Adaptation,mitigation and risk-taking in climate policy

The future consequences of climate change are highly uncertain and estimates of economic damages differ widely. Governments try to cope with these risks by investing in mitigation and adaptation measures. In contrast to most of the existing literature, we explicitly model the decision of risk averse governments on mitigation and adaptation policies. We also consider the interaction of the two strategies in presence of uncertainty. Mitigation efforts of a single country trigger crowding out as other countries will reduce their mitigation efforts. This may even lead to lower mitigation on the global scale. In contrast, a unilateral commitment to large adaptation efforts benefits the single country and can reduce the global risk from climate change at the expense of other countries.     

Willingness to Pay for Ancillary Benefits of Climate Change Mitigation

Assessing the Willingness to Pay (WTP) of the general public for climate change mitigation programmes enables governments to understand how much taxpayers are willing to support the implementation of such programs. This paper contributes to the literature on the WTP for climate change mitigation programmes by investigating, in addition to global benefits, the ancillary benefits of climate change mitigation. It does so by considering local and personal benefits arising from climate change policies. The Contingent Valuation Method is used to elicit the WTP for ancillary and global benefits of climate mitigation policies in the Basque Country, Spain. Results show that WTP estimates are 53–73% higher when ancillary benefits are considered.     

Why uncertainty matters: discounting under intertemporal risk aversion and ambiguity

Uncertainty has an almost negligible impact on project value in the standard economic model. I show that a comprehensive evaluation of uncertainty and uncertainty attitude changes this picture fundamentally. The illustration of this result relies on the discount rate, which is the crucial determinant in balancing immediate costs against future benefits, and the single most important determinant of optimal mitigation policies in the integrated assessment of climate change. First, the paper removes an implicit assumption of (intertemporal or intrinsic) risk neutrality from the standard economic model. Second, the paper introduces aversion to non-risk uncertainty (ambiguity). I show a close formal similarity between the model of intertemporal risk aversion, which is a reformulation of the widespread Epstein–Zin–Weil model, and a recent model of smooth ambiguity aversion. I merge the models, achieving a threefold disentanglement between risk aversion, ambiguity aversion, and the propensity to smooth consumption over time.     

The stability likelihood of an international climate agreement

Results derived from empirical analyses on the stability of climate coalitions are usually very sensitive to the large uncertainties associated with the benefits and costs of climate policies. This paper provides the methodology of Stability Likelihood (SL) that links uncertainties about benefits and costs of climate change to the stability of coalitions. We show that the concept of SL improves upon the robustness and interpretation of stability analyses. Moreover, our numerical application qualifies conclusions from a recent strand of literature based on stylised models with ex-ante symmetric players that learning has a negative impact on the success of coalition formation in context of uncertainty.      

The Impact of Climate Change on the Balanced Growth Equivalent: An Application of <Emphasis Type="Italic">FUND</Emphasis>

The Stern Review added balanced growth equivalents (BGE) to the economic climate change research agenda. We first propose rigorous definitions of the BGE for multiple regions and under uncertainty. We show that the change in the BGE is independent of the assumed scenario of per capita income. For comparable welfare economic assumptions as the Stern Review, we calculate lower changes in BGE between a business as usual scenario and one without climate impacts with the model FUND than the Stern Review found with the model PAGE. We find that mitigation policies give even lower changes in BGE and argue that those policy choices should be the focus of the research effort rather than total damage estimates. According to our results, the current carbon tax should be below $55/tC. Sensitivity analyses show that the Stern Review chose parameters that imply high impact estimates. However, for regionally disaggregated welfare functions, we find changes in BGE that are significantly higher than the results from the Stern Review both for total damage as for policy analysis. With regional disaggregation and high risk aversion, we observe fat tails and with that very high welfare losses.      

Climate Policy Under Fat-Tailed Risk: An Application of Dice

Uncertainty plays a significant role in evaluating climate policy, and fat-tailed uncertainty may dominate policy advice. Should we make our utmost effort to prevent the arbitrarily large impacts of climate change under deep uncertainty? In order to answer to this question, we propose a new way of investigating the impact of (fat-tailed) uncertainty on optimal climate policy: the curvature of the optimal carbon tax against the uncertainty. We find that the optimal carbon tax increases as the uncertainty about climate sensitivity increases, but it does not accelerate as implied by Weitzman’s Dismal Theorem. We find the same result in a wide variety of sensitivity analyses. These results emphasize the importance of balancing the costs of climate change against its benefits, also under deep uncertainty.     

Pushing the boundaries of climate economics: critical issues to consider in climate policy analysis

Climate policy choices are influenced by the economics literature which analyses the costs and benefits of alternative strategies for climate action. This literature, in turn, rests on a series of choices about: the values and assumptions underlying the economic analysis; the methodologies for treating dynamics, technological change, risk and uncertainty; and the assumed interactions between economic systems, society and the environment, including institutional constraints on climate policy. We identify and discuss such critical issues, pushing at the boundaries of current climate economics research. New thinking in this area is gathering pace in response to the limitations of traditional economic approaches, and their assumptions on economic behaviour, ecological properties, and socio-technical responses. We place a particular emphasis on the role of induced technological change and institutional setups in shaping cost-effective climate action that also promotes economic development and the alleviation of poverty.     

The role of the United States in the global economy and its evolution over time

This article aims at assessing the role of the United States in the global economy and its evolution over time. Based on a Global VAR modeling approach, this article shows first that countries with a large trade exposure with the U.S. economy have a relatively larger sensitivity to U.S. developments. However, even for countries that do not trade so much with the U.S., they are largely influenced by its dominance through other partners’ trade. Moreover, while no clear trend seems to emerge, it seems that the role of the U.S. in the global economy has changed over time. Overall, for most countries—the latest recession excluded—a change in U.S. GDP had weaker impacts—though more persistent—for most recent periods. The latest recession, however, led to some renewed increase in the sensitivity of the economies to U.S. developments.     

Individual option prices for climate change mitigation

Willingness-to-pay for climate change mitigation depends on people's perceptions about just how bad things will get if nothing is done. Individual subjective distributions for future climate conditions are combined with stated choices over alternative climate policies to estimate individual option prices (the appropriate ex ante welfare measure in the face of uncertainty) for climate change mitigation. We find statistically significant sensitivity of estimated option prices to both expected future conditions and uncertainty about future conditions.     

Analysing shock transmission in a data-rich environment: a large BVAR for New Zealand

We analyse a large Bayesian Vector Autoregression (BVAR) containing almost 100 New Zealand macroeconomic time series. Methods for allowing multiple blocks of equations with block-specific Bayesian priors are described, and forecasting results show that our model compares favourably to a range of other time series models. Examining the impulse responses to a monetary policy shock and to two less conventional shocks—net migration and the climate—we highlight the usefulness of the large BVAR in analysing shock transmission.     

Proportionality of Willingness to Pay to Small Changes in Risk: The Impact of Attitudinal Factors in Scope Tests

Sensitivity (proportionality) of willingness to pay (WTP) to (small) risk changes is often used as a criterion to test for valid measures of economic preferences. In a contingent valuation (CV) study conducted in Austria, 1,005 respondents were asked their WTP for preventing an increase in the risk of being killed in an avalanche of 1/42,500 and 3/42,500 respectively. WTP for the higher variation in risk is significantly greater than WTP for the lower risk change. We find evidence that those respondents who have had personal experience of avalanches in recent years combine the information about future risk increase—as provided in the survey—with the observed number of fatal avalanche accidents in the past. Proportionality of WTP holds if such prior experience is taken into account and if attitudinal factors in scope tests are controlled for. This research was funded by alpS GmbH—Center for Natural Hazard Management, Innsbruck, Austria.     

Research Frontiers in the Economics of Climate Change

Academic and policy debates over climate change risks and policies have stimulated economic research in a variety of fields. In this article I briefly discuss eight overlapping areas of current research in which further effort is particularly warranted. These areas include decision criteria for policy; risk assessment and adaptation; uncertainty and learning; abatement cost and the innovation and diffusion of technology; and the credibility of policies and international agreements. Further analysis in these areas not only will advance academic understanding but also will provide insights of considerable importance to policymakers.     

Potential output growth in several industrialised countries a comparison

In this paper, we present international comparisons of potential output growth among several economies—Canada, the euro area, France, Germany, Italy, Japan, the Netherlands, the United Kingdom, and the United States—for the period 1991–2004, for which we construct consistent and homogenous capital stock series. The main estimates rely on a structural approach where output of the whole economy is described by a Cobb–Douglas function and Total Factor Productivity (TFP) is estimated allowing for possible breaks in the deterministic trend. The results confirm that over the considered period the potential gross domestic product growth has been faster in the United States than in other studied countries, reflecting a combination of higher labour contribution and faster TFP growth. Overall, this paper might help to shed some light on cross-country differences in economic performance over the recent period.     

Impact of economic uncertainty in a small open economy: the case of Chile

We construct the first news-based economic uncertainty index for Chile, which allowed us to rebuild 23 years of the history of economic uncertainty in the country and quantify its impact on the economy. We find that an increase in economic uncertainty conveys a fall in GDP, investment, and employment, even after accounting for the small open economy nature of Chile. In contrast to previous studies for big and developed economies, we do not find evidence of an overshooting effect when uncertainty dissipates; therefore, increases in economic uncertainty have negative effects on the economy, even in the long-run. Our estimates suggest that these impacts range from 10% to 20% for aggregate investment, 2.5% to 5% for GDP, and 1.3% to 4.2% for employment. Extensions suggest that economic uncertainty affects both mining and non-mining investment, with the former showing a more pronounced decline. We also find that the bulk of effect of economic uncertainty on aggregate investment is via private investment, with some short-run impacts on public investment. Moreover, compared to the GDP response, aggregate consumption responds in almost the same way to an economic uncertainty shock.     

The Effect of Risk Context on the Value of a Statistical Life: a Bayesian Meta-model

This paper presents the first value of statistical life (VSL) meta-analysis that empirically estimates correction factors for ‘out of context’ benefits transfer (BT) purposes. In the field of mortality risk reductions elicited willingness to pay values in one risk context, say road safety, are frequently applied in other risk contexts like air pollution. However, differences in risk perception and the population at risk across contexts are likely to result in diverging VSL estimates. In a meta-analysis of 26 international stated preference studies, a Bayesian model is estimated regressing contingent values for mortality risk reductions, originating from three different risk contexts, on the characteristics of the risk reduction itself and additional variables characterizing the underlying studies. A willingness to pay (WTP) premium for mortality risk reductions in the air pollution and general mortality risk context relative to improving road safety is observed. Evaluated at the mean, road safety VSL estimates should be multiplied by a factor 1.8 before being applicable in the air pollution context. Moreover, in an illustrative BT exercise we find limited overlap in the set of context specific predictive VSL distributions. Consequently, ‘out of context’ BT results in a substantial over- or underestimation of the VSL.     

Unspoken ethical issues in the climate affair: Insights from a theoretical analysis of negotiation mandates

Taking climate change as an example, this paper provides new insights on the optimal provision of a long-term public good within and across generations. We write the Bowen–Lindhal–Samuelson (BLS) conditions for the optimal provision of the public good in a world divided into N countries, with two periods, present and future, and we simultaneously determine the optimal response in the first and second periods for a given rate of pure time preference. However, the Negishi weights at second period cannot be determined unambiguously, even under a “no redistribution constraint” within each generation, because they depend on non-observable future incomes; and thus on the answers to two often-overlooked ethical questions: (i) Do rich countries agree on deals which recognize that developing countries may catch up with developed countries in the long run, or do they use their negotiating powers to preserve the current balance of power? And (ii) does each country consider only the welfare of its own future citizens (dynastic solidarity) or does it extend its concern to all future human beings (universal solidarity)? Answers to (i) and (ii)—critical in the debate about how to correct the market failures causing global warming—define four sets of Negishi weights and intertemporal welfare functions, which we interpret as four mandates that countries could give to the Chair of an international negotiation on climate change to find an optimal solution. We find that in all mandates, public good provision expenditures are decreasing functions of income at first period. But each mandate leads to a different allocation of expenditures at second period and to different optimal levels of public good provision at both first and second periods. Finally, we show that only one of these four mandates defines a space for viable compromises.     

How does economic policy uncertainty drive gold–stock correlations? Evidence from the UK

In this article, we investigate the effects of economic policy uncertainty (EPU) on correlations between the UK stock market and gold market. We find that less certain economic policies result in lower correlations, while more certain economic policies result in higher correlations. The correlations are symmetric and show no structural breaks caused by the recent financial crisis. The recent financial crisis has not changed EPU effects on the correlations. The effects of one positive one-standard-deviation shock of the logarithmic change rate of the EPU on the correlations last approximately 19 months.     

Property rights and liability for deforestation under REDD+: Implications for ‘permanence’ in policy design

Reducing Emissions from Deforestation and forest Degradation (REDD+) is critical in efforts to mitigate the effects of anthropogenic climate change. Despite uncertainty about the exact form of a future, international REDD+ system, REDD+ carbon property rights would need to be created and allocated with liability assigned for the potential loss of climate benefits in the event of carbon reversal from deforestation. This commentary explores the links between forest property rights and liability, to different REDD+ policy options and their implications for permanence. Should national governments retain liability for permanence then project-level activities that have individually-assigned REDD+ carbon rights may have a higher risk of carbon reversal than policies where rights are assigned to the state. Knowledge of pre-existing forest rights is necessary for some policies implemented with government-assigned REDD+ rights in order to compensate for potential income losses from policy implementation.     

Believers vs. deniers: Climate change and environmental policy polarization

This paper theoretically studies the consequences of partisanship with an application to environmental policy. We model an election between a right-wing and a left-wing candidate who strategically propose environmental policies to gain the support of an electorate divided based on their climate change beliefs and productive assets. While environmental regulations imply a trade-off between a more sustainable environment and higher incomes for all voters, climate change believers have a higher belief in human activity-induced climate change, which translates into greater expected environmental benefits from policy, and high-asset voters care relatively more about mitigating economic costs. Voters view the left-wing candidate as more effective in addressing environmental challenges, whereas her right-wing opponent is the better candidate to deliver relief from the economic burden of regulations. In equilibrium, there exists policy divergence and the right-wing candidate always proposes the more pro-industry policy. We find that higher asset inequality moves equilibrium policies in a pro-industry direction as long as high-asset voters are ideologically more homogeneous than low-asset ones. Equilibrium policies become further polarized with greater partisanship as those voters with the same climate change belief hold similar ideologies.