The Total Cost of Climate Policy Isn’t What Matters Most

The Intergovernmental Panel on Climate Change (IPCC) is out with its synthesis report and the coverage, beyond warning of the consequences from unfettered emissions, has emphasized that tackling the problem would shave only 0.06 percentage points off annual global growth. That’s almost certainly wrong – realistic models would predict higher figures – but, when it comes to the cost of climate policy, not what really matters.

The problem with the models is that they assume idealized climate policies. Countries encourage emissions reductions through efficient carbon taxes and well-functioning cap-and-trade systems rather than by using hodgepodges of costlier and more opaque regulations, mandates, subsidies, and tax measures that would make Rube Goldberg blush. But it’s these messy policies that characterize the actual world. A colleague of mine once summed up the essence of climate policy by asking: “How much will people pay to not know how much they’re paying?”. The answer appears to be a lot – which means that climate policy is likely to be costlier than IPCC estimates.

And that’s just the domestic policy problem. The models imagine that global emissions reductions are pursued (PDF) wherever they’re cheapest – which happens to be predominantly in the developing world – rather than in the wealthy countries where they’re most politically practical. In principle, rich countries could pay massive sums for emissions cuts in poor ones, squaring economic efficiency with capacity to pay. That used to be the focus of international climate talks. But that has its own forbidding political barriers, which is why, rhetoric aside, today’s global climate talks essentially focus elsewhere. One upshot is that real-world climate policy is likely to feature emissions cuts in countries where they are relatively costlier than where the models assume rational policymakers would select.

That’s all bad news, but it isn’t as devastating as it might seem at first blush. Suppose that curbing climate change is twice as expensive as the IPCC projects. By fifty years from now that would amount to a loss of six percent of annual output. This is a massive sum of money but less than two years of global growth.

The real thing that matters about the cost of climate policy isn’t its aggregate impact – it’s how it affects individuals, groups, and countries. No country lives the global average GDP and no person lives their country’s average economic performance. Climate policy could be costless on average, and various individuals and groups would still be big winners and losers. Their support for the policies necessary to curb emissions will hinge not on average outcomes but on how climate policy affects them.

Think about trade. Well-designed trade agreements benefit both the world and individual countries on average. But that’s politically near-irrelevant: what matters is that there are lots of big winners and losers that the averages wipe out.

In the face of unfounded claims that serious climate policy will inevitably exact crippling economic costs, it’s understandable for advocates and analysts to push back with arguments that the macroeconomic costs of climate policy are much smaller. They shouldn’t forget, though, that keeping costs anywhere close to the IPCC estimates requires a commitment to sensible policies, and that getting the political economy of the whole thing right is an entirely different challenge.