Application of Cost-Benefit Analysis to Climate Change*

Mohan Munasinghe
The World Bank

*Editor's Note: For an in-depth examination of this topic, see Munasinghe, M., P. Meier, M. Hoel, S. Hong, and A. Aaheim, "Applicability of Techniques of Cost-Benefit Analysis to Climate Change," in Global Climate Change: Economic and Policy Issues, M. Munasinghe (ed.), World Bank Environment Paper Number 12, The World Bank, Washington, D.C., pp. 33-82.

In their paper, Munasinghe, Meier, Hoel, Hong, and Aaheim broadly interpret cost-benefit analysis as a family of techniques that may be used to evaluate various projects and public policy issues. An analysis of costs and benefits, even if they cannot all be measured in monetary units, offers a useful framework for organizing information about the consequences of alternative actions for addressing climate change. The family of techniques involved starts with traditional project-level cost-benefit analysis, and extends to cost-effectiveness analysis, multicriteria analysis, and decision analysis. Traditional cost-benefit analysis attempts to compare all costs and benefits expressed in terms of a common economic numeraire, usually expressed in monetary units. An analysis of costs and benefits, even if they cannot all be measured in economic units, offers a useful framework for organizing information about the consequences of alternative actions for addressing climate change. Cost-effectiveness analysis essentially seeks to find the lowest cost option to achieve a specified objective. Multicriteria analysis is designed to deal with problems where some benefits and/or costs are measured in nonmonetary units. Decision analysis focuses specifically on making decisions under uncertainty.

In principle, this group of techniques could contribute to improving public policy decisions concerning the desirable extent of actions to mitigate global climate change, the timing of such actions, and the methods to be employed. In this context, cost- benefit analysis provides a systematic framework by which to determine a rule or target for undertaking climate change mitigation actions. It seeks to identify the most efficient climate change strategy by balancing the marginal costs of mitigation and adaptation measures against marginal damages avoided by those measures. In Figure 2-1Oc of the paper, the cross-hatched curves represent uncertain marginal costs estimates and R(opt), is an estimate of the optimal (efficient) level of emission reduction. Emission reduction is used as a rough proxy measure for the state of the global environment. A more rigorous analysis would need to examine actual greenhouse gas concentrations and/or consequent changes in global temperature (both the level and rate of change would be important to determine, for example, the impact on the survival probability of many species).

A second type of approach is based on the concept of an affordable safe minimum standard, which would specify a maximum atmospheric concentration of greenhouse gases based on an assessment of the risks associated with different atmospheric concentrations and the costs of achieving those concentrations. As shown in Figure 2-1Ob of the paper, judgment is exercised to determine the affordable safe minimum standard R(min), so that the cumulative area under the marginal mitigation cost curve is less than some predetermined value of maximum affordable costs. Although less rigorous than the previous approach, the iterative use of risk and affordability criteria enable the policymaker to determine a standard without reference to an explicit marginal damage cost curve. Multicriteria analysis could be used to help choose the affordable safe minimum standard.

Finally, a more arbitrary rule may be derived based on an absolute standard. Such an approach, as shown in Figure 2-1Oa in the paper, might define a maximum atmospheric concentration of greenhouse gases that is considered to constitute "dangerous anthropogenic interference with the climate system" on the basis of the risks posed by climate change. The vertical line implies that the (notional) marginal damage costs are very high, and therefore the standard may be set largely independently of the economic and social costs of achieving the standard. These rule-making procedures need not necessarily be used in a mutually exclusive fashion. Rather, policy judgments may be improved by combining these perspectives, and recognizing that over time, targets and standards may need to be adjusted in the light of better data and analyses. Whatever the method or rule used to determine the desirable standard, cost-effectiveness analysis would be helpful in identifying the least-cost method of achieving such a standard.

The authors indicate that in the practical application of cost-benefit analysis to the problem of climate change, there are important difficulties because of the global, regional, and intergenerational nature of the problem. The literature on the consequences of climate change is thin, and even physical damage estimates vary widely. The literature on actions to address climate change is also limited. Economic valuation of the consequences of climate change is a central feature of traditional cost-benefit analysis, but confidence in valuation estimates for important consequences (especially nonmarket consequences) is low. For some categories of ecological, cultural, and human health imparts, even well-accepted economic concepts of value are not available. Furthermore, the techniques of cost-benefit analysis would not be useful in analyzing questions involving equity -- for example, in determining who should bear the costs.

Cost-effectiveness and multicriteria analyses can be used to compare and evaluate specific adaptation and mitigation measures.

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