TESTIMONY OF DR. JANET YELLEN CHAIR, COUNCIL OF ECONOMIC ADVISERS Thank you, Mr. Chairman. The President has said that we can work to avert the grave dangers of climate change, while at the same time maintaining the strength of our economy. I agree and am pleased to have this opportunity to appear before the Committee to elaborate on the Administration's views on these issues. The international agreement that was reached in Kyoto this past December is a crucial step forward in addressing global climate change. But it is only one step in a journey. Since the international effort to reduce greenhouse gas emissions is still in some respects a work-in-progress, it is not yet possible to provide a full authoritative analysis of it. Many of the specifics in several crucial areas are not completely resolved in the diplomatic arena, forcing analysts to make a variety of assumptions about the ultimate form of the international regime. In my testimony today, I will attempt to identify key elements of the agreement and the Administration's policy, such as international emissions trading, meaningful developing country participation, inclusion of land-use activities that absorb carbon (“sinks”) and six categories of gases, as well as domestic initiatives, that together can ensure that reductions in global greenhouse gas emissions are consistent with continued strong economic growth. I will explain the reasoning underlying our conclusion that, under these conditions, economic impacts are likely to be modest. The Administration is strongly committed to ensuring that these key elements are reflected in our domestic and international climate change policies. We are firmly committed to meaningful developing country participation, the use of sinks to offset emissions requirements, and emissions trading both domestically and internationally. And as you know, the President's FY 1999 budget includes a $6.3 billion package of tax cuts and R&D investments over the next 5 years; this package makes good sense in terms of energy policy and will jumpstart our efforts. A final component of the President's climate change policy is his support for electricity restructuring in a manner that will offer approximately $20 billion in cost savings to electricity consumers, while reducing greenhouse gas emissions. I. Basic Economic Rationale of the Kyoto Treaty To begin our analysis, it may be worth stepping back and examining the larger question of the basic rationale, from an economist's perspective, for the Kyoto Protocol. The earth's surface appears to be warming from the accumulation of greenhouse gases from myriad sources worldwide. None of these emitters presently pays the cost to others 2 result of these distorted incentives, disruption of the Earth's climate is likely to proceed at an excessive pace and if left uncontrolled may pose substantial costs in terms of harm to commerce and the environment alike. The fundamental economic logic of the Kyoto Protocol is thus that without such an international agreement, individual nations will not have the proper incentives to address the threats from global climate change. II. Costs of Climate Change In evaluating efforts to mitigate global warming, the first step is to consider the costs of inaction. These costs - and they are significant provide the primary motivation for actions to reduce greenhouse gas emissions. The Intergovernmental Panel on Climate Change (IPCC) jointly established by the World Meteorological Organization and the United Nations Environment Programme, concluded in 1995 that “the balance of evidence suggests that there is a discernible human influence on global climate." Current concentrations of carbon dioxide, methane, nitrous oxide, and the other so-called greenhouse gases have reached levels well above those of preindustrial times. Of these, carbon dioxide (CO2) is the most important: net cumulative CO2 emissions resulting from the burning of fossil fuels and deforestation account for about two-thirds of potential warming from changes in greenhouse gas concentrations related to human activity. Climatic Impact If growth in global emissions continues unabated, the atmospheric concentration of CO2 will likely double relative to its preindustrial level by midway through the next century and continue to rise thereafter. As a result of the increased concentration of CO2, the IPCC estimates that global temperatures will increase by between 2 to 6 degrees Fahrenheit in the next 100 years, with a best guess of about 3.5 degrees Fahrenheit. While scientists believe that human activities are leading to a gradual warming of the average temperature of the earth, the change in temperature in a given region at a given time may differ substantially from this average. Indeed, models predict warming will be greater in high latitudes than in the tropics, and greater over land than ocean. Potential consequences associated with this shift in climate include a rise in sea levels, greater frequency of severe weather events, shifts in agricultural growing conditions from changing weather patterns, threats to human health from increased range and incidence of diseases, changes in availability of freshwater supplies, and damage to ecosystems and biodiversity. Economic and Monetary Damages The derivation of quantitative or monetary estimates of the damages from such a change in the climate is extremely difficult given the capacity of today's models. 3 areas: agriculture, sea-level rise, air conditioning and heating, water supply, human life and health, air pollution, and other costs (hurricanes, relocation costs, human amenity, construction, leisure activities, urban infrastructure, and ecological damages such as forest loss and species loss). Although the quantification of these effects is quite demanding, researchers have developed estimates that prompt substantial concern. The IPCC reports that a doubling of carbon dioxide levels would lead to approximately 10,000 estimated additional deaths per year for the current U.S. population from higher summer temperatures, even after netting out the effects of warmer winters and assuming acclimatization. Other researchers have predicted sea level increases of about 20 inches by 2100, with greater increases in subsequent years. Despite the difficulties, respected researchers have developed estimates of the monetary damages expected from an average worldwide temperature increase. For example, William Cline, then of the Institute for International Economics, estimated that a temperature change of 4.5 degrees Fahrenheit would impose annual damages of about 1.1 percent of GDP per year on the U.S. economy. That amounts to $89 billion in today's terms. (Cline's original estimate is quoted in 1990 dollars. The figure given above translates this number into 1997 terms by scaling it to current GDP.) William Nordhaus of Yale University has likewise computed estimates of the dollar loss attributable to a doubling of greenhouse gas concentrations. Although he uses methods that differ from Cline's in several respects, Nordhuas estimates that a slightly larger temperature change of 5.4 degrees Fahrenheit would impose losses equal to about 1 percent of GDP. A third independent estimate reported by Nordhaus is close to Cline's. It must be noted, however, that this similarity among aggregated estimates masks the true uncertainty associated with forecasts of the damages from given increases in global warming the estimates are all fundamentally based on extrapolations from current and past experience, and may not fully incorporate effects that will unfortunately become apparent only with future experience. One key difficulty in interpreting and monetizing these estimates of damages is uncertainty over the extent that they should be discounted because they occur in the distant future. Since the benefits of stemming future climate change accrue over not only decades but centuries, small changes in the discount rate can produce substantial changes in the results. But the precise discount rate that should be used to evaluate questions as important as the future climate of the planet remains a subject of intense debate. It is safe to say that there is, as yet, no professional consensus on the issue. Indeed there can be no technical answer to the ethical question how we should value the welfare of future generations. A similar difficulty with such estimates is that they do not include potential nonlinearities in the relationships between greenhouse gas concentrations and temperature, between temperature and economic damages, or in the various other complicated relationships governing interactions between greenhouse gas emissions, the climate, and 7 1 value of reducing the unknown risk of large-scale and potentially irreversible discrete events with potentially catastrophic consequences. Two such possibilities serve as illustrations. Warming of Northern tundra may release huge amounts of methane from the permafrost, thereby leading to accelerated warming. We do not know at what point, if any, such potentially unstable activity would be triggered. Second, evidence from climate models suggests that some types of climate change may lead to changes in ocean currents, including weakening of the Gulf Stream that warms Western Europe. Scientific evidence suggests that abrupt seawater temperature shifts have occurred over periods as short as decades. To what extent are we willing to take such chances with our planet? There is a strong argument for the Kyoto Protocol as a form of planet insurance. But what numerical weight should one assign to these catastrophic risks? In other words, what is the value of the insurance policy? Although it is difficult for an economist, or anyone, to know, reductions in the risk of such catastrophic outcomes must be considered in addition to the costs and benefits that can be reasonably quantified. Since human beings are typically averse to risk, such catastrophic risks are especially important in evaluating whether the benefits of a particular climate control policy justify the costs. One must have at least some sympathy with those who criticize economists on the grounds that the effects of climate change are extremely difficult to quantify in a single monetary number. III. Addressing Global Climate Change in an Efficient Manner The costs of unabated climate change may thus be difficult to quantify, but they are nonetheless real and provide the motivation for reducing greenhouse gas emissions. In taking action to reduce those emissions, economic analysis suggests that two elements are absolutely essential: • The effort must be global, to address the global externality inherent in the nature of the problem. • The effort must be flexible and market-based, to ensure that we achieve our objectives in the most efficient manner possible. Need for Global Action Climate change is a global problem requiring a global solution. As I mentioned earlier, no single country has an incentive to reduce emissions sufficiently to protect the global environment against climate change. Each has an economic incentive to "free ride" on the efforts of others. Even if the United States sharply reduced its emissions unilaterally without an international agreement limiting emissions abroad, greenhouse gas emissions from all other countries would continue to grow, and the risks posed by climate change would not be significantly reduced. It is important to emphasize that emissions of 5 The threat of disruptive climate change has led to coordinated international efforts to reduce the risks of global warming by reducing emissions of greenhouse gases. A landmark international agreement to address global warming was the Framework Convention on Climate Change signed during the Earth Summit in Rio de Janeiro in 1992. This convention established an objective of limiting greenhouse gas concentrations and called upon industrial countries to return their emissions to 1990 levels by 2000. Since then, it has become clear that the United States and many other participating countries will not meet this voluntary goal; quite the contrary, emission levels have continued to rise not fall among both developed and developing countries. To address the lack of progress among many industrialized countries toward meeting the Rio objective, the United States and approximately 160 other nations agreed in negotiations held in Kyoto, Japan, last December, to reduce emissions of greenhouse gases. The Kyoto Protocol, which requires the advice and consent of the Senate, would place binding limits on each industrial country's combined emissions of the six principal categories of greenhouse gases: carbon dioxide (CO2), nitrous oxide (N2O), methane, sulfur hexafluoride, perfluorocarbons, and hydrofluorocarbons. These limits apply to the 38 so-called Annex I countries, which are the industrialized countries, defined to include Russia, Ukraine, and most Eastern European countries. Under the Kyoto Protocol, each industrial country's baseline is its 1990 emissions of CO2, methane, and N2O and its choice of 1990 or 1995 levels of the other three categories of gases. The United States agreed to a target of 7 percent below this baseline by the period between 2008 and 2012. Given the changes in the definition of the baseline for the three long-lived chemical compounds (HFCs, PFCs and SF6) from 1990 to 1995 combined with a change in the way sinks are accounted for in the baseline, the actual reduction required in the U.S. is no more than 2-3% more than the President originally proposed as the U.S. negotiating position. The targets for the European Union and Japan are 8 percent and 6 percent below 1990 levels, respectively. Australia, New Zealand, Norway, Russia, and Ukraine all have limits somewhat less ambitious when phrased as cuts relative to their 1990 levels. In sum, over the period from 2008 to 2012, the industrial countries are expected to reduce their average emissions of greenhouse gases to about 5 percent below their 1990 levels. The President has made clear that he will not submit the Kyoto Protocol to the Senate without meaningful participation from key developing countries (who are not included in Annex I). There are several reasons why meaningful participation from developing countries is essential. First, developing countries are projected to contribute a majority of world emissions around 2030 under a continuation of business-as-usual. Without the participation of developing economies, efforts by the industrialized countries to limit emissions will therefore not provide adequate protection from climate change. Second, developing country participation is crucial because it would permit relatively |