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Below a small article I submitted to 'Planners' Newsletter' as an item for discussion.
'Planners' Newsletter' was an e-mail forum within Shell up until 2004.

Economics and Climate Policies
the fallacy of cost benefit assessments

by Evert Wesker, with reference to
to an article from ESB (see bottom)

The economics of climate policies are quite often characterized by the following notions:

  • Cost benefit assessments
  • Optimal policy
  • ‘Optimal’ timing

To be able to make a cost benefit assessment a project (or a scenario) needs to be defined, which starts from an assumed emission reduction (of greenhouse gases), a climate change or a combination of both.

As the benefits of a climate policy include the costs avoided due to climate change, it is required to know the potential climate changes irrespective of the policy to be implemented.

Dealing with uncertainties

However, there is a great uncertainty in each step in the following cause-consequence chain:

Emission of greenhouse gases, effects on the climate, subsequent consequences for the hydrosphere and the biosphere, social / economic reactions and finally the consequences for (human) health and the wealth distribution in the world.

This is already very difficult or next to impossible for ‘normal’ climate change scenarios. In such studies the consequences of a ‘drastic’ scenario (e.g. a temporary shut-down of the North Atlantic drift, putting Europe in the cold) are not included. And my feeling is that they cannot be included. It would end up in wild speculations.

Another source of uncertainty is the issue of local developments all over the world. It is on a timescale of say 50 years very difficult to forecast what will happen where (from an economic point of view). The same holds for climate change projections. For the World as a whole, forecasts can be made (with quite a margin of uncertainty: a temperature rise of 1.5-6 degrees C by 2100), but as soon as one tries to make more localized forecasts the margins of uncertainty become even bigger.

Secondly, damaging weather incidents tend to behave very erratically. When in 1992 Andrew made its $30 billion hit onto Florida, the Caribbean enjoyed a quiet hurricane season! Since 1995 (with exception of the El Niño year 1997) there has been much more hurricane activity in the North Atlantic and the Caribbean. In spite of this there haven’t been any real straight hits like Andrew. This may be plain luck, but makes the point quite clearly.

There is no ‘optimum’

A serious and solid climate policy will include structural adjustments in the energy infrastructure and transportation systems. This will require increased fundamental knowledge, technical innovation and a drastic change in the way infrastructures are run.

It will also imply the unlocking of dominant technologies, especially in the fields of energy, materials and transport. However, necessary changes in the economic structures are uncertain and may well develop more slowly than anticipated. Therefore it is in my opinion wise to stimulate the developments mentioned above at an early stage.

The notion of an ‘optimal’ investment strategy with respect to these new developments, e.g. looking for a good timing, is in my opinion leaning too much on the assumption that the future is predictable and can be managed into a desired direction. (In Dutch: "maakbaarheid")

Dealing with complexity

We are dealing with a very complex issue which is characterized by uncertain facts, values in dispute, high stakes and potentially urgent decisions.

As typified above, it is extremely doubtful whether it is possible to make a model of a climate-biosphere-economy system. The report "Limits to Growth" of the Club of Rome contained a model which was slashed down as too simplistic by many economists. But are the present models on the economics of climate change much better? As an example, one may look at the following: as a consequence of climate change, food production collapses in a part of the world. If this is a (highly) developed country it will mean a decrease of its Gross National Product by 1-2%. However, needless to say, the consequences can be much more far reaching. It may initiate a total economic collapse.

If one compares the risks of climate change with the ‘tiny chance - catastrophic effects’ of nuclear energy, one can observe that cost benefit assessments didn’t play a role in the debate on the use of nuclear energy. One could take a similar stance with respect to climate change.

A precautionary approach

Adaptation under stable conditions is safer than adaptation under unstable conditions. Waiting longer in order to get more information is not useful. The biosphere is so complex that the position of critical thresholds remains an unknown. Therefore the chance of a discontinuous catastrophic change can never be eliminated. Against this background, a climate policy based on a strategy of precaution is a rational one.

The use of cost benefit assessments is in my opinion useless, even harmful. They are often only used to maintain the status quo by opponents of climate policies, in spite of the fact that the value of these assessments is extremely nebulous.

What finally remains is the debate on how far one should go in the use of the precautionary principle, and how it should be handled. This is not always done in a proper way, as was shown in the Waddenzee (a fragile coastal wetland in the Netherlands) discussion in the Dutch parliament. Drilling (for natural gas) was forbidden, whilst the effects on the environment would be very small, but fishing for cockles and mussels was not forbidden in spite of proven adverse effects (it contributed to mass starvation of Eider Ducks).

Ref: ESB, 8 maart 2002, J.C.J.M. van den Berg, "Economie van klimaatbeleid: kritiek en alternatief"
I was thinking about writing something similar - in line with other stuff on this site - when I read this excellent article. I dicided to use it straight away and turn it into a discussion item on my internet site and within Shell. (E.W.)