February 6, 2011

Modeling Costs of Climate Change

This is a good overview by John Carey of the disputes among economists over how to model the long term effects of climage change. An extract:
[T]here’s a deeply rooted perception that the U.S. economy will suffer little damage from climate change. That view dates back to work from the mid-1990s by the influential Yale University economist William Nordhaus. Nordhaus took what was known about the science of climate change, then constructed an economic model to estimate the monetary harm. The model put the economic cost to the U.S. of raising global temperatures by 2.5 to 3 degrees C (expected by about 2100) at about ¼ to ½ percent of GDP. “There are both good and bad impacts, but they offset each other,” explains Robert O. Mendelsohn, professor of forest policy and economics at Yale University and a frequent collaborator with Nordhaus. 
The original economic model wasn’t complete, Nordhaus readily acknowledges. It didn’t include some sectors of the economy or “non-market” damages — effects that economists can’t easily quantify, such as loss of species. “We basically guessed on those, and that got us up to between 1 and 2 percent of GDP,” says Nordhaus — still relatively small. Since then, Nordhaus has worked extensively on the analysis, but the general conclusion is the same. There’s little threat to U.S. GDP. “Do I think that the measured GDP of the U.S. or Britain or Japan is seriously at risk from global warming over the next 100 years?” Nordhaus asked in an interview. “No,” though he adds that “GDP is a poor indicator of economic welfare.”

Other experts see the hit to GDP as much greater. “We did a survey of top economists in the country, asking what they think about the costs and benefits of climate legislation,” says Michael Livermore, executive director of the Institute for Policy Integrity at New York University School of Law. “They said that climate change is a clear threat to America and the global economy.” Adds Berkeley’s Hanemann: “I don’t want to be Dr. Gloom, but our complacency in the U.S. is wrong.”

An earlier version of this debate flared into public view and the media for a short time in 2006. A report prepared for the British government by economist Sir Nicholas Stern found that the cost of unconstrained global warming would be huge — up to a 20 percent drop per year in the world’s GDP by 2050. The widely disparate conclusion compared to Nordhaus’, however, turned largely on one single factor: Stern put a higher value on costs far out in the future — and on the future return from climate change reduction investments made today — than Nordhaus did. Or in economists’ jargon, he used a lower discount rate. “You can change the discount rate and get a totally different answer,” explains NRDC’s Lashof.

Who’s right? The late climate scientist Stephen Schneider liked to ask economists if they really do value their grandchildren far less than their children, as implied by a higher discount rate. Nordhaus, who dismissed the Stern report in a 2007 book as “political in nature,” with “advocacy as its purpose,” says that’s not a fair comparison. “The argument is not how we value our grandchildren, it’s primarily about the return on capital,” he says. “My view is that the return on capital is high, so that the threshold is pretty high if we are going to compete with other uses of our investment dollars.” That makes efforts to fight global warming seem less cost-effective.

But the tiff over discount rates is really a sideshow. There are now new critiques of the low estimates of the costs of climate change that challenge core details of how those damages were calculated, such as whether the analyses correctly included the costs of heat waves, more intense hurricanes, and other extreme events predicted to become more common. The original work “has been enormously influential, but for a number of reasons, I think the analysis is profoundly wrong,” says Hanemann.

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