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Cost-Benefit Analysis and the Environment

Further Developments and Policy Use

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This book explores recent developments in environmental cost-benefit analysis (CBA). This is defined as the application of CBA to projects or policies that have the deliberate aim of environmental improvement or are actions that affect, in some way, the natural environment as an indirect consequence. It builds on the previous OECD book by David Pearce et al. (2006), which took as its starting point that a number of developments in CBA, taken together, altered the way in which many economists would argue CBA should be carried out and that this was particularly so in the context of policies and projects with significant environmental impacts.

It is a primary objective of the current book not only to assess more recent advances in CBA theory but also to identify how specific developments illustrate key thematic narratives with implications for practical use of environmental CBA in policy formulation and appraisal of investment projects.

Perhaps the most significant development is the contribution of climate economics in its response to the challenge of appraising policy actions to mitigate (or adapt to) climate change. Work in this area has increased the focus on how to value costs and benefits that occur far into the future, particularly by showing how conventional procedures for establishing the social discount rate become highly problematic in this intergenerational context and what new approaches might be needed. The contribution of climate economics has also entailed thinking further about uncertainty in CBA, especially where uncertain outcomes might be associated with large (and adverse) impacts.

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The social cost of carbon

The social cost of carbon (SCC) is the central concept for the inclusion of climate change damages in the Cost-Benefit Analysis of public policy and public investments. It measures the present value in monetary terms of the damages incurred when an additional ton of carbon (or any other Greenhouse gas) is released into the atmosphere. The SCC can be added as a cost item for projects that induce carbon emissions, and as a benefit item for projects which induce a net reduction in carbon emissions. Most public projects have an impact on carbon emissions, but energy, transport and agriculture are key areas of concern where it will be important that the SCC is taken into account. In environmental policy, the SCC informs the optimal carbon price and the optimal level of emissions abatement. Implementation of carbon price (e.g. via a tax or permit system) will provide incentives for reduced carbon emissions across all sectors of the economy. Many countries now recognise the importance of the SCC and, as a result, have their own approaches to the estimation of the SCC. In this chapter the theoretical underpinnings of the SCC are explained, and the different approaches to the estimation of the SCC are elaborated upon. Since emissions of carbon have global impacts, which vary across time and space, and in many different sectors, calculation of the SCC is complex, requiring inputs from many different disciplines ranging from climate science, to agronomy, to social science, incuding economics. There are also considerable uncertainties at every stage of the process through which carbon causes damages. Three important questions which make the calculation of the SCC difficult are: What path will emissions take? How will emissions affect temperatures? How will temperatures cause damages? There are considerable uncertainties at each step of this calculation, which are compounded by the potentialfor ‘threshold effects’ and catastrophic outcomes. Yet the importance of climate change as a global problem, and the need to implement policies in line with commitments under international agreements means that many countries have already implemented carbon taxes or use the SCC routinely in their regulatory analysis. In this chapter the methods currently used to analyse and calculate the SCC are discussed. Some of the difficulties and disagreements on the issue are highlighted, and examples of current international practice on using the SCC in the CBA of public policy are explained.

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