Economic costs of aggressive climate policy

ABSTRACT

Whether aggressive climate policy is warranted crucially depends on the economic costs of emission cuts. Different from previous studies, this study estimates the economic costs of emission costs with a reduced-form approach. The major advantages of this approach are its simplicity and less assumption dependence. Based on the study’s parameter estimates, it is found that a 25% aggressive reduction in CO₂ emissions from 1990 levels will lead to a 3.69% decrease in the combined GDP of developed OECD countries. Although the cost is significant, in relation to the benefits of such policy, this study’s finding still suggests that nations should implement more aggressive climate policy.

KEYWORDS:

• Climate change policy
• carbon emissions
• economic costs
• fixed-effects panel regression
• reduced-form model

Notes

¹ As a result, this reduced-form approach is gaining popularity in the global warming literature (e.g., Nordhaus, 2006; Dell et al., 2008 and 2009; Horowitz, 2009; and Ng and Zhao, 2011).

² The Kaya identity was developed by Yoichi Kaya. In his equation, CO₂ emissions are determined by population, GDP per capita, energy use per unit of GDP, and CO₂ emissions per unit of energy consumed (Kaya and Yokobori, 1997).

³ There is a huge literature on the relationship between energy consumption and economic growth. See Ozturk (2010) for a comprehensive review. This paper instead focuses on the relationship between CO₂ emissions and income. Coondoo and Dinda (2002) find that for developed countries the causality between income and emission runs from emission to income.

⁴ See Choinière and Horowitz (2006) for another application.

⁵ See Pereira and Pereira (2010).

⁶ See http://www.eia.doe.gov/environment.html.

⁷ Alan Heston, Robert Summers, and Bettina Aten, Penn World Table Version 6.3, Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania, August 2009.

⁸ The authors’ another paper suggests that the literature (e.g., Schmalensee et al. (1998)) may have overestimated CO₂ emissions beyond 1990 due to their use of the pre-1990 period.

⁹ Direct benefits could be measured by the damages avoided by climate change policy; and ancillary benefits are additional benefits resulting from emission reductions.