Cost/Benefit Analysis of Waxman-Markey

Is Mitigating Climate Change Worth It?

It comes down to this: What do we pay and what do we get?
BY JAMES MANZI

The Public discussion of climate change has operated on many levels: A scientific debate about the human contribution to climate change, an economic debate about the costs of avoiding catastrophe and a moral debate about our responsibilities. I propose to consider it on a practical level. Advocates for aggressive reductions in global greenhouse gas emissions are asking us to forgo consumption today in return for future benefits in the form of reduced expected damage from climate change. That is, they are making an invest request. What are the expected economics of this proposed investment?

Background Analysis

According to the authoritative U.N.Intergovernmental Panel on Climate Change (IPCC), under a reasonable set of assumptions for global economic and population growth, the world should expect to warm by about 2.8°C over the next century. Also according to the IPCC, a global increase in temperature of 4°C should cause the world to lose about 1–5 percent of its economic output. So if we do not take measures to ameliorate global warming, the world should expect to be about 3 percent poorer sometime in the 22nd century than it otherwise would be. This is very far from the rhetoric of global destruction. Because of its geographical position and mix of economic activities, the United States is expected to experience no net economic costs from such warming through the end of this century, and to begin experiencing net costs only thereafter. The White House and Congressional leadership are now making the most serious push ever for legislation to force reductions of U.S. carbon-dioxide emissions for the stated purpose of reducing potential future harm from human-caused climate change. The vehicle is a climate- and-energy bill, commonly referred to as Waxman-Markey. It has passed in the House, and the Senate is considering it.

A government program to force emissions reductions to avoid some of these potential future losses would impose a cost of its own: the loss in consumption we would experience if we used less energy, substituted higher-cost sources of energy for fossil fuels, and paid for projects—which are termed “offsets”— to ameliorate the effect of emissions (an example would be reforestation). It’s complicated to estimate the cost of an emissions reduction program, but the leading economists in this area generally agree that it would be large, and that we should simply let most emissions happen, because it would be more expensive to avoid them than to accept the damage they would cause. This makes sense, if you consider that most such plans (for example, Waxman-Markey) call for eliminating something like 80 percent of carbon emissions within the next 40 years or so. Even if the economy becomes more efficient over this period, such a quick transition away from our primary fossil fuel sources will be expensive.

If a) the total potential benefit of emissions abatement is about 3 percent of economic output more than 100 years from now, b) we can avoid only some of this damage and c) it’s expensive to prevent those emissions that we can prevent, the net benefit of emissions reduction will likely be a very small fraction of total economic output. William Nordhaus, who heads the widely respected environmental-economics- modeling group at Yale, estimates the total expected net benefit of an optimally designed, implemented and enforced global program to be equal to the present value of about 0.2 percent of future global economic consumption. In the real world of domestic politics and geostrategic competition, it is not realistic to expect that we would ever have an optimally designed, implemented and enforced global system, and the side deals made to put in place even an imperfect system would likely have costs that would dwarf 0.2 percent of global economic consumption. The expected benefits of emissions mitigation do not cover its expected costs. This is the root reason that proposals to mitigate emissions have such a hard time justifying themselves economically.

The mechanism for mitigation proposed in the Waxman-Markey bill is a “cap-and-trade” plan. Despite the gee-whiz name, the idea is quite simple: The government sets a fixed annual limit to total carbon-dioxide emissions and distributes ration cards for the right to emit a portion of this amount (that’s the “cap”); it also allows those who receive ration cards to sell them (that’s the “trade”). The Obama administration originally expected to sell ration cards, bringing the government $80 billion a year in revenue over the next decade. This revenue represents a cost increase for more or less any company that uses lots of fossil-fuel energy in one way or another (i.e., most of the economy). Like all raw-material cost increases, these will be passed along to consumers in the form of higher prices. So in reality this is a backdoor tax on energy that conscripts private companies into being collection agents. In fact, the political horse trading that was required just to get the bill through the House has resulted in so many permits being given to powerful industries, that there appears to be no hard cap on emissions for the next 10 years, and the government now expects to collect only about $2 billion per year for the next decade—all that’s left of the bill for the foreseeable future is the economic inefficiencies it imposes and the political rents.

Cost/Benefit Analysis of Waxman-Markey

But could these costs be justified by the benefits we could expect Waxman- Markey to create over time? Let’s start with the costs. The Environmental Protection Agency (EPA) has done the first cost estimate for Waxman-Markey. It finds that by 2020Waxman-Markey would cause a typical U.S. household to consume about $1,100 less per year than it otherwise would by 2050. (This projection does not factor in potential benefits from avoiding warming.) That doesn’t sound like the end of the world, but this cost estimate is based on a number of assumptions that are unrealistic, to put it mildly.

First, it assumes that every dollar collected by selling the right to emit carbon dioxide will be returned to taxpayers through rebates or lowered taxes. Waxman-Markey establishes this intention but doesn’t describe how it would be achieved, which reflects the political difficulty of achieving it. Second, it assumes no costs for enforcement and other compliance measures. Third, it assumes that large numbers of cheap emissions credits from foreign countries will be available for purchase; without these, costs to our domestic companies would be far higher. Fourth, it assumes that the rest of the world will begin similar carbon reduction programs. (Lack of such foreign action would either increase U.S. costs or risk a trade war if we tried to compensate for lack of international cooperation with targeted tariffs.) Fifth, it assumes that there will be no exemptions, free ration cards or other side deals—that is, no economic drag created by the kind of complexity that has attached to every large, long-term revenue-collection program in history.

The EPA forecast is something like an estimate of what would happen in a laboratory, under ideal conditions; in the real world, expected costs are far above 0.8 percent of economic consumption by 2050. The EPA does not forecast costs beyond 2050.

The role for the U.S. federal government is to fund prediction, mitigation and adaptation technologies that would provide alternatives in the event that we discover that future climate damages are far worse than currently anticipated.

Remember that the U.S. should not expect any net economic damage from global warming before 2100. That is, the bill’s benefits would accrue to U.S. consumers— who are also bearing its costs— sometime in the next century. The EPA underestimate has costs rising from zero to 0.8 percent of consumption between now and 2050, and offers no projection beyond that year; but to what level would costs rise over the more than 50 years between 2050 and the point in the 22nd century when we might actually expect some net economic losses from global warming? The answer is likely to be much higher than 0.8 percent of consumption.

Now consider the potential benefits, of which neither the EPA nor the bill’s sponsors have produced an estimate. Standard climate models project that, under the scenario for global economic and population growth referenced above, Waxman-Markey’s emissions reductions would have the net effect of lowering global temperatures by about 0.1°C by 2100.

Remember that the estimated cost of a 4°C increase in temperature (40 times this amount) is about 3 percent of global economic output. Assume for the moment that global warming has the same impact on the U.S. as a percentage of GDP as it does on the world as a whole (an assumption that exaggerates the impact on the U.S.). A crude estimate of the U.S. economic costs that Waxman-Markey would avoid sometime later than 2100 would then be about one-fortieth of 3 percent, or about 0.08 percent of economic output. This number is one tenth of 0.8 percent, the EPA’s estimate of consumption loss from Waxman- Markey by 2050. To repeat: The costs (of Waxman-Markey) would be more than 10 times the benefits, even under extremely unrealistic assumptions of low costs and high benefits. More realistic assumptions would make for a comparison far less favorable to the bill.

I’ve had to rely on informal studies and back-of-envelope calculations to do this cost/benefit analysis. Why haven’t advocates and sponsors of the proposal done their own? Why are they urging Congress to make an incredible commitment of resources without even cursory analysis of the economic consequences? The answer should be obvious: This is a terrible deal for American taxpayers.

Two Common Objections

One potential objection to my analysis is that the bill is part of a global drive for all countries to reduce emissions, and that the U.S. needs to “show leadership.” By this logic, we should ascribe much larger benefits to the Waxman-Markey bill—specifically, the benefits to American consumers of the whole world’s engaging in similar programs. There are two obvious problems with this argument, however. First, ascribing all of the benefits of a global deal to reduce emissions to a specific bill that does not create such a commitment on the part of any other countries is loading the dice. The benefit we should ascribe to the bill is rather that of an increase in the odds of such a global deal. But would Waxman- Markey actually increase them, or might it decrease them instead? Whenever one nation sacrifices economic growth in order to reduce emissions, the whole world can expect to benefit, because future temperature should decrease for the entire globe. Every nation’s incentive, therefore, is to free ride on everybody else. Our most obvious leverage with other emitting nations would be to offer to reduce our emissions if they reduced theirs.

You may not be a climate change expert, but I bet you’ve negotiated things in your career. What do you think of a negotiating strategy that calls for giving up this leverage and hoping that our unilateral reductions would put moral pressure on those nice men who rule China, Russia, Brazil and similar countries to reduce their emissions? Second and more fundamentally, even if the whole world were to enact similar restraints on emissions, the economics would still not be compelling, for the reasons outlined at the beginning of this article.

Scare stories are meant to be frightening, but we shouldn’t become paralyzed by them.

A second potential objection to my analysis is that we owe it to the rest of the world to limit our emissions because of our historical role as an emitter. What this ignores is that the reason the U.S. and Europe have historically emitted carbon dioxide is that they invented the modern economy. Along with putting all that carbon dioxide in the air, the West invented the polio vaccine, the limited- liability corporation, the high efficiency power turbine and so on. It invented, that is, the tools for creating wealth that successful parts of the developing world are now using to escape poverty—and, incidentally, to emit more carbon dioxide. It is less than obvious why we should put a special burden on the West to make reparations for carbon-dioxide emissions while ignoring the fact that the net global effect of the system that created these emissions has been extremely positive.

Ask yourself this question: Would you rather be born at the median income level in Bangladesh today, or at the median income level in Bangladesh in an alternative world in which the entire Northern Hemisphere never escaped life at the subsistence level—that is, to live in a world of lower carbon emissions, but no science, no hospitals, no foreign aid and no meaningful chance of changing the material conditions of your life? If advocates of Waxman- Markey intend it to be, in effect, a gigantic, and spectacularly inefficient, foreign aid program for people yet to be born in equatorial regions of the globe, they should at least be clear about this.

The Problem of Uncertainty

A third and more serious potential objection to my analysis is that while Waxman-Markey may not create benefits if the projections I offered above turn out to be accurate, climate science is highly inexact, and the bill is an insurance policy against higher-than-expected costs. Now, climate and economics modelers aren’t idiots, so it’s not as though this hadn’t occurred to them. Competent modelers don’t assume only the most likely case, but build probability distributions for levels of warming and associated economic impacts (e.g., there is a 5 percent chance of 4.5°C warming, a 10 percent chance of 4.0°C warming and so on).

The economic calculations that compose, for example, the analysis by William Nordhaus that I cited earlier are executed in just this manner. So the possibility of “worse than expected” impacts means, more precisely, the possibility of “impacts worse than those derived from our current probability distribution.” That is, we are concerned here with the inherently unquan-tifiable possibility that our entire probability distribution is wrong.

This concept has been called, somewhat grandiosely, the “precautionary principle.” Once you get past all the table- pounding, this is the crux of the argument for emissions abatement. It is an emotionally appealing political position, as it is easy to argue that we should oppose some consumption now to head off even a low-odds possibility of disaster.

But this is to get lost in the world of single-issue advocates and become myopic about risk. We face lots of other unquantifiable threats of at least comparable realism and severity. A regional nuclear war in central Asia, a global pandemic triggered by a modified version of the HIV virus and a rogue state weaponizing genetic- engineering technology all come immediately to mind. Any of these could kill hundreds of millions of people. Scare stories are meant to be frightening, but we shouldn’t become paralyzed by them.

We should be very cautious about implementing government programs that require us to slow economic growth and technological development in the near term in return for the promise of avoiding inherently uncertain costs that are projected to appear only in the long term. Such policies conceal hubris in a cloak of false humility. They inevitably demand that the government coerce individuals in the name of a nonfalsifiable prediction of a distant emergency. The problem,of course, is that we have a very bad track record of predicting the specific problems of the far future accurately.

We can be confident that humanity will face many difficulties in the upcoming several centuries, as it has in every century. We just don’t know which ones they will be. This implies that the correct grand strategy for meeting them is to maximize total technical capabilities in the context of a market-oriented economy that can integrate highly unstructured information into prices that direct resources, and, most important, to maintain a democratic political culture that can face facts and respond to threats as they develop.

What Should We Do?

In the face of massive uncertainty on multiple fronts, the best strategy is almost always to hedge your bets and keep your options open. Wealth and technology are raw materials for options, and a much more sensible strategy to deal with climate risk would emphasize technology rather than taxes. The role for the U.S. federal government is to fund prediction, mitigation and adaptation technologies that would provide alternatives in the event that we discover that future climate damages are far worse than currently anticipated.

The danger here, of course, is that we may end up back in the failed game of industrial policy. The federal government, after all, was the key sponsor of, for example, the shale-oil and large-scale-wind-turbine debacles in response to the energy crisis 30 years ago. Setting the right scope for such a program and managing the funding process carefully would be essential to prevent it from becoming corporate welfare.

Government investments should meet specific criteria: They should be related to detecting or ameliorating the effects of global warming, serve a public rather than a private need and provide no obvious potential source of profit to investors if successful. Examples would include improved global-climate-prediction capability, biotechnology to capture and recycle carbon-dioxide emissions, and geo-engineering projects to change the albedo of the earth’s surface or atmosphere. In contrast, most technologies that would contribute to the ongoing long-run transition of the economy away from fossil fuels, such as more efficient fuel cells for autos or lower-cost solar power sources, need no government funding, since there is ample profit motive to develop them. Massive amounts of venture funding and large-company internal capital allocations are flowing to these opportunities right now. Government attempts to direct such development would almost certainly destroy value through political allocation of resources.

Clarity about costs and benefits is the enemy of the Waxman-Markey proposal. No amount of tinkering is going to change the fundamental reality that even a perfect implementation of the Waxman-Markey concept is a very poor economic deal for Americans. The alternative should not be tax-based or rationing-based efforts to make energy more expensive, but a targeted research program to provide insurance against unanticipated and unpredictable consequences. We should keep coming back to one practical question: What do we pay, and what do we get?

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JimManzi is a senior fellow at theManhattan Institute and executive chairman of Applied Predictive Technologies (APT), an Arlington, Va.-based applied artificial intelligence software company.