Risk Mitigation and the Social Cost of Carbon

by Makari Krause

In 2009 the Obama administration convened a working group to determine the social cost of carbon. To achieve this goal the group used three main models: Nordhaus’ (2008) ‘‘Dynamic Integrated Climate Economy’’(DICE) model; Hope’s (2008) ‘‘Policy Analysis of the Greenhouse Effect’’ (PAGE) model; and Anthoff and Tol’s (2010) ‘‘Climate Framework for Uncertainty, Negotiation, and Distribution’’ (FUND) model. The group decided to use discount rates of 2.5%, 3%, and 5% in each of the models. These discount rates were chosen based on a review of the literature.

Under the 5% discount rate the group determined that the social cost of carbon was $4.7 per ton in 2010. Under the 2.5% rate the cost of carbon was $35.1 per ton. Many critics argued that these values were based on overly optimistic models so the group subsequently used a fat tailed distribution on climate sensitivity and came up with $64.9 per ton at a discount rate of 3%. This number still falls far short of many other estimates.

Howarth et al. (2014) argue that appropriately accounting for risk mitigation might substantially increase the social cost of carbon above previous estimates. The authors use a previously developed model to show that greenhouse gas emissions mitigation is incredibly valuable up until the point at which catastrophic impacts are avoided. Once this level has been reached the model showed that there was low marginal benefit to any further reductions. These results suggest that the social cost of carbon therefore depends heavily on the stringency of emissions reduction policies. Under all scenarios emissions are completely mitigated by the year 2270. Without any mitigation measures market forces act slowly to accomplish this mitigation and atmospheric greenhouse gas levels peak at 740 ppm in 2100. With stringent mitigation, emissions begin to drop off immediately and atmospheric levels peak at only 460 ppm by mid century. Under the “no mitigation” scenario there is a 0.33% chance of climate catastrophe under the fat tailed assumptions about climate sensitivity. (Howarth et al. take climate catastrophe to mean that the standard of living is driven down to the subsistence level at some point in the next 400 years.) Under thin tailed assumptions this percentage drops to 0.025%. While these percentages are very low, Howarth et al. used a study that showed that peoples’ risk aversion is high enough that these catastrophic events, no matter how unlikely, are enough to warrant stringent controls on emissions.

Howarth et al. conclude that with low risk aversion, the social cost of carbon is $10 in 2010. Using the observed risk aversion in financial markets, however, the social cost of carbon in 2010 is $25,700 for fat tailed uncertainty and $1,690 for thin tailed uncertainty. In both of these scenarios the cost of carbon drops off quickly once the risk of catastrophic climate events are mitigated. Howarth et al. suggest that moving from the no abatement situation to one in which there is stringent abatement could produce benefits equal to a four fold increase in per-capita consumption. This is because abatement measures can decrease the probability of catastrophic climate events to essentially zero and are really the only way to deal with these catastrophic events. Traditional forms of risk mitigation will not work because these climate events will affect the economy as a whole. Once these catastrophic events have been avoided, Howarth et al. found that there is low marginal benefit in additional mitigation.

Howarth, R. B., Gerst, M. D., & Borsuk, M. E., 2014. Risk mitigation and the social cost of carbon. Global Environmental Change 24, 123-131. http://www.sciencedirect.com/science/article/pii/S0959378013002203

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