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SUMMARY FOR POLICYMAKERS:
THE ECONOMIC AND SOCIAL DIMENSIONS
OF CLIMATE CHANGE

1. INTRODUCTION

potential for irreversible damages or costs, a very long planning

horizon, long time lags between emissions and effects, wide regional Working Group III of the Intergovernmental Panel on Climate variation in causes and effects, the irreducibly global scope of the Change (IPCC) was restructured in November 1992 and charged problem, and the need to consider multiple greenhouse gases and with conducting "technical assessments of the socio-economics of aerosols. Yet another complication arises from the fact that effective impacts, adaptation and mitigation of climate change over both protection of the climate system requires global cooperation. the short and long term and at the regional and global levels". Working Group III responded to this charge by further stipulating Still, a number of insights that may be useful to policymakers can be in its work plan that it would place the socio-economic drawn from the literature: perspectives in the context of sustainable development and, in accordance with the UN Framework Convention on Climate • Analyses indicate that a prudent way to deal with climate change is Change (UNFCCC), provide comprehensive treatment of both through a portfolio of actions aimed at mitigation, adaptation and mitigation and adaptation options while covering all economic improvement of knowledge. The appropriate portfolio will differ for sectors and all relevant sources of greenhouse gases and sinks. each country. The challenge is not to find the best policy today for

the next 100 years, but to select a prudent strategy and to adjust it This report assesses a large part of the existing literature on the socio- over time in the light of new information. economics of climate change and identifies areas in which a Earlier mitigation action may increase flexibility in moving toward consensus has emerged on key issues and areas where differences stabilization of atmospheric concentrations of greenhouse gases exist!. The chapters have been arranged so that they cover several key (UN Framework Convention on Climate Change, Article 2). The issues. First, frameworks for socio-economic assessment of costs and choice of abatement paths involves balancing the economic risks benefits of action and inaction are described. Particular attention is . of rapid abatement now (that premature capital stock retirement given to the applicability of cost-benefit analysis, the incorporation will later be proved unnecessary) against the corresponding risk of of equity and social considerations, and consideration of intergener- delay (that more rapid reduction will then be required, necessitatational equity issues. Second, the economic and social benefits of ing premature retirement of future capital stock). limiting greenhouse gas emissions and enhancing sinks are reviewed. • The literature indicates that significant "no-regrets"? opportunities Third, the economic, social and environmental costs of mitigating are available in most countries and that the risk of aggregate net greenhouse gas emissions are assessed. Next, generic mitigation and damage due to climate change, consideration of risk aversion, and adaptation response options are reviewed, methods for assessing the application of the precautionary principle provide rationales for costs and effectiveness of different response options are summarized, action beyond no regrets. and integrated assessment techniques are discussed. Finally, the • The value of better information about climate change processes report provides an economic assessment of policy instruments to and impacts and society's responses to them is likely to be great. In combat climate change.

particular, the literature accords high value to information about

climate sensitivity to greenhouse gases and aerosols, climate In accordance with the approved work plan, this assessment of the change damage functions, and variables such as determinants of socio-economic literature related to climate change focuses on economic growth and rates of energy efficiency improvements. economic studies; material from other social sciences is found mostly Better information about the costs and benefits of mitigation and in the chapter on equity and social considerations. The report is an assessment of the state of knowledge -- what we know and do not know — and not a prescription for policy implementation. Countries can use the information in this report to help take decisions they 1 The UN Framework Convention on Climate Change defines climate believe are most appropriate for their specific circumstances.

change" as a change of climate which is attributed directly or indirectly to human activity that alters the composition of the global atmosphere and which is in addition to natural climate variability observed over comparable time periods. The question as to whether such changes are potential or can

already be identified is analyzed in the volume on the science of climate 2. SCOPE OF THE ASSESSMENT

change of the IPCC Second Assessment Report (SAR).

Climate change presents the decision maker with a set of formidable complications: a considerable number of remaining uncertainties (which are inherent in the complexity of the problem), the

2 "No regrets measures are those whose benefits, such as reduced energy costs and reduced emissions of local/regional pollutants equal or exceed their cost to society, exduding the benefits of climate change mitigation. They are sometimes known as 'measures worth doing anyway".

CLIMATE CHANGE 1995: IPCC SECOND ASSESSMENT REPORT

adaptation measures and how they might change in coming

decades also has a high value. • Analysis of economic and social issues related to climate change,

especially in developing countries where little work of this nature has been carried out, is a high priority for research. More generally, research is needed on integrated assessment and analysis of deci. sion-making related to climate change. Further, research advancing the economic understanding of non-linearities and new theories of economic growth is also needed. Research and development related to energy efficiency technologies and non-fossil energy options also offer high potential value. In addition, there is also a need for research on the development of sustainable consumption patterns.

concentration, the emissions path toward this level, the discount rate, and assumptions concerning the costs and availability of

technologies and practices. • Despite its widespread use in economic policy evaluation, Gross

Domestic Product is widely recognized to be an imperfect measure of society's well-being, largely because it fails to account for degradation of the environment and natural systems. Other methodologies exist that try to take these nonmarket values and social and ecological sustainability into account. Such methodologies would provide a more complete indication of how

climate change might affect society's well-being. • Given the interrelated nature of the global economic system,

attempts to mitigate climate change through actions in one region or sector may have offsetting economic effects that risk increasing the emissions of other regions and sectors (so-called leakages). These emission leakages can be lessened through coordinated actions of groups of countries. The literature suggests that flexible, cost-effective policies relying on economic incentives and instruments, as well as coordinated instruments, can considerably reduce mitigation or adaptation costs or increase the cost-effectiveness of emission reduction measures.

A portfolio of possible actions that policymakers could consider, in accordance with applicable international agreements, to implement low-cost and/or cost-effective measures to reduce emissions of greenhouse gases and adapt to climate change can include:

Equity considerations

In considering equity principles and issues related to greenhouse gas emissions, it is important for policy consideration to take into account in particular Articles 3, 4.2a and 11.2 of the UN Framework Convention on Climate Change, Principle 2 of the Rio Declaration and general principles of international law.

Scientific analyses cannot prescribe how equity should be applied in implementing the UN Framework Convention on Climate Change, but analysis can clarify the implications of alternative choices and their ethical basis.

• Implementing energy efficiency measures, including the removal of

institutional barriers to energy efficiency improvements; • Phasing out existing distortionary policies and practices that increase

greenhouse gas emissions, such as some subsidies and regulations, non-internalization of environmental costs and distortions in trans

port pricing • Implementing cost-effective fuel switching measures from more to

less carbon-intensive fuels and to carbon-free fuels such as renewables; • Implementing measures to enhance sinks or reservoirs of greenhouse

gases, such as improving forest management and land use practices; • Implementing measures and developing new techniques for reducing

methane, nitrous oxide and other greenhouse gas emissions; • Encouraging forms of international cooperation to limit greenhouse

gas emissions, such as implementing coordinated carbon/energy

taxes, activities implemented jointly and tradable quotas; • Promoting the development and implementation of national and

international energy efficiency standards; • Promoting voluntary actions to reduce greenhouse gas emissions; • Promoting education and training, implementing information and

advisory measures for sustainable development and consumption

patterns that will facilitate climate change mitigation and adaptation; • Planning and implementing measures to adapt to the consequences

of climate change; • Undertaking research aimed at better understanding of the causes and

impacts of climate change and facilitating more effective adaptation

to it; • Conducting technological research aimed at minimizing emissions of

greenhouse gases from continued use of fossil fuels and developing

commercial non-fossil energy sources; • Developing improved institutional mechanisms, such as improved

insurance arrangements, to share the risks of damages due to climate change.

• Developing countries require support for institutional and endo

genous capacity building, so that they may effectively participate

in climate change decision-making. • It is important that both efficiency and equity concerns be

considered during the analysis of mitigation and adaptation measures. For the purposes of analysis, it is possible to separate efficiency from equity. This analytical separation pre-supposes that (and is valid, for policy purposes, only if) effective institutions exist or can be created for appropriate redistribution of climate change costs. It may be worthwhile to conduct analyses of the equity implications of particular measures for achieving efficiency, including their social considerations and impacts.

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Contribution of economics

Since climate change is a global issue, comprehensive analyses of mitigation, adaptation and research measures are needed to identify the most efficient and appropriate strategy to address climate change. International decision-making related to climate change, as established

.

Estimates of the costs and benefits of stabilizing greenhouse gas concentrations are sensitive, inter alia, to the ultimate target

SUMMARY FOR POLICYMAKERS: THE ECONOMIC AND SOCIAL DIMENSIONS OF CLIMATE CHANGE

by the UNFCCC, is a collective process in which a variety of concerns such as equity, ecological protection, economics, ethics and povertyrelated issues, are of special significance for present and future generations. Treatments of decision-making under uncertainty, risk aversion, technology development and diffusion processes, and distributional considerations are at present relatively poorly developed in international environmental economics, and especially in the climate change literature.

Decision-making related to climate change must take into account the unique characteristics of the "problem": large uncertainties (scientific and economic), possible non-linearities and irreversibilities, asymmetric distribution of impacts geographically and temporally, the very long time horizon, and the global nature of climate change with the associated potential for free riding. Beyond scientific uncertainties (discussed in the volume on the science of climate change of the IPCC Second Assessment Report (SAR)) and impact uncertainties (the volume on the scientific-technical analyses of impacts, adaptations and mitigation of climate change of the IPCC Second Assessment Report (SAR)), socio-economic uncertainties relate to estimates of how these changes will affect human society (including direct economic and broader welfare impacts) and to the socioeconomic implications of emission abatement.

The literature also emphasizes that delaying responses is itself a decision involving costs. Some studies suggest that the cost of delay is small; others emphasize that the costs could include imposition of risks on all parties (particularly the most vulnerable), greater utilization of limited atmospheric capacity and potential deferral of desirable technical development. No consensus is reflected in the literature.

The other dimension that magnifies uncertainties and complicates 4. decision-making is geographical: climate change is a global problem encompassing an incredibly diverse mix of human societies, with differing histories, circumstances and capabilities. Many developing countries are in relatively hot climates, depend more heavily on agriculture, and have less well developed infrastructure and social structures; thus, they may suffer more than average, perhaps much more. In developed countries, there may also be large climate change impacts.

The global nature of the problem - necessitating collective action by sovereign states - and the large differences in the circumstances of different parties raise consequential as well as procedural issues. Consequential issues relate to outcomes while procedural issues relate to how decisions are made. In relation to climate change, the existence of an agreed legal framework involves a collective process within a negotiated framework (the UNFCCC). Accordingly, decision-making can be considered within three different categories of frameworks, each with different implications and with distinct foci: global optimization (trying to find the globally optimal result), procedural decision-making (establishing and refining rules of procedure) and collective decision-making (dealing with distributional issues and processes involving the interaction of numerous independent decision makers).

Application of the literature on decision-making to climate change provides elements that can be used in building collective and/or market-oriented strategies for sharing risks and realizing mutual benefits. It suggests that actions be sequential (temporally distributed), that countries implement a portfolio of mitigation, adaptation and research measures, and that they adjust this portfolio continuously in response to new knowledge. The potential for transfers of financial resources and technology to developing countries may be considered as a part of any comprehensive analytical framework.

Elements of a market-related strategy concern insurance and markets for risk. Pooling risk does not change the risk, but it can improve economic efficiency and welfare. Although insurance capable of sharing climate change risks on a global basis currently does not exist, one of the important potential gains from cooperating in a collective framework, such as the UN Framework Convention on Climate Change, is that of risk sharing. Creating an insurance system to cover the risks of climate change is difficult3 and the international community has not yet established such sophisticated instruments. This, however, does not preclude future International action to establish insurance markets sufficient for some international needs.

EQUITY AND SOCIAL CONSIDERATIONS

Equity considerations are an important aspect of climate change policy and of the Convention. In common language equity means "the quality of being impartial" or "something that is fair and just”. The UNFCCC, including the references to equity and equitable in Articles 3.1, 4.2.a and 11.2, provides the context for efforts to apply equity in meeting the purposes and the objective of the Convention. International law, including relevant decisions of the International Court of Justice, may also provide guidance.

A variety of ethical principles, including the importance of meeting people's basic needs, may be relevant to addressing climate change, but the application to relations among states of principles originally developed to guide individual behaviour is complex and not straightforward. Climate change policies should not aggravate existing disparities between one region and another nor attempt to redress all equity issues.

Equity involves procedural as well as consequential issues. Procedural issues relate to how decisions are made while consequential issues relate to outcomes. To be effective and to promote cooperation, agreements must be regarded as legitimate, and equity is an important element in gaining legitimacy.

Procedural equity encompasses process and participation issues. It requires that all parties be able to participate effectively in international negotiations related to climate change. Appropriate measures

3 Without knowing the extent of potential impacts, the ability of private markets to insure against losses associated with climate change is unknown.

CLIMATE CHANGE 1995: IPCC SECOND ASSESSMENT REPORT

to enable developing country parties to participate effectively in negotiations increase the prospects for achieving effective, lasting and equitable agreements on how best to address the threat of climate change. Concern about equity and social impacts points to the need to build endogenous capabilities and strengthen institutional capacities, particularly in developing countries, to make and implement collective decisions in a legitimate and equitable

manner.

Consequential equity has two components: the distribution of the costs of damages or adaptation and of measures to mitigate climate change. Because countries differ substantially in vulnerability, wealth, capacity, resource endowments and other factors listed below, the costs of the damages, adaptation and mitigation may be borne inequitably, unless the distribution of these costs is addressed explicitly.

Climate change is likely to impose costs on future generations and on regions where damages occur, including regions with low greenhouse gas emissions. Climate change impacts will be distributed unevenly.

The Convention recognizes in Article 3.1 the principle of common but differentiated responsibilities and respective capabilities. Actions beyond "no-regrets” measures impose costs on the present generation. Mitigation policies unavoidably raise issues about how to share the costs. The initial emission limitation intentions of Annex I parties represent an agreed collective first step of those parties in addressing climate change.

Equity arguments can support a variety of proposals to distribute mitigation costs. Most of them seem to cluster around two main approaches: equal per capita emission allocations and allocations based on incremental departures from national baseline emissions (current or projected). Some proposals combine these approaches in an effort to incorporate equity concerns not addressed by relying exclusively on one or the other approach. The IPCC can clarify scientifically the implications of different approaches and proposals, but the choice of particular proposals is a policy judgment.

There are substantial variations both among developed and developing countries that are relevant to the application of equity principles to mitigation. These include variations in historical and cumulative emissions, current total and per capita emissions, emission intensities and economic output, and factors such as wealth, energy structures and resource endowments. The literature is weak on the equity implications of these variations both among developed and developing countries.

In addition, the implications of climate change for developing countries are different from those for developed countries. The former often have different urgent priorities, weaker institutions, and are generally more vulnerable to climate change. However, it is likely that developing countries' share of emissions will grow further to meet their social and developmental needs. Greenhouse gas emissions are likely to become increasingly global, even whilst substantial per capita disparities are likely to remain.

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Sustainable development is one approach to intergenerational equity. Sustainable development meets "the needs of the present without compromising the ability of future generations to meet their own needs". A consensus exists among economists that this does not imply that future generations should inherit a world with at least as much of every resource. Nevertheless, sustainable development would require that use of exhaustible natural resources and environmental degradation are appropriately offset — for example, by an increase in productive assets sufficient to enable future generations to obtain at least the same standard of living as those alive today. There are different views in the literature on the extent to which infrastructure and knowledge, on the one hand, and natural resources, such as a healthy environment, on the other hand, are substitutes. This is crucial to applying these concepts. Some analysts stress that there are exhaustible resources that are unique and cannot be substituted for. Others believe that current generations can compensate future generations for decreases in the quality or quantity of environmental resources by increases in other resources.

Discounting is the principal analytical tool economists use to compare economic effects that occur at different points in time. The choice of discount rate is of crucial technical importance for analyses of climate change policy, because the time horizon is extremely long, and mitigation costs tend to come much earlier than the benefits of avoided damages. The higher the discount rate, the less future benefits and the more current costs matter in the analysis.

Selection of a social discount rate is also a question of values since it inherently relates the costs of present measures, to possible damages suffered by future generations if no action is taken. How best to choose a discount rate is, and will likely remain, an unresolved question in economics. Partly as a consequence, different

4 A related (somewhat stronger) concept is that each generation is entitled to inherit a planet and cultural resource base at least as good as that of previous generations.

5 A social discount rate is a discount rate appropriate for use by governments in the evaluation of public policy.

SUMMARY FOR POLICYMAKERS: THE ECONOMIC AND SOCIAL DIMENSIONS OF CLIMATE CHANGE

discount rates are used in different countries. Analysts typically conduct sensitivity studies using various discount rates. It should also be recognized that the social discount rate pre-supposes that all effects are transformed to their equivalent in consumption. This makes it difficult to apply to those nonmarket impacts of climate change which for ethical reasons might not be, or for practical reasons cannot be, converted into consumption units.

The literature on the appropriate social discount rate for climate change analysis can be grouped into two broad categories. One approach discounts consumption by different generations using the "social rate of time preference," which is the sum of the rate of "pure time preference" (impatience) and the rate of increase of welfare derived from higher per capita incomes in the future. Depending upon the values taken for the different parameters, the discount rate tends to fall between 0.5% and 3.0% per year on a global basis - using this approach. However, wide variations in regional discount rates exist, but these may still be consistent with a particular global average.

The second approach to the discount rate considers market returns to investment, which range between 3% and 6% in real terms for longterm, risk-free public investments. Conceptually, funds could be invested in projects that earn such returns, with the proceeds being used to increase the consumption for future generations.

6.

The choice of the social discount rate for public investment projects is a matter of policy preference but has a major impact on the economic evaluation of climate change actions. For example, in today's dollars, $1,000 of damage 100 years from now would be valued at $370 using a 1% discount rate (near the low end of the range for the first approach) but would be valued at $7.60 using a 5% discount rate (near the upper end of the range for the second approach). However, in cost-effectiveness analyses of policies over short time horizons, the impact of using different discount rates is much smaller. In all areas analysts should specify the discount rate(s) they use to facilitate comparison and aggregation of results.

APPLICABILITY OF COST AND BENEFIT ASSESSMENTS

Many factors need to be taken into account in the evaluation of projects and public policy issues related to climate change, including the analysis of possible costs and benefits. Although costs and benefits cannot all be measured in monetary terms, various techniques exist which offer a useful framework for organizing information about the consequences of alternative actions for addressing climate change.

The family of analytical techniques for examining economic envi ronmental policies and decisions includes traditional project level cost-benefit analysis, cost-effectiveness analysis, multicriteria analysis and decision analysis. Traditional cost-benefit analysis attempts to compare all costs and benefits expressed in terms of a common monetary unit. Cost-effectiveness analysis seeks to find the lowest

cost option to achieve an objective specified using other criteria. Multicriteria analysis is designed to deal with problems where some benefits and/or costs are measured in nonmonetary units. Decision analysis focuses specifically on making decisions under uncertainty.

In principle, this group of techniques can contribute to improving public policy decisions concerning the desirable extent of actions to mitigate global climate change, the timing of such actions and the methods to be employed.

Traditional cost-benefit analysis is based on the concept that the level of emission control at each point in time is determined such that marginal costs equal marginal benefits. However, both costs and benefits may be hard, sometimes impossible, to assess. This may be due to large uncertainties, possible catastrophes with very small probabilities, or simply because there is no available consistent methodology for monetizing the effects. In some of these cases, it may be possible to apply multicriteria analysis. This provides policymakers with a broader set of information, including evaluation of relevant costs and benefits, estimated within a common framework.

Practical application of traditional cost-benefit analysis to the problem of climate change is therefore difficult because of the global, regional and intergenerational nature of the problem. Estimates of the costs of mitigation options also vary widely. Furthermore, estimates of potential physical damages due to climate change also vary widely. In addition, confidence in monetary estimates for important consequences (especially nonmarket consequences) is low. These uncertainties, and the resolution of uncertainty over time, may be decisive for the choice of strategies to combat climate change. The objective of decision analysis is to deal with such problems. Furthermore, for some categories of ecological, cultural and human health impacts, widely accepted economic concepts of value are not available. To the extent that some impacts and measures cannot be valued in monetary terms, economists augment the traditional cost-benefit analysis approach with such techniques as multicriteria analysis, permitting some quantitative expression of the trade-offs to be made. These techniques do not resolve questions involving equity - for example, determining who should bear the costs. However, they provide important information on the incidence of damage, mitigation, and adaptation costs and on where cost-effective action might be taken.

Despite their many imperfections, these techniques provide a valuable framework for identifying essential questions that policymakers must face when dealing with climate change, namely:

• By how much should emissions of greenhouse gases be reduced? • When should emissions be reduced? • How should emissions be reduced?

These analytical techniques assist decision makers in comparing the consequences of alternative actions, including that of no action, on a quantitative basis — and can certainly make a contribution to resolution of these questions.

6 Despite the differences in the value of the discount rate, policies developed on the basis of the two approaches may lead to similar results.

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