Reply to Davidson and Robson

Phillip Adams and Peter Dixon have prepared a reply (over the fold) to the opinion piece by Robson and Davidson in the Australian which offered a range of incoherent criticisms of proposals to reduce emissions of greenhouse gases. Disgracefully, but not at all surprisingly, the Oz has declined to print it, marking yet another step in its decline.

Admittedly, the debate is so one-sided that printing the reply would have made it obvious how ill-advised it was to publish the Davidson-Robson piece in the first place. Dixon is Australia’s pre-eminent economic modeller, and Adams is his successor as Director of the Centre of Policy Studies at Monash. They have published extensively in leading economic journals on modelling and climate change, and their expertise shows. Robson and Davidson have essentially zero professional expertise on these issues, and that shows too. Of course, they have exactly zero professional expertise in climate science, and that hasn’t stopped them claiming the entire profession is wrong, so we shouldn’t be surprised.

Tim Lambert cleans up what’s left

Insurance against catastrophic climate change: backing the Kyoto protocol

In an opinion piece (The Australian, 11/5), Alex Robson and Sinclair Davidson attempt to ridicule a petition currently being signed by university economists calling on the Australian Government to ratify the Kyoto Protocol.

We have signed the petition for three connected reasons: (1) compelling advice from the scientific community suggests that a sharp cut in world greenhouse gas (GHG) emissions would substantially reduce the risk of catastrophic climate change over the next century; (2) the Kyoto forum offers the best available possibility for Australia to play a constructive role in setting up world-wide arrangements for cutting GHG emissions; and (3) as part of a world-wide effort, Australia could achieve deep cuts in its own GHG emissions at only a moderate cost in terms of reduced economic welfare.

It is on point (3) that economists have particular expertise, justifying the presentation of an “economists� petition.

Cutting GHG emissions is like buying an insurance policy: we incur a cost (a loss in GDP) to reduce a risk (catastrophic climate change). In any insurance decision, the cost matters. If a worthwhile reduction in risk costs 50% of income, then living with the risk may be preferable. But if it costs 1% of income, then taking the insurance policy may be the best option. So what will it cost?

For the last 20 years, we have been undertaking economic modelling exercises for Australian and overseas organizations on the costs of GHG reductions. Our modelling, and that of other quantitative economists around the world, supports the claim in the petition that:
“Credible estimates suggest that a 50% emissions reduction is achievable for less than one year’s economic growth�.

Robson and Davidson have difficulty in figuring out what this means. Just to be clear, we will explain it in terms of the report by the Allen Consulting Group to the Business Roundtable on Climate Change (March, 2006).

Modelling we contributed to that report shows Australia’s real GDP growing between now and 2050 at an annual rate of 2.2% under the assumption of no new GHG policies. In this scenario, Australia’s GHG emissions by 2050 are 80% above their level in 2000.

In an alternative scenario, Australia undertakes policies to reduce its GHG emissions by 2050 to 60% below their level in 2000. Even with this very deep cut in emissions, Australia’s GDP grows between now and 2050 at an annual rate of 2.1 per cent. The implication is that a massive 60% cut in GHG emissions (relative to the 2000 level) costs about 20 months growth – the level of GDP that we would have reached on January 1, 2050 is not reached until September 1, 2051. A lesser cut would incur a lower cost. Taking account of non-linearities (the first 1% cut is much easier than the last 1% cut), a reasonable estimate for the cost of the 50% cut mentioned in the petition is 12 month’s growth.

Why do modelling results suggest that GHG emissions could be sharply reduced at seemingly moderate cost? Are these results plausible?

The main GHG-emitting activities are fossil-fuel-based provision of electricity and motor fuels. In Australia, these account for about 5.4% of GDP. Advice from scientists and engineers indicates that the adoption of current alternatives to fossil-fuel-based technologies would no more than double the costs of electricity and motor fuels. As a back-of-the envelope calculation, this suggests that Australia could make a 50% switch to alternative technologies at a cost of 2.7 per cent of GDP, a little over an average year’s growth.

But this is a pessimistic view of the costs of climate insurance. If the world embraced the need for deep cuts in GHG emissions, we would expect rapid technical progress in GHG-benign technologies which would reduce the costs of their adoption.

Professor Philip Adams and Professor Peter Dixon
Director and former Director of the Centre of Policy Studies
Monash University

90 thoughts on “Reply to Davidson and Robson

  1. SD #74, would you be Ok if I said ‘the people of a number of countries’? But it can be aggregated and shown as a percentage of national income. I can also assure you that between 30 and 40% is not uncommon in East Asia. You could fairly easily do the research.

  2. Sinclair – I am definitely not trying to put words in your mouth. I wrote what I concluded from the discussion. I can refine the “2/100” by saying ‘approximately 2/100’. See Mark U’s calculations and statements.

    I also don’t know where 34/100 comes from.

  3. In #67 Mark shows some calculations. I did the same in excel. If we start with GDP = 100 in 2007. The PV of the difference between 2.2% growth pa and 2.1% growth pa discounted at 6% pa is 34. So the pv cost is 34/100.

    Melanie, in a previous life I used to teach a subject called Asian Capital Markets. I don’t recall national aggregate investment rates at that level year in and year out.

  4. I found this list. A lot of low-income economies do have high gross fixed investment (this is for business only amd 2006 only).

  5. The following data are from a dataset downloadable from the World Bank. I just picked the 5 most successful economies in East Asia. Hope the time series are long enough for you. The high numbers are often to be found in the 1980-90s rather than in the earlier stages of growth.

    Investment as a percentage of GDP (unweighted averages)
    Japan 1960-97: 32.3 (low 27.7, high 39.0)
    Korea 1970-99: 31.0 (low 21.3, high 39.9)
    China 1978-99: 37.1 (low 32.5, high 43.3)
    Singapore 1970-99: 39.5 (low 32.8, high 48.5)
    Hong Kong 1970-99: 27.7 (low 20.5, high 35.3)

    Australia 1960-97: 24.6 (I gather it has dropped rather dramatically since 1997)

  6. SD, possibly you didn’t see such large numbers when you were teaching because most of the investment was not via capital markets, but via state-owned entities such as banks or, in Singapore, the CPF and SGIC (except in Hong Kong). In that sense it was the ‘countries’ that did the investment.

  7. Sinclair,

    If I do what you have said I get the calculations below. The 35.9 (which I assume matches up with your 34) should be looked at as a proportion of 2269.2. That is, we calculate the PV of the loss of output over the 43 year period as a percentage of the PV of total output over the 43 year period. This loss is 1.6%, which is even less than the 2.5% we get with a zero discount rate.

    Discount Rate 6%
    Growth Status Quo Emissions Reduction Difference % Difference
    2.2% 2.1%
    2006 100.0 100.0 0.0 0.0%
    2007 96.4 96.3 -0.1 -0.1%
    2008 93.0 92.8 -0.2 -0.2%
    2009 89.6 89.4 -0.3 -0.3%
    2010 86.4 86.1 -0.3 -0.4%
    2011 83.3 82.9 -0.4 -0.5%
    2012 80.3 79.9 -0.5 -0.6%
    2013 77.4 76.9 -0.5 -0.7%
    2014 74.7 74.1 -0.6 -0.8%
    2015 72.0 71.4 -0.6 -0.9%
    2016 69.4 68.7 -0.7 -1.0%
    2017 66.9 66.2 -0.7 -1.1%
    2018 64.5 63.8 -0.8 -1.2%
    2019 62.2 61.4 -0.8 -1.3%
    2020 60.0 59.2 -0.8 -1.4%
    2021 57.8 57.0 -0.8 -1.5%
    2022 55.8 54.9 -0.9 -1.6%
    2023 53.8 52.9 -0.9 -1.7%
    2024 51.8 50.9 -0.9 -1.7%
    2025 50.0 49.1 -0.9 -1.8%
    2026 48.2 47.2 -0.9 -1.9%
    2027 46.5 45.5 -0.9 -2.0%
    2028 44.8 43.8 -1.0 -2.1%
    2029 43.2 42.2 -1.0 -2.2%
    2030 41.6 40.7 -1.0 -2.3%
    2031 40.1 39.2 -1.0 -2.4%
    2032 38.7 37.7 -1.0 -2.5%
    2033 37.3 36.3 -1.0 -2.6%
    2034 36.0 35.0 -1.0 -2.7%
    2035 34.7 33.7 -1.0 -2.8%
    2036 33.4 32.5 -1.0 -2.9%
    2037 32.2 31.3 -1.0 -3.0%
    2038 31.1 30.1 -1.0 -3.1%
    2039 30.0 29.0 -1.0 -3.2%
    2040 28.9 28.0 -0.9 -3.3%
    2041 27.9 26.9 -0.9 -3.4%
    2042 26.9 25.9 -0.9 -3.5%
    2043 25.9 25.0 -0.9 -3.6%
    2044 25.0 24.1 -0.9 -3.7%
    2045 24.1 23.2 -0.9 -3.7%
    2046 23.2 22.3 -0.9 -3.8%
    2047 22.4 21.5 -0.9 -3.9%
    2048 21.6 20.7 -0.9 -4.0%
    2049 20.8 20.0 -0.9 -4.1%
    2050 20.1 19.2 -0.8 -4.2%
    2051 19.3 18.5 -0.8 -4.3%
    Sum (zero discount rate) 2269.2 2233.4 -35.9 -1.6%

  8. Sinclair, your numbers don’t make sense even if one were to treat GDP as ‘future cash flows’ as understood in Finance.

    You refer to Mark U’s numbers. Using these numbers, the difference in the GDP index over 44 years (2006 = 100 to 2050)is 11 in 2050. The PV of 11 at 2006, using your 6% compound, is 0.897926. As a percentage of the GDP index at 2006, the number is 0.8% and NOT 34%.

    I don’t know why anybody would want to do such calculations though. Obviously, if the maximum projected growth rate of GDP is 2.2% then, applying a discount rate of 6% results in something less than 2.2% and not something bigger.

  9. Sorry, Mark. I’m not following what you’ve done.

    Ernestine – there is a GDP diferential every year, the sum of the PVs of that differential is 34 (not just the last year). Why would the discount rate be less than a growth rate?

    Melanie, I’ll check my notes from the time. I used to make the students read the World Bank ‘East Asain Miricle’ publication. So I am aware the growth rates were high and capital markets played a very small role. Those numbers are a bit higher than I recall, but you’re probably right.

  10. Sinclair Davidson,

    Yes, there is a projected GDP differential every year and I believe you that the sum of the PV at 6% compound over 44 years is 34, on the GDP index.

    But where does the 34/100 (the ‘big number’) come from?

    I gather you relate 34 to the ‘current GDP'(index = 100). But, surely you would have to relate “34” to the discounted sum of GDPs for 44 years.

    How big is the number when you compare apples with apples? Would you still call it ‘big’?

  11. That’s exactly were I got the 34/100 from. That is apples with apples. How big is the cost compared to our current GDP is a standard yardstick that everyone understands.

  12. It’s been a long thread, but two points are clear. * If you compare stocks to stocks, or flows to flows, you’ll get a ratio close to 2 per cent.
    * If you compare stocks to flows, you can get any number you like

  13. Sinclair,

    You say you didn’t follow what I have done at #82. All I have done in the second set of numbers at #82 is discount each year’s GDP in #67 by 6% back to 2007 for each growth scenario. The final row is incorrectly labelled – it should say 6% discount rate. This last row shows the sum of discounted GDP in each year over the entire period. This brings out the key point that the sum of the losses in PV terms is 35.9 and this must be compared with the 2269.2, giving 1.6%.

    I can understand using current annual GDP as a yarstick but only to look at annual losses of GDP, not the sum of all annual losses over a 43 year period.

  14. carbonsink

    You need to differentiate between *metallurgical coal* and *steam coal*.

    http://www.australiancoal.com.au/exports0506.htm

    according to these numbers, 2/3rds of Australian coal exports are metallurgical coal. $16.8bn v. $7.8bn.

    The latter Australia could give up exporting. But if this led to the burning of less efficient brown coal in the export countries, then it would be a net loss to CO2 reduction. AFAIK Australian steam coal is primarily bituminous ie relatively high grade (which also happens to be the best coal for the IGCC carbon sequestration technology, if it is ever implemented).

    Metallurgical coal is high value anthracite (hard coal with a high carbon content). It is the basis of the primary steel industry (secondary steel, produced by remelting scrap, is big in the US and other developed countries).

    You can’t actually abolish primary steel making nor is there any substitute for metallurgical coal in it. The secondary steel industry (naturally) can’t produce any more steel than is available in scrap from the primary industry, and also secondary steel doesn’t, I don’t think, have quite the structural properties of primary steel (the same problem occurs recycled v. primary aluminium – you don’t use the former in aircraft wings for example).

    Most of those exports go to Japan and Korea, but the steel is then shipped to China. Note also India is a relatively important customer.

    Metallurgical coal is actually in short supply. The original metallurgical coal fields in the UK and many in the US Appalachians are nearly exhausted.

    Cut that supply and the price of steel goes up (potentially a lot). This has all kinds of negative impacts:

    – countries use more concrete/cement (cement is the world’s leading greenhouse gas source, after cars)

    – price of wind power and other alternative energies goes up (they use a lot of steel)

    – more marginal deposits in other countries are extracted at a higher energy, CO2 cost, and at the cost of more workers’ lives

    What the developed world can do is mandate the best coal burning technologies in the recipient countries.

    But I can’t see Oz giving up exporting metallurgical coal. At the very least it would also significantly hurt the *iron* mining industry (since Australia’s other great export to the steel industry, is iron ore).

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