The True Cost of Fixing the Climate

Despite the brouhaha over stolen e-mails from the University of East Anglia, the science of climate change is well enough established by now that we can move on to the essential question: what's the damage going to be?

The total bill, if emissions are left unchecked, could reach 20 percent of annual per capita income, says Nicholas Stern, the British economist who led an influential Whitehall-sponsored study. That's ruinous—the world hasn't seen a drop in living standards like that since, well, never. But don't start stockpiling flour and batteries just yet. William Nordhaus, a Yale economist, puts his "best guess" at 2.5 percent of yearly global GDP. That's significant, but not apocalyptic. And according to Dutch economist Richard Tol, the economic impact of a century's worth of climate change is "relatively small" and "comparable to the impact of one or two years of economic growth."

These estimates aren't just different—they're different by an order of magnitude. And while some might dismiss the cost estimates as mere intellectual exercises, they're intellectual exercises with real impact. The Copenhagen meeting may be a bust, but countries from the United States to China are individual-ly considering cap-and-trade schemes, carbon taxes, and other expensive policies aimed at curtailing greenhouse gases. To be effective, a tax or cap-and-trade charge would have to force today's emitters to pay the true "social cost of carbon"—in other words, the amount of damage an extra ton of carbon will cause in the coming centuries.

Figuring out what that cost is, however, is no simple task. That's largely because most of the bill won't come due for many decades. A ton of carbon dioxide emitted today will linger in the air for anywhere from one to five cen-turies. Virtually every cost study shows that, even if economic growth continues apace and there's no effort to slash emissions, the damage from climate change will be negligible until at least 2075. It could take 100 years before we see noticeably negative effects, and even more before we need to launch massive construction projects to mitigate the damage. "How do you value the cost of having to build a dike or move a highway or an airport 100 years from now?" asks Nordhaus.

The answer is a bit of accounting sleight of hand called the discount rate, which is the focus of much of the controversy over the financial cost of climate change. In finance, the discount rate (generally the prevailing interest rate) is used to assign a present value to payments that happen in the future. So if Microsoft promises to pay its shareholders a $10 dividend in a year's time, accountants would discount that by today's interest rate (the prime rate is currently 3.25 percent) to come up with a current value of $9.67. If the payoff date were in 2019, the discount would be applied over 10 years, for a current value of $7.26—assuming interest rates stay the same over that period. Of course, they won't. "We're at basically a zero percent interest rate now," says Nordhaus. "But if you go back to 1981 and 1982, real interest rates were 20 percent." And if interest rates aren't constant over 20 years, they certainly won't remain constant over the -centuries-long lifetime of a ton of carbon. As a result, the estimated damage caused by that ton of carbon will change dramatically depending on what discount rate is used. "When you're talking about a 200-year span, the difference between discounting at zero percent and even 3 percent is enormous," says Nordhaus.

That makes it easy to distort cost estimates by tweaking one number—and that number has become a politicized tool. Stern came to his 2006 forecast of catastrophic economic fallout using a discount rate of 0.1, or essentially zero. Many academics dismiss this as far too low, since it implies that we care about our hypothetical great-great-grandchildren just as much as our flesh-and-blood children. Although we might like to think of ourselves as being that magnanimous, it clearly is not the case. Nordhaus has called the Stern review a "radical revision of the economics of climate change." Tol calls it "the best-known example of pseudoscientific exaggeration" and, in a meta-analysis of more than 200 cost estimates, concludes that the Stern review is an outlier. The critics charge that Stern's choice of discount rate was meant to accommodate not science but then–prime minister Tony Blair and his political priorities.

The other side chooses numbers strategically too. The Copenhagen Consensus Center, run by self-proclaimed "skeptical environmentalist" Bjørn Lomborg, has commis-sioned a number of cost-benefit estimates from prominent climate-change researchers. One paper by a team including Gary Yohe, an economist at Wesleyan University, used a discount rate of 5 percent. Yohe says, "That choice was imposed by Bjørn," who questions the benefits of taking drastic action against climate change. "Five percent is about as high as you could possibly justify using over such a long time horizon," says Yohe. Lomborg says it's well within standard practice and useful to employ a range of discount rates.

To some extent, the choice of discount rate is a value judgment. A lower rate makes the future seem more valuable relative to today, and justifies spending heavily to reduce carbon emissions now. That, certainly, is the conclusion of Stern, who recommends the world spend 2 percent of annual GDP, or $1.2 trillion a year, to offset the social cost of carbon, which he pegs at $314 per ton. The current political proposals for taxing carbon are far, far lower, with most in the range of $10 to $40 per ton. Those numbers are backed up by other, competing cost estimates—in fact, just about any tax can be justified by one of the hundreds of cost estimates out there, which range from $0 per ton to $2,400. Whatever strategy we ultimately decide on to limit carbon emissions, it'll be based not on science or economics but on politics.