Predicting the Costs of Climate: Who Is Right?

Some economic projections say that greenhouse gas limits will cause economic pain, while others predict economic gain. Why the big difference? It depends on the assumptions you choose–and now you can choose your own.

Even the policy wonks are having trouble keeping track of the myriad studies on economic impacts of climate change legislation. Two weeks ago, the National Association of Manufacturers and the American Council for Capital Formation released their latest study on the impacts of the America’s Climate Security Act of 2007—known as the Lieberman/Warner bill. Their analysis predicts GDP would decrease around $650 billion annually in the year 2030 as a result of the legislation. That’s about 2.5% of the “business as usual” GDP forecast.

Nearly the same day and analyzing the same bill, the U.S. EPA released their own analysis predicting GDP losses between $238-983 billion (0.9-3.8%) in 2030.

But analysis from the Clean Air Task Force projects GDP in 2030 would decrease only $182 billion (0.7%). Often-cited research from consulting firm McKinsey & Company, while not looking specifically at Lieberman-Warner, also concludes the costs of emissions reductions would likely be far less—if we start reducing emissions soon.

A little context on these enormous numbers. Billion dollar forecasts are staggering, but the size of the U.S. economy is currently $14 trillion, and is projected to be $26 trillion in 2030. And keep in mind that all forecasts are in reference to the 2030 number. The forecast is never that the economy will shrink; it’s that it won’t grow as much as it would otherwise, by a few percentage points at most, over two decades.

Even still, the models vary by about $800 billion—more than the U.S. now spends on Social Security, and bigger than the economy of Florida. Why the enormous difference?

The answer is that every economic model includes a series of assumptions about how individuals, investors, corporations, and the economy as a whole will respond to a change in policy—or lack thereof. It’s almost certain that limits on greenhouse gas emissions would push up the costs of using carbon-based fuels, such as coal and gasoline. But would consumers respond by using less fuel, or switching to more efficient cars and appliances? Would carbon constrains drive significant investments in clean energy technologies? Would new jobs in clean technologies offset job losses elsewhere?

Those are the $800 billion dollar questions.

Which brings us to SeeForYourself, an interesting new tool from Robert Repetto at the Yale School of Forestry and Environmental Studies (and a former WRI analyst). SeeForYourself lets you control seven of the biggest economic assumptions, and specify how likely you think each one is to occur:

• Will households adjust to higher energy costs by using energy more efficiently?
• Will the U.S. participate in the Kyoto Protocol?
• Will wind and solar power be cost-competitive with coal and natural gas?
• If emissions were not reduced, would climate change impacts adversely affect the economy?
• Would carbon dioxide caps also reduce other pollutants like carbon monoxide and mercury?
• How strongly would the capital markets respond to carbon limits?
• How much revenue would an auction of emissions permits generate, and would the government use that money for economic adjustment assistance?

SeeForYourself takes your assumptions and performs a “meta-analysis” (a sort of analysis of other analyses) using the assumptions and results of over 1,400 simulations from other studies. As expected, your answers will vary—a lot. In the worst case scenario, economic losses in 2030 are over 10 percent of business-as-usual GDP. But if everything goes right, the economy actually does slightly better than it would have without any caps on greenhouse gases.

One final point: studies of the economic costs of environmental policies have a dismal track record. For example, “cap and trade” in the United States got its start in the Clean Air Act Amendments of 1990, as a way to reduce sulfer dioxide emissions. At the time, economic models were predicting costs of $579-1,935 per ton of SO2. But during the following decade through 2003, the spot market price never got much above $200/ton.

Fortunately, the projections often err on the good side. Nonetheless, estimates of economic impacts should be treated as the estimates that they are, and not certainties.