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What exactly is the social cost of carbon? What should policymakers do in the face of uncertainty surrounding its value? Is a global carbon tax a good response to global warming? This episode addresses these questions. It considers the problems policymakers face when confronting a range of potential catastrophes — as happened in 2020. Should countries plan for each potential disaster as a separate event?
This podcast series is produced by Fernando Di Laudo and Jonathan Davidar.
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Transcript
Roumeen Islam: This is the World Bank's infrastructure podcast. Today, we discuss the social cost of carbon and policies to address climate change and other potential catastrophes. Don't forget to listen to the summary of the main points at the end of the podcast.
Participants at the World Economic Forum on the Middle East and North Africa could see the effects of global warming on the Dead Sea firsthand. Lower rainfall and high temperatures have contributed to the saltwater shrinking by almost a third in the last two decades. Alexandria on the Mediterranean coast of Egypt has the opposite problem.
As sea levels rise, the city of 5 million people is sinking. NASA reports that the Arctic ocean is expected to become essentially ice free in summer, before midcentury. Climate related disasters, such as floods and tropical cyclones effected over 75 million people in Asia and the Pacific region. East Africa faced the triple crises of the pandemic, floods, and locusts.
Policies to deal with climate and other catastrophes are at the top of policymakers’ minds. Let's find out how to approach these issues. Good morning and welcome. I am Roumeen Islam, host of "Tell Me How." And today I have here, Robert Pindyck, Professor of Economics at the Sloan School of Management at MIT, who has thought about and written extensively on climate change, more generally about policies to protect against all manner of potential catastrophes. Welcome, Bob.
Robert Pindyck: Thank you. It's nice to be here. I'm looking forward to talking with you.
Roumeen Islam: Very nice to have you. So, Bob, in the discussion on global warming, a central concept is that of the social cost of carbon. So, what is meant by the social cost of carbon, and why is it important?
Robert Pindyck: The social cost of carbon is essentially the price we put on an externality. When you buy a pint of ice cream, you buy the ice cream, you eat it and that's it. You paid for it. You paid $5, whatever, and that's it. And it didn't have anything to do with me or anybody else.
But when you buy a gallon of gasoline for your car and you burn the gasoline, and you drive the car, you paid for the gasoline, but I did too in a way, because when you burn the gasoline, you're emitting carbon dioxide and other pollutants into the atmosphere. And that causes damage to everybody. It contributes to climate change and it causes damage, but you didn't pay for that.
That additional damage caused by your burning the gasoline is what we call an externality. It's external to the price you paid, to what you did, and instead, is paid by society. The social cost of carbon is simply the value of that externality with regard to carbon dioxide. The idea is that when people burn carbon in any form, whether it's gasoline, whether it's home heating oil, whether it's coal for a coal-fired power plant, kerosene for an airplane, whatever it is. When people burn carbon in any form, and it emits carbon dioxide, it imposes a social cost and externality.
And we call that the social cost of carbon. And the idea, and the reason it's important is that it's the basis for a tax. What we'd like to do is force you to pay for whatever it is you consume. If you impose a cost on society, the idea is that you ought to pay for that cost. You ought to cover the cost. And the social cost of carbon tells us what that is.
And if we impose a tax on carbon equal to the social cost, then what we're doing is forcing you or anybody else who burns carbon to pay for what they're doing — to pay for the cost they're imposing on society.
Roumeen Islam: Thank you. That was a good, comprehensive answer. So, I want to talk a bit about what determines the social cost of carbon, and you’ve found a few, and I'm actually thinking specifically of one of your papers that goes through these elements very nicely. I think it's called, "What We Know and Don't Know About Climate Change." What are the elements that you need to know to estimate this in practice?
Robert Pindyck: Here's the way to think about it: You, burn a ton of carbon, alright? And we're going to look at this, and compare this to a world in which you do not burn that ton of carbon. We're looking at one extra ton of carbon that you went out and burned. What happens when you do that? First, it emits carbon dioxide, which goes into the atmosphere. And it stays there a long time; a hundred, 200 years it'll stay in the atmosphere and it will raise the overall concentration of carbon dioxide in the atmosphere. So that's the first thing that happens. It goes up into the air, stays there.
The next thing that happens is that because there's now more carbon dioxide in the atmosphere, that's going to contribute to global warming. It's going to raise a little bit, because we're talking about just 1 ton, it's going to raise the global mean temperature, the average temperature around the world. Now the temperature goes up. What happens next? After the temperature goes up, it does some damage. What does it do?
It could cause some melting of sea ice. It could cause increases in sea levels. It could cause issues with crop yields. It creates damage. So now we've got some climate change. And the climate change caused or creates damage. We measure that in terms of a reduction in GDP, gross domestic product, not just this year, but into the future, because remember the carbon dioxide stays in the atmosphere.
Now, what we do is we ask what's the present value of the reduction in GDP over the next 20, 50, 100 years caused by your burning 1 ton of carbon. And that present value of GDP, the loss of GDP, is the social cost of carbon. That's it.
Roumeen Islam: But how difficult is it to estimate the temperature increase associated with emissions? And then the damages from that temperature increase. I assume these are very difficult things to estimate.
Robert Pindyck: It's very hard to measure or even to estimate or predict these things. So, let's begin with what happens to temperature when the concentration of carbon dioxide increases. There's a number called when we increase the amount of carbon dioxide, temperature will go up. But we don't know how much it will go up. We have a range of estimates, a very wide range of estimates of how much the temperature will go up. It's called climate sensitivity. And we don't really know what the number is. We have a very wide range so we can get a rough sense of how much the temperature will go up, but we'd really don't know with any precision how much it will go up.
That's the first problem. Then, even if we did know how much the temperature will go up, the next question is all right, what will that do to the economy? Broadly speaking, when I say GDP, I'm including anything else that's relevant, health effects, mortality effects, whatever. And the answer is we have no idea what it will do. We don't know what would happen to the world economy. If the global mean temperature goes up by two degrees or three degrees or four degrees, we've never experienced it. And we don't have any theory, economic theory, physical theory, any theory that tells us what will happen. So the bottom line is that when it comes to the impact of the additional carbon dioxide on temperature and the impact of a higher temperature on GDP, on the economy, we're in the dark, we don't know what will happen, and that's a big problem.
Roumeen Islam: So I suppose that explains why the social cost of carbon that's estimated varies so widely, but I'm assuming there are also other reasons why, because we talked about, first of all, you don't know how much temperature will increase. You don't know what the damage will be from that. You don't know what the distribution of the damages will be, nor do you know how different countries will value that, and different generations. How can we, if there's so much uncertainty, determine what the correct level of a carbon tax should be?
Robert Pindyck: This is the problem. Let me just mention that there are estimates of the social cost of carbon and those estimates range from $20/$30 a ton, a metric ton, to $300, $400, $500 a metric ton. That is a huge range. And if you translate it into a carbon tax, it could mean a carbon tax of $20 a ton, a carbon tax of $300/$400 dollars a ton, quite a big range. What do we do if we have such a huge range? I have an opinion about that, but it's not one that everybody else might share.
What I've noticed is that there are people who say, look, let's go with a high number because that's safe. Let's go with the $300 carbon tax. Other people say, look, we don't know yet, let's go with the low number: $20. And my own view about this is that there are two things we should do. First, we can all agree that whatever the number is, it's above zero. It's a positive number. We can all agree that whether it's $30, a hundred dollars, $200. It's not zero. So, let's begin with a carbon tax. And that's important because even if it's a low number, even if it's too low, it gets everybody to understand that there is this externality. There is this problem that we must address, and it gets politicians to understand that. And that's very important.
So, the first thing is, any carbon tax is good, anything, let's start with something. Now, if you asked me what should the number be? I've done some surveys. I've tried to get rough numbers. And my own feeling is that given the range that's out there, given the uncertainty, I would pick something like a hundred dollars a ton. If I was in charge of choosing the carbon tax, I would choose a hundred dollars a ton, but that's just my own view. And other people will disagree with that.
Roumeen Islam: Now do you mean that everyone should start with the same rate, a harmonized rate, for countries around the world? Or do you mean that you talking about the U.S.?
Robert Pindyck: Yeah, so one of the problems with climate change is that it is a global problem. If the United States simply stopped emitting carbon dioxide completely — we turn off the lights, we get rid of our cars, we stop flying in airplanes, we close down the economy completely in the United States — that would reduce global emissions of carbon dioxide by about 15%, not enough. Even if the United States and Europe together completely stopped emitting carbon dioxide, that would reduce global emissions by maybe 30%. So, the problem we've got is that when any country emits carbon dioxide, India, Indonesia, Malaysia, Russia, any country, it contributes to climate change. And what that means is that when we talk about the social cost of carbon, we mean the world. The global social cost of carbon. When I burn a ton of carbon, I'm creating damage, not only to people in the United States, but to people everywhere in the world.
And when someone in Indonesia burns a ton of carbon, they're causing damage to everyone in the world. So, we need a carbon tax that applies everywhere in the world that every country will impose because we need every country to reduce emissions of carbon.
Roumeen Islam: But that doesn't mean that every country needs to go with the same rate. There may be different initial conditions, different abatement costs that they will incur, different discount rates and capabilities. So, not everyone perhaps should have the same tax rate.
Robert Pindyck: That's a good point. And that's another problem. You're absolutely correct. A country that is not as wealthy might say, Look, for us, it's very hard to impose a carbon tax, very costly, harder for us to absorb that cost than it is for the United States or the UK. And that's an issue, but here's the problem. We need an international agreement. We need to have all countries or almost all countries, and certainly the big ones, sign up and agree to a carbon tax. And once we get into the game of each country wants a low tax and says, "Let the other countries take care of this problem. They're to blame, not us. Let them deal with it." Once we get into that, we won't have an international agreement. We'll never get an international agreement.
And my view about this is that's the reason, the rationale for a harmonized carbon tax, meaning every country imposes the same carbon tax. And if it's, let's say let's pick a number, a hundred dollars a ton. We agree that the number's a hundred dollars a ton and every country will impose that carbon tax. Some countries could argue it's unfair, not unfair, but this is a lot easier to get an agreement on then agreeing on what the tax should be in every individual country. So, my view is we should have a harmonized tax that applies everywhere.
Roumeen Islam: Okay. I just want to put this in context that of course there is recognition that countries with different initial conditions and different development paths actually can choose and should choose different policies towards the climate agenda. So, I understand that you think having a harmonized tax would be the simplest solution, but that is not where we are right now. So, I just wanted to ask you if you had any other recommendations or any other points you wanted to bring out.
Robert Pindyck: Look, you could have a harmonized tax and still have side payments. In other words, let's suppose you have a country that, for whatever reason, it would be very difficult for them to impose the tax. And in a moment, I can tell you why actually there are advantages that make a harmonized tax politically attractive, but you might have a country that would find it very difficult.
You could have side payments. You could have an international agreement where part of the harmonized tax involves a transfer of money from rich countries to poor countries. That can still happen. It doesn't mean that we are forcing every country to follow the same path. We can use these side payments to make it easier for less well-to-do countries.
Roumeen Islam: Okay. Thank you for the clarification. Now, let's make this a bit more general, because you've written a lot on other potential catastrophes as well. And for the climate agenda, what you said is that what really matters is the chance of a catastrophic outcome. So global warming is just one of the potential income-destroying events that could happen. And you've written about some others. Here's the pandemic and, we've got nuclear war, or diseases, other diseases, bioterrorism attacks. In your opinion, are these things as serious and as threatening as climate change?
Robert Pindyck: Unfortunately, the answer is yes. And they may be even more threatening, and they may happen sooner. First let me just back up. In climate change, what we really worry about is a catastrophic outcome. I said earlier that there's a lot of uncertainty. We don't know what will happen to the global mean temperature or what that will do to the world economy, but it's conceivable that we will have a catastrophic outcome, meaning the temperature might increase a lot and the damage will be huge. That could happen. We don't know the probability, the chances, but that's really what we worry about, a climate catastrophe.
But once we're in the world of catastrophes and we start thinking about that, there are other very bad things that can happen. And I don't want to depress your listeners, but the fact is that, we are vulnerable. Society is vulnerable to a range of catastrophic events. We don't like to think about that. Most of the news has been about climate change. Now, of course, in the past year, it's also been about pandemics, namely with COVID-19. But before last year, before February or March of 2020, we didn't worry much about pandemics. There was not much concern about pandemics. Even though we had a terrible pandemic in 1918-19, namely the Spanish Flu. We didn't think about that much. Now we do.
There are other things that could happen, and they could happen soon. Those are things like nuclear terrorism, nuclear war, bioterrorism, serious earthquakes, not a normal earthquake, but a mega earthquake that could occur. There are a variety of events that could occur that could be extremely damaging. And they could occur sooner, much sooner than the climate catastrophe. So, I think we need to worry about all of these things and pay more attention to all of them.
Roumeen Islam: But then how should countries think about all of them? Should they have policies for each potential catastrophe evaluated independently?
Robert Pindyck: I've done some research on this question and shown that in fact, these potential catastrophic events are interrelated and that to do things optimally, you really cannot do a cost benefit analysis on them one by one. Nonetheless, my view at this point is that we're doing almost nothing.
But if we're joining almost nothing about climate change for that matter. And if we start doing something about these other catastrophes and climate change, that would be a huge step forward. So, my view is that we shouldn't sacrifice the good for the perfect and my view at this point is let's start thinking about these other things and taking action.
Roumeen Islam: What do you think? Should we then just focus on what we think as the catastrophe with the highest likelihood of happening or what? Should we just focus all our efforts on that or the one that might have the largest expected damage? I know that there's no single number for that either, what should we do then?
Robert Pindyck: I think we need to lay out the set of potential catastrophes. What are the things we need to worry about? Put aside the things that are less important. Look at that set of potential catastrophes and ask first, what would each of them do? What's the potential damage. And second, what can we do to reduce the probability to reduce the chance of it happening? And then come up with an action plan. What are our resources? What set of catastrophes can we realistically address? And how can we address them? Countries do this. A good example is earthquakes. If you look at Chile, Chile is vulnerable to major earthquakes, but Chile has imposed very strict building codes. When skyscrapers are built in Santiago, they're built in a way that they are not vulnerable or not very vulnerable to an earthquake. So that's expensive. It's more expensive to build them that way. But it's necessary. So, you take actions that are feasible, that can be done. We could start doing more in the way of intelligence gathering. We could start spending more resources on protection. So, there are steps that we could take. It wouldn't eliminate the threat completely, but it would reduce the chances.
Roumeen Islam: Yes. There is always a trade-off to be made, right? Are our governments going to be thinking of all these potential catastrophes and collecting taxes for that, or thinking, about other day-to-day events, non-catastrophic events. And I guess there's always that decision to be made. How high a tax rate do you want to levy on your population?
Robert Pindyck: Roumeen, you're absolutely right. And we'll come back to climate change. You've made the argument that people make actually against the carbon tax. People say, look, climate change is a problem.
Roumeen Islam: I didn't mean to do that, believe me.
Robert Pindyck: Let me elaborate on what you said. You're right that you impose a carbon tax, we worry about climate change, and people would say, look, first of all, it's not going to happen next year. It's not going to happen in 10 years. We're looking at fairly slow process. It's going to happen in 20, 40, 50, 60 years. And right now, we've got a big problem. We have countries that are poor. We have people that can't eat. We have poverty, even in rich countries. The United States has a high rate of poverty. And now you're saying, look, we should impose a tax that's going to make it more difficult for people to drive, make it more expensive for people to heat their homes and so on. Don't we need to first spend money on eliminating poverty, fixing up healthcare in the United States and in other countries before we worry about this threat of a climate catastrophe? We already know that we've got big problems that need to be dealt with right away. So, how can we be spending all this money on other things? That's the big trade-off. That’s the problem. How do you weigh these problematic events, these potential catastrophic events with problems that are staring us in the face right now?
Roumeen Islam: Bob you're right. Economic policymaking is exactly like that and you have to face a number of trade-offs, make decisions, but from you, what should we take as the main takeaway? You already said we should be doing something about the possibility of a catastrophic global warming event. And do you think, also I presume the answer is yes, that we should be doing something about other potential catastrophes as well?
Robert Pindyck: Yes. I think that we do need to worry about these other things. I think we need to worry about climate change and start out with the carbon tax. Start out with the carbon tax that you know, people can tolerate. Maybe it's $20, $30, $40 a ton. That's a pretty low tax, by the way, would not hurt very much. Start out with something because we have to acknowledge that there is a climate problem. And start to look at some of these other potential catastrophes. Prior to COVID-19 the budgets for the World Health Organization and for the CDC in the United States were being cut, their spending was being cut. So, what happened before COVID is that we spent less and less money every year on the kinds of things that could have prevented COVID, a pandemic, or reduced the chance of a pandemic. We spent less money on international surveillance at the CDC. Let's at least increase our spending in these areas and let's do what we can to try to improve the ability to respond to future pandemics, nuclear terrorism, other forms of terrorism, and climate change. And also worry about things like poverty. So that means that we probably need to increase taxes. I'm sad to say that's what we need to do to deal with all of these things.
Roumeen Islam: Thank you for clarifying. Now, this was a really interesting discussion, but before we leave it, I'd like to ask you, is there anything else you'd like to add?
Robert Pindyck: No, I think this has been very interesting. I've enjoyed talking with you. I hope I have clarified at least a few things. I guess I've left everybody with the sense that there's a lot of uncertainty. There's a lot that we don't know about climate change, for example. But that doesn't mean we shouldn't do anything.
I like to think about a carbon tax, about climate change action, as insurance. Some people say that if we don't know these things and we don't know how much the temperature will go up, if we don't know the damages, we don't know the social cost of carbon. Let's not do anything. Let's just wait until we know more.
And that's not the right answer. The uncertainty itself creates a need to do something because it creates a need for insurance. What we need to do is worry about the possibility of a really bad outcome. People who own homes, insure their homes. You don't know whether a big storm will come and, cause a tree to fall on your house or cause your home to be washed away, or whatever. You don't know if that will happen. You don't know what the chances are, but you buy insurance against the possibility of a really bad outcome. And that's a way to think about a carbon tax, as insurance against a possible bad outcome. So, that would be my takeaway at the end of this.
Roumeen Islam: Bob, thank you very much for such an illuminating discussion. And, I understand you've got a book coming out. Would you like to tell our listeners about it just before we end?
Robert Pindyck: Yes, thank you. The book is called: "Climate Future, Averting and Adapting to Climate Change." The book provides an overview of how climate change occurs, how it works, the uncertainties, the things we know and don't know about climate change, and what are the things that we need to do and can do, both to avert it, to prevent climate change, or reduce the amount of climate change, but also to adapt to it. It covers a variety of areas of adaptation, things like seawalls, geoengineering, a variety of things, and that book will be coming out soon.
Roumeen Islam: Thank you very much.
Robert Pindyck: My pleasure. Thanks for having me.
Roumeen Islam: So, listeners what did we learn today? Firstly, we learned about the social cost of carbon and that there is substantial uncertainty surrounding the estimates of this cost. Secondly, this uncertainty translates into uncertainty regarding the optimal carbon tax. Thirdly, our speaker proposes that all countries adopt a carbon tax, even if it is at the lower bound of estimates and that there be a global harmonized tax rate. In this scenario, compensation could be provided to poorer countries, to recognize their differentiated abilities and conditions. Finally, rather than dealing with each catastrophic outcome as a single independent event, it is better for governments to plan and budget strategically for the set of potential disasters that might occur. Thank you, and bye for now.
If you have questions or comments, we’d love to hear from you. You can reach us at tellmehow@worldbank.org. Don’t forget to subscribe and thanks for listening!
This episode was recorded in June 2021.
View all episodes on our Tell Me How: The Infrastructure Podcast Series homepage