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Richard Tol and Marty Weitzman on The Costs of Ignoring Carbon

There is a new paper out by economist Richard Tol that summarizes all of the economic work on climate change over the past two decades, in light of recent analyses, particularly the ground-breaking new work by Harvard’s Marty Weitzman on how the “fat tail” of climate risk affects cost-benefit analysis.  Tol is attached to the Economic and Social Research Institute (Dublin), the Institute for Environmental Studies, Vrije Universiteit (Amsterdam), and the Department of Engineering and Public Policy, Carnegie Mellon University.

Tol`s paper, “THE SOCIAL COST OF CARBON: TRENDS, OUTLIERS AND CATASTROPHES”, is here: http://www.fnu.zmaw.de/fileadmin/fnu-files/publication/working-papers/margcostmetawp.pdf

 Tol`s conclusions?

There are three implications.

Firstly, greenhouse gas emission reduction today is justified. The median of the Fisher-Tippett kernel density for peer-reviewed estimates with a 3% pure rate of time preference and without equity weights, is $20/tC. This compares to a future price of carbon permits of $8/tC in the European Union (and a spot price of ¢3/tC).  The case for intensification of climate policy can be made with conservative assumptions. One does not have to rely on dodgy analysis as in Schneider et al. (2007) and Stern et al. (2006).

Secondly, the uncertainty is so large that a considerable risk premium is warranted. With the conservative assumptions above, the mean equals $23/tC and the certainty-equivalent $25/tC. More importantly, there is a 1% probability that the social cost of carbon is greater than $78/tC. This number rapidly increases if we use a lower discount rate – as may well be appropriate for a problem with such a long time horizon – and if we allow for the possibility that there is some truth in the scare-mongering of the gray literature.

Thirdly, more research is needed into the economic impacts of climate change – to eliminate that part of the uncertainty that is due to lack of study, and to separate the truly scary impacts from the scare-mongering. Papers often conclude with a call for more research, and often this is a call for funding for the authors or a justification for further papers by the authors. In this case, however, quality research by newcomers in the field would be particularly welcome.

Tol drew these conclusions from the principal results of his research, which were as follows:

Besides more data and more advanced statistical analysis, this paper offers four results.

Firstly, there is a downward trend in the estimates of the social cost of carbon – even if the IPCC (Schneider et al., 2007) would like to believe the opposite.

Secondly, the Stern Review (Stern et al., 2006) is an outlier – and its impact estimates are pessimistic even when compared to other studies in the gray literature and other estimates that use low discount rates.

Thirdly, the uncertainty about the social cost of carbon is so large that the tails of the distribution may dominate the conclusions (Weitzman, 2007) – even though many of the high estimates have not been peer-reviewed and use unacceptably low discount rates.

Fourthly, if everyone were to pay a carbon tax equal to the social cost of carbon (but not reduce emissions), there is a fair chance that annual taxes would exceed annual income for many people.

(emphasis added)

The recent Marty Weitzman paper that Tol refers to is here:

Marty Weitzman: “On Modeling and Interpreting the Economics of Catastrophic Climate Change”, December 5, 2007 [Update: Weitzman has revised; the latest version is dated Februaru 8, 2008]; http://www.economics.harvard.edu/faculty/weitzman/files/modeling.pdf

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