One aspect of neoclassical economics that is extremely useful is the representation of an economic theory in a graphical form. Where would any introductory course be without Alfred Marshall’s supply and demand curves? For many years, the ideas of John Maynard Keynes’s ideas were synthesised in the Sir John Hicks’s IS-LM curves. These graphs have the advantage of enabling analysis of the logical consequences of changes in the overall context of the problem under consideration. In climate, there is a lot of shouting between the different camps, but what appears to be a complete inability to put the consequences of global warming and the mitigation policy option of globally constraining the growth of greenhouse gas emissions into their proper context. Therefore, when assumptions are changed, or new information becomes available, it is difficult to put those into the overall context of the “climate change” issue.

Sir Nicholas (now Lord) Stern’s report of 2006 (In the Summary of Conclusions) had the two ideas separated when it claimed

Using the results from formal economic models, the Review estimates that if we don’t act, the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year, now and forever. If a wider range of risks and impacts is taken into account, the estimates of damage could rise to 20% of GDP or more. In contrast, the costs of action – reducing greenhouse gas emissions to avoid the worst impacts of climate change – can be limited to around 1% of global GDP each year.

This leads to two offsetting sets of costs. The first is the “do-nothing approach” of letting greenhouse gas emissions spiral out of control, raising global temperatures by a number of degrees and throwing the weather systems out of control. The other is the policy costs of constraining the rise in emissions by switching to “cleaner” forms of living in general and energy-production in particular. It is should not be confused with a cost-benefit approach. Stern is proposing to exchange a very high set of costs in the distant future, with a much lower set of policy costs now. His proposal is not to incur costs in exchange for a stream of benefits (like when constructing a new motorway), but to minimize total costs of climate change and policy.

Constructing the graph

We are told by the climate scientists that some of the minor consequences of around 0.8^oC of warming over the last century are already visible. But their climate models project this is utterly insignificant compared to what will happen if greenhouse gases continue to increase unchecked for the next century or more. The large increases in temperature – around 4^oC to 7^oC or higher – would cause massive disruption to the climate system. It is fair to say that as global temperatures increase, these costs would increase exponentially. These “costs” are in the broadest sense. They are not just the human costs of property damage, failed harvests, population migrations and land being submerged by rising seas. These include the damage to the eco-systems and species extinction. Assuming a top end of 7^oC the cost curve would look something like this.

The relative cost scales 7^oC of warming are set to be twenty times the costs of constraining global warming to 3^oC, or the mid-range of estimates by the IPCC for a doubling of CO2 from pre-industrial levels of 280ppm, and an approximate policy target.

Conversely, the cost of stopping any more warming will be huge. Hugely aggressive policies would quickly stop any increases in emissions and could bring about major reductions. But such policies would bring to a halt the fast-growing economies of China and India, and would considerably worsen the recession in much of Europe. However, it is possible to postulate that low-cost policies that give the odd nudge here and there over a long period could reap large rewards. In line with climate costs, I have set the relative cost of constraining the rise in global temperatures to 3^oC above the pre-industrial levels to 1. So the curve might look like the one below.

Combining the two curves gives a total cost graph.

The total costs curve is derived by the addition of the climate and policy cost curves.

This replicates Stern’s statement above. The “do-nothing” scenario is ten times more expensive than the optimal cost-minimization scenario.

Some points to note.

First is that the total cost curve has quite a wide minimum area. Even if a lot of the main policy targets are missed, doing something looks to be far better than doing nothing at all.

Second, is that cost minimization strategy is at a higher temperature level than the intersection of the curves. However, a risk-averse strategy (which most people would expect in avoiding a prospective global catastrophe) would aim for a somewhat lower temperature increase.

Third is that “policy” should be called mitigation policy. That is preventing climate change costs from occurring by constraining the rise in greenhouse gases. As will be seen later, the alternative (or complementary) adaptation policies are included within the climate costs curve. The full reasons will be explained later, but the main one is that climate mitigation is something that, by definition, needs to be tackled at a global level, whereas adaptation can be done at the local, country or regional levels.

Fourth, is a clear separation of mitigation policy considerations from the projections of climate science. Yet new information from the science and policy areas can be put into a total context of acting in the best interests of the planet and the human population.

Fifth, an issue with the policy curve is the change in gradient. There must exist a set of policy options which are low cost, high impact (LC-HI) as well as the high cost, low impact (HC-LI). There are two possible types of policies which should be avoided. First are those with costs, but with zero impact (C-ZI) and second are those with a net negative impact (NNI).

Sixth, any look at climate projections and policy options show they are all over the place. The assumptions of single curves are highly restrictive ones. But like in

Finally, on climate costs there is an issue with projections about future costs. The data we have is from less than one degree of warming, and a minute fraction of projected costs. As shall be shown, the handling of this issue is crucial.

Kevin Marshall

The risks from policy are becoming increasingly well-known. The question is how to manage these risks. Assuming there is a genuine problem, which is possible to overcome through policy, what are we doing to make a real difference? The policy curve gradient assumes there must exist a set of policy options which are low cost, high impact (LC-HI) as well as the high cost, low impact (HC-LI).

There are two possible types of policies which should be avoided. First are those with costs, but with zero impact (C-ZI) and second are those with a net negative impact (NNI). All of these costs may include unintended consequences, which may not be fully recognized.

The choice is quite clear. Policy creation and policy implementation requires a high degree of focus in driving through effective emission reductions.

One of the aspects of neoclassical economics is that you make a whole host of assumptions, some of which are highly unrealistic. This enables one to look at the consequences of removing or changing the assumptions one at a time. For this exercise, let us assume the global cost curves are correct. That is to assume that if no policy is enacted that there will be significant global warming with catastrophic consequences for the planet and the people upon it, whilst there are a set of feasible global policies that mitigate against this.

As stated above, for a viable mitigation policy curve to exist, there must exist a set of low cost, high impact (LC-HI) policies. If you believe, as I do, that public policy should aim to make the maximum positive difference, and at a minimum to avoid net harm, then for climate change there is a duty of care in creation and implementation of policy that this truly happens.

The Small Country Problem

A small country is faced with the same climate cost curve as the entire planet. That is, if nothing is done to constrain the growth in greenhouse gas (GHG) emissions this country will face the same escalating costs of climate change. The only difference is that this cost is no longer relative to total gross world product (GWP), but relative to its own GDP. Assuming that the country’s emissions are an insignificant part of the total world amount to begin with, no matter how effective that country is in constraining its own emissions growth path, or even in cutting its total emissions, its policy cost curve will be vertical. It will move to the right with the relentless rise in global temperatures.

The total costs curve, for any temperature level will simply be the addition of the climate change costs and the money spent on emissions reductions.

The more spent by this small country, the greater its prestige in the green movement for unilaterally leading the way on “saving the planet.” But if nobody follows the small country’s example, then its “conspicuous impoverishment”⁽¹⁾ will be in vain.

Avoiding the small country example

How do we avoid the small country example, where the total costs are just added to by wasted effort on cutting emissions?

The standard answer is along the lines of saying if everybody does their bit, with the rich countries taking the lion’s share of the responsibility, then everything will be just fine. What is more, Britain already has some of most draconian emissions reductions targets in the world, as imposed by the Climate Change Act 2008 and others, such as the EU and Australia are also contributing. The small country argument does not hold.

The minority of countries pursuing emission reduction policies I will term the PC1 group. Still assume for the moment that the policy cost curve is correct. The current issue is to enlarge that group to make it the PC2 group. Eventually it is to convince every country to join making the policy curve truly global. As the group enlarges the policy curve shifts to the left.

If all PC1 countries commit to restrain global warming to 3^oC, then they can only do so by crippling their economies. The relative cost is a global one after all. They still could cripple their economies if they went to the climate costs equal policy costs point. If the PC1 countries accounted for 25% of GWP, then they would have a benefit a quarter of all the countries acting together. So should the in the economic interests of an outsider country to help create an enlarged group PC2, that represents 50% of GWP? The PC1 group will rid the planet of over 75% of the climate change costs. The PC2 group could halve that again.

Would it be in the economic interests of a country to join the PC2 group, or stay outside?

My Excel graph gets a bit blocky here – sorry.

Let’s do the maths, with approximate numbers. Enlarging the policy-enacting group moves from point A to point B.

PC1 group members have a climate cost of 3.1 plus a policy cost of 3.1/25% = 12.4

Non PC1 members have a climate cost of 3.1 = 3.1

PC2 group members have a climate cost of 1.7 plus a policy cost of 1.7/50% = 5.1

Non PC1 members have a climate cost of 1.7 = 1.7.

So to join the enlarged PC2 group, would increase costs from 3.1 to 5.1. To stay outside the policy countries would be better for the citizens of that country, even if there is a workable policy to adopt and the clear prospect of catastrophic global warming if no mitigation policy is enacted.

Later arguments on the effectiveness of policy and prospective costs of climate will make this choice look even more unambiguous. This aspect of all countries not acting together to share proportionately the costs has not, as far as I am aware, been seriously looked at in the literature. This is why the annual COP meetings – conferences in exotic locations – will never get anywhere. Any leaders that are persuaded to join the policy-enactors, unless their country will be disproportionately made worse by climate change, are acting against their own national interests.

Policy Risk

Policies carry risks. There is a risk of them not being effective, and costs running out of control. There is also a risk of a ratchet effective. That is once the policy is implemented, vested interests are created that make it very difficult to withdraw the policy even if results fall far short of those expected. The above assumes policy success. Policy failure within PC1 countries will demonstrate to potential PC2 countries that they should avoid adopting mitigation policies, no matter how great they believe in the looming climate catastrophe.

1. Thorstein Veblen attacked in the rich for the “conspicuous consumption”. The “conspicuous impoverishment” of the global warming movement is a variant on this, the difference is that the “prestige” that Veblen went to those wasting their money. The “prestige” heaped on the unilateralist country by the green movement on those implementing the policy and not those suffering the policy consequences.
   

In the first part on the mitigation policy curve I looked at

• The Small Country Problem. How one small country acting unilaterally will make an insignificant impacts of global climate change.
• How it is very likely to be against the economic interests of any country to join the small group of countries already with climate mitigation policies.

In this section I will look at two examples that go completely against logical thinking. There can be instances (like in Britain) where bold policies increase global warming at great cost to that economy, but the shale gas, which constrains global warming at net benefit to the gas-producing country?

To see the effect of policy, there is a need for analysis both at the front-end (prior to implementation), during and after. The question is about the gradient of the policy cost curve, at the point

Policy increasing global emissions?

We know that policy countries are in a minority of countries. With the structure of global growth this amount will fall.

Look at the long-term. Implementing a policy, you are saying to businesses that, ceteris paribus, your energy costs are going to rise year-on-year relative to those in non-policy countries. There will be a bigger incentive to make technological efficiency gains in these countries, but those gains can be transplanted to non-policy countries. In this global emissions may decrease more rapidly than they would have done, but the policy countries bear well over 100% of the costs and it becomes a policy benefit to the non-policy countries. By implication they will achieve around 200% of the global decline in emissions.

Question is, will it be more or less than 200% of the decline? Could it be that the policy countries energy-efficient factories are replaced by less energy-efficient factories in the non-policy countries?
There is some economic theory needed here. The Solow growth model shows a technological growth curve. Developing countries can achieve rapid growth by adapting to higher-productivity by adapting existing technologies. Their lower-unit labour costs will enable to undercut the more advanced economies, but the growth in these economies will grow the global economy as well. Most of this is unit labour costs. But by adapting previous generation technologies and exploiting labour costs less than a tenth those of the rich countries, they can under-cut the rich world. Greater technological advance is mostly in unit labour costs, but it can also mean lower unit energy costs. The portion of global output transferred from the rich countries to the poorer developing countries could result in higher total energy use, and ceteris paribus, higher CO2 emissions.

What is clear is that policy countries will increase unit energy costs. There is a two-pronged approach in Britain. The European-wide carbon-trading scheme will restrict supply of energy, bidding up the price. But also renewables cost more than fossil fuels. So the two-pronged approach doubly increases unit energy costs. Increasing unit energy costs accelerates the switching of manufacturing to developing countries, mostly China. The blue bit above postulates that energy per unit of output is globally could increase. But that is part of the problem. China has much higher CO2 emissions per unit of output as Britain. If Britain’s aggressive rush to renewables is successful, then this gap will increase, as much of Chinese energy output is from coal. A de-carbonised British economy will also be a de-industrialised one. But overall global emissions will have increased through switching of output to China.

The biggest cost of the policy for Britain is nothing to do with switching low-CO2 emitting production to high CO2 emitting countries. It is the restriction on economic growth. Loss of jobs from manufacturing, and pushing up higher energy costs elsewhere constrains growth. Due to the long-term consequences of that pushes policy costs through the roof. In the sectors where jobs are lost overseas, the policy curve is positive. If British Climate Change Act 2008 is massively unsuccessful in meeting the carbon targets, it could be a very expensive policy to increase global CO2 emissions.

The Shale-Gas Counter Example

In the USA, a consequence of the shale gas revolution has been to drastically reduce unit energy costs to industry. But also there has been a switch away from coal. As CO2 emissions of gas are around half that of coal, US CO2 emissions have been falling with electricity prices. The US is enjoying both cheaper and cleaner energy. Consequently, some chemical factories that relocated to China have returned to the USA. China has a greater proportion in its electricity production than USA, and the gap is widening. So the switching of a factory from USA reduces global CO2 emissions, even though the total energy usage remains the same.

Let me show this graphically.

Suppose (as is likely at present), the Climate Change Act 2008 falls a long way short of its target but unintentionally moves a substantial part of manufacturing to China through higher costs. For Britain this will be a large cost relative to British, but may be a net contributor to global warming. The policy curve points gets a positive slope! Conversely, “free market” shale gas in the USA has constrained global carbon emissions doubly by reducing US carbon emissions per unit of output, and switching production from China, where carbon emissions per unit of output are higher. It is having positive benefits on the US economy as well (hence negative costs), whilst constraining (slightly) the top-end of global warming.