Greg Ip

Articles by The Economist’s U.S. Economics Editor

The novel accounting of greenhouse gas regulations: We are the world

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Applying a dollar sign to death, disease and catastrophic climate change is a macabre business. Nonetheless, the cold-eyed math of cost-benefit analysis is the biggest contribution economics can bring to the often emotional questions that environmental and other types of regulations raise. In deciding whether a new rule does more good than harm, the Environmental Protection Agency routinely applies a cost-benefit test. Its sweeping propsal to cap greenhouse gas emissions from existing power plants appears to pass with flying colours. By the EPA’s reckoning, the rule will, by 2030, cost just $7.3 billion to $8.8 billion a year (in 2011 dollars), while producing benefits worth $55 billion to $93 billion per year.
But this calculation rests on a novel calculation of the benefits of reducing greenhouse gases that takes regulatory policy into contentious new territory. As calculated, the costs are borne entirely by Americans, but the benefits accrue to the whole world. Using American benefits only, the benefits of reduced carbon dioxide (CO2) would be far smaller. The remaining benefits would be so-called co-benefits, which are basically good things that happen that weren’t the main intent of the rule. Those co-benefits come from reductions in soot that are a by product of sulfur dioxide emissions (SO2) and rest heavily on assumptions as opposed to hard scientific evidence.

Since the 1980s, cost-benefit analysis has been progressively integrated into federal rule making by executive orders issued by various presidents. As Ted Gayer of the Brookings Institution and Kip Viscusi of Vanderbilt University point out in a recent working paper, those orders are all framed in terms of improving the lives of Americans, not the world.  Bill Clinton’s 1993 executive order seeks a regulatory system that “best serves the American people”, and Barack Obama’s 2011 order prioritizes “the well-being of the American people.” In 2003, George Bush’s White House told agencies, “Your analysis should focus on benefits and costs that accrue to citizens and residents of the United States. Where you choose to evaluate a regulation that is likely to have effects beyond the borders of the United States, these effects should be reported separately.” Both the Clean Air Act and the Clean Water Act frame their goals as benefiting Americans, not the world.
However, in 2010, the Obama administration initiated an interagency effort to develop a uniform, scientifically-grounded estimate of the social cost of carbon (SCC). This, for the first time, opened the door to a more expansive definition of benefits: “consideration of both global and domestic benefits is generally permissible.” Since then, many rules have been passed incorporating global benefits from reducing CO2 emissions, but those benefits were usually small or secondary to the rule’s purpose. One exception were the CAFE standards on car fuel efficiency issued in 2011 where the benefits of reduced CO2 were significant, but still secondary to the benefits of reduced petrol consumption.
By contrast, reduced CO2 is front and center in both the purpose and accounting of the EPA’s new carbon pollution proposal for power plants. In its regulatory impact analysis, the EPA relies on the White House SCC estimate which “includes a wide range of anticipated climate impacts, such as net changes in agricultural productivity and human health, property damage from increased flood risk, and changes in energy system costs, such as reduced costs for heating and increased costs for air conditioning.”
Using a range of models and discount rates, the original White House report pegged the social cost of carbon in 2020 at $7 to $81 (in 2007 dollars) per metric ton. (Michael Greenstone, Elizabeth Kopits and Ann Wolverton, who were all involved in the process, describe how the estimates were arrived at in this NBER working paper.) Last year those estimates were updated to incorporate newer models, resuting in a higher projected social cost of carbon in 2020 of $12 to $129.
Those are global costs; Mr Viscusi and Mr Gayer, using the methodology of the White House panel, reckon America’s share would be 7% to 23%. They write, “Imposing a global perspective on benefits will increase the apparent desirability of the policy but will overstate the actual benefits to the American people.”
The EPA reckons the benefits of CO2 emissions range from range from $9.5 billion to $94 billion in 2030 (in 2011 dollars) depending on how the rule is implemented and the discount rate used; at a 3% discount rate, (the most commonly selected), the benefits are $31 billion. Applying Mr Viscusi and Mr Gayer’s percentages, the American benefit would only range from $2 billion to $7 billion – not enough to justify the $7.3 billion to $8.8 billion in costs. However, the EPA also, in keeping with traditional practice, adds in the co-benefits- the reduction in deaths and respiratory illnesses that comes through lower emissions of nitrogen dioxide, sulfur dioxide and soot that result when carbon emissions are also reduced. This, too, is somewhat contentious because the EPA assumes that mortality from exposure to soot continues to decline even at low concentrations for which little or no empirical data exists – often to concentrations well below threshholds already mandated in federal law. These benefits are worth $23 billion to $62 billion in 2030, and serve to vault total benefits well past total costs, irrespective of the benefits of reduced CO2 emissions.
So the question is, should America be passing regulations that primarily pass the cost-benefit test based on benefits to non-Americans? (This is analogous to a related problem in climate change policy: how much should today’s generation pay to prevent harm to people who haven’t been born yet?) It’s hard to justify based on any traditional reading of American law, and applying the precedent to other fields would, as Mr Viscusi and Mr Gayer note, produce politically intolerable policies: open borders to immigrants, massive income transfers to poor countries, a Pentagon that defends every innocent country invaded by a belligerent neighbor.
I put the question to Mr Greenstone, a principal author of the original White House report on the social cost of carbon. He is now at the Massachusetts Institute of Technology and will soon head to the University of Chicago.
He said:
“The tricky part of carbon reduction is that when we reduce a ton, we benefit China, and when China reduces a ton, they benefit us. It’s a classic business deal. If we don’t cooperate, we’ll all be in a lesser state of the world. Cooperation in this case means accounting for the benefit we are providing for others. If one looks at international negotiations, the U.S. would not be able to show up and have much influence if we came and only talked about domestic damages. We’re also asking the world to do things that make us better off. We spent 15 to 20 years trying the other strategy which is, “You guys go first,” and I think it’s not working. China and India have a pretty good case for not doing that much unless we come with something deliverable. Will we continue to have these rules if we learn that in no state of the world will China cut its emissions? Probably not. Just as in the classic prisoner’s dilemma, we’d change our position.”
To its credit, the EPA has tried, in this rule, to encourage the most economically efficient way to reduce emissions, such as by diversifying energy supply, investing in energy efficiency, or even cap and trade. And it’s entirely possible that with the spur of these rules, ingenuity will produce much cheaper ways to reach the target. But in the end, this is not a rule that can be justified on cost-benefit analysis alone. It will live or die on whether it causes the rest of the world to reciprocate. It is as much foreign policy as domestic policy, and for Mr Obama lately, foreign cooperation has been even more elusive than the domestic sort.The original post is linked here.


Written by gregip

June 3, 2014 at 12:14 am

Posted in Uncategorized

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