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Time horizon, uncertainty and cost benefit analysis.

Time horizon, uncertainty and cost benefit analysis.

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Time horizon, uncertainty and cost benefit analysis.

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  1. Time horizon, uncertainty and cost benefit analysis. Long run discount rate for environmental goods.

  2. Cost benefit analysis

  3. The cost of Kyoto : the verdict of models. • Why models ? • Sectoral effects (électricityé). • effect on final demande: econometrics of price effects.… • General interactions. • Which models ? • sectoral.aggregate. • Computable general equilibrium.macroéconomics. • The double dividend controversy.

  4. The benefits of climate policies • The difficulties • Many chapters • Agriculture, extreme weather events • Bio-diversity, health, quality of climate. • Flooding, large scale migrations.. • Difference across regions • Northern areas and vulnerable, (southern) places. • Differences according to the range of temperature • 1 to 3 degrees : agriculture in northern areas. • Above high reductions of general fertility. • Uncertainty has to be faced.

  5. The benefits of climate policies • The solutions of the Stern review. • A comprehensive qualitative coverage of the phenomena. • A long run probabilistic assessment • A synthetical money assessment • Damages = (T/2,5) power g, g=1,5 to 3 • Probabilistic assesment : high climate scenario, markets and non market impacts, 95th percentile 35per cent of global GDP in 2200. • The presentation of numbers. • Equivalent GDP loss. • Skips partly the discount rate issue.

  6. The discount rate in the Stern Review. • The issue : • How should one unit of consumption for the present generation be valued in comparison of the same unit for the present generation. • If perfect altruism the answer depends upon the elasticity of marginal utility (xU``/U`) or relative risk aversion. • Pure rate of time preference. • Example : • Isoelastic utility function • U= [1/(1-  ’]t=0infini{(exp(-  t))[U(xt)](1 - ’)} • The solution of the Stern review • Elasticity close to one (Log utility…) • Does not kill the future. • Underestimate risk aversion….

  7. Questions on long run discount rates for environmental goods. • Discounting « kills » the distant future. • 10 per cent discount rate :120 in 50 years, 14000 in 100 years • 7 per cent, discount rate : < 30 in 50 years, 860 in 100 years, • 5 per cent discount rate : 130 in 100 years, 17 000 in 200 years, • 2 per cent discount rate : 2,7 in 50 years, 7,3, in 100 years, 52 in 200 years. • Is standard discounting appropriate for long run decisions ? • Argument 1 : « ecological intuition » • Discounting=selfishness of existing generations, ethically unacceptable • Destroys our common natural patrimony, for second rate interests. • Argument 2 : « economic reason » • Cost benefit analysis provides the weights for decisions about public versus private goods. • Cost benefit analysis rightly stresses that it is useless to sacrifice present generations to future and much wealthier generations.

  8. How to reconcile economic and ecological intuition ? • Ingredient 1 Environmental goods and the long run. • They differ from • private goods : out put cannot be continually expanded. • non renewable resources : not destroyed by cautious use. • in the long run, their relative scarcity (/ private goods) increases. • Ingredient 2Uncert. lowers long run discount rate. • Argument : valuation by generation 0 of 1 euro given to generation T : exp(-Rt) • If uncertainty : R or r, R>r • (1/2) exp(-Rt) + (1/2)exp(-rT) = • exp(-rT) [(1/2)+(1/2)exp((-R+r)T)]= • exp(-r ’(T)T), • r ’(T) tends to r when T tends to infinity • Weitzman (2000), AER

  9. How to reconcile CB analysis and economic intuition. • Ingredient 3 : Substitutability : • If private and environmental goods were perfectly substitutable, then, no reason to treat them differently in Cost Benefit analysis.: • If they are strict compléments • Min{x,y} • Private output increases, the environmental good level does not. • After a while, increasing the welfare of a wealthier future generation relies on improving environmental quality. • Discount rate for private good : +  • Discount rate for environmental good : almost zero. • Ingredient 4 : « ethical » considerations. • Pure rate of time preference close to zero • > probability of the planet’s survival ?

  10. A formal modelRG « Calcul économique et Développement durable », Revue Economique, 2004, • 2 goods : • aggregate consumption good : quantity. • « environnemental quality » • Utility function : • Formulation. • v(xt ,yt) ={[xt((- 1)/  ) + yt(( -1)/  ) ] ( /( -1))} • V(xt ,yt) =[1/(1-  ’)][v(xt ,yt)](1 - ’) • Comment. • y/x decreases of 1/100, the willingness to pay increases of (1/) •   pour 100 • Iso-élastic cardinal utilty for generation t, • Constant relative risk aversion ’. • Uncertainty : • On the long run elasticity of substitution between private and environnemental good, 

  11. A formal modelRG « Calcul économique et Développement durable », Revue Economique, 2004, • 2 goods : • aggregate consumption good : quantity. • « environnemental quality » • Note : •  only parameter, summary statistics of much information •   ’ different possible interprétations. • Social welfare • U= [1/(1-  ’]t=0infini{(exp(-  t))[v(xt ,yt)](1 - ’)} • Remarks • Index t associated to generation • Utilitarian. • When __0, « ethical » viewpoint. • Cost Benfit analysis at the margin • A « reform » viewpoint. • Combines the four previous ingredients.

  12. Results • « Canonical » Ecological Cost benefit Analysis • Generation 0 evaluates an investment (at 0), generating an improvement of the environmental quality for generation t • The value of the improvement is measured with the marginal willingness to pay of generation 0 : « canonical procedure » • Proposition A : • If the probability of « ecological strangling » in the long run is null. • Standard discount rate : Min (g’)+ • ethical « canonical » ecological long run discount rate : • lim T (T) = g[ ’-(1/ )] • Min{g}[Min{’}-1/{Min  } : • (1) (1,4 - 0.9) = 0,5 pour cent !

  13. Results • « Canonical » Ecological Cost benefit Analysis • Generation 0 evaluates an investment (at 0), generating an improvement of the environmental quality for generation t • The value of the improvement is measured with the marginal willingness to pay of generation 0 : « canonical procedure ». • Proposition B : • If the probability of « ecological strangling » in the long run is non zero. • The ethical long run discount rate for private goods : Min{g/ } • The ethical « canonical » ecological long run discount rate is zero. • Lessons : • Substitutability is essential … • and uncertain..

  14. Irreversibility and option value. • Irreversibility of the greenhous effect. • Irreversibility of concentrations • Climate irreversibility. • Cost benefit analysis : the value of preserving options. • A stylised argument. : • To morow cost, value C, prob. (½), 0, prob. (1/2) • action allow to avoid it cost a, • Information will arrive : C or 0 • Willingness to pay to keep the option ? : (1/2)(C-a)>0 • Possibly (1/2)C-a<0, • More generally….

  15. Some references. • Aldy, J.E., P. R. Orszag and J. E. Stiglitz, ''(2001) ''Climate Change: An Agenda for Global Collective Action'', Prepared for the conference on ``The Timing of Climate Change Policies'', Pew Center on Global Climate Change, October. • Bradford, D.F. (2001), « Improving on Kyoto: A No Cap but Trade Approach to Greenhouse Gas control » Princeton University. • Chakrovorty U, Magné B. and Moreaux M, (2003) « Energy resource substitution and carbon concentration targets with non stationary needs'', Leerna 31, Université de Toulouse. • Cooper, R., (1998), ''Toward a real global warming treaty'', Foreign Affairs, vol. 77 no 2, March-April C • Carraro C.(1999) ''The Structure of International Agreements on Climate Change''in C. Carraro C. (ed), International Environmental Agreements on Climate Change, Kluwer Academic Publishers, Dordrecht, NL • Chandler L and Tulkens H. (2005) « Stability issues and climate related dynamic externalities »38p

  16. Some references. • Freixas X, Guesnerie R, et Tirole J. (1985) « Planning under incomplete information and the ratchet effect », Review of Economic Studies, LII, 173-191.. • Guesnerie R. (2003) « Les enjeux économiques de l'effet de serre » in «Kyoto et l‘économie de l'effet de serre », sous la direction de R. Guesnerie, La Documentation Française, Paris. • Guesnerie R. ( 2004) « Calcul Economique et Développement Durable », Revue Economique, p.363-382. • Guesnerie R. (2005) ''Assessing Rational Expectations :2- ''Eductive'' stability in economics », MIT Press, 453 P. • Guesnerie R. (2006) The design post Kyoto climate schemes : an introductory analytical assesment ».  • Ha-Duong M, Grubb M et. Hourcade J.C, (1997) ''Influence of socio--economic inertia and uncertainty on optimal CO2-emissions abatment'', Nature, Vol. 390. • Newell, R.G. and W.A. Pizer, (2000), « Regulating Stock Externalities Under Uncertainty », Discussion Paper 99-10, Resources for the Future, Washington DC, February.

  17. Some references. • Nordhaus, W.D, (2002), ''After Kyoto: Alternative Mechanisms to Control Global Warming'', Paper prepared for the meetings of the American Economic Association and the Association of.IEA/SLT(2002)28 • Philibert, C. (2000). ``How could emissions trading benefit developing countries.'' Energy Policy , volume 28, no 13. • Philibert, C., and J. Pershing. (2001). ``Des objectifs climatiques pour tous les pays : les options.'' Revue de l‘Energie 524. • Pizer, W.A., (2001), ''Combining Price and Quantity Control to Mitigate Global Climate Change'', Journal of Public Economics, 85,(3), 409-434. • Rieu J.(2002) ''Politiques nationales de lutte contre le changement climatique et réglementation de la concurrence : le cas de la fiscalité », mimeo. • Weitzman, M. L., (1974) ''Prices vs. Quantities'', Review of Economic Studies, vol.41, October. • Weitzman, M. L., (2000),AER