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Executive Summary

The Economics of Climate Change

by Steven J. DeCanio

Climate change is emerging as one of the central policy concerns of our time. The problems it raises are difficult ones involving science and economics, decision-making under uncertainty, and the balancing of the interests of the generations now alive and those not yet born. Yet despite these complexities, a great deal of common ground can be found for reasonable policies to address the issue. The recent Economists' Statement on Climate Change, signed by over 2,500 members of the American Economic Association, is an example of the kind of agreement on basic principles that can guide the formation of climate policy.

People are concerned about climate change because of damages that can be foreseen and because of the risks entailed in conducting an irreversible experiment with the planet, an experiment whose outcome is presently unknown. Both economic theory and common sense point to the desirability of taking measures to reduce the risks and avoid the known damages. Climate change could result in the emergence or exacerbation of a large number of potential public health problems, including heat-induced mortality and increased geographical ranges of deadly diseases such as malaria and dengue fever. Loss of species biodiversity, changes in weather patterns (with increased damage from storms), sea level rise, and infrastructure costs are among the economic and ecological harms that have been identified. In addition, climate change could trigger potentially catastrophic changes in certain earth systems. Even if the probability of such disasters is small, taking action now to avert them is warranted. Uncertainties about the magnitude of the risks posed by climate change provide a strong rationale for action rather than passivity.

Estimates of the cost (excluding environmental benefits) of policies to avert climate change vary both in methodology and magnitude. However, the most reliable sets of estimates show that the standard of living of the present population would not be harmed (and might be improved) by sensible policies. Estimates based on economy-wide economic models tend to show only slight reductions in gross domestic product (GDP) from greenhouse gas emissions reductions; alternative estimates based on technical and engineering studies of the potential for cost-effective energy-saving investments tend to show modest GDP increases. The assumptions underlying the estimates are important predictors of the size and sign of GDP effects, but in all cases the most important determinants of material standards of living in the long run are the rates of economic growth and technological progress. "No regrets" policies (such as reducing subsidies that encourage fossil fuel consumption) would improve economic performance even without factoring in the economic benefits of reduced climate change; when the economic benefits of climate protection are included in the calculations, the range of economically warranted policies expands.

The design and implementation of measures to reduce greenhouse gas emissons makes a difference in terms of cost and efficiency. Market-based policies including provisions for international cooperation are likely to do the best job of (a) effectively reducing greenhouse gas emissions globally, and (b) doing so with minimum disruption of other economic activity. Well-designed greenhouse gas control policies would not cause large-scale job losses or capital flight, although it would be both feasible and appropriate to assist workers in a few sectors (such as coal mining) in making the transition to a less fossil fuel-intensive economy.

The transformation of the economy to one less dependent on burning carbon for energy would provide opportunities for expansion of employment in technologically sophisticated sectors. Similarly, reaching an international agreement to coordinate national policies to reduce greenhouse gas emissions offers an opportunity to promote global economic progress and environmental protection simultaneously. The Montreal Protocol on Substances that Deplete the Ozone Layer shows that this kind of cooperation is possible, effective, and beneficial to all countries. It is a worthy goal for the 21st Century to achieve the same sort of international consensus on measures to protect the global climate.

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