QUARTERLY ESSAY 44 Man-Made World

 

Correspondence

John Quiggin

As an economist working on climate change and trying to communicate with interested members of the public, one of the greatest challenges I’ve faced is to explain the magnitude of the likely costs of meeting Australia’s climate targets for 2020, and of decarbonising the economy in the longer term. In particular, I’ve talked about the estimated cost of a program that does enough to limit warming to around 2 degrees Celsius (relative to pre-industrial climates). Such a program will require Australia and other developed countries to cut emissions by around 90 per cent by 2050.

Most such estimates suggest that if a market-based approach were adopted globally, income per person would be about 1 to 5 per cent lower by 2050 than if no further action were taken. Since Australia is an energy exporter, the impact here would be higher than elsewhere, so I’ll use the upper end of the range and suppose that a comprehensive mitigation program would reduce our income by 5 per cent by the time it was fully implemented.

Is that a lot, or a little? Australia’s national income (this is a more relevant measure than the more widely quoted GDP, but the two don’t differ much) is currently around $1.2 trillion a year, so a reduction of 5 per cent would be around $60 billion a year. Over forty years, using standard discounting procedures, the aggregate reduction in income could be around $2 trillion.

That sounds like an awful lot, but in reality it just illustrates our difficulty in handling large economic numbers over long periods. To put the same estimate differently, the best estimate of our likely average growth in income per person in the long run is around 2 per cent per year, which implies that income per person will double in about thirty-five years. An ambitious mitigation program would reduce the rate of growth by around 0.1 percentage points, and delay the time at which income would double by around two and a half years.

An important implication is that, in terms of overall living standards, the typical household will barely notice the impact of such a change. Household incomes are quite volatile, commonly varying from one year to the next by 10 per cent or more. That’s more than twice as much as the entire impact of a climate change program over forty years. Even for the aggregate economy, the difference between a recession and a boom is more than 5 per cent. Obviously, effects of this kind vary a lot from household to household.

Another useful comparison is with health care, which currently accounts for 9 per cent of GDP in Australia. On current projections of demographic changes and developments in medical technology, it’s very likely that this share will increase to 15 per cent by 2050 (it’s already around this level in the US). That change would be similar, in economic terms, to the impact of decarbonisation.

Changes of this kind require a substantial reorientation of economic activity, with some industries contracting substantially and others expanding. But there is nothing special about this. Over the course of the twentieth century, employment in agriculture fell from 30 per cent of the workforce to 3 per cent. After peaking at almost 50 per cent of total employment in the middle of the century, the combined share of manufacturing and mining contracted to around 20 per cent by 2000. The recent mining boom has not reversed this trend, as modest growth in mining sector employment has been offset by continued contraction in manufacturing.

Provided the economy is growing, adjustments of this kind usually go fairly smoothly. Something like 20 per cent of Australian workers change their jobs every year, so the labour market can certainly accommodate structural changes far larger than those that will be associated with decarbonisation. Still, the impacts will not be trivial, particularly at the regional level. Some parts of the country will do better and others worse.

If the costs for Australia are significant but manageable, how would a global agreement to decarbonise the economy affect the world as a whole? It depends on the kind of bargain that is struck, of course, but the most obvious basis for an agreement is “contract and converge.” That is, all countries should eventually converge on a common entitlement for emissions per person. Countries with higher emissions would buy tradeable permits from those with lower emissions.

For an agreement on this basis, Australia’s costs would, as I’ve already suggested, be at the high end. The cost for rapidly developing countries like China and India would be less than 5 per cent of national income (at current rates, around six months’ worth of growth). There is no fundamental conflict between a sustainable climate and continued economic progress.

Why has it been so hard for me to explain this to non-economists? The debate over energy seems to have led people to think in binary terms. Either the problem of climate change is one that can easily be solved with a few small adjustments (turning off light switches, some modest subsidies for renewable energy and so on) or it requires changes that amount to the end of industrial civilisation as we know it. There is, it seems, no middle ground. 

This brings me, at last, to Andrew Charlton’s essay. His title implicitly endorses the binary choice of options I’ve criticised above. In the end, however, he argues that there is a way to resolve this dilemma, namely that we should look once more to technology and innovation for solutions.

Focusing on the Australian debate, Charlton correctly observes that the adjustments required even to meet the government’s 2020 target of a 5 per cent reduction in emissions will be too large to be achieved with the currently proposed carbon tax. If the target is to be met, we will have to resort to importing emissions credits, a path that can’t be pursued forever and obviously is not available to the world as a whole. As Charlton says, “Pretending that addressing the problem will be without cost is a recipe for failure.”

But, as is typical in this debate, Charlton then jumps to the opposite extreme. He claims that price-based policies like carbon taxes or emission trading schemes cannot possibly achieve the necessary reductions in emissions, and that it is necessary to pursue an alternative path, namely that of large investments in research to produce a technological solution.

There are two big problems here. The first is that there is a large element of magical thinking in the invocation of a technological solution. Charlton gives us no reason to suppose that the research program he advocates would be more cost-effective than the investments (including in research) that would result from the adoption of a carbon price. (So if a carbon price would cost too much, in terms of foregone growth opportunities, to be feasible, the same would probably be true of a publicly funded research program.) 

But the much bigger problem is that, having shown that a carbon price so low as to be effectively cost-free will not achieve the necessary reductions, Charlton offers no serious analysis of whether the goal can be achieved at costs that are significant, but still affordable. He makes vague references to billions, but in an economy that generates over a thousand billion a year in output, that is scarcely conclusive.

The most substantive analysis Charlton offers is in his discussion of Australia’s target for 2020, which he addresses using the Kaya Identity. Charlton states that “energy efficiency can be assumed for this analysis to continue to improve at its historic rate of about 1 per cent per year.” That assumption is reasonable if the price of carbon is so low as to have only modest effects on demand.

But suppose that the price were raised to $100 per tonne as the Greens have suggested. That would add 10 cents per kilowatt-hour to the cost of electricity generated by burning black coal. At that price, the energy used by an inefficient fridge or air-conditioner would be substantially more than its purchase price, producing a strong incentive to seek more efficient alternatives, or to focus on less energy-intensive forms of consumption. The incentives for business to reduce energy use would be even sharper. It seems reasonable to suppose, under such circumstances, that the annual rate of improvement in energy efficiency might rise to 2.5 per cent and that the growth rate of demand for energy-intensive forms of consumption might fall below the rate of GDP growth, say to 1 per cent.

Redoing Charlton’s calculation with these assumptions radically changes the conclusions. Now the demand effects of higher prices would reduce energy use by more than 20 per cent over ten years. On that basis, only 10 per cent of existing emissions would need to be replaced. Moreover, the price incentives associated with a $100 per tonne carbon price would make both wind and solar renewable energy competitive with gas. Existing brown coal plants would become uneconomic, as would new investments in black coal plants.

Charlton implicitly concedes this point, saying, “Most of the scalable clean options are so expensive that the carbon price required to encourage genuinely commercial investment would need to be in the range of $100–500 per tonne, not the $20–30 now planned.” These numbers are exaggerated (most estimates suggest that wind power needs a carbon price of $50 per tonne, while recent cost reductions make solar PV competitive at less than $100). More importantly, Charlton does not even try to make a case that a price of $100 per tonne is not feasible.

So would a carbon price of $100 per tonne, phased in over ten years or so, be economically ruinous? It’s easy to see that it would not be. The government’s current policy is expected to raise about $10 billion in revenue, most of which will be redistributed back to households. If the price were four times as high, and produced a 25 per cent additional reduction in emissions, the total revenue would be around $30 billion after the contraction in the tax base was taken into account. That’s less than the revenue raised by the GST.

To put things more bluntly, the objections to a carbon price high enough to stabilise the global climate are political, not economic. The problem is not that a price-based climate policy would destroy economic growth but that it would create (in fact, has already created), in Charlton’s words, “a political firestorm.” Advocacy of a technological solution, which is never going to be funded on the scale necessary to achieve the desired outcomes, amounts to a choice to back away from a problem that, for the moment, appears to be in the political “too hard” basket.

 

John Quiggin is ARC Federation Fellow in Economics and Political Science at the University of Queensland. He has worked extensively on the economics of climate change and its implications for the Murray-Darling Basin. His most recent book is Zombie Economics: How Dead Ideas Still Walk Among Us (new edition 2012).

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This correspondence featured in Quarterly Essay 45, Us & Them.


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