Is Cost Benefit Analysis the Right Tool for Federal Climate Policy? »Yale Climate Connections


Cost-benefit analysis (CBA) may seem like the domain of clumsy bureaucrats tinkering around the edges of big policy initiatives. But ABC can have huge consequences, especially in the context of climate change. When calculating climate damage, seemingly small assumptions made by economists can make or break political intervention.

Think about how we make decisions about future earnings: Would you rather have a thousand dollars today or a year from now? The decision of a rational actor would be to receive the money now, because investing it will bring in more money in a year. This notion that the same amount of money is worth more now than in the future is applied in the ACA as a “discount rate”. A discount rate is essentially an assumption about future returns on capital. When applied over long periods in climate policy analysis, discount rates estimate future generations at pennies on the dollar.

Federal government suggests using discount rates of seven and three percent. With a 7% discount rate, $ 5,000 billion in climate change damage in 2100 would be valued at around $ 24 billion in 2021. A 3% discount rate would bring in $ 484 billion in 2021 A seemingly small assumption gives very different results for how much we should spend to avoid harming future generations. In addition, these rates are based on the assumption that the economy will continue to grow and create stable returns on capital over time. But as climate change worsens, the global economy can stagnate and destabilize, meaning the growth assumptions embedded in discount rates are no longer accurate. An economic growth assumption is used to justify additional emissions which may themselves destabilize growth.

To give another example, let’s say that an economist pose that the damage caused by climate change will be linear and extrapolates this damage based on scientists’ predictions of damage for 1 to 3 degrees Celsius of warming. But at higher temperatures, uncontrollable feedback loops could mean that the damage caused by climate change is much more severe than a linear model would predict. A cost-benefit analysis may reveal that a solar panel installation in your neighborhood will not be justified after using its linear damage prediction. But a more accurate model that takes into account the possibility of catastrophic damage might find that solar panels are a good investment.

Role of cost-benefit analysis on climate change

At present, almost all major federal policies must undergo a CBA before it can be implemented by the executive. This ABC process originated in the Reagan administration, but every administration since then has kept some form of it in place. President Biden could change this process by executive order if he wanted to pursue more aggressive climate policies. By changing the way climate policies are assessed and correcting some of the ABC’s biases against climate action, Biden could move towards more ambitious executive action.

President Biden has already shown some willingness to rethink how the costs and benefits of climate change are calculated. Following the Trump administration’s attempts to eliminate the social cost of carbon, Biden, on the day he was sworn in, summoned a task force to reinstate and update this important measure for government-wide emission reductions. So far the group has fix the cost roughly the same levels as the Obama administration ($ 51 per tonne of CO2 issued), but he intends to go further. The working group recognized in February that the models “used to produce these provisional estimates do not include all of the significant physical, ecological and economic impacts of climate change recognized in the climate change literature.” Group technical support documents admit that models’ quantification of climate change damage “lags behind the most recent research” and that because of this and other shortcomings, Obama-era figures “underestimate probably the societal damage caused by [greenhouse gas] emissions.

This process of reassessing the social cost of carbon is part of a growing scientific consensus. A plethora of new research suggests that previous analyzes have terribly underestimated the likely damage resulting from climate change. A higher social cost of carbon informed by this new research would allow us to better understand the short- and long-term damage. But refining the estimates for this variable is only part of a larger and more complicated picture: prominent economists have started to debate whether CBA is an appropriate approach to climate policy in terms of climate change. first place.

Beyond a higher social cost of carbon?

Cost-benefit analysis in the context of climate change is vulnerable to seemingly weak assumptions, creating massively skewed results. While some people believe these issues can be resolved by making more specific assumptions, others are skeptical of ACA.

MIT economist Robert Pindyck, for example, wrote that ABC climate models “have critical flaws that make them almost useless as tools for policy analysis:

  • “Some inputs (eg, the discount rate) are arbitrary, but have huge effects on the SCC estimates produced by the models.
  • descriptions of models of the impact of climate change are completely ad hoc, without theoretical or empirical basis; and models can’t tell us anything about CCS’s most important driver, the possibility of a catastrophic climate outcome.
  • [These] analyzes of climate policy create a perception of knowledge and precision, but this perception is illusory and misleading.

The assumptions and shortcomings of these models are not only arbitrary, but also biased. The most difficult benefits to quantify are often environmental values, such as species conservation or open spaces. While it is easy to calculate how much emissions reductions will cost a coal-fired power plant, it can be much more difficult to measure the broad societal benefits of such a policy.

Temple University lawyer Amy Sinden studied 45 ACAs conducted by the EPA for core rules between 2002 and 2015. She find that 80% “excluded categories of benefits that the agency itself described as being actually or potentially ‘important’, ‘significant’ or ‘substantial’ because they were not quantifiable due to data limitations . “

For these academics and other ABC skeptics, the ABC is so loaded with assumptions and biased that it probably cannot be saved, at least in the context of climate change.

Should cost-benefit analysis disappear?

Earlier this year, Nicholas Stern of the London School of Economics and Nobel Laureate in Economics Joseph Stiglitz of Columbia University published an paper suggesting that President Biden should reform the government’s approach to factor climate change into policy decisions. Stern and Stiglitz Argue that policymakers should:

  • “First, describe the likely consequences of climate change, within the framework of current arrangements;
  • second, to examine how the economy and emissions could be managed to give a good chance of stabilizing at different temperatures; and
  • third, to combine these two elements in a judgment on an approach to a temperature target.

This method is known as cost-effectiveness analysis.

Cost-effectiveness analysis deals less than CBA with preserving the economic benefits of greenhouse gas emissions, and more with evaluating the cheapest pathways to a more stable climate. Rather than trying to estimate an “effective” level of greenhouse gas emissions based on flimsy assumptions about future damage, Stern and Stiglitz suggest putting the plow behind the horse: by starting with the temperature objectives that elected officials wish to achieve, then by adjusting the economic activity and the resulting emissions to achieve these objectives. For example, climate policy could be built around a specific goal that warming does not exceed 1.5 degrees Celsius.

Not surprisingly, this provocative suggestion sparked controversy. Joseph Aldy, AJ Meyer and James Stock of Harvard and Matthew Kotchen of Yale released a reply in Stern and Stiglitz in Science last August. The confrontation between Stern and Stiglitz and their respondents seems to boil down to two main problems. First, are the existing climate-economic models sufficiently precise to be able to serve as a basis for setting emission limits in a situation of significant uncertainty? Stern and Stiglitz don’t think so. Second, would we prefer to set targets based on these models or through the political process? Stern and Stiglitz favor the latter.

The first question is empirical: some are optimistic on the capacity of models to better integrate climate science. Others combat that models are inherently laden with biased assumptions that discourage climate action. The second question raises deeply political questions about the comparative advantages of technocracy, democracy and markets. Cost-benefit analysis uses observed individual spending patterns as indicators of people’s desires, while cost-effectiveness analysis focuses on their collective political preferences. Cost-benefit analysis uses technocratic models to try to determine the most economically efficient outcome, and then shapes government action to match that outcome. Cost-effectiveness analysis, on the other hand, uses economic expertise to determine how to achieve a politically determined goal.

Reasonable minds can certainly differ on these two questions. But if the Biden administration is serious about breaking the boundaries of traditional economic cost-benefit analysis and reshaping the dialogue around climate policy, Stern-Stiglitz’s thesis may provide insight into doing just that. A cost-effectiveness analysis would justify more aggressive climate action than CBA.

Part 2 of this series, which will be released on October 15, will examine some of the legal and bureaucratic hurdles the Biden administration could face if it advocates for CBA reforms.

Lexi Smith is a third year student at Yale Law School. She studied environmental science and public policy as an undergraduate at Harvard, and worked as an advisor to the mayor of Boston on climate policy before enrolling in law school.


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