Huib M.A. Jansen
Institute for Environmental Studies, Free University Amsterdam Amsterdam, The Netherlands
The environment has no price but it certainly has a value. Restoring the environment or preventing environmental damage does have a price, but is it worth the value? T h e question on the benefits of GHG reduction is a political question with respect to the trade-off between costs and benefits. However, the present state of the art of monetary valuation of environmental damage of climatic change is such, that either the range of t h e monetary estimation is extremely large, or the estimation is severely biased downward (or both), which prevents such a trade-off in most cases. A good survey of estimates of damage is given in, e.g., Cline (1992), and an attempt t o trade-off can be found in, e.g., Ayres and Walter (1991). Both are essentially speculations.
At the present state of the art, estimates of benefits of GHG reductions are, a t most, wild guesses of the order of magnitude, that do not allow a fine-tuned trade-off of policy alternatives. They can, perhaps, be used as circumstantial evidence t o justify political choices, not more. In this paper some reasons are given why this is the case.
T h e common use of the word "benefits" is somewhat euphemistic. Ben- efits of GHG reduction are prevented damages. As long as no reductions are being realized, it is more precise t o speak of damages. The two words will be used interchangeably in this paper.
1. Subst it utability
In economics, scarcity is measured in terms of utility, and the measuring unit is most often money. The aim of economics is t o maximize utility.
A basic, but not always evident, assumption behind the maximization of utility is that various types of utility are substitutable. This substitutability is indeed guaranteed if markets exist where goods and services can be freely traded, and money is a good expedient t o facilitate this trade. Climatic change and its effects cannot be traded in a market. When climatic change
occurs there is no possibility t o undo it a t the expense of other goods or services, money included.
Although climatic conditions certainly have a utility, we cannot exchange it for other types of utility. This is not too bad, if at least we can compensate with other types of utility, so as t o feel equally well off. Even in the absence
The case is comparable to the valuation of human life. In various sectors (traffic, medicine, food, environment) a trade-off must be made between costs of measures and the resulting reduction of risk, and valuation of human life is helpful t o ensure efficiency within and between these various sectors. But for any individual, the question of value of his life is meaningless, as substitution is not possible.
The discipline of economics is concerned with small changes in prices, quantities, and utility. When such small changes occur, it is indeed probable that compensation or substitution is possible. But this basic assumption is not guaranteed when essential, irrevocable changes are involved. This makes monetary valuation questionable. vide the substitutability between present expenditures or gains and future ones. But a person's or a firm's time preference can also be higher than the interest rate.
Time preference of governments is generally lower than that of individ- uals; the official discount rate of the Dutch government is 5%, which means that the utility derived from Dfl 1 now is valued equal to the utility next
small amount of money is invested in the bank or in a good enterprise, it will make a much larger amount after 50 years. But environment and climatic conditions cannot be banked, neither can they be bought back after 50 years with money invested now. The substitutability between the present and the future is not guaranteed with goods and services that cannot be traded in a market.
This is not t o say that the concept of time preference is useless for environment. A trade-off has t o be made in any case between present and future use of the environment.
The Brundtland Commission (WCED, 1987) introduced the concept of sustainable development, which is "development that meets the needs of the present without compromising the ability of future generations t o meet their own needs". This concept was officially accepted by many governments. The needs of present and future generations are put a t the same level in the view of the Brundtland Commission. Discounting, when applied t o essential living conditions that cannot be bought back with money, is therefore not in line with sustainability.
Although discounting is perfectly logical if applied t o values that can be bought back, there is certainly a tension between discounting and sus- tainability when irreversible effects are concerned that are vital t o meet the needs of future generations. And climatic change indeed bears the risk of compromising the ability of future generations t o meet their needs, a t least in some parts of the world. Thus, discounting and sustainability, both officially accepted concepts, are inconsistent.
In practice, discounting is being applied in the comparison between costs and benefits of GHG reduction; otherwise both costs and benefits are infi- nite. If sustainable development is the point of view, discounting leads t o underestimation of the benefits of GHG reduction.
3. Cost-Benefit Approach
Typically, a cost-benefit analysis (CBA) approach is adopted when com- paring the pros and cons of GHG reductions (Jansen et al., 1991). It is well-known from theory that CBA is only applicable for marginal changes.
If changes are more substantial, all kinds of adaptation and secondary effects will occur and CBA is no longer sufficient. But no models are available t o reliably estimate the secondary effects of GHG reduction, in particular be- cause climatic change has very long-term effects. Thus, the CBA approach is used for lack of alternatives.
Adaptation and secondary effects will generally diminish the primary effects of environmental changes, and thus the CBA approach tends to over- estimate, not underestimate, the benefits of GHG reduction. But this goes for the costs as well.
In the comparison of costs and benefits of GHG reduction, which one of the two is more overestimated? We do not know, but one could guess that the possibilities for adaptation are larger on the cost side. Costs are financial and can therefore be compensated by other financial effects, such as economic growth. It was estimated (Steering Group, 1992) that a 100%
energy charge in the Netherlands would lower the GNP with 6 to 7%. That is the economic growth of a few years only. Benefits of GHG reduction, or damage of no reduction, may be measured in money terms, but are not financial, for most part. This may limit the possibilities of adaptation. It is questionable if the adaptation mechanisms of the economic system are working equally well a t the benefits side as a t the cost side.
So although the CBA approach tends to overestimate both costs and benefits, it seems probable that the overestimation is larger on the cost side and, therefore, that the benefits are relatively underestimated.
4. Comprehensiveness and Completeness
Monetary estimates of benefits lack completeness and comprehensiveness (Kuik et al., 1991, 1992). An estimate of benefits is complete if it contains all types of benefits. And it is comprehensive if all value categories are included, i.e., also consumers' surplus, option value, existence value, and bequest value. Some types of benefits (or damages) are easy to estimate in monetary terms. For instance, sea level rise will lead t o costs of construction of higher dikes in the Netherlands. This is a purely financial effect. But many other effects of climatic change are much more difficult t o estimate in monetary terms, for instance loss of ecologically valuable wetlands, loss of human life, loss of quality of life of ecological refugees. If such intangible effects are t o be included in the monetary estimation, one has t o resort t o valuation methods that give results with very broad ranges of confidence, and even an indication of the order of magnitude may be unattainable. Value components such as consumers' surplus, option value, existence value, and bequest value are difficult t o estimate reliably; yet they may well be of great importance in the case of climatic change.
To give an example: Ayres and Walter (1991) estimate the damage t o one ecological refugee a t $1,000. Perhaps this may be a sound estimate of
the costs t o society of resettling, but clearly the suffering of the refugees is not included.
An economist finds himself between Scylla and Charybdis: either he makes an accurate estimate by deleting types of damage and value compo- nents, or he makes a more complete and comprehensive estimate with such broad ranges that it is not useful for making a comparison with the more accurately measured costs. In practice, no estimate is fully complete and comprehensive, so each estimation is biased downward. Benefits are more underestimated to the extent that they are more accurate.
5. Risk and Uncertainty
Although often mentioned in one breath, risk and uncertainty are not the same. They may go together, but are different.
Uncertainty is simply not knowing. The occurrence of climatic change, its extent, and its long-term effects are for a large part uncertain. Policy makers can take different attitudes to uncertainty. The attitude of the Dutch government - a t least in words, not so much yet in policy actions - seems t o be that uncertainty with respect to irreversible effects urges to more caution.
But the United States, a more important C 0 2 emitter, hold the view that as long as no more certainty is reached, no costly policy actions should be taken; clearly an attitude of underestimation of potential damages.
Risk has to do with probability distributions. The risk of flooding and hurricanes may well increase as a result of climatic change. Most often, the valuation of risk events is made with the expected value, i.e., probability
x
monetary value of the event. In particular with low probability-high effect risk events, the expected value approach leads to underestimation. People in general are risk-averse for such extreme events with negative effects, and a risk aversion premium should be added. It is, however, difficult to estimate that premium accurately.