presentation to the research seminar on “complexity economics … · 2015. 5. 22. · 1 the...

1

The Global Deal: treating anthropogenic climate change as

an economic internality

Terry Barker, University of Cambridge

Presentation to the research seminar on “Complexity Economics for Sustainability” supported by the UK ESRC

and the Environment Agency, Oxford, 27-28 November 2008

FP6 project no. 018476-GOCE : Adaptation and Mitigation Strategies: Supporting European Climate Policy

2

Outline: The Global Deal• Summary: the global deal as an immediate solution to the

twin climate and financial crises• Contrasting “new economics” with “traditional economics”

– interpreting the “evidence” from equilibrium modelling• A new economics understanding

– the twin crises and their common solution (in the short term)– the whole-systems concept of “internalities”

• The global deal– transforming the global energy and economic systems through

internationally-coordinated climate policy portfolios– air-quality and climate-change synergies– the role of technology policies (standards and fiscal incentives)

• Why portfolios including strong regulation provide an efficient solution to the crises

• Interpreting the net economic benefits (benefits-costs) of the global deal: the positive sum solution to the crises in which every negotiating country benefits

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Summary • The twin climate and financial crises require solutions

that reduce systemic risks of wild weather and global depression

• The G8 50% target or 450ppmv CO2-eq are probably not stringent enough to avoid dangerous climate change (AR4)– a zero-carbon global target is required by at least 2050

• Current monetary and fiscal policies are rapidly worsening the credit crunch, by eroding trust in money

• An urgent and strong global fiscal reflation, based on new investment justified by social values and discount rates, will take up resources left unemployed by the credit crunch, and kick-start the much delayed shift towards decarbonising the global economy– costs critically depend on international co-ordination

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6

Climate change policy and economics: traditional models are “past their sell-buy date”Critical

differencesTraditional economics

New economics

ethics and society

Utilitarian: optimising rational self-interested individuals

Observed: satisficing altruistic punishers in evolving social groups

time and equilibrium

Full employment forever: higher GDP growth ruled out by assumption; no double dividend for policy

Path-dependency: many unused resources and new business plans in response to threats

uncertainty Normal: distributions derived from the past; use of “certainty equivalence”

Non-linear: catastrophic surprises are inherent in complex systems

technology Exogenous: CGE and growth models have no feedbacks via technology

Induced: by climate policies

7

Treatment of values

new•

values formed by social groups

•

multiple values

•

no optimum•

value of human life from social consensus depending on context

traditional•

individual independent preferences

•

monetized social welfare

•

an optimal solution•

value of human life from economic theory and observation

8

Treatment of location effects

new•

place of pollution and transmission of effects over distance is critical

•

climate and geography matter

•

diffusion of effects usually makes clean-up impossible

traditional•

no treatment of place in elementary theory

•

all activity at points in space

•

no transport costs•

no diffusion effects

9

Treatment of temporal effectsnew

•

non-linear systems assumed with chaotic behaviour

•

time and duration of pollution and effects intrinsic to problem

•

dynamic analysis•

irreversibilities (through accumulation of stocks)

traditional•

existence of equilibrium assumed

•

no treatment of time lags in elementary theory

•

static analysis•

implicit symmetry in timing, and reverse flows if costs

10

Theoretical consistency

new•

highly context specific

•

maturing but fragmented theory

•

draws on practical solutions of ecological problems

traditional•

based on coherent theory

•

generally applicable to many problems

•

draws on massive body of economic theory

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New economics is better than traditional in explaining the characteristics of the global

economy• Specialising production & generalising consumption

• increasing trade leading to more currency unions, lower trade barriers

• global branding and life-styles• markets increasing in numbers, scale and specialisation with

associated reduction in costs

• Competitive innovation & obsolescence • information costs falling rapidly

• Persistent long-term trends in all regions• rural to urban• agriculture to manufacturing to services• more human & product mobility (travel to work, tourism, migration)

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New economics is better than traditional in explaining the characteristics of the global energy system

• Increasingly unequal distribution of oil & gas resources– proven oil reserves concentrated in OPEC– gas supplies increasing insecure

• Plentiful coal, limited proven oil and gas– escalating costs for oil extraction

• Transport costs falling – economies of scale in pipelines and tankers

• No clear trend in oil price volatility

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Most equilibrium models are unsuitable for analyses of the economy, the energy system or

climate stabilisation• Use of one year’s data for 100-year projection

– all dynamic characteristics of responses are assumed– lack of attention to trends leads to incoherent GDP

projections• Assumption of constant returns to scale

– no treatment of systemic changes across all sectors, led by technological change and increasing returns to scale e.g. computing and telecoms technologies

• Based on inappropriate theory– in general CGEs have no stable or unique equilibria

(Ackerman, 2002; DeCanio, 2003) (see notes for literature)

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BUT: equilibrium models dominate quantitative sustainability analysis

• IPCC IAM SRES/TAR/AR4 models – all use economic cost components based on DICE/CGE- type models e.g. MARKAL-MACRO

• EMF16/19/21 studies: nearly all models are equilibrium (both aggregate and CGE)

• World Bank: CGE appears to be methodology of choice for structural analysis

• In summary it is a very popular methodology– extensive CGE literature and many applications for policy– flourishing world-wide CGE community– solution software (GAMS) and specially-constructed CGE

database and parameters of standard forms are available (GTAP)

– cheap or even free DICE/FUND/CGE models (just 1 week of your time to build one, but garbage-in-garbage-out)

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E.g. characteristics of the EMF21 models: (1) most models are equilibrium-based (2) but the equilibrium approach is misleading if not wrong

Source: Van Vuuren, D.P., J. Weyant, and F. de la Chesnaye, 2006a. Multi-gas scenarios to stabilize radiative forcing. Energy Economics, 28, pp. 102-120.

Colour code

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Macroeconomic modelling of mitigation policies 2009-2020

• Sectoral approach helpful (c/f aggregate models such as DICE or FUND)– substitution by gas is an important mitigation option– fuel-using sectors (power, transport, residential) have

different costs of mitigation– carbon-saving capital can use very different

technologies and life-times (CCGT’s, car engines, dwellings)

• Use of fuels depends on capital stock, so short- term price responses may be low: therefore CGE models can be very misleading for annual analysis

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IPCC AR4 WG3 chapter 3 GDP losses: (1) not all models show that policies lead to GDP costs (2) the increase in costs as targets become more stringent is illusory

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5

Stabilization level (W/m2)

GDP

loss

es in

203

0 (p

erce

nt p

er y

ear)

A1 A2 B C D E

G(

)

ISGM - CCSP

MERGE - CCSP

MiniCAM - CCSP

MESSAGE - A2

ASF - A2 PS

AIM - A1 - PS

MiniCam - A1 - PS

WorldScan - A1 - P

DEMETER - IMCP

ENTICE - IMCP

MIND - IMCP

RICE FAST - IMCP

MESSAGE - B2

WorldScan - B2 - P

MESSAGE - B1

2030

5

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5


GDP

loss

es in

205

0 (p

erce

nt per

yea

r)

A1 A2 B C D E

2050

2100

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5


GDP loss

es in

210

0 (perce

nt per yea

r)

ISGM - CCSP

MERGE - CCSP

MiniCAM - CCSP

MESSAGE - A2

ASF - A2 PS

AIM - A1 - PS

MiniCam - A1 - PS

WorldScan - A1 - P

DEMETER - IMCP

ENTICE - IMCP

MIND - IMCP

RICE FAST - IMCP

MESSAGE - B2

WorldScan - B2 - P

MESSAGE - B1

A1 A2 B C D E

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year 2030

FUND Cat. B

CCSP-IGSM

0

20

40

60

80

100

120

140

-60 -55 -50 -45 -40 -35 -30 -25 -20 -15 -10 -5 0

CO2 (% difference from base)

Car

bon

pric

e $(

2000

)/tC

O2-

eq

IMCP 450ppmvCO2-only

EMF21 4.5 W/m2CO2-only

Other 550 CO2-eq stabilisation

EU ETS price April

2005

Carbon prices and CO2 effects for 550ppm CO2 -eq stabilisation from modelling studies: outliers can lead to mis-representative results

Note that to achieve the stabilisation target, non-CO2 GHGs are also assumed to be reduced by the CO2 -equivalent prices for all scenarios shown.

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New economics• all economic activities are specific to a place

and a time (representative agent assumption is not just wrong but misleading)

• the presumption is that all people and social groups are different (different location, different history)

• econometrics is about averaging & finding tendencies

• ecological “whole systems” economics dominates the individual utility-maximising rational economic man-molecules of 19thC energetics-based general equilibrium

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Assessing risk and return• Risks are different for climate change, adaptation,

mitigation and the financial crisis– for countries and time periods– outcomes are not smooth, but can be abrupt and irreversible– risks can be asymmetrical: e.g. (unbounded?) risks of higher rather

than lower temperatures and sea level rise

• There are possibilities of catastrophe (IPCC WG1 Box 10.2: approx. 3% probability of climate sensitivity leading to > 8ºC).– conventional cost-benefit analysis is “especially and unusually

misleading” (Wietzman, 2007)– and a sea level rise of several meters over this century

cannot be ruled out (Hansen et al, 2008)• Assets such as the Amazon rainforest or coral reefs

cannot be substituted by money, partly because their loss is effectively irreversible

• Economic assessment should cover both costs & benefits and such risks, e.g. of collapse of banks

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The Big Crunch• With the bankruptcy of Lehman Brothers (15/09/08),

the global money stock was abruptly reduced by an unknown amount

• Many if not all banks with substantial exposure to “toxic” debt may now be insolvent, depending on stock market valuations

• The crisis became apparent when banks ceased to trust one another in summer of 2007, but has been concealed by creative accounting and failure to value assets at realizable values

• The crisis is one of international money: the banks have been creating new forms of money that are now seen to have a highly uncertain worth, i.e. “bad money”

• The Fed’s proposal (19/09/08) was to exchange the bad money for good government-backed money, then gradually liquidate the underlying debt

• On 12/11/08 the Fed abandoned plans to buy toxic assets in favour of recapitalisation

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Dow Jones Index - 1980 to 2008

6.00

6.50

7.00

7.50

8.00

8.50

9.00

9.50

10.00

02/0

1/19

80

02/0

1/19

82

02/0

1/19

84

02/0

1/19

86

02/0

1/19

88

02/0

1/19

90

02/0

1/19

92

02/0

1/19

94

02/0

1/19

96

02/0

1/19

98

02/0

1/20

00

02/0

1/20

02

02/0

1/20

04

02/0

1/20

06

02/0

1/20

08

Log

of D

ow J

ones

Inde

x

International banking crisis, 1980 - 1982

SE Asian & Russian crises, 1997 - 1998

Dot Com bubble, 10/3/2000

Black Monday, 19/10/1987

The Big Crunch: history 1980 to present

Lehman crash, 15/9/2008

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The Big Crunch: history of the OIS spread

Losses rise Q3 to Q4; Fed cuts

interest rateRun on Northern Rock

Bear Stearns collapse

Indy Mac fails and is taken over

Lehman collapse

Bear Stearns pledge $3.2 bn to

bailout hedge fund

OIS: Overnight Indexed SwapSwap spreads reflect expectations of credit risks and of interbank lending risksSource: to be confirmed.

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The Big Crunch changes everything: economic

activity is based on trust, and trust in money has gone

• Trust underlies our use of money• Private banks lost some of our trust• No trust = no banking• No banking means no bank loans for real

investment (or consumption)• The Big Crunch = global financial catastrophe

– Non-linear event with extreme outcomes– Unprecedented in economic history in its scale– Unlike the tulip mania or South Sea Bubble, it is not primarily based

on speculation, but on banks creating money – The bail-outs deepen and prolong the depression

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The Big Crunch and Global Warming• Similarities

– Both arise out of the pursuit of self-interest– Both are market failures associated with systemic risk and,

arguably, both are the greatest market failures the world has ever seen

– Both are highly nonlinear systems’ failures leading to extreme events (economic and climatic)

– Both threaten the economy with catastrophic collapses– Both require strong regulation for efficient economic outcomes

• Differences– Timing: big crunch happened in a day, arguable a week, year,

or even two decades; global warming is a four-century process– Risks: big crunch risks are to trust in money and global

deflation; global warming risks are wild weather and floods/droughts

– Solutions: big crunch requires and supports immediate solution (banks reputations destroyed; global warming solutions can be delayed and subverted more easily by special interests

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Anthropogenic climate change as a whole-system internality

• Proposed new macro definition (c/f/ Wikipedia’s behavioural economics micro definition of personal “types of behaviours that impose costs … in the long-run that are not taken into account when making decisions in the present.”)

• Whole-systems internalities are “social behaviours (such as those leading to emissions of greenhouse gases) that impose costs on future generations, which do not take into account these costs when decisions are made by present generations.”

• For example, at the level of global economic activity, greenhouse gas emission (GHG) is an internality affecting crops and real estate, but solar activity is an externality affecting the biosphere and radio communication.

• Traditional economics treats GHG emissions as an externality assuming that the organisations, such as oil companies, take into account the effects of their actions on themselves, but not on others. In fact, because such social groups are myopic, they do not take any such effects into account and therefore the Pigouvian tax/permit rate are too low, even in the traditional approach.

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The Big Crunch: implications for climate policy

• The period of the creation of the bad money has seen a massive mis-allocation of investment funds towards the financial services

• The real investments supported by these services and the incomes from them (buildings, luxury goods etc) will stop and engender a global recession

• The gap in global effective demand could be closed by a massive effort to invest in decarbonising the real economy, but requires– Recognition of the opportunity– Rapid development and deployment of mitigation policies

aimed at raising investment especially where real resources are becoming unemployed (construction, vehicle manufacture)

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Solution: a seven-point plan1. Allow markets to work and bankrupt bad banks, whilst

maintaining their institutional knowledge2. Co-ordinate an global interest-rate cut to zero3. Temporarily fix exchange rates (implement capital controls)

and fix key international prices (e.g. carbon, coal, oil, gas)4. Consolidate the bad debt into regional banks5. Reflate via an agreed global investment plan, supported by

the good banks and scaled to maintain effective demand6. Reduce the risks of regulatory capture by a global

regulatory authority having the power to “name and shame”7. Reform international company law and standards to reduce

costs of decarbonising the global economy

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Point (5) Reflate

via a global investment plan

• Investment should be justified by cost- benefit analysis, allowing for all risks

• The programme should be co-ordinated on a global, macro scale but tailored by governments to regional needs and conditions

• Investment backed by good banks may restore banks and the “real” economy

• Opportunity of the century to scale-up investment in decarbonisation (AR4 WG3 chapters 4 to 11)

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Air quality and climate change synergies:IPCC conclusions, 2007

• Near–term health benefits from reduced air pollution may offset a substantial fraction of mitigation costs– Mitigation can also be positive for: energy security,

balance of trade improvement, provision of modern energy services to rural areas and employment

– Mitigation in one country or group of countries could lead to higher emissions elsewhere (“carbon leakage”) or effects on the economy (“spill-over effects”)

• These co-benefits for human health and crop productivity are especially high in developing countries

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The role of technology policies• Third to Fourth Assessment report

– “remarkable progress has been achieved in applying approaches based on induced technological change to stabilisation studies; however, conceptual issues remain” (SPM, p. 28) (EMF19, IMCP)

– technology is now responsive to carbon prices in many models• In the models that adopt these approaches, projected

costs for a given stabilization level are reduced– the reductions are greater at lower stabilisation levels.

• Although most models show GDP losses, some show GDP gains – because they assume that baselines are non-optimal and

mitigation policies improve market efficiencies– or they assume that more technological change may be induced

by mitigation policies.

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“New engineering”

–

an economist’s view of new modelling for decarbonisation

• Problem: how to decarbonise whole systems at lowest costs as soon as possible with a trade-off between doing a good job and doing it even faster

• Conditions today– technologies being developed (e.g. CCS, electric vehicles,

expert systems)– relative prices (oil, carbon) fluttering– national and international policies rapidly evolving– but with inertia in human and physical systems

• Problem separable into interacting engineered systems– Electricity, vehicles, dwellings, offices, steel, cement, etc– can be decarbonised separately, but a fit between them required

• Enabling structures and networks for low-cost solution– direct current grid– guaranteed global carbon and fossil-fuel prices– technological agreements and standards

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(a) Averaged effects of multigas abatementon carbon price $(2000)/tCO2-eq

AIM

EPPA

FUND

GRAPE

0

50

100

150

200

250

300

2000 2025 2050 2075 2100

Years

Car

bon

price

EMF21models:4.5W/m2CO2-only

EMF21 9-modelaverage:4.5W/m2multigasEMF21 9-modelaverage:4.5W/m2CO2-only

(c) Averaged effects of multigas abatement on GDP

AIM

AMIGA

COMBAT

EPPA

FUND

GRAPE-14

-12

-10

-8

-6

-4

-2

0

2

2000 2025 2050 2075 2100

Years

Cha

nge in

GDP

(%



(b) Averaged effects of multigas abatement on CO2

EPPA

FUND

-120

-100

-80

-60

-40

-20

0

20

2000 2025 2050 2075 2100

Years

Cha

nge in

CO 2 (

%)



(a) Averaged effects of including ETC on carbon price $(2000)/tCO2

-100

0

100

200

300

400

500

600

2000 2025 2050 2075 2100

Years

Carbo

n pr

ice

Models -450ppmvw ith ETC550ppmvw ithout ETC

450ppmvw ithout ETC

550ppmvw ith ETC

450ppmvw ith ETC

(b) Averaged effects of including ETC on CO2

-100

-80

-60

-40

-20

0

20

2000 2025 2050 2075 2100

YearsCha

nge in C

O 2 (%)

Models -450ppmvw ith ETC

550ppmvw ithout ETC

450ppmvw ithout ETC

550ppmvw ith ETC

450ppmvw ith ETC

(c) Averaged effects of including ETC on GDP

-14-12-10-8-6-4-20246

2000 2050 2100

Years

Cha

nge in G

DP (%

)

Models -450ppmvw ith ETC550ppmvw ithout ETC

450ppmvw ithout ETC

550ppmvw ith ETC

450ppmvw ith ETC

Average effects on carbon prices, CO2 and GDP of stabilization targets: EMF21 IMCP

Reduction in costs: multigas abatement induced technological change

38

GDP and CO2 effects for 550ppm CO2 -eq stabilisation from modelling studies: outliers can provide interesting alternative views

year 2030

FUND Cat. B

CCSP-IGSMAIM

-5

-4

-3

-2

-1

0

1

2

3

-60 -55 -50 -45 -40 -35 -30 -25 -20 -15 -10 -5 0

CO2 (% difference from base)

GD

P (%

diff

eren

ce fr

om b

ase) IMCP 450ppmv

CO2-only

EMF21 4.5W/m2CO2-only

Other 550 ppmvCO2-eqstabilisationPost-SRES450ppmv CO2-only

Note that to achieve the stabilisation target, non-CO2 GHGs are also assumed to be reduced by the CO2 -equivalent prices for all scenarios shown.

39

Electricity investment in context: global investment, 2000 $bn

56 68 80 93 107 121 13884 98 113 128 143 159 178

180 233 288 342 397 457 523168 220 277 341 406 475 54756 69 83 98 114 133 154

168 214 263 316 372 435 507189 246 305 364 426 493 566141 177 216 256 297 343 391117 154 196 244 296 353 415135 169 205 241 277 319 364

169 219 274 333 396 466 546241 296 355 414 475 543 616231 300 375 448 522 602 685226 284 347 416 490 572 66349 61 75 90 107 127 149

74 93 112 133 155 178 206506 636 775 913 1077 1230 1400111 143 178 216 256 299 34692 117 140 162 184 208 225

485 627 787 958 1136 1334 1539

2404 3155 3973 4803 5634 6527 7479

Global investment, 2000 $bn

0

200

400

600

800

1000

1200

1400

42 Dwellings

38 Public Admin.

26 Distribution

36 Prof. Services

29 Land

32 37 Other Bus.

33 Banking &

40 Health &

27 Retailing

41 Misc.

1 Agriculture etc

22 Electricity

25 Construction

39 Education

5 Food, Drink &

28 Hotels &

3 Oil & G

as etc

19 Motor

2 Coal

40

Conclusions: elements of the global deal

• Governments are meeting in Poznan 8-12 December 2008 (COP/MOP 14) and will consider policies to resolve the climate and financial crises: negotiating groups are OECD, China, India, OPEC, Russia

• Seven-point plan can resolve both crises, with the main benefit being rapid employment recovery in all countries

• A Global Emission Trading Scheme (GETS) for international transportation will decarbonise the sector and fund developing country mitigation and adaptation programmes

presentation to the research seminar on “complexity economics … · 2015. 5. 22. · 1 the...

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