On the Economics of Climate Policy

We analyze the central features of economic policies to mitigate climate change. The basic structure of Pigouvian “carbon pricing” is shown to follow from a standard Hotelling problem for the intertemporal pricing of an exhaustible resource. We extend this analysis to consider the strength and timing of research incentives, the costs of implementation delay and the impact of anticipated future technologies on current carbon prices. We study a variety of issues related to the valuation of climate investments, including uncertainty as to the future timing and distribution of climate impacts and the appropriate social rate of discount for valuing policies. Under reasonable circumstances the insurance properties of climate investments may warrant unusually low discount rates. We use the same framework to argue that policy makers in developing countries will discount the expected returns from climate investments more heavily, because such investments have weaker insurance value in the developing world.