Climate Change 2001:
Working Group III: Mitigation
Other reports in this collection

7.2 Elements in Costing

7.2.1 Introduction

This section addresses a number of key conceptual issues related to mitigation cost concepts, including definitions of private and social costs and methods to assess the side effects and equity aspects of mitigation policies. An overview is given of analytical approaches to assess mitigation costs, including a classification and discussion of different modelling approaches and critical assumptions. The issue of ancillary and co-benefits of climate change mitigation is discussed. Valuation techniques are presented, as is the treatment of barrier removal and implementation costs. A review of recent developments in the field of discounting is then presented and the section concludes with an investigation of the linkages between adaptation and mitigation.

7.2.2 Cost Estimation in the Context of the Decisionmaking Framework

Actions taken to abate GHG emissions or to increase the size of carbon sinks generally divert resources from other alternative uses. The theoretically precise measure of the social costs of climate protection, therefore, is the total value that society places on the goods and services forgone as a result of the diversion of resources to climate protection. A social cost assessment should ideally consider all welfare changes that result from the changes in resources demanded and supplied by a given mitigation project or strategy in relation to a specific non-policy case (see Hazilla and Kopp, 1990). The assessment should include, as far as possible, all resource components and implementation costs. This means that both the benefits and the costs of a mitigation action should be included in the estimation. In some cases, the sum of all the benefits and costs associated with a mitigation action could be negative, meaning that society benefits from undertaking the mitigation action.

The conceptual foundation of all cost estimation is the value of the scarce resources to individuals. Thus, values are based on individual preferences, and the total value of any resource is the sum of the values of the different individuals involved in the use of the resource. This distinguishes this system of values from one based on “expert” preferences, or on the preferences of political leaders. It also distinguishes it from value systems based on ecological criteria, which give certain ecological goals a value in themselves, independent of what individuals might want, now or in the future.

The values, which are the foundation of the estimation of costs, are measured by the applied welfare economic concepts of the willingness to pay (WTP) of individuals to buy the resource, or by the individuals’ willingness to accept (WTA) compensation to part with the resource. The WTP measure of value reflects the maximum people are willing to pay to live in a world with climate policy in force rather than not. WTA is the minimum compensation people would accept to live without this climate policy (e.g., Willig, 1976; Randall and Stoll, 1980; Hanemann, 1991; Shogren et al., 1994). The concepts of WTP and WTA therefore play a critical part in defining the social cost method.

WTP or WTA is most commonly approximated by the consumer and producer surplus as revealed in the demand and supply schedules for the resources whose consumption and production is affected by the mitigation action. These measures are standard economic tools of cost–benefit analysis (Hanley et al., 1997). In some cases, however, the resources that are affected do not have well-defined markets and hence lack identifiable demand and supply schedules. Examples are changes in air quality, or changes in recreational use of forests. In such cases other methods of measuring WTP and WTA are required. These have been developed recently and can now provide credible estimates for a range of non-marketed resources, though some debate remains over the application of such values to all policy-relevant impacts.

There is also a relationship between WTP and WTA and the conventional aggregate measures of economic activity such as gross domestic product (GDP). The classic paper on this is Weitzman (1976), which showed that GDP less depreciation of capital (or “net national product”) is a measure of the net output that represents the income on the economy’s capital stock when that economy is operating according to competitive market rules. However, a competitive economy is also one that maximizes the sum of consumer and producer surpluses. Hence GDP is closely linked to consumer and producer surplus maximization for commodities that operate through the market place. However, the relationship breaks down if competitive markets do not exist for all scarce resources. In this case, GDP changes do not fully reflect changes in social welfare.

A frequent criticism of this costing method is that it is inequitable, as it gives greater weight to the “well off”. This is because, typically, a well-off person has a greater WTP or WTA than a less well-off person and hence the choices made reflect more the preferences of the better off. This criticism is valid, but there is no coherent and consistent method of valuation that can replace the existing one in its entirety. Concerns about, for example, equity can be addressed along with the basic cost estimation. The estimated costs are one piece of information in the decision-making process for climate change that can be supplemented with other information on other social objectives, for example impacts on key stakeholders and the meeting of poverty objectives.

Other reports in this collection