Emission targets put us in bullseye of climate fight

The Australian government commissioned economic modeling to focus on the economic consequences of the upcoming negotiations under the United National Framework Convention on Climate Change to be held in Paris in December. The two reports that I prepared were released by the government late last week. Both the earlier leaked media coverage of these reports and the subsequent media coverage have been quite misleading in the way the results from these studies are interpreted.

Both reports are based on a global economic model. The results in these reports should be treated very cautiously because of the enormous uncertainty involved. The outcomes for the consequences of any particular emission target depend on many factors such as the particular model used, the future projections of the world economy which would occur without the imposition of a carbon target and the nature of the policies that are actually used to reach any given emissions targets. The usefulness of applying a well-documented and transparent model to evaluate policies is that the assumptions are clear and the key sensitivities in the analysis can be explored to get a better idea of the range of possible costs for a given target. It is easy to argue that a policy would devastate an economy or would be costless, but a model based exercise forces the analyst to be explicit in the assumptions that are required to generate these alternative worlds. Models can easily be criticized but the alternative is worse, a good deal more flexible and very popular with extreme proponents in any debate.

The first report explored the impact on the global economy if all major countries (except Australia) achieved the targets they have pledged, either with the policies they proposed or with a reasonably efficient policy in lieu of an actual policy announcement. Many countries have pledged energy efficiency improvements which in many cases appears to be a “free lunch”. Someone has to pay for improvement in energy efficiency and this was explicitly taken into account in the modeling. The focus of the report was what impact this would have on the global and Australian economies and key sectors by 2030.

It is no surprise that fossil fuel industries in Australia were most affected with coal bearing the largest costs. Coal exports by 2030 are estimate to be about 7.8% lower than otherwise and coal production in Australia 8.3% lower (although still higher than 2015 levels). Exports of non-fossil fuels sectors are projected to rise, as a weaker Australian dollar would make these other sectors more competitive in global markets. Overall Australian GDP would be roughly 0.16% lower than otherwise by 2030 – or if the absence of an Australian policy response increased the risk in the energy sector, this loss might be doubled.

The second study considered four alternative emission targets for Australia: reductions of 13%, 26%, 35% and 45% relative to 2005 emissions. Also considered were the costs of alternative energy options in electricity generation and the impact of access to international credits.

In considering the impact on overall GDP, there are at least three different ways of measuring these impacts. Commentators have chosen whichever measure suits their argument. You can compare the level of GDP lost in 2030 relative to what would have been without the Paris commitments. GDP is 0.6% lower than it would otherwise be in 2030. This translates into a GDP loss in 2030 of around $20 billion. You can also calculate the sum of GDP lost each year until 2030 to get a cumulative GDP loss by 2030 which is close to $200 billion. If you calculate the impact on the average growth rate from 2015 to 2030 then the rate of economic growth is roughly 0.01% lower. All of these figures mean the same thing when scaled by the appropriate metric. Whether this is a large or a small cost is in the eyes of the reader.

Another lesson from the analysis is that if international permits are available and if they are as cheap as they are today (the assumption of the modeling) then this cost might be reduced by 50%. If the cost of international permits where higher than the cost of reducing carbon domestically then none would be used and the economic costs would be unchanged by this option. If technology costs are cheaper than expected then this figure might also be reduced but if they are higher then this cost would rise. There is a wide range of uncertainty on the economic costs just as there is a wide range of uncertainty over the impact of carbon emissions on temperatures.

In summary, the report finds that Australia’s target of 26% to 28% below 2005 emissions, when compared to other countries in terms of economic costs, is at the high end of the commitments made by all countries for Paris. The extent of effort is better measured by the economic costs than the size of the target. The size of the global target is important for climate change but an equal allocation across countries is not a measure of effort. It is a political measure used for political purposes.

In aggregate, it is reasonable to argue that the Paris commitments by all countries are not sufficient to meet the reductions estimated by many climate scientists that are needed to avoid two degrees of warming. However to argue that Australia is not making a large contribution to the overall effort for Paris is incorrect. Only focusing on the emissions target is playing politics. Until the economic costs relative to the environmental benefits are at the core of the global response, there will not be an effective global agreement.

Editor’s Note: This op-ed originally appeared in The Australian Financial Review