Waxman-Markey Cost-Benefit Analysis
There has been widespread agitation in the influential blogosphere for a cost-benefit analysis of the Waxman-Markey cap-and-trade proposal. This sure seems like a reasonable request to me, and you have to wonder why the sponsors and advocates of this bill – who are, after all, proposing an enormous commitment of resources – haven’t provided one. So I tried to do a quick version of it. I have a longer and more complete version of this coming in the next National Review, but wanted to get the bones of the analysis out for discussion as rapidly as possible.
Background Analysis
According to the authoritative U.N. Intergovernmental Panel on Climate Change (IPCC), under a reasonable set of assumptions for global economic and population growth, the world should expect (Table SPM.3) to warm by about 2.8°C over the next century. Also according to the IPCC (page 17), a global increase in temperature of 4°C should cause the world to lose about 3 percent of its economic output. So if we do not take measures to ameliorate global warming, the world should expect to be about 3 percent poorer sometime in the 22nd century than it otherwise would be. This is very far from the rhetoric of global destruction. Because of its geographical position and mix of economic activities, the United States is expected (Table 3) to experience no net material economic costs from such warming through the end of this century, and to begin experiencing net costs only thereafter.
A government program to force emissions reductions to avoid some of these potential future losses would impose a cost of its own: the loss in consumption we would experience if we used less energy, substituted higher-cost sources of energy for fossil fuels, and paid for projects—which are termed “offsets”—to ameliorate the effect of emissions (an example would be planting lots of trees). It’s complicated to estimate the cost of an emissions-reduction program, but the leading economists in this area generally agree that it would be large, and that we should simply let most emissions happen, because it would be more expensive to avoid them than to accept the damage they would cause. This makes sense, if you consider that most such plans (for example, Waxman-Markey) call for eliminating something like 80 percent of carbon dioxide emissions within the next 40 years or so. Even if the economy becomes more efficient over this period, such a quick transition away from our primary fossil-fuel sources will be expensive.
If a) the total potential benefit of emissions abatement is about 3 percent of economic output more than 100 years from now, b) we can avoid only some of this damage, and c) it’s expensive to prevent those emissions that we can prevent, the net benefit of emissions reduction will likely be a very small fraction of total economic output. William Nordhaus, who heads the widely respected environmental-economics-modeling group at Yale, estimates (page 84) the total expected net benefit of an optimally designed, implemented, and enforced global program to be equal to the present value of about 0.2 percent of future global economic consumption. In the real world of domestic politics and geostrategic competition, it is not realistic to expect that we would ever have an optimally designed, implemented, and enforced global system, and the side deals made to put in place even an imperfect system would likely have costs that would dwarf 0.2 percent of global economic consumption. The expected benefits of emissions mitigation do not cover its expected costs. This is the root reason that proposals to mitigate emissions have such a hard time justifying themselves economically. (If interested, you can read much more about this here).
Costs vs. Benefits of Waxman-Markey
Let’s start with the costs. The Environmental Protection Agency (EPA) has done the first cost estimate for Waxman-Markey. It finds (page 17) that by 2020 Waxman-Markey would cause a typical U.S. household to consume about $160 less per year than it otherwise would, and about $1,100 less per year by 2050 (before any potential benefits from avoiding warming). That doesn’t sound like the end of the world, but this cost estimate is based on a number of assumptions that seem pretty unrealistic, to put it mildly.
First, it assumes that every dollar collected by selling the right to emit carbon dioxide will be returned to taxpayers through rebates or lowered taxes. Waxman-Markey establishes this intention but doesn’t (as of the time I’m writing this) describe how it would be achieved, which reflects the political difficulty of achieving it. Second, it assumes no costs for enforcement and other compliance measures, which would be awfully nice. Third, it assumes that large numbers of foreign offsets will be available for purchase; without these, costs would be far higher. Fourth, it assumes that the rest of the world will begin similar carbon-reduction programs. Lack of such foreign action would either increase U.S. costs or risk a trade war if we tried to compensate for lack of international cooperation with targeted tariffs. Fifth, it assumes that there will be no exemptions or other side deals—that is, no economic drag created by the kind of complexity that has attached to every large, long-term revenue-collection program in history. And so on.
The EPA forecast is something like an estimate of the pure loss in economic productivity from replacing some fossil fuels with less economically efficient fuels or conservation in a laboratory setting; in the real world, expected costs are far above 0.8 percent of economic consumption by 2050. The EPA does not forecast costs beyond 2050.
Remember that the U.S. should not expect any net economic damage from global warming before 2100. That is, the bill’s benefits would accrue to U.S. consumers—who are also bearing its costs—sometime in the next century. The EPA underestimate has costs rising from zero to 0.8 percent of consumption between now and 2050, and offers no projection beyond that year; but to what level would costs rise over the more than 50 years between 2050 and the point in 22nd century when we might actually expect some net economic losses from global warming? The answer is likely to be much higher.
Now consider the benefits. Climatologist Chip Knappenberger has applied standard climate models to project that, under the scenario for global economic and population growth referenced above (A1B), Waxman-Markey’s emissions reductions would have the net effect of lowering global temperatures by about 0.1°C by 2100. Remember that the estimated cost of a 4°C increase in temperature (40 times this amount) is about 3 percent of global economic output. Assume for the moment that global warming has the same impact on the U.S. as a percentage of GDP as it does on the world as a whole (an assumption that almost certainly exaggerates the impact on the U.S.). A crude estimate of the U.S. economic costs that Waxman-Markey would avoid sometime later than 2100 would then be about one-fortieth of 3 percent, or about 0.08 percent of economic output. This number is one-tenth of 0.8 percent, the EPA’s estimate of consumption loss from Waxman-Markey by 2050. To repeat: The costs would be more than ten times the benefits, even under extremely unrealistic assumptions of low costs and high benefits. More realistic assumptions would make for a comparison far less favorable to the bill.
I’ve had to rely on informal studies and back-of-envelope calculations to do this cost/benefit analysis. Why haven’t advocates and sponsors of the proposal done their own? Why are they urging Congress to make an incredible commitment of resources without even cursory analysis of the net economic consequences? The answer should be obvious: This is a terrible deal for American taxpayers.
Two Potential Objections
One potential objection to my analysis is that the bill is part of a global drive for all countries to reduce emissions, and that the U.S. needs to “show leadership.” By this logic, we should ascribe much larger benefits to the Waxman-Markey bill—specifically, the benefits to American consumers of the whole world’s engaging in similar programs. There are two obvious problems with this argument, however. First, ascribing all of the benefits of a global deal to reduce emissions to a specific bill that does not create such a commitment on the part of any other countries is loading the dice. The benefit we should ascribe to the bill is rather that of an increase in the odds of such a global deal. But would Waxman-Markey actually increase them, or would it decrease them instead? Whenever one nation sacrifices economic growth in order to reduce emissions, the whole world can expect to benefit, because future temperature should decrease for the entire globe. Every nation’s incentive, therefore, is to free ride on everybody else. Our most obvious leverage with other emitting nations would be to offer to reduce our emissions if they reduced theirs. Giving up this leverage and hoping that our unilateral reductions would put moral pressure on China, Russia, Brazil, and similar countries to reduce their emissions reveals a touchingly sunny view of human nature, but it strikes me as a poor negotiating strategy. Second and more fundamentally, even if the whole world were to enact similar restraints on emissions, the cost / benefit economics would still not be compelling, for the reasons outlined at the beginning of this post.
A second and more serious potential objection to my analysis is that while Waxman-Markey may not create benefits if the projections I offered above turn out to be accurate, climate science is highly inexact, and the bill is an insurance policy against higher-than-expected costs. Now, climate and economics modelers aren’t idiots, so it’s not as though this hadn’t occurred to them. Competent modelers don’t assume only the most likely case, but build probability distributions for levels of warming and associated economic impacts (e.g., there is a 5 percent chance of 4.5°C warming, a 10 percent chance of 4.0°C warming, and so on). The economic calculations that compose, for example, the analysis by William Nordhaus that I cited earlier are executed in just this manner. So the possibility of “worse than expected” impacts means, more precisely, the possibility of “impacts worse than those derived from our current probability distribution.” That is, we are concerned here with the inherently unquantifiable possibility that our entire probability distribution is wrong.
This concept has been called, somewhat grandiosely, the “Precautionary Principle.” Once you get past all the table-pounding, this is the crux of the argument for emissions abatement. It is an emotionally appealing political position, as it easy to argue that we should reduce some consumption now to head off even a low-odds possibility of disaster. The most compelling version of this argument, by far, has been presented by Martin Weitzman. You can read my detailed response here (note that this was to a slightly earlier edition of the paper). The essence of my response is that in order to drive a decision, Weitzman must take his argument from the conceptual idea of a “fat-tailed distribution” of danger to a numerical estimate of risk. He recognizes that the logic of his argument entails this. In his article, he ends up having to do the kind of armchair climate science that has been the bane of the “global warming is all a hoax” set. He uses a couple of ice bore studies to develop his own probability distribution for potential warming that calls for a 1% chance of 22.6C or more of warming by 2100. To put this in perspective, a 22.6C increase in the earth’s temperature would mean that the average global year-round temperature would be the same as summertime Death Valley is today. If you could convince me that there was a reliably-quantified 1% chance of this happening, you wouldn’t need all of the mathematical formalism of Weitzman’s paper – I’d be the biggest emissions mitigation proponent on earth. The problem is that the IPCC has already built a distribution of potential temperature changes (see Figure 10.28, page 808) that looks nothing like this. If you don’t want to believe me, read Cass Sunstein’s book about why the Precautionary Principle, even in sophisticated form, is a very bad decision rule.
In the end, clarity about costs and benefits is the enemy of Waxman Markey. It is hard to get around the conclusion that it can not be justified rationally based on the avoidance of climate change damages.
“Also according to the IPCC (page 17), a global increase in temperature of 4°C should cause the world to lose about 3 percent of its economic output.”
The 3% GDP loss is doing a lot of work in this argument. Drilling down into the IPCC, page 17 tells us to check page 802 Chart A, where we see that the 3% GDP loss is a mean of several models – notably the studies of Mendelsohn (1998) and Nordhaus (2000), not a confidence interval, and that that estimate is a literature summary from 2001. (Indeed that chapter of the IPCC is mostly about ecology; it throws in GDP to make a point that GDP losses is correlated with temperature increases before going back to water and plantlife.)
Do you know of updates to the GDP losses? Are those numbers staying the same as people think more about it? I haven’t kept up, but I remember hearing Stern talk about a floor of 5% GDP loss with business as usual…
— rortybomb · May 20, 03:20 AM · #
rortybomb:
Yes, I’ve gone back and forth a bit about it in these comboxes. These studies (which were directly focused on GDP impacts, as per the other Mendelsohn study I linked to) are still oeprative, which is why they are the basis for a SPM-level conclusion in the 4AR. There are studies through 2006 / 2007 that show the same basic results.
The thing is, the conclusions aren’t at all sensitive to where in ths range you end end up. Assume it’s 5%, you still get the same conclusion. And this ignores the fact that I’ve really underplayed the regional US effect, whihc many studies (again you can see it in the regional effects paper to which I’ve linked, and any reputable study on this topic) the actual dmaages in the US up to quite large temperature increases are way, way disporportionately small vs. global average damages as a percentage of GDP.
— Jim Manzi · May 20, 03:26 AM · #
It sounds so clean when you say that the United States is expected to experience no net material economic costs till 2100.
Why don’t you complete your thought and lay out your position clearly: that we Americans should not crimp on our lifestyle because the only people who are going to be flooded out of their homes are poor Africans and Peruvians?
— Lak · May 20, 06:20 PM · #
It doesn’t seem like the costs of Ocean Acidification are included here – am I wrong? These costs are also much more directly addressed through emissions cuts than are temperature related costs. A larger point though is how do you account for non-economic costs. Lets say, for example, coral reefs as we know them are gone by 2100 (entirely possible, even likely at this point), surely the costs are far greater than lost fisheries, tourism, and all associated jobs (though these are significant). How do you calculate the intrinsic value of something like that?
— Cameron McDonald · May 20, 07:25 PM · #
Cameron:
It’s an entirely valid point, and outside the scope of the analysis. I was trying to evaluate the economic (in the narrow sense) costs vs. benefits (from avoided AGW damages) to a US citizen of this proposed legislation.
We sometime do things which cost us money. The reason I thought this was a rleevant post is that I couldn’t find anybody who had done this more formally (which is what I’d really like to see).
— Jim Manzi · May 20, 07:32 PM · #
Question: How does this change if we use more recent predictions that warming may be 5 degrees C over the next century? (E.g. Here.)
— Chris · May 20, 07:34 PM · #
Chris:
I’ve read that study. There are frequent individual estimates in speicfic papers that are higher and lower (some A LOT higher). One of the purposes of the huge every-five-years IPCC process is to integrate all of these finding into a consensus finding. The key scaling parameter of climate sensitivity has been stable at about 3C +/- 1.5C from the pre-IPCC NAS Charney Commission in 1979 through each of the four IPCC Assessment reports. So I wouldn’t over-interpret this.
IF one were to accept that actual expected warming were to be almost twice as high as current estimates, it would change some things. If you could structure a global deal, such a thing might make sense under these conditions. Doing the math quickly, I think one could still not come close to economically justifying Waxman-Markey on a standalone basis.
— Jim Manzi · May 20, 07:50 PM · #
Bjorn Lomborg has done the cost-benefit analysis and recently wrote in the New York Times that we should rather spend more on developing wind, solar, nuclear, etc.:
“Fortunately, there is a better option: to make low-carbon alternatives like solar and wind energy competitive with old carbon sources. This requires much more spending on research and development of low-carbon energy technology. We might have assumed that investment in this research would have increased when the Kyoto Protocol made fossil fuel use more expensive, but it has not. Economic estimates that assign value to the long-term benefits that would come from reducing warming — things like fewer deaths from heat and less flooding — show that every dollar invested in quickly making low-carbon energy cheaper can do $16 worth of good. If the Kyoto agreement were fully obeyed through 2099, it would cut temperatures by only 0.3 degrees Fahrenheit. Each dollar would do only about 30 cents worth of good.”
— Joe Richer · May 20, 08:11 PM · #
Fair enough, but I wasn’t really asking about the reliability of any one study. It seems to me that the cost of global warming is a highly nonlinear function of the degree of warming, and I’m curious as to how the cost estimates scale with warming. To put my question another way: at what amount of warming does something like W-M become cost effective? (This is assuming that cost/benefit is the right way to look at things.)
Another question. What’s the reliability of the economic cost projections? While there’s lots of discussion of the uncertainty of climate projections, I rarely (e.g. never) see similar discussions for the economic cost projections. In particular, the last time cap-and-trade was done (in the 70s, right?) how did the actual costs compare to the cost estimates. (It seems to me that the natural bias in doing the cost estimates always ends up favoring the “do nothing” conclusion.)
— Chris · May 20, 08:24 PM · #
Chris: The U.S.‘s most recent experience with cap-and-trade was (and is) the sulfur dioxide trading program that started in the mid-1990s. The costs of the program have been far less than projected.
— Jonathan · May 20, 08:59 PM · #
It wonder if you may be neglecting the possibility of discontinuities in temperature increases, and therefore associated damages. This is really about lowering the risk of impacts if we are wrong and the climate is very sensitive to increased GHG levels. Directionally, newer information is not hopeful here.
If one could build a wall around the US and isolate it from global events/conditions, it might be well and good to presume that global changes would not impact the US. But changes globally will change where large populations might like to live which has geopolitical impacts. I’m not aware that economic models of damages capture this.
Finally, the cost of WM, according to most model output I’ve seen is on the order of less than 2% off a still growing baseline. Not free, but not devastatingly expensive (or indeed particularly noticeable). In fact, the costs to the US of acting as part of a global agreement are rather minimal compared to many states.
Finally, I’m not aware of “leading economists” in this area who think it would make more sense to simply let things happen. This seems a mischaracterization of those at who are very active in analyzing this problem. Check out: http://globalchange.mit.edu/ and http://belfercenter.ksg.harvard.edu/project/56/harvard_project_on_international_climate_agreements.html
— Kevin · May 20, 10:15 PM · #
Err.. reading along more closely …Knappenberger’s analysis presumes that ONLY the US takes on a WM type commitment. It is well understood by most in the debate that if the US acts alone and no one plays ball, then yes, the effort is a waste of time and yes, the very small impact on tempuratures will result.
Even when Knappenberger purports to look at the impact if the world plays along, he continues to insist the developing world will not, therefore, he doesn’t include them in his analysis.
I hope this was the result of hurried composition and not an effort to mislead.
— Kevin · May 20, 10:40 PM · #
Chris:
The uncertainties associated with each step of the prediction process are significant. I linked to the Weitzman paper that goes into this. It is the martest argument IMHO for exactly what I oppose. I also linked to my response to it.
Jonathan:
That is correct. The huge issue in comparing C-and-T for SO2 and CO2 is that simple existing technology was deployed to resolve the SO2 probelm, while no such technology exists to replace in any feasible engineering sense our current energy infrastructure.
Kevin:
The U.S. Congress is considering a law that will place certain requirements on U.S. citizens and companies doing business in the U.S. This law will impose certain costs, and the actions that it can force should create certain benefits. It doesn’t seem to me that many advocates are saying that “hey if we just do this, it will be a complete waste of time that will destroy a lot of wealth for the U.S.”. It may be the case that this law will also act to improve the odds that other countries will do other things that will benefit U.S. citizens. To simpl assume that these others things, that the law will not force, will come about seems like loading the dice if you assign these benefits against the costs of the bill. You would have to, IMHO and as per the post, handicap this change in odds. I see no compelling reason why it should even create a positive change in the odds.
— Jim Manzi · May 21, 01:28 AM · #
Thanks Jim. I think you need to look more closely at the intent and the clear next steps that policymakers have in mind, many of which can not be defined by the legislation, but have been clearly articulated by the State Department. No one is suggesting that the US implement WM and then stop and hope that China joins in just because they’ll like us better. The intent is that concurrent with this the US will aggressively pursue agreement with China, either bi-laterally or via multi-lateral agreements. To ignore this or say that because it isn’t guaranteed it should be excluded from the analysis certainly tilts the table toward the “waste of time” conclusion. Why, when you know the wider context, do you want to go there? Wouldn’t it be better for your readers to frame this as “IF the US and EU are the only ones to take action and China remains on the sidelines through 20XX, this will be a waste of money and effort.” Battelle and MIT both have produced good analysis of this question and reached some important conclusions.
Your frame sets this up as “This is a waste of money and effort” without qualifying under what scenarios this is so. You’re a better analyst and writer than that.
Rather than seeming to attempt to simply blow up WM by claiming it doesn’t pass economic muster, wouldn’t it be more helpful to set out clearly that this bill only gets proponents part of what is needed (a deal with China)?
— Kevin · May 21, 02:24 AM · #
would it help you to think of shutting down coal-fired plants as the only hedge available?
— hapa · May 21, 07:02 AM · #