Marjohan proudly displays a wad of cash, more than 800,000 Indonesian rupees in freshly printed notes. It's his first pay packet, which he will hand over to his mother. He has been taken on to work for a palm oil operation, 35 kilometres from his village, set up in the middle of the jungle. His job involves cutting down and then burning the trees of the tropical forest. Once the forest has been cleared, he hopes to find a permanent job on the new plantation, which would enable him to free himself from the family rice-growing business.

With Marjohan's wages, the family will be able to buy a motorbike. As well as helping them go back and forth to the nearby town Samarinda, he is also intending to use it to travel to work. At present he is dependent on the bus chartered by the Australian plantation manager, which does the return journey once a week. He hopes to have a little more freedom of movement once the family motorcycle has been acquired.

If we include the emissions produced by Marjohan's new job in the national inventory of Indonesian emissions, the picture is completely different. For each hectare of forest cleared, the combustion of the wood burned on the spot emits around 600 tonnes of carbon dioxide (CO2) into the atmosphere. When the forest has grown in a damp environment such as a peat bog, the soil has to be drained before planting palm trees for the plantation.

The reluctant countries are different from the rich, enthusiastic nations examined in Chapter 3 for two reasons. One is to do with interests. Reluctant countries have other priorities than spending their own resources to slow global warming. The other reason is low and variable administrative capacity. These countries are “developing” in part because their administrative systems are weak, fragmented, and often erratic in their functioning. In some sectors of the economy, the government has mercurial control – for example, most energy systems in the largest developing countries are directly owned by governments and staffed with government employees. Yet in other parts of the economy, the government is barely able to monitor behavior and implement policy. In such settings, even with strong inducements it is hard for governments to make credible commitments about policies they will reliably implement at home.

Such problems are hardly new in international affairs. Diplomats fix them in two ways. One is by creating incentives that lead reluctant nations to rethink their interests. Those incentives include sticks (e.g., trade sanctions) and carrots (e.g., subsidies for projects that reduce emissions and for administrative capacity-building). I start this chapter by looking at the sticks and carrots that have been deployed so far and showing how they can be made more effective. Sticks are difficult to use because they create many risks. Trade sanctions against countries that don't mitigate emissions can easily touch off broader trade wars that leave people much worse off. Politically, carrots are easier to offer.

The village of Bagepalli is located in Karnataka, one of the states of southern India. The area is semi-arid. The inhabitants collect wood and plant residues for cooking their food and boiling water to make it safe to drink. This requires increasingly long journeys. Indeed the resource is disappearing: 75 per cent of the forest in Karnataka is no longer being replanted. The method of cooking using traditional baked clay ovens is relatively inefficient, and the resulting household waste is toxic.

The local government is trying to help the villagers by remedying the situation as quickly as possible. It subsidizes the use of kerosene, which most families cannot otherwise afford to buy. But this type of measure makes the population dependent on public monies without providing a sustainable economic answer. In health and environmental terms, it is frankly harmful. Kerosene exposes the inhabitants to more toxic residues than wood and emits more carbon dioxide (CO2) of fossil origin.

The local non-governmental organization (NGO), Women for Development, has worked for several years with the families from the village. In 2006, it was able to increase the scale of its work, thanks to the Clean Development Mechanism (CDM) introduced by the Kyoto Protocol. The mechanism allows carbon credits to be given to projects that reduce greenhouse gas emissions. Collecting wood from a deteriorating environment and the use of subsidized kerosene results in each family emitting on average 3.5 tonnes CO2 equivalent a year. In Bagepalli, the average family owns four cows.

Avoiding global warming impacts is a game of chance. And the dice are increasingly loaded for nasty outcomes as the stock of warming gases accumulates in the atmosphere. Already the planet has warmed, on average, about 0.8 degrees Celsius since the onset of the industrial revolution. Another 0.3–0.6 degrees of warming is already built-in to the planet but not yet measured by thermometers because the planet's big oceans are slow to warm. Because human and technological systems are slow to change, even a crash program to regulate emissions probably wouldn't prevent another 0.5–0.7 degrees of warming on top of the warming already built into the planet. I'll call this total – 1.6–2.1 degrees – the inevitable warming. That's bad news not just for the planet but also for the posse of diplomats that trot the globe signing communiqués claiming their goal is to stop warming at 2 degrees. The hard truth is that after two decades of dithering, the 2 degree goal is probably already history.

This chapter is about how to brace for the large impacts that will accompany large changes in climate. I look at two kinds of impacts: those that are easy to predict and highly likely and those that are a lot harder to pin down. In my view, the really big dangers with warming lie in the latter variety. They lie way out in the “tails” of the probability distributions.

1. 1. Agrawala, S. and Fankhauser, S. (2008) Economic Aspects of Adaptation to Climate Change: Costs, Benefits and Policy. Paris: OECD. Available at: www.oecd.org/env/cc/adaptationeco.

2. The authors emphasize the fragmentary nature of knowledge about the cost of adaptation policies to climate change. They warn about the unreliability of regularly used figures and suggest ways of improving economic instruments.

3. 2. Aldy, J. E. and Stavins, R. N. (2009) Post-Kyoto International Climate Policy: Implementing Architectures for Agreement. Cambridge: Cambridge University Press.

4. Arising initially from a seminar held at Harvard in the spring of 2006, the second edition of this collective work has been considerably expanded. The editor sensibly provides a short version of what has become a standard reference work in American universities.

5. 3. Bellassen, V. and Leguet, Benoît (2008) Comprendre la compensation carbone. Paris: Pearson.

6. Well-known as specialists in the field of carbon offsets, Valentin Bellassen and Benoît Leguet provide a very helpful guide to the economics of emissions reduction. For the first time, the rules of the Kyoto Protocol are explained in simple and straightforward language.

7. 4. Broecker, Wallace S. and Kunzig, Robert (2008) Fixing Climate: What Past Climate Changes Reveal about the Current Threat – and How to Counter it. New York: Hill and Wang.

8. Wallace Broecker was one of the first scientists to reconstruct the history of past climates. With the journalist Robert Kunzig, he provides a new view on climate risks and how to reduce them. An acerbic interpretation.

9. 5. Chevalier, J-M. (2009) The New Energy Crisis. Basingstoke: Palgrave Macmillan. (Originally published in French under the title Les nouveaux défis de l'énergie, Economica, 2009).

10. […]

This book is intended to offer value to anyone interested in the science and economics of climate change. The text is suitable for use in an interdisciplinary course on climate science and economics. The comprehensive framework presented here could also provide value for scientists, economists, and policy analysts who already have a thorough knowledge of some aspects of climate issues. The work incorporates a survey of the latest journal articles, working papers, and books on climate change issues as of the time of writing. For anyone who has tried to absorb the thousands of pages written by the Nobel-prize winning Intergovernmental Panel on Climate Change, the presentation below will hopefully be seen as mercifully concise yet still informative.

The analysis also reflects a unique perspective of the author. Although I have long been deeply interested in earth sciences, I worked full time on climate issues only in the last several years. For nearly two decades prior to that, I held a day job as an economist at the Federal Reserve Board – an officer responsible for some of the staff work on interest rate management. The history of the Federal Reserve and of central banking around the world holds important lessons for climate policy. Communicating those lessons is one key motive for writing this book.

Since its creation early in the twentieth century, the Federal Reserve has made numerous mistakes in the conduct of monetary policy.

THE FIRST 4 BILLION YEARS

In its long history, Earth has seen extremes of fire and ice that would have made human life impossible. The planet was born in a cauldron of volcanic eruptions and million-megaton impacts from outer space. Any hydrogen or helium in the early atmosphere soon escaped into space. In time, only heavier molecules remained, including nitrogen and the greenhouses gases: water vapor, carbon dioxide, methane, and ammonia. No free oxygen was present.

A gas is called a greenhouse gas (GHG) because it lets sunlight through but absorbs outgoing heat radiation from the surface of the Earth. The absorbed heat energy is reradiated in all directions. Because some of it returns to the surface, the GHG boosts the planet's temperature. If no GHG were present in the atmosphere, the world's current average temperature would be about 0°F rather than the actual level of 58°F (14.5°C).

About half a billion years after its formation as a planet, Earth had cooled enough for rain to fall and the oceans to form. Life emerged soon – in geological terms – thereafter. The Sun was weaker back then, emitting only about 70% of the radiation of today. The Earth would have frozen solid were it not for the high concentrations of GHG in the atmosphere. The Sun was less radiant than today largely because it had less helium. As with any star, nuclear fusion in the core of the Sun converts hydrogen into helium.

THE MAIN GASES

A GHG is transparent to sunlight, similar to a physical greenhouse made of glass. However, a GHG does not physically block the rising warm air. Rather, it absorbs outgoing infrared radiation emitted from the warmed surface of the planet. The gas then reradiates its absorbed thermal energy in all directions, some of which goes back to the surface of the Earth. Each GHG differs in its ability to absorb various parts of the spectrum of infrared radiation.

GHGs represent only a small share of the atmosphere, which is mainly composed of nitrogen (78%), oxygen (almost 21%), and argon (almost 1%). The three main GHGs released by human activities are carbon dioxide (CO2), methane (CH4), and nitrous oxide (N2O). Other GHGs include several compounds of fluorine (the “F-gases”) and ground-level ozone. In addition, chlorofluorocarbons (CFCs) play a greenhouse role and also damage the ozone layer of the stratosphere. Some anthropogenic emissions provide cooling effects. For instance, coal-burning industries release considerable CO2, but they also emit particles of sulfur dioxide (SO2).

GENERAL RATIONALES FOR POLICY MANDATES

In a pure command-and-control economy, government bureaucrats decide on the goods to be produced and the prices at which they will sell. History has shown that a market system generally delivers better economic performance. However, markets do not always achieve social objectives when left on their own. Incomplete information, diverging incentives between producers and consumers, coordination problems, and the presence of public goods can result in market failures. Command-and-control techniques can sometimes be used effectively in a targeted manner to overcome these problems. Indeed, some regulation of markets is needed to safeguard important social values aside from economic efficiency.

Coordination and information problems crop up in a variety of ways. For example, consider the differences in incentives between landlords and tenants. If a tenant is responsible for the costs of fuel and electricity, a landlord does not have an incentive to invest in improved insulation and weather-stripping.

CAP-AND-TRADE: WHO GETS REGULATED?

As in the case of a tax, an upstream or downstream approach could be employed for cap-and-trade. In a downstream system, any enterprise above a certain size or level of emissions would be required to surrender emission allowances. In an upstream system, oil refineries and natural gas pipelines would be required to submit allowances not only for their own emissions but also for the fuel they sell. Allowances would be required for fuel sales to cover the emissions that occur when downstream users burn the fuel. The refineries and pipelines could do nothing to abate the emissions associated with their sale of fuels. However, the requirement to surrender allowances would boost their costs and those cost increases would be passed on to downstream users in the form of higher prices. The resulting price signal would provide an incentive for consumers to increase energy efficiency. Spurring energy-saving activities by fuel users is a key advantage of this upstream approach, along with lower costs of monitoring and enforcement.

CLIMATE AND HUMAN EVOLUTION

Around 160 Mya, while circling the Sun in the inner portion of the region between Mars and Jupiter, an asteroid 65 km wide struck another of 160 km in diameter. Fragments from the collision, known as the Baptistina family of asteroids, continued orbiting the Sun, but on new, less stable trajectories. Many of the pieces gradually found their way into the inner solar system, doubling the usual rate of impact by large objects. One mountain-sized chunk may have hit the moon around 108 Mya, blasting out the 80-km-wide Tycho Crater.

MONETARY POLICY GOALS AND INSTITUTIONAL FRAMEWORKS

Several cap-and-trade proposals, including the 2008 Lieberman-Warner bill, have called for the establishment of an independent board modeled on the Federal Reserve to assist with the implementation of the program. This chapter addresses the need for such a climate board and other lessons that can be drawn from the experiences of monetary policy. The chapter begins by explaining how the context of monetary policy compares with the framework of a cap-and-trade program for GHG.

Consider the policy challenge faced by a monetary authority. With a single primary policy instrument, it must try to achieve two key economic objectives: low inflation and full employment of resources. In the short run, there is a trade-off between these objectives. Stimulating the economy maximizes employment and production, but if overdone, it can lay the seeds for future price inflation.

Discount rates are used to compare current and future costs. Confusion sometimes arises because of the failure to distinguish between a discount rate and a discount factor. To illustrate the difference, suppose you have a government savings bond that will be worth $1,000 next year. Because you need the money today, you sell the bond and only get $935. The discount factor is 935/1000 or 0.935. If you waited till next year, you would get the remaining $65. Your rate of return on holding the bond another year would thus be 65/935, which is 7%. That is the discount rate.

With a discount factor of 0.935, anything in the far-off future has a minuscule present value. For instance, if you multiply 0.935 by itself a hundred times, the answer is only 0.001. The implication is that $1,000 of climate damages a hundred years from now is worth only $1 today. If a dollar spent on climate investments today would offset less than $1,000 of damages a century ahead, it would make more sense to invest in the stock market, assuming the market keeps earning the average 7% return it has in the past. A $1 investment in stocks at that rate of return would give your heirs $1,000 in a hundred years.

As the historical average real rate of return on the stock market, 7% represents the average rate of return on private sector investments in the economy.

The second half of the book draws from the lessons of Earth's climate history and outlook to assess alternative possible policy responses. It begins with a broad discussion of policy goals, including a review of efforts to assess the costs of the prospective damages from climate change. It then considers major options among policy mandates and market-based approaches. Market-based alternatives include taxes and cap-and-trade systems; the latter may take quite different forms, depending on their detailed design features. Existing and proposed options for cap-and-trade design are assessed and insights are drawn from the experiences with monetary management. The final portion of the book discusses existing and prospective frameworks for the international coordination of climate policies.

Climate change is already underway in response to rising temperatures and CO2 concentrations. To mitigate the damages from future climate change, a substantial transformation of major economic sectors may be required. How much risk of damages should we permit and how much should we spend to try to offset the rest? To begin answering these questions, efforts to quantify the value of climate damages need to be considered. If we were confident of the damage estimates, we could compare them with estimates of the costs of mitigating and adapting to climate change in an overall cost-benefit analysis. But a point estimate is insufficient; the risks of being wrong about our cost forecasts also need to be weighed.

DAMAGE ESTIMATES

A wide variety of studies have tried to evaluate likely damages from climate change. Many have focused on specialized aspects of the problem, such as the effects on agricultural production in a particular region. Comprehensive studies are rarer, and even these efforts typically fail to include components that are especially difficult to estimate. Moreover, unresolved methodological issues have potentially profound effects on the predicted monetary losses.

As noted in the previous chapter, the major impacts of climate change will be felt on coastal regions, agriculture, health, and ecosystems. Economic losses to coastal areas could come from sea level rise, increased storm damage, and forced migrations. Over wider geographic areas, the production of crops, livestock, and fisheries will be affected.