In a business-as-usual scenario global mean temperatures may well go to 5 degrees Celsius above pre-industrial levels. This creates many economic costs, especially for developing countries, in terms of lost output and destruction of productive capacity. Obviously, there will be human costs as well in terms of diseases, deaths and migration upheavals. And there will be ecological costs in terms of changes in and destruction of the number of biological species. The costs increase more than proportionally with global warming. On top of that there is the danger of climate tipping points. The challenge for this laboratory is to design strategies, both at a national and a global level, which can avert global warming at the least economic costs. This requires well-articulated views of the process of growth and development and a careful trade-off of the welfare of present and that of future generations.
If carbon taxes are politically infeasible, other policy measures such as subsidizing backstop technologies including solar energy and wind energy are often proposed. Alternatively, carbon taxes are postponed and implemented at future dates. Both types of policies suffer however from the Green Paradox: emphasizing the demand side whilst neglecting the supply side of the energy systems, might be counterproductive, in the sense that the supply of fossil fuels will be brought forward instead of postponed. One aim of the proposed research is to critically investigate the Green Paradox, from a theoretical as well as an empirical perspective. In particular we will take a broad welfare economic perspective, thereby not only paying attention to what is called green welfare, but also look at potentially positive overall welfare effects following from the proposed policy measures. We will focus on carbon-free alternative energy sources, but consider a large variety of them in terms of emissions generation and economic costs. We will in particular pay attention to the monopolistic features of oil markets: oil importers then try to capture some of the scarcity rents on oil whilst oil exporters try to capture part of the climate rents of those countries fighting global warming. It is of special interest to see how climate policy can be designed in a global economy with different jurisdictions, each having different interests.
We will put forward theoretical models as well as large-scale numerical integrated assessment models of both growth and development and global warming. We can thus analyse the optimal development over time of the global economy, taking account of emissions of greenhouse gases, capital investments and consumption patterns over time and space so as to maximize welfare. We will also investigate what is needed to implement such optimal outcomes in a market economy. Although seminal contributions by William Nordhaus and the Stern Review deal with similar issues, we offer at least six important innovations.
First, we allow for second-best trade-offs between endogenous growth and climate change. There will thus be trade-offs between on the one hand investment in productive growth-enhancing infrastructure and lower taxes on productive activities versus investment in green technology, carbon capture and storage and pricing carbon. This will not only affect the rate of economic growth, but also the direction of economic growth. Second, we allow for an analysis of stranded assets and of how much fossil fuel to lock up in the crust of the earth. The more fossil fuel is locked up, the less carbon will accumulate in the atmosphere and thus the less will be global warming. Third, we allow for scarcity of fossil fuel and the associated anticipation effects implicit in oil pricing arbitrage relationships. In this context, it is also important to look at carbon capture and storage and more generally at the need to lock up fossil fuel in the earth and not burn it. Fourth, the optimal policy of extracting fossil fuels and combating climate change should take into account the order in which the fuels are to be extracted. Note that here differences in extraction costs for the various sources of energy as well as differences in carbon emission ratios play a role. What is also important is to study the timing, order and speed of extraction in conjunction with the introduction of carbon-free energy alternatives. Fifth, climate change may not be marginal but may occur abruptly in a non-marginal fashion. An important part of the research is thus to devise precautionary strategies that can really tackle climate change and global warming, both to be better prepared when the calamity strikes and carbon pricing policies designed to curb global warming and thereby curb the risk of climate catastrophes. Finally, the proposed research will pay attention to the plight of resource-rich countries and their possible contributions to dealing with the global problem of climate change. In this context, we will pay attention to the so-called resource curse and Dutch disease as well as to the issue of capital flight and diversion of foreign direct investment.
Crucial determinants of the answers to these important policy questions are intergenerational inequality with future generations being possibly richer than current generations, the inequality between citizens currently alive and the need for development in large parts of the globe, the efficiency of tax systems, the rate of time impatience, and the way uncertainty and climate risk should be modelled. We therefore pursue an integration of both exogenous and endogenous growth theory and the theory of non-renewable resources.
The proposed research will not only have to concern itself with the implications of conventional gas, oil and coal reserves, but also with the potential huge increases in unconventional oil and gas reserves including shale gas. The research needs to take account of gas being less carbon intensive whilst coal and the tar sands being much more carbon intensive than oil. Many argue in this light that the ‘peak oil’ hypothesis is no longer relevant. To the extent that is the case, a more ambitious climate policy is required. It is also necessary to look at other carbon-free alternatives such as nuclear energy, which has problems and risks of its own. For each of these energy sources, it is crucial to analyse the huge investments that are required to get it off the ground. And one needs to look at hold-up and time inconsistency problems, since governments can ruin the desire to invest in alternatives to fossil fuel if it at some later time reneges by abandoning a policy of gradually making climate policy more ambitious. Finally, it is important to gain insight into how to develop the non-gas sectors of economies that are blessed with substantial natural gas reserves which requires transforming below-ground natural resource wealth in to above-ground physical and human capital which can engender further and sustained growth and development.