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November 15, 2006

Insuring Against Global Warming

How much should countries spend to avoid the uncertain risk of climate change?


For environmental scientists, the question isn’t whether there will be global warming, but how much. The Earth’s temperature may rise 3 degrees centigrade in the coming decades, some scientists estimate, while others say the increase might be double that or more. The effects may arrive within the next 20 years, or possibly not until the end of the century. With such a wide range of variables, scientists have found it difficult to predict how global warming will change everyday life.

Professor Geoffrey Heal, working with Bengt Kristrom of SLU-Umeå (the Swedish University of Agricultural Sciences), examined how this uncertainty should factor into government decisions on prevention measures. Most scientists blame the warming on car emissions and other greenhouse gases, which trap heat in the atmosphere. But since the extent of the problem is unclear and cutting back on emissions might be costly, some U.S. policymakers have argued against taking any action until the uncertainty is resolved.

However, as Heal points out, waiting for certainty is not a practical solution. “Until the events have actually occurred, we don’t know exactly what they will be,” he says. “And at that point, it will be too late to take action to avoid them.”

In fact, at least some of these changes have already arrived. A September report by a research team led by James Hansen, an adjunct professor in Columbia’s Department of Earth and Environmental Sciences, showed that the Earth’s temperature is the highest it has been since the end of the last Ice Age — about 12,000 years ago. And higher temperatures in the Indian and Pacific Oceans may translate into more El Niño weather anomalies, such as severe flooding.

Heal approached this policymaking problem by drawing upon ideas that are common in finance. Deciding to reduce emissions is similar to buying an insurance policy for one’s house or car, he says. “There are lots of things in everyday life about which we’re uncertain: I’m uncertain about whether my car will be stolen; I’m uncertain about whether I’ll be taken sick,” he says. “We live with all of these uncertainties, and we react to them by buying insurance. So one way of seeing the policies designed to reduce the emissions of greenhouse gases is to think of them as insurance — insurance against the worst possible outcomes that might occur if the more pessimistic models of climate change are correct.”

To calculate how much a country should spend on insurance, Heal and his coresearcher came up with a formula that takes into account a nation’s degree of risk aversion, the size of the risk it faces and its discount rate. The discount rate — a way to measure the relative weight of future and present costs — is particularly important because much of the impact of climate change won’t be felt for decades. “One of the things that we found in this study is that what you pick as a discount factor matters a great deal,” Heal says. The discount rate reflects how much less a country is willing to pay to prevent possible environmental damage that will occur 100 years from now, rather than five years from now.

Applying this model to the United States and using a range of scientific estimates on climate change, Heal determined that it might be worth spending from 0.5 percent to 3 percent of national income to reduce the risk of global warming. For other countries, that figure might be higher. “The United States is less threatened by climate change than many other countries and also happens to be less risk-adverse,” Heal says. Since climate change is not an all-or-nothing scenario, a country can choose to spend more or less to cut emissions and constrain its risk.

“Uncertainty, risk and our attitudes towards risk really do matter in making policy decisions,” Heal says. “They should be taken quite explicitly into account in formulating policy on climate change.”

Geoffrey Heal is the Paul Garrett Professor of Public Policy and Business Responsibility at Columbia Business School and a research scholar with the Earth Institute at Columbia University.

Read the Research

Geoffrey Heal

"Uncertainty and Climate Change"

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