Climate mitigation: sustainable preferences and cumulative carbon

1. Climate mitigation: sustainable preferences and cumulative carbon Dr Simon Buckle Grantham Institute Imperial College London 15 September 2010

2. Structure of talk • Motivation: How fast do we need to act on climate? • Sustainable preferences approach • Stylised Model & Optimal solutions • Initial endowments and political economy • How we care for the long-term matters • Conclusions Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

3. How fast do we need to act? “There is an amazing disjunction between economists and natural scientists on this issue…… Who is missing something important here - the economists or the scientists?” Geoff Heal, Climatic Change (2009) • Mitigation policy conclusions depend crucially on assumptions and judgements regarding: • Discounting (e.g. Stern vs. Nordhaus) • Non-market impacts (ecosystem goods and services) • How we model climate damages – Weitzman 2009 Optimal carbon dioxide emission paths in amended version of the DICE model (Sterner & Persson, Rev Environ Econ Policy 2008) Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

4. Sustainable preferences approach • In Utilitarian approach, discount rate reduces importance of far future, depending on • Pure rate of time preference • Elasticity of marginal utility of consumption, “η” • Parameter η is having to do a lot of work: • Inequality in space • Inequality over time • Risk aversion • Want to model a concern for the far future and for natural capital. For simplicity I don’t model uncertainty and risk. • The key feature here is the symmetric treatment of discounted utility (consumption) and the long-term climate damages from production – a sustainable preferences approach (Chichilnisky 1995) Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

5. Modelling approach Climate damages to ecosystem goods and services • DICE has multiplicative damages and just manufactured goods • This model incorporates additive climate damages and consumption of both manufactured and ecosystem goods & services • Manufactured and ecosystem goods are assumed perfect substitutes, but manufactured and natural capital are not. Stylised framework • Want to keep the model as simple as possible – insights, not realism. • One country world, representative agent. • AK endogenous growth model in two periods. • Assume utility is linear in consumption (I don’t care too much about the precise timing of consumption and there is no uncertainty). Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

6. The model setup • Initial endowments of capital and atmospheric CO2. • Production takes place at the start of each of the two periods. • CO2 cumulates in atmosphere and increases temperature. • Proportion of CO2 stock is absorbed in each period is (1-δ). • Consumption in each period is reduced by (lagged) climate damages depending on the level of CO2 relative to an assumed ‘neutral’ level. • Sustainable preferences weighs long term damages against utility of consumption in periods 1 & 2 Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

7. Optimisation problem Maximise Subject to: ; Initially choose ; • A is constant productivity parameter, • θ is the pure rate of time preference • sn is the ‘neutral’ level of atmospheric CO2 at which damages are assumed zero Climate damages in each period: Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

8. Optimal solutions for CO2 levels and capital Net cumulative emissions: Second period capital: • Unique level of optimal cumulative emissions – irrespective of whether the economy invests or disinvests. • For this choice of Φ, optimal cumulative emissions are independent of emissions coefficient, carbon cycle and endowments Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

9. 1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 Optimal solutions for CO2 levels and capital Change in long term marginal costs depends on specification of Φ Marginal benefit rises (falls) as technology becomes cleaner (dirtier) AK Marginal benefits with AK • Optimal solution equates marginal benefits of an extra tonne of CO2 emitted by period 2 production and the marginal long term climate costs • NB comparison with Cobb-Douglas production function – far smaller 2nd period emissions Marginal benefits with CD Cobb-Douglas Emissions in period 2 Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

10. Outcomes depend on initial endowments Optimising solutions (Case 1) • Case 1a: agent still wishes to invest though less than in BAU • Case 1b: agent disinvests (“mitigates”) Constrained solution (Case 2) • Economy’s resources limit investment. Marginal benefits of investment exceed long term marginal climate damages. Unsustainable (Cases 3, 4 & 5) • Case 3: sustainable economic activity infeasible • Case 4: climate damages in second period greater than available resources • Case 5a: high initial level of CO2 imposes high damages in first period • Case 5b: climate damages overwhelm in both periods Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

11. Outcomes depend on initial endowments The dependence of outcomeson initial endowments is suggestive of real-world policy difficulties, though we need to develop a multi-country model. (NB parameters relevant to different countries will be different) Small Island States? China? US, EU? India? Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

12. Option 1: Option 2: Option 3: How we care for the long-term matters… • Parameter Φ determines how we balance present discounted consumption against long term climate damages – in other words it represents how we care for the long term. • Illustrate through three different choices and their corresponding optimal Net Cumulative Emissions Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

13. Concluding remarks (1) • Optimal level of cumulative carbon emissions emerges naturally from the sustainable preferences framework and captures a fundamental ethical choice between present discounted consumption and future long term climate damages. • The way in which we care for the long term matters. This is because the adoption of clean technology increases the marginal benefit of each tonne of CO2 emitted in production (i.e. (A-θ)/γ). • So unless our values (i.e. Φ) reflect our endowments of technology and wealth, clean technology on its own will not limit long-term climate damages. Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

14. Concluding remarks (2) • Even with an aggressive AK model and full substitution between production and ecosystem goods, as initial wealth increases, concern for long-term damages drives stringent mitigation action (and therefore demand for clean technologies). • The dependence of outcomeson initial endowments is suggestive of real-world policy difficulties, e.g. China vs. India vs. US vs. small island states. Work is needed on a multi-country model. Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

15. Thank you! Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial

16. Source: Schmidt & Archer, Nature (2009) Cumulative carbon budgets “Cumulative carbon” is a useful analytical concept for assessing the impact of CO2 emissions which is relatively insensitive to emissions pathways Black line shows the probability of the peak global mean temperature >2 °C above pre-industrial before 2100 as a function of the cumulative emissions from 2009 to 2049. Climate Mitigation: sustainable preferences and cumulative carbon Simon Buckle, Grantham Institute, Imperial