Harvard Environmental Economics Program

1 Martin L. WeitzmanHarvard UniversitySome Basic Economics of Extreme Climate ChangeHarvard Environmental Economics ProgramDiscussion Paper 09-10 Email: Website: Harvard Environmental Economics Program The Harvard Environmental Economics Program develops innovative answers to today s complex Environmental issues, by providing a venue to bring together faculty and graduate students from across the University engaged in research, teaching, and outreach in Environmental and natural resources Economics and related public policy. The Program sponsors research projects, develops curricula, and convenes conferences to further understanding of critical issues in Environmental and resource Economics and policy around the world.

2 Acknowledgements The Enel Endowment for Environmental Economics , at Harvard University, provides major support for HEEP. The endowment was established in February 2007 by a generous capital gift of $5 million from Enel, SpA, a progressive Italian corporation involved in energy production worldwide. HEEP enjoys an institutional home in and support from the Mossavar-Rahmani Center for Business and Government at Harvard Kennedy School. As its name suggests, the Center is concerned with the interaction of the public and private sectors, including with regard to Environmental issues. HEEP is grateful for additional support from: Shell, Christopher P. Kaneb ( Harvard AB 1990); the James M. and Cathleen D. Stone Foundation; Paul Josefowitz ( Harvard AB 1974, MBA 1977) and Nicholas Josefowitz ( Harvard AB 2005); and the Belfer Center for Science and International Affairs at the Harvard Kennedy School.

3 The Harvard Project on International Climate Agreements, co-directed by Robert N. Stavins and closely affiliated with HEEP, is funded primarily by a grant from the Doris Duke Charitable Foundation. HEEP along with many other Harvard organizations and individuals concerned with the environment collaborates closely with the Harvard University Center for the Environment (HUCE). A number of HUCE s Environmental Fellows and Visiting Scholars have made intellectual contributions to HEEP. Citation Information Weitzman, Martin L. Some Basic Economics of Extreme Climate Change Discussion Paper 2009-10, Cambridge, Mass.: Harvard Environmental Economics Program , April 2009. The views expressed in the Harvard Environmental Economics Program Discussion Paper Series are those of the author(s) and do not necessarily reflect those of the John F.

4 Kennedy School of Government or of Harvard University. Discussion Papers have not undergone formal review and approval. Such papers are included in this series to elicit feedback and to encourage debate on important public policy challenges. Copyright belongs to the author(s). Papers may be downloaded for personal use only. Some Basic Economics of Extreme Climate ChangeMartin L. WeitzmanFebruary 19, 2009 AbstractClimate change is characterized by deep structural uncertainty in the science cou-pled with an economic inability to evaluate meaningfully the welfare losses from hightemperature changes. The probability of a disastrous collapse of planetary welfarefrom too much CO2is non-negligible, even if this low probability is not objectivelyknowable.

5 This paper attempts to explain (in not excessively technical language) someof the most basic issues in modeling the Economics of catastrophic climate paper builds to a tentative conclusion that, no matter what else is done realis-tically to slow CO2buildups, economic analysis lends some support to undertakingserious research now into the prospects of fast geoengineering preparedness as astate-contingent emergency option o ering at least the possibility of knocking downcatastrophic temperatures IntroductionFour big questions often asked about climate change are: (1)how muchglobal warmingand climate change will occur; (2)how badwill it get; (3)whenwill all this occur; (4)whatshould be done about it. This paper attempts to explain why science and economicscannot resolve these questions to anywhere near the degree of accuracy that we have cometo expect from more traditional applications of cost-bene t analysis (CBA), because thereis so much deep structural uncertainty associated with climate change.

6 The unknownunknowns of climate change make CBA signi cantly more fuzzy in this arena than inmore traditional applications like constructing roads, strengthening bridges, or settingbuilding codes in earthquake-prone zones. The paper tries to make sense of this anomaloussituation and explores what might be done in terms of actionable alternatives under suchfuzzy change is so complicated, and it involves so many sides of so many di erentdisciplines and viewpoints, that no analytically-tractable model or paper can aspire to il-luminate more than a few facets of the problem. Because the problem is so complex,economists typically resort to numerical computer simulations. An Integrated AssessmentModel (hereafter IAM ) for climate change is a multi-equation computerized model linkingaggregate economic growth with simple climate dynamics in order to analyze the economicimpacts of global warming.

7 An IAM is essentially a dynamic model of an economy with acontrollable GHG-driven externality of endogenous greenhouse warming. IAMs have proventhemselves useful for understanding several aspects of the Economics of climate change es-pecially in describing outcomes from a complicated interplay of the very long lags and hugeinertias key starting point for any CBA of climate change should recognize that future temper-atures or damages cannot be known exactly and must be expressed as a probability densityfunction (PDF). Yet, most existing IAMs treat central forecasts of temperatures or dam-ages as if they were certain and then do some sensitivity analysis on parameter values. Inthe rare cases where an IAM formally incorporates uncertainty, it typically uses thin-tailedPDFs including, especially, truncation of PDFs at arbitrary cuto s.

8 (Often this truncationis more implicit than explicit because a nite discrete-point PDF is used.) What typicallyemerges from conventional IAM analysis is the so-called policy ramp of gradually tighten-ing emissions over time. The underlying rationale of the policy ramp is to postpone pain onclimate change prevention, because it is an investment whose payo comes only in the distantfuture (by human, if not geological, standards). When the distant-future payo times areconsidered, the rate of return on GHG mitigation is lower than the rate of return on edu-cation, health, infrastructure, or a variety of other quicker-yielding public investments. Aswill be explained later, policy-ramp gradualism seems quite sensitive to the functional formof the assumed disutility of high temperature changes, to how the extreme tail probabilitiesare speci ed, and to the rate of pure time preference used to discount future utilities uncertain catastrophes presents some very strong challenges to economic analy-sis, the full implications of which have not yet been adequately confronted.

9 Cost-bene tanalysis based on expected utility (EU) theory has been applied in practice primarily tocope with uncertainty in the form of a known thin-tailed PDF. I will argue that the PDFof distant-future temperature changes is fat tailed. A thin-tailed PDF assigns arelativelymuch lower probability to rare events in the extreme tails than does a fat-tailed (Even1As I use the term, a PDF has a fat (or thick or heavy ) tail when its moment generating function(MGF) is in nite , the tail probability approaches zeromore slowlythan exponentially. The standard2though both limiting probabilities are in nitesimal, theratioof a thick-tailed probability di-vided by a thin-tailed probability approaches in nity in the limit.) Not much thought hasgone into conceptualizing or modeling what happens to EU-based CBA for fat-tailed dis-asters.

10 A CBA of a situation with known thin tails, even including whatever elements ofsubjective arbitrariness it might otherwise contain, can at least in principle make comfortingstatements of the generic form: if the PDF tails are cut o here, then EU theory will stillcapture and convey an accurate approximation of what is important. Such accuracy-of-approximation PDF-tail-cuto statements, alas, do not exist in this generic sense for whatin this paper I am calling fat-tailed CBA. Fat-tailed CBA has strong implications that have neither been recognized in the litera-ture nor incorporated into formal CBA modeling of disasters like climate-change catastro-phes. These implications raise many disturbing yet important questions, which will be dealtwith somewhat speculatively in the concluding sections of this paper.