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EU's 2020 CO2 target 'will add a year to economic slump'

Emission cuts are 'too much too soon'

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The EU's effort to cut carbon dioxide emissions by 20 per cent is twice as costly as it needs to be, and is likely to impact growth across the continent, according to a new study by a leading environmental economist.

Europe failed to produce a cost-benefit analysis when it set its climate target, so Dr Richard Tol has filled the gap. He contributed to the IPCC's 2007 AR4 report, has more than 100 published papers and doesn't quibble with the scientific consensus, but merely tries to put a price on the proposed "cures".

Tol argues that a well-designed set of climate policies should not have a significant economic impact. Optimally, the marginal cost of implementing a policy should equal the marginal cost of the global warming-induced damage it seeks to prevent.

But getting parity can only be achieved by aggressively setting the discount rates in the calculations to a very low number. A discount rate is, crudely speaking, the projected economic damage in the future compared to the cost of mitigation in the present day.

By adopting a low discount rate in their calculations, Europe's leaders have declared two things: the damage that is posited to take place far in the future will cost an awful lot to fix in today's money, and the costs of a policy in the immediate future are underestimated*.

"A well-designed, gradual policy can substantially reduce emissions at low cost to society [but] ill-designed policies, or policies that seek to do too much too soon, can be orders of magnitude more expensive", Tol writes. "While the academic literature has focussed on the former, policy makers have opted for the latter."

A century of climate change (aka global warming) could conceivably cost, say, a year in lost growth. However, the European Union's grand scheme to achieve a 20 per cent reduction in CO2 from a 1980 baseline by 2020, including a 20 per cent renewable energy target known as 20/20/2020, will squeeze that cost into a much shorter and more immediate time frame.

Between now and the end of the decade, Tol believes the union's efforts to cut carbon dioxide emissions could lose the continent roughly a year of economic expansion:

For the EU as a whole ... climate policy is costly. A loss of 1.3 per cent is of course not dramatic, but it is projected to occur over the space of only eight years (2013-2020), so that roughly one in every ten years of growth is lost.

Only Holland and Belgium will see significant positive welfare impacts from the policy, while most will see a negative impact of about four per cent.

Tol concludes, therefore, that the Eurozone's schemes are "unlikely to meet the benefit-cost test. For a standard discount rate, the benefit-cost ratio is rather poor (1/30)".

He notes that Europeans support the intention to "do something" about climate change. Meanwhile, India, China and Brazil have charged on, valuing economic development and lifting their populations out of poverty (and poverty-related illness) much more highly than measures that inhibit domestic growth. As a consequence, climate has been relegated to the margins of political debate, even in Anglophone countries. The costs don't go away, however.

The new paper furthers Tol's work from 2009 on the costs of the EU schemes [PDF]. ®

Bootnote

* Notoriously the Stern Report from 2006 used a discount rate close to zero, specifically 0.1 per cent. Nicholas Stern, the former chief economist of the World Bank and permanent secretary at the UK Treasury, used a low "social time discount rate" to justify sucking money out of the economy today. He argued it would have little impact on the welfare of future generations. The three per cent used by economist William Nordhaus is widely considered to be more realistic. Hal Varian discussed this here, asking "is it really ethical to transfer wealth from someone making $7,000 a year to someone making $94,000 a year?"

According to Tol, "Stern essentially tried to impose his views on others - like a colonial master would tell the savages what to think". Stern has since received a peerage and is Baron Stern of Brentford.

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