Volume CXXXIII, Number 7 October 26, 2001 f

Economic Update: President Bush, Kyoto, and the economics of global warming
TA HERRERA AND RICK FREEMAN
FACULTY CONTRIBUTORS

When President Bush announced in June 2001 that the U.S. would not honor its commitments under the Kyoto Protocol for curbing global warming by reducing emissions of greenhouse gasses, he was criticized by environmentalists and others. To date the President has not proposed any alternative approaches to controlling greenhouse gas emissions, leads some to believe he does not take the threat of global warming seriously.

Bush's environmental stance aside, many economists and other policy analysts believe the Kyoto Protocol is badly flawed. But if Kyoto is problematic, what do we recommend? We take the threat of global warming seriously and think economic analysis can make an important contribution to policy formulation.

Since the mid-1970s, earth's atmospheric temperature has risen above the global historical average by about one degree Fahrenheit. Most earth scientists agree this rise is due in large part to the "greenhouse effect," whereby gases, primarily carbon dioxide (CO2), emitted by humans form a shield preventing dissipation of solar heat away from the earth. A United Nations sponsored group of scientists, the Intergovernmental Panel of Climate Change, predicts that if nothing is done to control emissions of CO2 and other greenhouse gasses, CO2 concentrations in the atmosphere will double from pre-industrial levels by the end of this century. The result will be a global average temperature increase of 2.5 to 10.4 degrees Fahrenheit by the year 2100.

If global warming is to be substantially retarded, global emissions of CO2 and other greenhouse gasses must be substantially reduced. This issue was addressed by 160 nations in Kyoto, Japan, in December 1997. The result was the Kyoto Protocol, which commits the industrialized nations of the world to reducing emissions of CO2 to about 5 percent below 1990 levels by sometime between 2008 and 2012. The Clinton administration signed the Protocol, agreeing to a 7 percent reduction in U.S. emissions. It was this commitment that the Bush administration repudiated this spring.

The problems with the Kyoto Protocol are the following: it did not call for enough reduction of greenhouse gas emissions; it tried to do it too quickly, thereby; imposing higher costs on the world economy than were necessary and justified by the benefits of slowing global warming; and it did not require any actions now or in the future by any developing nations.

Even if the industrialized nations meet their targets by 2012, concentrations of CO2 will continue to grow, in part because of the growing emissions of developing nations (especially China, soon to be the world's largest CO2 emitter, and India) not committing to reductions of their own. Thus, the Kyoto Protocol would delay doubling of CO2 concentrations by only a few years.

Achieving these reductions by 2012 would cost more than necessary because of the need to retrofit power plants, automobiles, buildings, etc. with currently available technologies, rather than allowing firms to take advantage of normal replacement cycles and the better technologies expected to arise over time.

One tool for evaluating policies is "benefit-cost analysis." A policy is economically desirable only if its benefits outweigh the costs when both are converted into current dollars. Determination of benefits and costs of global warming policy is very difficult for a number of reasons and this makes the evaluation of candidate policies a contentious (though very interesting) undertaking.

The primary problem in evaluating costs and benefits of global warming policies is the magnitude of the scientific and economic uncertainty surrounding the consequences of different policies. For each trajectory of emissions, scientists must forecast not only global average but regional temperatures and precipitation patterns for up to two centuries into the future. The costs and benefits of alternative trajectories of reduced emissions depend on global population, the rate of technological improvement in energy use and emissions control, and how future populations adapt to changing climate.

Comprehensive assessments of alternative policies tend to support modest emissions reductions, but suggest more aggressive proposals would have costs substantially in excess of benefits. However, most assessments do not consider the other environmental benefits (including human health) resulting from reduced use of carbon-based fuels in the energy and transportation sector. There are also substantial uncertainties in all of these estimates; the possibility of unforeseen catastrophic climate responses cannot be ruled out.

Emissions within a country can be reduced via "command and control," with each polluting firm forced by the government to reduce emissions by some percentage. Such policies neglect the fact that different sources may have radically different costs associated with reducing carbon emissions and therefore do not tend to achieve emission reduction in the least costly way.

Economists generally prefer "economic incentive systems," such as pollution taxes or tradable permits with strict emissions caps. To keep total global control costs as low as possible, it will be important to use an incentive based system rather than command and control. At an international level, we strongly recommend caps on each country's emissions with trading both within and between nations.

The total costs of controlling emissions of CO2 could be substantially reduced if nations were allowed to trade emissions permits with other nations. If the right to emit carbon were a valuable resource, polluters would profit from cleaning up, and industries would develop to reward innovative development of new carbon-reducing technologies. The U.S. has been clear that trading among nations must be part of any framework that it would agree to; the Kyoto Protocol does allow for the development of an emission rights trading system among industrialized nations.

Trading, however, is politically difficult. Many analysts believe that obtaining the agreement of all participating nations in a "fair" allocation of valuable permits is an impossible hurdle. European countries claim they should be given a larger initial share of any newly allocated permits, as a reward for unilateral measures they have taken to reduce carbon emissions. The U.S. views the European claim as an attempt to put U.S. firms at a competitive disadvantage.