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Economic analysis of projects in a greenhouse world

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  • Hamilton, Kirk
  • Stover, Jana

Abstract

Recent carbon market prices are substantially lower than mean or median estimates of the social cost of carbon in the literature. Intuition would therefore suggest that'investment errors'are being made, in the sense that markets favor higher carbon-emitting projects, while global welfare would be larger with lower carbon-emitting projects. This intuition is correct in specific circumstances, but not others. For any comparison of two alternative projects, there is a carbon switching price that equalizes their net social benefits. From the perspective of maximizing global welfare, investment errors only occur when this switching price lies between the carbon market price and the social cost of carbon. Data on the costs of high-carbon and low-carbon electric generation projects suggest that there is no financing gap using mean or median published figures, but for precautionary (95th percentile) choices of the social cost of carbon, there is a financing gap between carbon market prices and the switching price that would trigger investment in the global welfare-maximizing low-carbon project. A global carbon fund to finance this gap could be conceived, but stricter emission caps and reforms of carbon markets are likely to be a more efficient solution to the problem.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 6117.

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Date of creation: 01 Jul 2012
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Handle: RePEc:wbk:wbrwps:6117

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Keywords: Climate Change Mitigation and Green House Gases; Climate Change Economics; Markets and Market Access; Carbon Policy and Trading; Energy Production and Transportation;

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  1. Sterner, Thomas & Persson, U. Martin, 2007. "An Even Sterner Review: Introducing Relative Prices into the Discounting Debate," Discussion Papers, Resources For the Future dp-07-37, Resources For the Future.
  2. Markandya, Anil & Pearce, David W, 1991. "Development, the Environment, and the Social Rate of Discount," World Bank Research Observer, World Bank Group, World Bank Group, vol. 6(2), pages 137-52, July.
  3. Wilfred Beckerman & Cameron Hepburn, 2007. "Ethics of the Discount Rate in the Stern Review on the Economics of Climate Change," World Economics, World Economics, Economic & Financial Publishing, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, World Economics, Economic & Financial Publishing, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, vol. 8(1), pages 187-210, January.
  4. Richard S. J. Tol, 2009. "The Economic Effects of Climate Change," Journal of Economic Perspectives, American Economic Association, vol. 23(2), pages 29-51, Spring.
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