The Social Cost of Carbon

7 minute read

Even if climate change isn’t at the very top of the list of global existential problems that keep you awake at night, you still need to worry about it because it makes all of the other problems worse.

The consequences of climate change are dire – an increase in frequency and severity of extreme weather events, sea level rises, wildfires, mass extinctions, the emergence of new infectious diseases, crop failures leading to famines and civil unrest, the list goes on. Climate change exacerbates almost every social issue you can imagine, but the intersection between climate change and everything else is all too often overlooked.

If you care about social issues, failure to address climate change is like trying to reach your goals by running the wrong way up an escalator. Put simply, emitting carbon comes with a social cost.

Climate change is a market failure. For decades, governments subsidised and propped up Carbon intensive industries making them artificially cheap and cementing their dominance versus cleaner alternatives, such as renewables.

The tide is beginning to change. The near-zero marginal cost of renewables have allowed them to take a strong foothold – onshore wind and solar are now the cheapest of all energy sources available today. This is a vitally important step in the fight against climate change, but not one we are going to discuss today.

Around the world, there has been a litany of attempts to instigate carbon markets and set a universal carbon price. A cynic might say that carbon offsets simply allow dirty industries to keep on polluting, albeit they must now pay for the right to do so (increased costs that will inevitably be passed on to consumers eventually). In fact, trading carbon will extend the lives of these industries, whereas what we really need is a swift, but carefully managed transition to low carbon alternatives.

I am inclined to agree. But we are not going to talk about a carbon price today either (well not exactly).

The most important environmental number no one has ever heard of?

Can you put a price on the harm climate change does to society? The Social Cost of Carbon (or SCC) is the monetised damages associated with each additional ton of GHG emitted – i.e. the incremental cost of climate change on society in dollar terms. And, if you are a follower of climate news, it’s a concept you’re going to hear an awful lot more of.

It’s the cost of inaction. Tackling climate change requires investment; but not doing anything costs money and, more importantly, lives. If fossil fuel prices reflected their true deadly cost to humanity, they would be considerably higher than they are now. You can think of the SCC as the benefit, in money terms, of reducing emissions.

So how much actually is it is dollars? – right now, probably a bit above $50 per ton. But as you might imagine, the components of the calculations are fiercely debated by economists, environmentalists and policymakers. To understand this we must take an unexpected detour into US politics because the SCC is in fact a US policy tool first dreamt up under the Obama administration (and predictably torn up by Trump).

Obama looked at it as a cost-benefit analysis, where a high SCC justified implementing more expensive (and better) climate policies – as the costs of not doing them were very high. At the end of Obama’s time in office, the SCC sat around $52 per ton in today’s money.

Then along came the Donald. The Trump administration massively reduced the scope of the damages considered by the SCC calculation (from global to just those felt directly by the US). They also pumped up the discount rate – effectively massively devaluing the damages that will be felt by future generations – this allowed him (well, his warped bean counters) to arrive at an SCC of between $1 and $7 per ton. This meant he could “justify” many of his environmental policy rollbacks, as he could argue that a low SCC meant that it was not worth spending any money on protecting the environment.

Fortunately (and expectedly) President Biden has swung firmly back towards the original approach and reconvened Obama’s working group, with an aim to come up with a final SCC figure by January 2022. Some academics are arguing that given the progress in our understanding of climate change, it is justifiable to amend the assumptions of the model in such a way that could see an SCC of around $125 per ton!

To cite a practical example that could drive decision making, Business In the Community, a UK charity, estimates that £1.1tn of social costs could be avoided if UK businesses achieve net zero by 2030 rather than 2050.

Sounds great. Sounds helpful if you are a lawmaker of a green persuasion. But is this really the right way to be thinking about it? Climate change kills. How do you put a price on each human life it takes? Are they all “priced” the same – i.e. different nationalities or income brackets? Or the current population of the earth versus future generations?).

Feels like very uncomfortable and murky waters to be honest.

Even less controversially, how can you calculate the monetary cost of biodiversity collapse without an enormous margin of error?

Don’t get me wrong, it’s a good thing that environmental and social damage are back on the list of considerations for the US when setting policies (and where the US leads, many other countries tend to follow). It’s also a good thing that the US will (most likely) significantly revise the SCC upwards as this too could prompt other countries to be loftier with their climate ambitions.

It does still feel though that approaching this problem as a cost/benefit analysis is too clinical a way to look at it. Not least because both the costs of climate change and the benefits of mitigating it, are subjective – just consider the relative perspectives of a Musk or Bezos or even a middle-class Brit versus (for example) an African subsistence farmer.

Some argue that a risk management approach is better suited to the problem of climate change – i.e. set an upper threshold for atmospheric GHG concentrations (based on the Paris Agreement) and work backwards from there to calculate how much GHG emissions policies can “permit”.

This is not without its problems either. Not least that to manage risk, you need a risk appetite to manage to – how do you get the world to agree on an appetite for catastrophic risk? We are back to the problem of perspective.

In reality, we will probably need a combination of both approaches – perhaps using the SCC as a tool within a wider risk management approach. We should expect to hear a lot more about the SCC, especially as the Biden administration continues on its journey to revise the calculations and incorporate it into their decision making. It will be fascinating to see where the journey takes them (and us).

This is both an economic and a philosophical issue and one which I have barely scratched the surface of here. If anyone has any deeper understanding or views on this I would love to hear them.