Update - Why We Should Be Willing to Devote More Resources...

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9 Giannini Foundation of Agricultural Economics University of California Why We Should Be Willing to Devote More Resources to Avoid Climate Change Larry Karp An important body of empirical models recommends modest efforts to reduce greenhouse gases. Although ostensibly scientific, these conclusions are actually largely driven by a value judgement. A recently developed, more flexible modeling approach produces dramatically different policy advice. A n important class of economic models imply that only modest efforts should be made to reduce greenhouse gas (GHG) emissions in the near term. These results can be interpreted as support for opinions expressed by several prominent economists in the late 1990s and early 2000s that the United States should reject the Kyoto Protocol. The models’ mathematical foundation gives them the imprimatur of science; this prestige, and the lack of an empirical alternative, have increased the audience for the models’ policy recommendations. Unfortunately, those recommendations are extremely sensitive to a parameter that reflects an ethical judgement rather than a “scientific” view: the long run discount rate. The choice of the value of this parameter has typically been constrained by technical limitations. A recent paper promotes a flexible alternative to the standard modeling framework. This alternative makes it possible to incorporate different (and arguably more reasonable) ethical judgements, which lead to significantly different policy advice: society should more aggressively seek to reduce GHG emissions. Climate change policy is controver- sial largely because of the many uncer- tainties regarding the costs of reducing which probably occur during the next five to ten years, with the stream of ben- efits that occur during the following sev- eral decades. Climate change policy, in contrast, requires comparing abatement costs which may occur over many decades, with the benefits (associated with reduced climate change) that may not begin for many decades but may last for centuries. With climate change policy, the time dimension of the trade- off is vastly greater than for standard cost-benefit analyses of construction projects. Consequently, the assumption made about the willingness to exchange current costs for future benefits is much more important in climate change models. We use the interest rate (also known as the discount rate) to compare dollar amounts at different points in time. For example, if the interest rate is five per- cent, a dollar one year from now is “equivalent” to 1/1.05 = 0.95 dollars today; 0.95 is the “discount factor” cor- responding to a five percent interest rate. A person who can borrow and lend at five percent would be willing to pay $0.95 today to avoid a one dollar pay- ment in one year; this is the amount that would have to be invested today to return one dollar in one year. A person would pay only 60 cents today to avoid a payment of one dollar in ten years, and would pay less than one cent to avoid
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This note was uploaded on 08/01/2008 for the course ARE 263 taught by Professor Karp during the Fall '06 term at University of California, Berkeley.

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Update - Why We Should Be Willing to Devote More Resources...

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