A Broken Crystal Ball

Global Warming Solution Studies Will Overestimate Costs, Underestimate Benefits

History shows that ignoring innovation will breed inaccurate results when studying the effects of the Lieberman Warner Climate Security Act.

Studies examining the economic effects of the Lieberman Warner Climate Security Act (S. 2191) will be released in the coming months leading up to Senate consideration of the bill. Many of these studies will likely predict that the reductions of greenhouse gases required by the cap-and-trade system will lead to huge hikes in electric rates, reductions in jobs, and all sorts of other economic havoc.

But these studies also have one other common element: They will eventually be proven wrong once the program is underway.

These studies base their cost assumptions on existing technologies and practices, which means that they do not account for the vast potential for innovation once binding reductions and deadlines are set. The Lieberman Warner Climate Security Act anticipates the need for innovation and creates economic incentives to spur engineers and managers to devise technologies and methods to meet the greenhouse gas reduction requirements more cheaply.

This isn’t the first time that pollution control studies have produced inaccurate predictions about the future. Remember what analysts predicted about acid rain controls from 1989 to 1990?

The acid rain title of the Clean Air Act of 1990 was the first and largest U.S. cap-and-trade pollution control program. Similarly to the current and upcoming studies on the Lieberman Warner bill, research on the Clean Air Act relied on flawed methodology that assumed no changes in operations or technology to meet the new requirements.

Credible predictions about the high cost of acid rain controls were eventually proven wrong, but they were used as an excuse to block reasonable compromise solutions of the problem. Opponents of global warming solutions will likely repeat this strategy with the Lieberman Warner bill.

During the acid rain debate a number of industry studies included hysterical predictions about acid rain controls on the sulfur emissions from coal fired power plants, including the loss of tens of thousands of jobs, and compliance costs totaling tens of billions of dollars.

Studies from the EPA and other “impartial” entities also predicted significant economic costs. In 1989, the EPA hired the firm ICF to calculate the expected compliance cost of an acid rain program. It predicted that the “annual cost of the program was expected to be $2.7 billion – 4.0 billion.” Yet an EPA analysis a decade later determined that the actual cost of cutting sulfur emissions by 40 percent was substantially lower—“$1 to $2 billion per year, just one quarter of original EPA estimates.”

Like the Lieberman Warner bill, the acid rain program allowed emissions trading, or cap and trade, to meet overall pollution reduction goals. During the congressional debate over acid rain controls in 1990, the EPA estimated that each allowance to emit a ton of sulfur would cost $750 during the first phase of the program. The actual prices began at $250-$300 in 1992, and eventually fell to $70 in 1996—one tenth of the predicted cost.

Even after more sulfur dioxide emissions reductions were required by the Clean Air Interstate Rule in 2005, the cost of a sulfur dioxide allowance was only $600, or $378 in 1990 dollars. So after complete implementation of the acid rain reduction program and an additional set of new requirements, the price per allowance ended up being only about half of what the EPA predicted for Phase I alone.

Another inaccurate prediction was that electricity rates would rise since the primary source of sulfur emissions was coal fired power plants. Yet according to the Department of Energy, the exact opposite occurred. Average electric rates dropped from 8.05 cents per kilowatt hour when the Clean Air Act was passed in 1990 (calculated in 2000 dollars) to 7.48 cents per kwh in the first year of the sulfur reduction requirements in 1995, to 6.81 cents per kwh when Phase II began in 2000. By 2006, electricity was up slightly to 7.63 cents per kwh (2000 dollars) but still 5 percent less than before the acid rain program began.

The same pattern occurred in average residential electricity rates. The deregulation of electricity rates in the 1990s helped reduce electric rates, but that does not change the fundamental fact that electricity rates did not increase as predicted, and declined instead.

Some of the direst predictions about acid rain controls were made about the loss of jobs, particularly in the coal mining industry. In 1990, the EPA predicted that at least 15,000 coal mining jobs would be lost. In fact, a 2001 EPA study found a “net loss of only 4,100 coal miner job slots,” or about one-quarter of the predicted job losses.

And it turns out that the real cause of most job loss in the coal fields was mechanization. The EPA found that even without the acid rain control program, “jobs for coal miners decreased as productivity improvements and other economic factors eroded the need for large numbers of miners … By 2010 … 95 percent of the decline [in mining jobs] is expected to be due to productivity gains, and only 5 percent of the loss in jobs (4,100) is expected to be attributable to Title IV [acid rain program].”

Even the most careful independent analyses of the economic effects of global warming legislation are likely to significantly overstate economic impacts. Why? Because these types of analyses usually assume static technology. As Douglas R. Bohi and Dallas Burtraw found in their 1997 report on the sulfur dioxide trading program, “The lesson is not so much that prior estimates were wrong but that they were static snapshots taken in a dynamic policy environment.”

The acid rain example demonstrates that in reality, binding pollution reductions and deadlines put a cost on emissions that were essentially free previously. This creates an economic incentive that spurs engineers and managers to devise technologies and methods to meet the reduction requirements as cheaply as possible.

Energy efficiency can dramatically reduce carbon dioxide emissions and save money. McKinsey & Company found, for example, that energy efficiency can dramatically reduce the cost of carbon dioxide reductions by producing income for the firm, “almost 40 percent of abatement could be achieved at ënegative’ marginal costs, meaning that investing in these options would generate positive economic returns over their lifecycles.”

McKinsey also found that “massive development of energy efficiency practices and technologies in the mid-range case would offset 33 percentage points of the projected 40-percent increase in electricity demand between 2005 and 2030.” Without a reductions program, however, there would be much lower incentive to innovate or adopt new technologies to improve efficiency.

Innovation and new technologies also create new jobs that are impossible to predict before the implementation of a pollution reduction program begins. A cap on greenhouse gases will likely boost employment in the renewable electricity sector, as well as create positions for retrofitting buildings and homes to be more energy efficient. These and other measures could create new industries and dramatically expand existing ones.

Studies often overlook how a pollution control program fits into the overall growing U.S. economy. The acid rain program, for example, was a significant element in the overall increase in pollution control spending in the 1990s. Yet it had a much smaller effect when considered in relation to the overall growth of the economy.

In that decade, pollution abatement spending grew by 60 percent, but when adjusting for overall economic growth, this becomes only a 30 percent increase in environmental spending as a portion of Gross Domestic Product. And while this increased investment was going on, the U.S. economy added 16 million new jobs.

The bottom line is that because compliance costs such as purchase of new technology are much easier to measure, many studies do not consider the significant benefits of reductions. The few studies that attempted to measure benefits during the acid rain debate provided very tentative predictions that primarily established a value for aquatic life. After the implementation of the program, the Office of Management and Budget found that “the Acid Rain Program accounted for the largest quantified human health benefits—over $70 billion annually—of any major federal regulatory program implemented in the last 10 years, with benefits exceeding costs by more than 40:1.”

Predictive studies rarely attempt to measure the cost of inaction. Yet a report by Sir Nicholas Stern, a senior British treasury official, determined that inaction on global warming will exact a heavy worldwide economic toll. “If we don’t act, the overall costs and risks of climate change will be equivalent to losing at least 5 percent of global GDP each year, now and forever.” And if a wider range of global warming effects occur, the “damage could rise to 20 percent of GDP or more.”

Damage costs should be included in economic studies of compliance costs, but that is unlikely. Most global warming reduction studies will instead focus solely on the compliance costs of a cap-and-trade program. Examinations of this element in isolation are too narrowly focused to give an accurate depiction of the costs or opportunities associated with a low carbon energy revolution.

These studies also ignore other policies that will reduce emissions. For instance, the 25 states that already have renewable electricity standards will signicantly reduce their carbon dioxide emissions. Analyses should include greenhouse gas reductions and monetary savings from other extant policies, including fuel economy improvements, use of biofuels in lieu of some gasoline, and dramatic increases in the energy efficiency of buildings and appliances. Yet, it is unlikely that economic studies of global warming legislation will include pollution reductions and monetary savings from such federal and state programs.

Any global warming reduction program will assess a cost for continued emission of greenhouse gases, and the costs of abating this pollution will be reflected in some goods and services. Greenhouse gas reductions will not be free. At the same time, accurately estimating these costs without consideration of these mitigating factors is neither science nor art; it is essentially guess work.

During the acid rain debate, independent studies predicted that total compliance costs would be high, electric rates would rise, and heavy job loses would occur. None of these events occurred. These studies did not foresee the innovation spurred by adoption of a 10 million ton reduction in acid rain pollution by 2000. Yet the affected industries and their congressional allies used the results from these inherently flawed studies as excuses for inaction. The negative forecasts caused more thoughtful legislators to hesitate before supporting comprehensive legislative proposals for fear of their economic impact, despite the urgency of the problem.

As a flurry of well intentioned, but methodologically defective studies of the Lieberman Warner Climate Security Act rain down on senators, we should learn from history. Clear rules for a cap-and-trade system stimulate investment and innovation. Complimentary policies will further speed reductions and reduce costs. There is mounting scientific evidence that time is running out to slow global warming, and we need to act now.

Thanks to Alexandra Kougentakis and Peter Swire.

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Daniel J. Weiss

Senior Fellow