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Economics & Finance - BLOG

Response to Henning Huenteler: Use Climate Funds to Deal With Consequences

Theo Vermaelen, INSEAD Professor of Finance |

The amount of money needed to comply with Paris Agreement would be better spent on funds that will alleviate climate change damage.

I would like to start by thanking Henning Huenteler for his thoughtful response to my blog post “Trump’s Climate Policy is based on Cost-Benefit Analysis”. In his retort, Huenteler suggests that my commentary in support of U.S. President Donald Trump’s withdrawal from the Paris Agreement overstates the costs of complying with it and ignores the risks of withdrawing from it. He argues that it was a mistake for Trump to withdraw from the accord.

On the contrary, I believe some of my earlier arguments may have even understated the true costs of complying with the agreement. Furthermore, with regard to risks, I would argue that the current and very costly approach to preventing climate change needs to be rethought. The massive costs being funnelled into climate change prevention might be better spent in mitigating its effects, for instance, since current Paris pledges are unlikely to keep global temperatures from increasing beyond 2 degrees Celsius.

First argument – costs

As I pointed out in the article, any forecasts about long term (over the next 100 years) macroeconomic consequences are highly uncertain. Indeed, according to Bloomberg New Energy Finance, in order to meet the Paris Climate Goal we will need to spend US$12.7 trillion on green energy facilities by 2100. It is difficult to believe that this energy revolution would occur without subsidies and government mandates.The whole idea of the Paris Agreement is to encourage/force consumers to use unreliable and costly alternative energy, such as wind and solar power and to discourage reliance on fossil fuel energy.The benefit to society is supposed to be the reduction in cost from an externality: global warming. If the energy revolution were a result of free market forces, we would not need a Paris Agreement.

Moreover, after the 2009 Cancun climate conference, industrialised countries committed to provide funds rising to US$100 billion per year to finance projects in developing countries and a significant fraction of these funds are supposed to be raised by the Green Climate Fund (GCF). At long term interest rates of 2 percent, a payment of US$100 billion per year means a commitment of US$5 trillion. Although some of this financing is supposed to come from private sources, it seems reasonable to assume that a significant chunk of this money will come from European taxpayers, now that the U.S. has pulled out. To put things in perspective, currently the aggregate EU debt is 12.3 trillion euros.

Now, unless I have been missing something, I have not seen any announcement from European politicians that says: “Dear voters, we just added trillions of euros to our government debt to comply with the Paris Agreement. This means that most of us are now in violation of that other famous treaty, the Maastricht Treaty. As a result, we are entering a new round of austerity and higher taxes.” Perhaps the politicians did not make this announcement because they don’t intend to pay. This is just window dressing for voters to show that polticians “do something about climate change”, which goes back to my third point (hypocrisy).This view is currently shared by many developing countries who claim developed countries have not met their commitments. They expected US$100 billion in new money but a chunk of the current commitment, which stands at US$60 billion, is in the form of development aid. If it takes seven years to raise US$60 billion, it seems unlikely the promise of US$100 billion per year will be respected.

The fact that many executives in the oil and gas industry support the treaty is not surprising as many have diversified into green energy. And everyone likes subsidies, so it’s not surprising that currently there are a lot of jobs created in a subsidised industry. The issue is whether this is economically sustainable in the long run without subsidies and government policies.

Second argument – benefits

Huenteler argues that spending trillions of dollars to reduce global warming by 0.9 degrees Celsius, and still living in a world with catastrophic warming of 3.3 degrees is worth it. I guess that’s a matter of opinion and I can’t really argue about opinions. I think we should think outside the box and deal with climate change the way we deal with other disasters such as earthquakes. We don’t spend money to prevent earthquakes: we build up reserves to deal with the consequences. If the seas are rising, you build dams or help people to move away from Miami Beach. Putting up reserves to insure against climate-driven disasters would have broad agreement from everyone, including those who don’t believe that global warming is a major problem. If there is global warming damage, we spend money to deal with it. If the sceptics are right and there is no catastrophic global warming, future generations will get a huge tax break in 2100. I understand that such an approach is politically impossible today given that European politicians would never accept that signing the Paris Agreement was a mistake. It would also face huge resistance from the green energy industry, which obviously benefits from “building the bridge even if the bridge is too short”.

Third argument – hypocrisy

Lastly, Huenteler argues that all other institutions such as the NATO, the World Trade Organisation and others are making promises they don’t intend to keep. So, Trump may as well join another one. During his recent trip to Europe, Trump blamed the allies for not living up to their NATO commitments. Perhaps he has a different opinion about whether hypocrisy should be the generally accepted principle of global organisations. Also, the idea that Trump would become more widely accepted as a “leader” by signing the Paris Agreement is an illusion.The fact is that most Europeans hate President Trump for so many other reasons, so at the margin, his European or global approval ratings will not be affected by signing the Paris Agreement.

Theo Vermaelen is a Professor of Finance at INSEAD and the UBS Chair in Investment Banking, endowed in honour of Henry Grunfeld. He is programme director of Advanced International Corporate Finance, an INSEAD Executive Education programme.

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Comments
Henning Huenteler,

Dear Professor Vermaelen,
Thank you very much for the detailed response and clarification of your arguments. I very much enjoy arguing with you and I believe that such discussions contribute to an eventual consensus on the road ahead. Although I feel the urge to comment on many of your statements, among others the somewhat outdated assumption, that renewable energies require subsidies to be financially viable, I will focus on the main point: I believe there is a misunderstanding about the general purpose of the Paris Agreement and agreed measures:
The ongoing negotiations and the Paris Agreement were never limited to climate change mitigation. In fact, at least equal importance lies on adaptation measures. Since the Cancun Adaptation Framework, the workstreams Loss and Damage and National Adaptation Plans address many of the measures you have proposed. In addition, the voluntary commitments, or Nationally Determined Contributions that all major parties have submitted, cover both mitigation and adaption in great detail.
Complementary to these processes, the agreed financing of $100B and the Green Climate Fund will be used to finance adaptation and mitigation measures. As you point out, it does not make sense to focus only on the mitigation. A recent study by the Climate Impact Lab estimates that each additional degree in warming will reduce US GDP by 1.2%. By supporting the poorest countries in adjusting to a changing environment and increasing our efforts to reduce the impact, we can try to make the transition less painful for all stakeholders.
I fully agree with you that mitigation alone will not be the magic bullet. As in finance, a well-diversified portfolio if key to success in climate action and the international community has been very comprehensive in the negotiations. Luckily, the process is not dominated by politicians of any ideologic couleur, but by a very diligently and comprehensively working body of technocrats. Due to the thoroughness and length of the negotiation process, the agreement itself is resilient against political knee-jerk reactions. Unfortunately, the actual implementation is not.

Dan Pangburn,

Failing to recognize that CO2 has no significant effect on climate is an egregious mistake but is dwarfed by ignoring the potential disasters of what actually does. Discover the three factors in an equation which matches the measured average global temperature trend 98% 1895-2016.

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