Question

Describe the key drivers that will either increase or decrease the costs of climate policy around the globe.

Answer 1

Where one believes a climate policy will fall within a range of costs depends on three factors: the ability to use flexible incentive systems to find low cost solutions, the degree to which emerging countries will participate in emission reductions, and the adoption of low-carbon energy technologies without price increases.

1. The costs will be lower if nations have flexibility to find low-cost solutions. Two flexible mechanisms are a global cap-and-trade market and carbon sequestration in forests and land. While promising, the exact details remain to be defined for both. The feasibility and contribution of global cap and-trade remains a wild card given risks in the global economy, and ambiguities exist about carbon sequestration given the challenge on how to measure and account for net carbon.

2. Costs are lower if developing nations like India and China participate significantly in global cap-and-trade. Global trading reduces costs because richer nations with high compliance costs can buy carbon permits from nations with low compliance costs. The open question is whether emerging economies will reduce carbon emissions. In their view, rich nations got rich through carbon-based energy, and these emerging nations want this same opportunity. A Kyoto-style treaty runs the risk that the emerging countries will give lip-service to climate policy because the costs of decreasing current economic growth are too high. If the US chooses to increase the relative costs of carbon, we risk tempting carbon-intensive industries to emerging countries, thereby making these economies more carbon-dependent as they try to grow their economies. The current addiction to growth can increases the costs of joining later.

3. Costs would fall if people adopted new energy-efficient technologies without a price hike in energy. But evidence suggests people ignore the short term advantages of energy efficient technologies that, in the long run, are good for both the pocketbook and the environment. This economic view contradicts engineering studies which suggest 20-25 per cent of existing carbon emissions could be eliminated at low costs if people switched to new technologies like compact fluorescent light bulbs, improved thermal insulation, heating and cooling systems, and energy-efficient appliances. Economists believe this switch is unlikely without a rise in the price of energy. People behave as if their time horizons are short, and they are unwilling to experiment with new devices at current prices. Plus consumers care about factors other than energy efficiency, i.e., quality, comfort, learning time.