The Economics of Climate Change (third of three posts)

Stern Review: Executive Summary (Part 3 of 3)


<> Adaptation policy is crucial for dealing with the unavoidable impacts of climate change, but it has been under-emphasised in many countries.

Adaptation is the only response available for the impacts that will occur over the next several decades before mitigation measures can have an effect.

Unlike mitigation, adaptation will in most cases provide local benefits, realised without long lead times. Therefore some adaptation will occur autonomously, as individuals respond to market or environmental changes. Some aspects of adaptation, such as major infrastructure decisions, will require greater foresight and planning. There are also some aspects of adaptation that require public goods delivering global benefits, including improved information about the climate system and more climate-resilient crops and technologies.

Quantitative information on the costs and benefits of economy-wide adaptation is currently limited. Studies in climate-sensitive sectors point to many adaptation options that will provide benefits in excess of cost. But at higher temperatures, the costs of adaptation will rise sharply and the residual damages remain large. The additional costs of making new infrastructure and buildings resilient to climate change in OECD countries could be $15 to 150 billion each year (0.05 to 0.5% of GDP).

The challenge of adaptation will be particularly acute in developing countries, where greater vulnerability and poverty will limit the capacity to act. As in developed countries, the costs are hard to estimate, but are likely to run into tens of billions of dollars.

Markets that respond to climate information will stimulate adaptation among individuals and firms. Risk-based insurance schemes, for example, provide strong signals about the size of climate risks and therefore encourage good risk management.

Governments have a role in providing a policy framework to guide effective adaptation by individuals and firms in the medium and longer term. There are four key areas:

* High-quality climate information and tools for risk management will help to drive efficient markets. Improved regional climate predictions will be critical, particularly for rainfall and storm patterns.

* Land-use planning and performance standards should encourage both private and public investment in buildings and other long-lived infrastructure to take account of climate change.

* Governments can contribute through long-term polices for climate-sensitive public goods, including natural resources protection, coastal protection, and emergency preparedness.

* A financial safety net may be required for the poorest in society, who are likely to be the most vulnerable to the impacts and least able to afford protection (including insurance).

Sustainable development itself brings the diversification, flexibility and human capital which are crucial components of adaptation. Indeed, much adaptation will simply be an extension of good development practice - for example, promoting overall development, better disaster management and emergency response. Adaptation action should be integrated into development policy and planning at every level.


<> An effective response to climate change will depend on creating the conditions for international collective action.

This Review has identified many actions that communities and countries can take on their own to tackle climate change.

Indeed, many countries, states and companies are already beginning to act. However, the emissions of most individual countries are small relative to the global total, and very large reductions are required to stabilise greenhouse gas concentrations in the atmosphere. Climate change mitigation raises the classic problem of the provision of a global public good. It shares key characteristics with other environmental challenges that require the international management of common resources to avoid free riding.

The UN Framework Convention on Climate Change (UNFCCC), Kyoto Protocol and a range of other informal partnerships and dialogues provide a framework that supports co-operation, and a foundation from which to build further collective action.

A shared global perspective on the urgency of the problem and on the long-term goals for climate change policy, and an international approach based on multilateral frameworks and co-ordinated action, are essential to respond to the scale of the challenge. International frameworks for action on climate change should encourage and respond to the leadership shown by different countries in different ways, and should facilitate and motivate the involvement of all states. They should build on the principles of effectiveness, efficiency and equity that have already provided the foundations of the existing multilateral framework.

The need for action is urgent: demand for energy and transportation is growing rapidly in many developing countries, and many developed countries are also due to renew a significant proportion of capital stock. The investments made in the next ten to twenty years could lock in very high emissions for the next half-century, or present an opportunity to move the world onto a more sustainable path.

International co-operation must cover all aspects of policy to reduce emissions - pricing, technology and the removal of behavioural barriers, as well as action on emissions from land use. And it must promote and support adaptation. There are significant opportunities for action now, including in areas with immediate economic benefits (such as energy efficiency and reduced gas flaring) and in areas where large-scale pilot programmes would generate important experience to guide future negotiations.

Agreement on a broad set of mutual responsibilities across each of the relevant dimensions of action would contribute to the overall goal of reducing the risks of climate change. These responsibilities should take account of costs and the ability to bear them, as well as starting points, prospects for growth and past histories.

Securing broad-based and sustained co-operation requires an equitable distribution of effort across both developed and developing countries. There is no single formula that captures all dimensions of equity, but calculations based on income, historic responsibility and per capita emissions all point to rich countries taking responsibility for emissions reductions of sixty to eighty percent from 1990 levels by 2050.

Co-operation can be encouraged and sustained by greater transparency and comparability of national action.


<> Creating a broadly similar carbon price signal around the world, and using carbon finance to accelerate action in developing countries, are urgent priorities for international co-operation.

A broadly similar price of carbon is necessary to keep down the overall costs of making these reductions, and can be created through tax, trading or regulation. The transfer of technologies to developing countries by the private sector can be accelerated through national action and international co-operation.

The Kyoto Protocol has established valuable institutions to underpin international emissions trading. There are strong reasons to build on and learn from this approach. There are opportunities to use the UNFCCC dialogue and the review of the effectiveness of the Kyoto Protocol, as well as a wide range of informal dialogues, to explore ways to move forward.

Private sector trading schemes are now at the heart of international flows of carbon finance. Linking and expanding regional and sectoral emissions trading schemes, including sub-national and voluntary schemes, requires greater international cooperation and the development of appropriate new institutional arrangements.


<> Decisions made now on the third phase of the EU ETS provide an opportunity for the scheme to influence, and become the nucleus of, future global carbon markets.

The EU ETS is the world's largest carbon market. The structure of the third phase of the scheme, beyond 2012, is currently under debate. This is an opportunity to set out a clear, long-term vision to place the scheme at the heart of future global carbon markets.

There are a number of elements which will contribute to a credible vision for the EU ETS. The overall EU limit on emissions should be set at a level that ensures scarcity in the market for emissions allowances, with stringent criteria for allocation volumes across all relevant sectors. Clear and frequent information on emissions during the trading period would improve transparency in the market, reducing the risks of unnecessary price spikes or of unexpected collapses.

Clear revision rules covering the basis for allocations in future trading periods would create greater predictability for investors. The possibility of banking (and perhaps borrowing) emissions allowances between periods could help smooth prices over time.

Broadening participation to other major industrial sectors, and to sectors such as aviation, would help deepen the market, and increased use of auctioning would promote efficiency.

Enabling the EU ETS to link with other emerging trading schemes (including in the USA and Japan), and maintaining and developing mechanisms to allow the use of carbon reductions made in developing countries, could improve liquidity while also establishing the nucleus of a global carbon market.


<> Scaling up flows of carbon finance to developing countries to support effective policies and programmes for reducing emissions would accelerate the transition to a low-carbon economy.

Developing countries are already taking significant action to decouple their economic growth from the growth in greenhouse gas emissions. For example, China has adopted very ambitious domestic goals to reduce energy used for each unit of GDP by twenty percent from 2006 to 2010 and to promote the use of renewable energy. India has created an Integrated Energy Policy for the same period that includes measures to expand access to cleaner energy for poor people and to increase energy efficiency.

The Clean Development Mechanism, created by the Kyoto Protocol, is currently the main formal channel for supporting low-carbon investment in developing countries. It allows both governments and the private sector to invest in projects that reduce emissions in fast-growing emerging economies, and provides one way to support links between different regional emissions trading schemes.

In future, a transformation in the scale of, and institutions for, international carbon finance flows will be required to support cost-effective emissions reductions. The incremental costs of low-carbon investments in developing countries are likely to be at least $20 to $30 billion per year. Providing assistance with these costs will require a major increase in the level of ambition of trading schemes such as the EU ETS. This will also require mechanisms that link private-sector carbon finance to policies and programmes rather than to individual projects. And it should work within a context of national, regional or sectoral objectives for emissions reductions. These flows will be crucial in accelerating private investment and national government action in developing countries.

There are opportunities now to build trust and to pilot new approaches to creating large-scale flows for investment in low-carbon development paths. Early signals from existing emissions trading schemes, including the EU ETS, about the extent to which they will accept carbon credits from developing countries, would help to maintain continuity during this important stage of building markets and demonstrating what is possible.

The International Financial Institutions have an important role to play in accelerating this process: the establishment of a Clean Energy Investment Framework by the World Bank and other multilateral development banks offers significant potential for catalysing and scaling up investment flows.


<> Greater international co-operation to accelerate technological innovation and diffusion will reduce the costs of mitigation.

The private sector is the major driver of innovation and the diffusion of technologies around the world. But governments can help to promote international collaboration to overcome barriers in this area, including through formal arrangements and through arrangements that promote public-private co-operation such as the Asia Pacific Partnership. Technology co-operation enables the sharing of risks, rewards and progress of technology development and enables co-ordination of priorities.

A global portfolio that emerges from individual national R&D priorities and deployment support may not be sufficiently diverse, and is likely to place too little weight on some technologies that are particularly important for developing countries, such as biomass.

International R&D co-operation can take many forms. Coherent, urgent and broadly based action requires international understanding and co-operation. These may be embodied in formal multilateral agreements that allow countries to pool the risks and rewards for major investments in R&D, including demonstration projects and dedicated international programmes to accelerate key technologies. But formal agreements are only one part of the story - informal arrangements for greater coordination and enhanced linkages between national programmes can also play a very prominent role.

Both informal and formal co-ordination of national policies for deployment support can accelerate cost reductions by increasing the scale of new markets across borders. Many countries and US states now have specific national objectives and policy frameworks to support the deployment of renewable energy technologies. Transparency and information-sharing have already helped to boost interest in these markets. Exploring the scope for making deployment instruments tradable across borders could increase the effectiveness of support, including mobilising the resources that will be required to accelerate the widespread deployment of carbon capture and storage and the use of technologies that are particularly appropriate for developing countries.

International co-ordination of regulations and product standards can be a powerful way to encourage greater energy efficiency. It can raise their cost effectiveness, strengthen the incentives to innovate, improve transparency, and promote international trade.

The reduction of tariff and non-tariff barriers for low-carbon goods and services, including within the Doha Development Round of international trade negotiations, could provide further opportunities to accelerate the diffusion of key technologies.


<> Curbing deforestation is a highly cost-effective way of reducing greenhouse gas emissions.

Emissions from deforestation are very significant - they are estimated to represent more than eighteen percent of global emissions, a share greater than is produced by the global transport sector.

Action to preserve the remaining areas of natural forest is needed urgently. Large-scale pilot schemes are required to explore effective approaches to combining national action and international support.

Policies on deforestation should be shaped and led by the nation where the particular forest stands. But those countries should receive strong help from the international community, which benefits from their actions to reduce deforestation. At a national level, defining property rights to forestland, and determining the rights and responsibilities of landowners, communities and loggers, is key to effective forest management. This should involve local communities, respect informal rights and social structures, work with development goals and reinforce the process of protecting the forests.

Research carried out for this report indicates that the opportunity cost of forest protection in eight countries responsible for seventy percent of emissions from land use could be around $5 billion per annum initially, although over time marginal costs would rise.

Compensation from the international community should take account of the opportunity costs of alternative uses of the land, the costs of administering and enforcing protection, and the challenges of managing the political transition as established interests are displaced.

Carbon markets could play an important role in providing such incentives in the longer term. But there are short-term risks of destabilising the crucial process of strengthening existing strong carbon markets if deforestation is integrated without agreements that strongly increase demand for emissions reductions. These agreements must be based on an understanding of the scale of transfers likely to be involved.


<> Adaptation efforts in developing countries must be accelerated and supported, including through international development assistance.

The poorest developing countries will be hit earliest and hardest by climate change, even though they have contributed little to causing the problem. Their low incomes make it difficult to finance adaptation. The international community has an obligation to support them in adapting to climate change. Without such support there is a serious risk that development progress will be undermined.

It is for the developing countries themselves to determine their approach to adaptation in the context of their own circumstances and aspirations. Rapid growth and development will enhance countries' ability to adapt. The additional costs to developing countries of adapting to climate change could run into tens of billions of dollars.

The scale of the challenge makes it more urgent than ever for developed countries to honour their existing commitments - made in Monterrey in 2002, and strengthened at EU Councils in June 2005 and at the July 2005 G8 Gleneagles Summit - to double aid flows by 2010.

Donors and multilateral development institutions should mainstream and support adaptation across their assistance to developing countries. The international community should also support adaptation through investment in global public goods, including improved monitoring and prediction of climate change, better modelling of regional impacts, and the development and deployment of drought- and flood-resistant crops.

In addition, efforts should be increased to build public-private partnerships for climate-related insurance; and to strengthen mechanisms for improving risk management and preparedness, disaster response and refugee resettlement.

Strong and early mitigation has a key role to play in limiting the long-run costs of adaptation. Without this, the costs of adaptation will rise dramatically.


<> Building and sustaining collective action is now an urgent challenge.

The key building blocks for any collective action include developing a shared understanding of the long-term goals for climate policy, building effective institutions for co-operation, and demonstrating leadership and working to build trust with others. Without a clear perspective on the long-term goals for stabilisation of greenhouse gas concentrations in the atmosphere, it is unlikely that action will be sufficient to meet the objective.

Action must include mitigation, innovation and adaptation. There are many opportunities to start now, including where there are immediate benefits and where large-scale pilot programmes will generate valuable experience. And we have already begun to create the institutions to underpin co-operation.

The challenge is to broaden and deepen participation across all the relevant dimensions of action - including co-operation to create carbon prices and markets, to accelerate innovation and deployment of low-carbon technologies, to reverse emissions from land-use change and to help poor countries adapt to the worst impacts of climate change.


<> There is still time to avoid the worst impacts of climate change if strong collective action starts now.

This Review has focused on the economics of risk and uncertainty, using a wide range of economic tools to tackle the challenges of a global problem which has profound long-term implications. Much more work is required, by scientists and economists, to tackle the analytical challenges and resolve some of the uncertainties across a broad front. But it is already very clear that the economic risks of inaction in the face of climate change are very severe.

There are ways to reduce the risks of climate change. With the right incentives, the private sector will respond and can deliver solutions. The stabilisation of greenhouse gas concentrations in the atmosphere is feasible, at significant but manageable costs.

The policy tools exist to create the incentives required to change investment patterns and move the global economy onto a low-carbon path. This must go hand-in-hand with increased action to adapt to the impacts of the climate change that can no longer be avoided.

Above all, reducing the risks of climate change requires collective action. It requires co-operation between countries, through international frameworks that support the achievement of shared goals. It requires a partnership between the public and private sector, working with civil society and with individuals. It is still possible to avoid the worst impacts of climate change; but it requires strong and urgent collective action. Delay would be costly and dangerous.

http://news.bbc.co.uk/2/shared/bsp/hi/pdfs/30_10_06_exec_sum.pdf


Bill Totten http://www.ashisuto.co.jp/english/index.html