 5% probability of keeping warming below 1.5.” Would you thus argue that the Paris agreement is ill-suited for achieving the 1.5°C target? And if yes, what would be a politically-feasible alternative?

Dietz: Clearly countries’ Nationally Determined Contributions to the Paris Agreement don’t put us on a path to limiting warming to 2C, let alone 1.5C. I wouldn’t completely give up hope yet, but the outcomes of the review/stocktake exercise that countries will have to undertake under the auspices of the UNFCCC in the next few years will be crucial. That is probably the last chance for countries to articulate 1.5°C-compatible contributions (using conventional mitigation). Having said all that, I tend to think that the Paris Agreement is about the best that could be achieved from an inter-governmental process, given the free-rider problem. I don’t see a better alternative.

My feeling is that most economists would agree with Simon Dietz’s assessment here. So another question certainly is how this would impact the way we do climate policy now.

Question: You write that a 1.5°C target would require “a global carbon price of more than $100/tCO… as early as 2020”. What does this imply for the European Emission Trading Scheme?

Dietz: It is quite clear that the EU ETS and the wider suite of EU climate policies aren’t sufficiently ambitious to put us on a 1.5°C path; you can indeed infer it from the carbon price in the EU ETS or from the expected emissions reductions that the EU ETS will achieve through to 2030. I expect that in the coming few years we will see some EU Member States revisit the overall level of ambition in their national policies and possibly increase that ambition towards long-term goals that are broadly compatible with Paris (e.g. net zero by no later than 2050). Presumably this will also filter up to Brussels. This is already happening in the UK, although presumably (sadly!) this will not have a direct impact on Brussels any more.

Thus, assuming that the 1.5°C target finds wide-spread support, and assuming that countries manage to converge on Nationally Determined Contributions that yield emission reductions in line with this target, then this would also need to induce significant alterations in the way we currently undertake emission trading in Europe. Let’s hope that this wake-up call for policy makers and industry was sufficiently loud.

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