Risk mitigation and the social cost of carbon

Abstract

The social cost of carbon – i.e., the marginal present-value cost imposed by greenhouse gas emissions – is determined by a complex interaction between factual assumptions, modeling methods, and value judgments. Among the most crucial factors is society's willingness to tolerate potentially catastrophic environmental risks. To explore this issue, the present analysis employs a stochastic climate–economy model that accounts for uncertainties in baseline economic growth, baseline emissions, greenhouse gas mitigation costs, carbon cycling, climate sensitivity, and climate change damages. In this model, preferences are specified to reflect the high degree of risk aversion revealed by private investment decisions, signaled by the large observed gap between the average rates of return paid by safe and risky financial instruments. In contrast, most climate–economy models assume much lower risk aversion. Given high risk aversion, the analysis finds that investment in climate stabilization yields especially large net benefits by forestalling low-probability threats to long-run human well-being. Accordingly, the social cost of carbon attains the markedly high value of $25,700 per metric ton of carbon dioxide in a baseline scenario in which emissions are unregulated. This value falls to just $4 per ton as the stringency of control measures is successively increased. These results cast doubt on the idea that the social cost of carbon takes on a uniquely defined, objective value that is independent of policy decisions. This does not, however, rule out the use of carbon prices to achieve the benefits of climate stabilization using least-cost mitigation measures.