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Economics & Finance - BLOG

Trump’s Climate Policy is Based on Cost-Benefit Analysis

Theo Vermaelen, INSEAD Professor of Finance  |

President Trump’s decision to withdraw the U.S. from the Paris accord is based on economic arguments.

President Donald Trump has pulled the United States out of the Paris climate agreement and, interestingly not because he does not believe in man-made global warming, something we could have expected since he called global warming a “hoax” during his campaign.  He could have used many different arguments to question the theory that climate change is mainly driven by human activity. Instead he used an economic argument. Signing up to the Paris Agreement would impose large costs on the U.S. economy without any significant impact on global temperatures. In his speech, Trump cited a 149-page study by National Economic Research Associates that argues the Paris Agreement would cost 2.7 million jobs by 2025, totalling  loss of US$3 trillion in lost GDP by 2040. He also cites the forecast of a study that predicts that the Paris Agreement would result in 0.2 degree Celsius less warming, a trivial impact. So, a project with significant costs and very little benefits should be rejected, as we teach in our investment courses.

Not surprisingly, the conclusions were immediately challenged by the Paris Agreement supporters.The first response, as usual, is to discredit the economic report by discrediting its authors: the report was produced for the American Council for Capital Formation that receives money from Exxon-Mobil and The Petroleum Institute. (Full disclosure: I am not subsidised by the oil and gas industry.) And, of course, unlike climate change forecasts, long-term macroeconomic forecasts are highly uncertain. Nevertheless, not even the strongest Paris Agreement defenders can deny some significant costs to developed countries, i.e. the US$100 billion per year (starting in 2020) of global climate finance to be raised by the Green Climate Fund (GCF). Although the private sector is supposed to contribute, the fact is that that taxpayers of the developed countries are expected to subsidise the GCF. To wit, the GCF currently has received $10 billion, largely financed by American, European, Canadian, Japanese and Australian taxpayers, with US$3 billion contributed by the U.S. by the Obama administration. So far I have been unable to find any trace of contributions from the private sector, which is not surprising considering that the S&P Global Clean Energy Index has lost 15 percent per annum over the last 10 years. So Trump is right in that the agreement represents a massive wealth transfer of trillions of dollars from developed countries to developing countries. United Nations officials in charge of environmental policy have admitted this; Ottmar Edenhofer, who co-chaired the UN Intergovernmental Panel on Climate Change working group from 2008 to 2015, said, “One has to free oneself from the illusion that international climate policy is environmental policy…We redistribute de facto the world’s wealth by climate policy.”

Tipping point?

The second response is to claim that Trump has cherry-picked a study that shows only a 0.2C degree decline in global warming because of the Paris accords. According to Climate Scoreboard, collaboration between MIT and Climate Interactive: "Full implementation of current Paris pledges plus all announced mid-century strategies would reduce expected warming by 2100 to 3.3 degrees Celsius, a reduction of 0.9 degree compared to the no change prediction of 4.2 degrees Celsius."

This would mean we spent trillions of dollars to reduce global warming by only 21 percent. Considering the significant uncertainty of making predictions over an 80-year horizon, this reduction does not seem to be statistically significant, in contrast to the costs. Moreover 3.3 degrees Celsius is above the “tipping point” where global warming would be run out of control. Implementing the Paris Agreement is like wanting to build a bridge across a river, but only having enough resources to build 20 percent of the bridge. In this case, it is better not to build a bridge and think of alternatives to reach the other side.

A third and most peculiar critique on Trump’s decision is that the Paris treaty is not a binding commitment. In 2015, the European Union had wanted to make it a binding commitment, but the only way all countries would sign on was to make the treaty non-binding. Countries can set their own targets, and revise them at any time. If they fail to meet their targets, there is no penalty. So, the Trump critics want him to follow the hypocritical attitude of his fellow politicians: pretending that you make a commitment without any intention of keeping it. At a time when voters questions are becoming increasingly sceptical about mainstream politicians, this is a remarkable recommendation indeed.

President Trump’s decision to withdraw from the Paris Agreement should not come as a surprise. Trump is not a traditional politician driven by ideology. He is a businessman trading off costs and benefits. Even the defenders of the treaty admit the impact of the Paris Agreement on the climate in 2100 will be trivial. At the same time, if the commitments are respected, the costs to taxpayers of developed countries will be substantial and honest European politicians should disclose this to their voters. If the commitments are not respected the whole Paris Agreement is an exercise in extreme hypocrisy.  So, I believe Trump should be complimented, rather than scorned, for rejecting leadership in wealth destruction and/or hypocrisy.

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
Patw,

To paraphrase the above - the Paris Accord is inadequate to prevent a global disaster so it's 'good business' to pull out of the accord and do less to ensure there is a total disaster that destroys business....... This is one of the most flawed pieces of logic I've ever read.

Theo vermaelen ,

The present value of 100 billion of subsidies to the GCF per year for 100 years is say 5 trillion. This will have to be paid largely by Europeans now that Trump had pulled out. The question is : could we have spent 5 trillion in a more effective way to deal with climate change? What about following the policy of dealing with earthquakes : we don't spend money to prevent earthquakes, but we build reserves to deal with the consequences. If we see the oceans start rising, we build a dam. If it gets too hot in Spain we provide relief by shipping people to Belgium etc. But don't spend 5 trillion on something that won't make a difference anyway.

Is this really happening?,

Dear Professor, as someone who has spent the past 10 years observing the international climate change negotiations, I do not know where to start. I will give it a try.
1.) The GCF was never designed as a charity but as a profit-driven fund. Yes, above-market returns are not its primary focus, but it was not designed to receive and distribute grants. Therefore the PV calculation is not applicable in this way. And that ignores that you assumed a 2% discount rate. Since you are the finance professor and I am not, I will give you the benefit of the doubt here.
2.) We are not spending money to prevent earthquakes, because science does not know any way to do that. This is different for climate change. Do we need to go into basic science?
3.) You are right, we can start building dams. This might work for the Netherlands. It does not work for the Ganges-Brahmaputra-Delta in Bangladesh. It does not work for the Everglades in Florida. And it does certainly not work for the rest of the world. At least not for less than the 5 trillion you calculated.
4.) Yes, we might be able to resettle 46 million Spaniards in Europe. It might bring Europe to the brink of collapse, but we'll manage. But please try to imagine the political implications of resettling hundreds of millions across the Mediterranean Sea from Africa?
5.) Something that won't make a difference anyway? You are a respected finance professor and you are well-respected for that. You might leave the climate science to the climate science professors.

Martina W,

What a lovely argument... the shipping of people to the EU has already started - it is called a migration/refugee crisis. Building higher dams-how high can they get? feeding the oceans CO2 is another interesting suggestion that I have not heard in a while... and most likely disturbing the balance in the oceans killing species with an unkown knock/on effect.

We all do not know what will happen in 80 years (agree) but we do know that we are using resources at a staggering rate and we are using them and discounting the cost of this use and transferring it, in the form of climate change, water pollution, endangering species like bees (vital to food production) to future generations. Maybe one of the INSÈAD economics professors could give some input to an INSEAD finance professor? In case they are not too busy calculating a trickle down effect from Trumps going backwards in free trade...

We can also not be sure that we will find another habitable planet all that soon (just imagine the cost/benefit analysis of shipping all Spaniards there)... so generally speaking it might make sense to at least try to address these issues... Paris might not have been the solution to it all but it might have been a step in the right direction, until the US pulled out. The argument you give here only confirms that business people and INSEAD professors do NOT have a sufficient big picture vision to be trusted with making decisions for all of us, there is more to this than a business perspective! If we think from quarter to quarter your argument makes of course complete sense, if we disregard the common good as something worthwhile considering, it does too, if we only look at northern Europe it might also *minus the shipped Spaniards of course - end of irony. If the only thing that matters is cost-benefit in the short term... in every other sense, breaking the one agreement that the international community has been able to make jointly is problematic in so many ways I do not want to even start... It feels particularly ironic to applaud Trumps decision as a business man - disregarding the fact that he is a president now, what makes sense from a business perspective is frankly only part of the equation at this level... one of the things we do in leadership development (my business) is that we help people in transitions find what their new roles really require, what success is in the new role... maybe one of the INSEAD professors of managerial behaviours would like to have a go at this - the difference between a business leader and a world leader?

Henning,

Dear Professor, without questioning your expertise in finance, where do you take the scientific expertise from, that allows you to conclude that spending money on climate change mitigation does not make a difference anyway? All major scientific organizations tell us otherwise. All of them.

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