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The climate conflict – and its economic and political implications

London, 2 March 2012

Deutsch Bank Research - Talking point: Currently, there is an ongoing debate about the pace, scope and damage potential of climate change as well as about the influence of humankind on this phenomenon. This may come as a surprise to casual observers of the debate, for over the past few years most people have been given the impression that scientists agreed that, first of all, climate change is proceeding rapidly, that, secondly, humankind has been a major contributor because of anthropogenic greenhouse gas emissions and that, thirdly, climate change will bring with it serious damage. This “climate conflict” is not at all new, however. Rather, it as old as the climate debate itself.

It is generally possible to identify four different “camps” in the climate change debate, although the boundaries separating the respective positions are fuzzy.

— The first camp completely, or at least largely, rejects any human influence on climate change.

— The second camp acknowledges human influences on climate change, but considers them very small overall and/or relative to other factors.

— The third camp contends that humans have a significant impact on climate change, but that the damage caused (in the short and medium term) will not be so severe and that other problems facing humankind are more urgent.

— Finally, the position of the fourth camp is that human activities play a substantial role in accelerating climate change, that climate change will be linked with major damage and that for this reason there should be a rapid change of tack.

To round off the spectrum of opinion, it should be mentioned that in some quarters the consequences of climate change are not regarded per se as negative for humankind.

What is quite confusing about the debate not only for interested lay people, but also for “climate experts” from disciplines other than the natural sciences (say, economists) is that each camp backs its own opinion with more or less convincing arguments. However, none of the camps can offer hard evidence for its own theories (in the sense of a reliably reproducible experiment). None of them makes this claim, either. In this respect, the existence of uncertainty within the climatology sphere is entirely beyond dispute.

So what are the economic and political implications of this climate conflict? Should policymakers radically alter their priorities? To answer these questions it should first be realised that economic agents – regardless of whether they be government, corporate or private individual – are almost always required to take decisions in an atmosphere of uncertainty. The uncertainties about climate change and the role played by human beings could – metaphorically – be applied to a problem of (economic) decision-making as faced by a car driver: imagine a driver travelling along a road at high speed. When a wall appears on the horizon the driver is uncertain whether he will run into this wall or pass it by. Since avoiding an accident has priority for the driver (not only) from an economic perspective, it is advisable for him to at least reduce his speed until the uncertainty has been cleared; incidentally, this is also the common sense course of action.

Drawing an analogy to climate change, this would mean it is certainly advisable for humans to reduce their carbon emissions, because there is an exceedingly large risk of massive damage from climate change.

More Efficiency!

What is of particular importance now is how humankind should go about lowering its emissions of greenhouse gases, or, to keep to the same metaphor, how the driver should apply the brakes. And, in this case, at least economists do give a clear answer: emissions should be reduced where it costs the least to do so. It follows that people should seize the most efficient measures to mitigate, that is avoid, carbon emissions; ultimately, this tallies with the basic idea of emissions trading. A host of carbon mitigation measures are worthwhile economically, because the savings on energy costs, for instance, are higher than the preceding investment. One way of recognising the degree of energy wasted at the global level, for example, is to compare carbon emissions by the United States and the European Union.

While the US only moderately outstrips the EU in terms of affluence, it emits more than twice as much CO2 per capita. Another example is that the carbon intensity of, say, the Chinese economy is nearly twice as high as that of the EU. The large subsidies for fossil fuels granted above all in the respective producing countries also result in wasteful use of scarce resources. Even barring the climate change phenomenon, economic sense demands that such wasteful usage be stopped in all the examples cited.

In any event, the finite nature of fossil fuels – again, completely regardless of climate change – is a further economic reason to reduce carbon emissions (and/or the consumption of those resources). After all, oil, natural gas and coal will probably tend to increase in price over the next few decades, and their extraction is increasingly linked with local environmental problems. At this juncture, the image of the car driver comes in handy again: even if the driver should pass the wall without hitting it, the road taken will at some point end in the middle of nowhere or a dead end.

So what can be concluded about the climate policy measures pursued to date? With its emissions trading system, the EU has put a price on carbon and created a platform enabling mitigation measures to be taken at the lowest cost possible in the participating sectors. On top of this, though, there is also a whole patchwork of (partly) climate-motivated measures across the EU; maximum CO2 emission limits for cars and the subsidisation of renewable energy sources are only two examples. This mixture of instruments results de facto in differing prices for, a homogeneous and, in the EU, tradable good. This difference is invariably a sign of economic and ecological inefficiency, yet political reality. By expanding emissions trading to more sectors of the economy the climate policy toolbox could be simplified.

Finally, we believe the EU’s climate policy is generally heading in the right direction, even though some very expensive (though no doubt well-meant) climate protection measures require adjustments and tweaking. Furthermore, the EU‘s quantitative carbon emissions reduction target as formulated to date (-20% by 2020 vs. 1990) is not overly ambitious, since the potential efficiency gains in the EU alone are likely sizeable. There is also justification for increasing R&D for climate protection, so that technological progress, for instance, can help lower the cost of today’s still expensive mitigation measures in future (static versus dynamic efficiency of climate protection measures).

It is a problem that other countries are not yet pursuing quantitative CO2 reduction targets. This distorts international competition and massively reduces the effectiveness of EU climate policy, for ultimately all the countries – to return to the image used above – are sitting in the same car, and its speed will slow just a little if only a few of them step on the brakes. In these countries not even the price signals are strong enough to at least halt the waste of energy. Therefore, the abolition of fossil fuel subsidies and/or higher energy taxes in those countries would be a good place to start.

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