The costs of climate policy – some arithmetic

One of the big puzzles about climate policy is that, according to most studies, reducing emissions, even by a large proportion, appears to cost very little, but despite this, the politics are hard. Why is this? One reason may have to do with the difference between how costs are typically  expressed in such studies on the one hand and how people actually experience them on the other.

Costs of mitigation are usually expressed as a percentage of GDP. For example, the Stern Review originally put the global costs of avoiding a greater than 2C rise in temperatures at 1% of GDP (although he subsequently revised this upwards to 2%). For the UK, ippr’s 2007 study put the cost of an 80% cut in carbon emissions at 2-3% of GDP by 2050, while the Climate Change Committee estimates the cost of hitting  a 34% reduction by 2020 would be 1% of GDP.

As noted, these sound like small numbers, especially considering we have just been through a recession in which the economy contracted by about 5% in one year. However, this % of GDP headline figure is misleading in terms of understanding the politics.

Take the UK as an example. 2009 GDP was £2.183 trillion, which converts to a little over £35,000 per head. Average household size is now about 2.4, so GDP per household is almost £84,000. Against this, a cost of mitigation of 1% of GDP per household of £873 isn’t that much (of course, many of the costs of mitigation will fall initially on businesses not households, but the former will tend to pass most of these through to the latter, as, for example, happens currently with the price of carbon in the emissions trading scheme).

Households earning £85k a year would probably spend £873 without batting an eyelid. But in a highly unequal society, the mean is not the same thing as the median, and the vast majority of households have an income nowhere near that high. In fact, the Institute for Fiscal Studies puts median, post-tax household income, adjusted for household size and composition, at £20,280.  Half of the UK’s households have a disposable income of between around £10,000 and £23,400 a year. Thus the centre of gravity of the income distribution is much lower than the abstract GDP/households figure, and it is this group that matters politically. For the median household, £873 is 4.4% of post-tax income. For a 2% of GDP cost of mitigation, the median household would be paying almost 9% of disposable income. For those on £10k a year, the figures are more like 9% and 17% respectively.

A final point is that the overall cost estimates mentioned above are generated by models that typically seek the optimal path to decarbonisation and assume that policymakers never make any costly mistakes. This is clearly unrealistic, and we can expect actual costs to be higher.

It is therefore easy to see how what look like negligible costs to (well-paid) policy wonks or international negotiators start to seem politically more difficult.

UPDATE: as one of our sharp eyed readers spotted – see comment below – just as income is not equally distributed, so the costs of mitigation will not be equally spread. But these costs will not be as unequal as one might think. A large element is the cost of decarbonising energy, and differences in energy use are nowhere near as large as the disparity in incomes. For example, in 2006, households on £20,000 a year spent an average of around £800 a year on energy, while households on £50,000 a year spent £950. While the distribution of mitigation costs will not be completely equal, it may not be far off .

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4 Comments

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4 responses to “The costs of climate policy – some arithmetic

  1. Daniel

    Interesting post but not sure I agree with all of your analysis;
    – Firstly you seem to have assumed that all households would share the costs evenly. Not clear why this would be the case. It is clear that poorer households spend a larger proportion of their income on heating and electricity but they’re also less likely to drive (particularly a 4×4) and consume less.
    – Secondly, you put inaction on tackling climate change down to estimated costs on poor households. Is this really the case? The perception I get is that it is the large polluting industries who are campaigning most against more effort to tackle climate change, and these industries seem to have significant influence with senior politicians around the world.

  2. OK, inequality is a problem. Indeed, inequality is such a problem that otherwise rational policies are not politically possible. This is true, and we’ve got to repeat it until we’re sick of listening to ourselves. But it’s still the beginning of the discussion, not the end.

    Two immediate thoughts:

    1) It’s glaring, in this piece, that you did not say anything about revenue recycling, which is the standard center-left mechanism of choice for this the problem that sharp income inequality in the North poses for stringent climate policy. You didn’t even mention Cap and Dividend. Why not? Do they have no significant profiles in the UK?

    2) It important to note that in the face of this problem, there are two board approaches. One is the approach that says that both inequality and climate are huge problems, and that we can only solve them together. The other seeks to ridicule the climate community, as elitist and as stupidly blind to the centrality of the inequality problem. The problem with not discussing the proposed fixes for this problem, or even mentioning their existence, is that you appear to support this second approach. Even though you don’t.

    • Hi Tom – thanks for the comments. We agree about the link between reducing inequality and making the low carbon transition (although, in my experience, some environmentalists don’t actually pay enough attention to it). We’ll be blogging shortly on our ideas about what we think the linked solutions might be.

  3. andrewpendleton

    To add to Matthew’s thanks, Tom, I’d say that all the usual policy approaches, including cap and dividend, are pretty well know in the UK and there’s already a lively debate about hypothecation of EU ETS auction revenues which, in the face of it, is the obvious approach. But at a time when public sector budgets are being mauled and people are losing basic services and welfare payments, the UK Treasury’s interest in hypothecating any revenue is even less than its usual zero. In fact, there’s also a concern that as oil prices rise, revenues will decline; the primary anxiety is about deficit reduction.

    Against this backdrop, I think we have to be a bit smarter than the usual ‘it’s costly and all we can do is soften the blow’ line. First, I’m not sure there will ever be a satisfactory level of fairness in charges associated directly with carbon. It’s hard to correct on the benefits side of the equation for something that’s regressive as an actual or de facto tax. Second, this means that while we’ll have to live with some regressive aspects of carbon pricing as it doesn’t appear we can dispense with this entirely, reducing costs and sharing these out better across societies (e.g. by paying through general taxation) will be important.

    More here soon.

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