Cost-Benefit Analysis

Economists have been trying to analyze the overall net benefit of Kyoto Protocol through cost-benefit analysis. Just as in the case of climatology, there is disagreement due to large uncertainties in economic variables. Still, the estimates so far generally indicate either that observing the Kyoto Protocol is more expensive than the not observing the Kyoto Protocol or that the Kyoto Protocol has a marginal net benefit which exceeds the cost of simply adjusting to global warming. The recent Copenhagen consensus project found that the Kyoto Protocol would slow down the process of global warming, but have a superficial overall benefit.

A study in Nature found that accounting only for local external costs, together with production costs, to identify energy strategies, compliance with the Kyoto Protocol would imply lower, not higher, overall costs.

Defenders of the Kyoto Protocol argue, however, that while the initial greenhouse gas cuts may have little effect, they set the political precedent for bigger (and more effective) cuts in the future. They also advocate commitment to the precautionary principle. Critics point out that additional higher curb on carbon emission is likely to cause significantly higher increase in cost, making such defense moot. Moreover, the precautionary principle could apply to any political, social, economic or environmental consequence, which might have equally devastating effect in terms of poverty and environment, making the precautionary argument irrelevant.

One problem in attempting to measure the "absolute" costs and benefits of different policies to global warming is choosing a proper discount rate. Over a long time horizon such as that in which benefits accrue under Kyoto, small changes in the discount rate create very large discrepancies between net benefits in various studies. However, this difficulty is generally not applicable to "relative" comparison of alternative policies under a long time horizon. This is because changes in discount rate tend to equally adjust the net cost/benefit of different policies unless there are significant discrepancies of cost and benefit over time horizon.

While it has been difficult to arrive at a scenario under which the net benefits of Kyoto are positive using traditional discounting methods such as the Shadow Price of Capital approach, there is an argument that a much lower discount rate should be utilized; that high rates are biased toward the current generation. This may appear to be a philosophical value judgment, outside the realm of economics, but it could be equally argued that the study of the allocation of resources does include how those resource are allocated over time.