Abstract
Abstract It is well-known that the discount rate is crucially important for estimating the social cost of carbon, a standard indicator for the seriousness of climate change and desirable level of climate policy. The Ramsey equation for the discount rate has three components: the pure rate of time preference, a measure of relative risk aversion, and the rate of growth of per capita consumption. Much of the attention on the appropriate discount rate for long-term environmental problems has focussed on the role played by the pure rate of time preference in this formulation. We show that the other two elements are numerically just as important in considerations of anthropogenic climate change. The elasticity of the marginal utility with respect to consumption is particularly important because it assumes three roles: consumption smoothing over time, risk aversion, and inequity aversion. Given the large uncertainties about climate change and widely asymmetric impacts, the assumed rates of risk and inequity aversion can be expected to play significant roles. The consumption growth rate plays multiple roles, as well. It is one of the determinants of the discount rate, and one of the drivers of emissions and hence climate change. We also find that the impacts of climate change grow slower than income, so the effective discount rate is higher than the real discount rate. Moreover, the differential growth rate between rich and poor countries determines the time evolution of the size of the equity weights. As there are a number of crucial but uncertain parameters, it is no surprise that one can obtain almost any estimate of the social cost of carbon. We even show that, for a low pure rate of time preference, the estimate of the social cost of carbon is indeed arbitrary—as one can exclude neither large positive nor large negative impacts in the very long run. However, if we probabilistically constrain the parameters to values that are implied by observed behaviour, we find that the expected social cost of carbon, corrected for uncertainty and inequity, is approximate 60 US dollar per metric tonne of carbon (or roughly $17 per tonne of CO2) under the assumption that catastrophic risk is zero. Data material available at http://www.fnu.zmaw.de/FUND.5679.0.html
Highlights
The social cost of carbon (SCC), the discounted value of damage associated with climate change impacts that would be avoided by a marginal reduction in carbon emissions along an arbitrary trajectory, is a useful measure for assessing the benefits of climate policy
Instead of following the lead of the Stern Review and imposing our own normative values on the selection of values for risk aversion and time preference, we look at the behaviours of democratically elected governments to infer distributions of these critical factors of Ramsey discounting that are used in practice
The Stern Review used the PAGE (Hope 2008) model—which truncates the tails of distributions of input parameters that FUND fully recognizes, but keeps vulnerability to climate change as in 1995 while FUND has vulnerability declining with development—the two main differences between the two models roughly offset one another if the evaluated with a similar time horizon
Summary
The social cost of carbon (SCC), the discounted value of damage associated with climate change impacts that would be avoided by a marginal reduction in carbon emissions along an arbitrary trajectory, is a useful measure for assessing the benefits of climate policy. The Review itself reported a SCC in excess of $300/tC in the absence of any climate policy for its lowest damage scenarios – an estimate that landed well above the range found in the previous literature (Tol 2005b) Many analysts attributed this to the very low rate of pure time preference adopted by the Stern author team (Arrow 2007; Jensen and Webster 2007; Mendelsohn 2008; Nordhaus 2007; Weyant 2008). Most of this material is standard, but we include it here for reasons of clarity and to suggest why it is important to look at all three aspects together; there are, in particular, no a priori reasons by which we can even predict the sign of changes driven by anything but time preference.
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