What was the issue?
Amid rising concern over the impact of climate change, policymakers have been looking at ways to reduce carbon emissions.
For economists the problem is that polluters are not required to bear the full cost of the pollution they create in terms of the costs to wider society.
Economists have argued that putting a “price” on carbon, so that polluters are forced to take into account the negative effects of their harmful emissions, must be a core element of an economically efficient strategy to curb these emissions.
However, the pricing of carbon emissions is by no means an easy or straightforward undertaking. The approaches to such pricing are numerous, complex and competing, making it particularly challenging for policymakers, many with only a layperson's understanding, to decide on an optimal approach.
The stakes are huge. Estimates suggest that the cost savings from an economically efficient policy intervention could be as high $1 trillion a year globally.
What did we do?
Many countries such as the UK use cost-benefit analysis to evaluate new spending and regulations. The original approach used to price a ton of emissions was the so-called “social cost of carbon” - the economic value of the damage caused by an extra ton of greenhouse gases in the atmosphere.
The Stern Review on the Economics of Climate Change (2006) estimated the total cost of climate change to be equivalent to a one-off, permanent 5-20% loss in global average (mean) per-person spending in today’s money. The cost of each extra ton of carbon emitted today was estimated to be around $312.
Researchers at LSE's Grantham Research Institute on Climate Change and the Environment, led by Associate Professor Simon Dietz, subsequently updated the economic modelling that they had produced for the Stern Review.
They showed that the social cost of carbon that had been used in the Stern Review had a high level of uncertainty. They concluded that the most robust measure of the price of carbon for cost-benefit analysis should be the cost of cutting each extra ton of emissions.
Professor Sam Fankhauser and colleagues also looked at the specific tools being proposed to impose a price on carbon, such as carbon taxes and cap-and-trade. The latter was an approach in which governments set a limit or "cap" on certain types of emissions and polluting companies could sell or "trade" the unused portion of their limits to companies that were struggling to comply.
The researchers examined important design elements of cap-and-trade systems. These included: how to bank and borrow emissions permits and how this process interacted with other markets, taxes and subsidies; and ways to keep the permit price from rising too high or falling too low.
They also documented how carbon pricing policies had been implemented across the world so that countries could learn about what other jurisdictions were doing and become aware of good ideas and practices being tested elsewhere.
“Thank you to the Grantham Research Institute of the LSE for their hard work behind the scenes.”
- Christiana Figueres, Executive Secretary of the United Nations Framework Convention on Climate Change.
The research has influenced both the policy thinking as well as the design and substance of carbon pricing legislation in the UK and elsewhere in the world.
Carbon pricing in the UK
In 2009 the UK Department for Energy and Climate Change (DECC) changed its guidance on the price of carbon for cost-benefit analysis, from using the social cost of carbon to using the marginal cost of cutting emissions, as the LSE research had proposed.
DECC's report cited Dietz, who had been one of six independent peer-reviewers of the interim guidance produced in 2007. He was employed as a consultant by DECC for the preparation of the new guidance in 2008/2009.
This change in carbon pricing was expected to increase the likelihood that the UK government would meet its statutory obligation per the Climate Change Act of reducing overall emissions by at least 26% by 2020 and 80% by 2050.
Carbon pricing worldwide
The research has also had an impact on legislation to introduce new carbon pricing policies in Australia, China, Mexico and South Korea, all of which have adopted new measures or are in the process of doing so.
The United Nations has referred to the Grantham research as contributing to the prospects for an international agreement on climate change.
The research was also used as the basis of discussions between UK and EU legislators and China’s chief negotiator, Minister Xie Zhenhua, in the House of Commons in October 2011 when the two sides examined examples of “good practice”.
The researchers have worked closely with GLOBE International, a global forum of parliamentarians. Their research fed directly into an international policy paper that aimed to help national legislators understand the nuts and bolts of carbon markets as they draft their own country-specific legislation.
The LSE team also provided direct advice on a particular technical point of the Australian trading scheme related to the treatment of carbon offsets (credits that can be earned by reducing greenhouse gas emissions in one location that can offset pollution elsewhere).