2nd K B Lall Memorial Lecture on Global Warming and Global Finance
By Prof. Lawrence H. Summers, former US Treasury Secretary - April 17, 2007

It is a great honor to be here at the ICRIER institution, which has done so much to foster economic reform with India, to be here with its distinguished Director, Rajiv Kumar, and to be here also with Isher Ahluwalia, who has done so much over the years to promote understanding of international economic relations and with whom I have been honored to serve in recent months as a member of a group advising the Asian Development Bank. I believe that when the history of our period is written 300 or 400 years from now, ICRIER’s central concern – the economic relations between developing countries and the broader world and how they played out, how they were managed – will be the central question in that history.

For what we are witnessing today is an unprecedented degree of economic integration between countries where standards of living differ by a larger factor than countries that were integrating ever before and with a more rapid rate of growth, particularly in the poorer countries, than you have ever seen before.

Think about it.

They called it the industrial revolution because for the first time in all of human history to that date growth had started at a rate where living standards might increase by as much as 75% within a single human lifespan. At rates your country has enjoyed in the last several years, and that China has enjoyed for a generation now, living standards do not increase just 75% within a single human lifespan, they can increase by as much as a 100-fold with profound consequences for every aspect of economic activity.

Now as an economist, and as Secretary of the Treasury, my primary concern with that interaction was the establishment of suitable global architectures for managing questions of the flow of capital and in the trade of goods so that this integration would take place harmoniously and successfully. That continues to be a major preoccupation. But I, like many others, have come to see in recent years, in ways that I certainly did not fully appreciate at the time, that I was in office that the challenge of global warming is another important dimension in which the global economic issues we face today are different not just quantitatively but different in kind than the global economic issues that we have traditionally faced.

For it is also true along with those unprecedented rates of growth and that unprecedented integration that for the first time in all human history, mankind’s economic activities have the capacity to affect the conditions of life on earth not just locally but globally on a planet-wide basis. So, I have chosen because of its transcendent importance to speak about global warming and global finance today. But there are also other reasons for choosing this topic, two principally.

The first is that I am convinced, as I will explain in the course of these remarks, that if appropriate solutions are to be found it would be essential that thought leadership come from the developing world that in crafting a solution. The solution cannot be an industrial country solution in which developing countries are brought along but must be a truly global solution. Your country has a long tradition of thought leadership on major international questions and, therefore, I believe a major role to play with respect to this issue in the coming decades. The second reason why I have chosen to address this subject as myself, now a professor and speaking at a distinguished research institute, is that I am convinced that this is at this point a profound intellectual problem.

I like to divide big public policy problems into two categories. The first category is where in some sense we basically know what to do but it is enormously difficult to do it politically. I would submit that much in economic reform in India falls in this category, that the completion of the Doha Round falls in this category, that even the task of crafting an appropriate peace agreement between the Israelis and the Palestinians falls in this category. The broad outlines of a solution are relatively clear; the challenge is one of finding the political will and the political consensus to enact that solution.

There is now a second category of political problems where even if there were not policy problems, or even if there were not political difficulties, it is far from clear what the right way forward is. In that category I would place transcendent issues of international relations across those with very different historical traditions, I would place the policy challenge we all face in dealing with failed states, and I would also place the problem of how we are going to address the twin challenges of development and global climate. So my remarks today will succeed if I am able to provoke thinking, provoke creativity, provoke research here at ICRIER and beyond on a problem where I believe the world has a great deal more understanding that it must seek to gain.

I wanted to do three things in these remarks. First, to seek to dimension and frame the global climate change problem as it appears right now in several of its central elements. Second, to provide a kind of report card on the progress that I believe the world has made and has not made over the past 20 years as this problem has become more focal and third, to make some observations and suggestions about the right way forward.

First, dimensioning and framing the problem. It now, as Montek said, cannot be doubted that mankind through his emission of greenhouse gases has had and will have on an increasing scale an impact on the global climate. To suggest otherwise is to join those who doubt the theory of evolution, or still maintain that tobacco smoking is not hazardous to human health. Nor can there be any substantial doubt at this point that the consequences of global warming were variegated and dispersed around the world; or much more likely to be adverse than they are to be congenial; or likely to bear harder on those who are closer to the equator and those who are poor than on others. And while there is an enormous amount we do not know, the surprises with respect to the impact of global warming are more likely to be adverse than to be congenial. Nor, and this is a point that is always understood but sometimes is not focused on, the question is not a question of whether there will be adjustment but a question of when and how there will be adjustments.

Here is one central fact of atmospheric science, and there are many facts, and I only understand a few of them, but I am only going to highlight one fact of atmospheric science that is central in understanding and reacting to this issue, and that is that the change in temperature, the change in the climate depends on the stock of greenhouse gases, it depends not on what was emitted this year or last year but what has been emitted over the last century. It follows that the problem does not remain constant if the world economy remains constant but continues to increase as global greenhouse emissions grow. Therefore, if there is some limit on how much temperature increase we can accept, at some point the stock will have to stabilize which means the level of the emissions will have to fall very substantially. It is a serious problem, it is an increasing problem, and it will require adjustment at some point.

The second observation, which is less familiar but I would suggest no less important in thinking about this problem, is that the uncertainties we have about the impact of global warming, as great as they are, are dwarfed by our uncertainties in perceiving what the global economy will be like when global warming starts to have major impacts 50 years or a century from now. Frankly, the record of economists in forecasting and the confidence that should be placed in their forecasts is, shall we say, minimal.

I participated in a very serious exercise of preparing briefings and analyses and thought for President Clinton during his transition in 1993 of how the global economy was changing, how the American economy was changing, what the major economic issues that he would face were. I believe I can report accurately that the word Internet or any synonym for it did not appear in that briefing in 1993. I do not think we were uniquely shortsighted at that time, but the record of century, half century, quarter century, forecasts is simply not one that commands confidence. I highlight this for this reason.

If one seeks, and the estimates are still preliminary and uncertain, to quantify the impact of global warming, the largest estimate that has yet been put forward by anyone and this estimate can be challenged on a number of grounds, is suggested in the Stern report that global warming would reduce global GNP by as much as 20%. This figure is suggested as an impact that could take place two centuries from now. Now it is a vast figure. But what is our uncertainty in looking even one century ahead you will each have your own views but I don’t see how any serious person could maintain a confidence interval less wide than 2% in forecasting global growth over a century and my own confidence interval would be far greater than that. But take 2% as a figure, 2% compound over a 100 years is a factor of 7. Our estimates of where the world economy will be global warming entirely apart are an order of magnitude greater than the uncertainties associated with global warming.

This is not to mention other aspects of economic conditions such as crucially the price of energy, or the availability of technologies for using energy in different ways than we can envision today. I am reminded of the great British economist Jevon’s study at the very end of the 19^th century in which on the basis of a very careful set of calculations he concluded that unless a major adjustment operation was undertaken every street in London would lie under two feet of coarse mineral by 1930s and calling for an appropriate adjustment program to control these coarse minerals. The nature of the solution that played out was not something that was envisioned at that time. So we need crucially to maintain awareness of the profound uncertainties that equal in importance of this problem. I highlight this because of the uniquely long period that we are discussing in the context of global warming.

The third observation I would make in dimensioning of the problem is this, and this is perhaps the most important thing I would say tonight. Industrial countries bear responsibility for global warming but no solution is possible without most of the action taking place in the developing world.

First, industrial countries are responsible for what has happened. They are, as Montek suggested, responsible for 75% of past emissions as we speak here the level of emissions in United States per person is 10 times the average in the developing world and about 20 times the level that is typical in India. And of course in any burden sharing exercise those who are affluent have more capacity to bear burdens of the solution to common problems. So, it is absolutely right to assert industrial countries responsibility.

But it is equally the case that solutions centrally involve the developing world. Of the increasing emissions that will take place over the next 25 years, 75% will take place in the developing world. Various forecasts, which are in my judgment relatively conservative, predict that between 2040 and 2050 about two-thirds of all emissions of greenhouse gases will come from the developing world. Beyond that there is the point of malleability.

Most of the infrastructure for the production of electric power, where the design of cities, where transportation arrangements, or where people live 20 years from now in United States or in Europe is in place today. Most of the infrastructure that will shape the development of the economy of China or India a quarter century from now has yet to be put in place. The degree of malleability and the consequent cost of adjustment are lower in the developing world than in the industrial world.

There are separately abundant opportunities in the developing world without parallel for action at very low cost to reduce the emission of greenhouse gases. I think, for example, of programs to preserve forests, programs to change irrigation practices so that agriculture emits less methane, opportunities to reduce gases that contribute to global warming at prices of 10 cents a ton by adopting practices in the production of chlorofluorocarbons that have long been standard in the industrial world.

The low hanging fruit is in the developing world, the malleability is greater in the developing world and ultimately most of the emissions will be coming from the developing world. If that was not sufficient to make the case for the centrality of the developing world, there is this. No partial solution can succeed with respect to many of the most important global emissions sources. Think about it. Efforts to control in one place by raising the cost or imposing other regulatory burdens that are not mirrored in other places will produce reductions in emissions from the controlled places and move emissions to the uncontrolled places. The result will be minimal impact on the global environment and so even to control those emissions that are coming from the industrial world in a way that is effective in reducing the global stock of emissions requires the consideration of what is taking place in the developing world.

In finding solutions then, there are three crucial elements. The problem has to be addressed. There are enormous uncertainties in the baseline against which it is going to be addressed, and industrial countries are responsible but developing countries are at the center of the solution. Where is our effort? Where in the broader sense is the global effort today?

First, the good news, the issue is now centrally on the international agenda. It is discussed at every international meeting. Language with respect to it is included in almost every international communiqué, public opinion in the industrial countries regards it as a problem of central concern. It has become a preoccupation of global business, indeed a majority of the executives present in Davos this year regarded global warming as the most important global issue that they were facing. There is a far greater recognition than there was even a few years ago of the fact that the relationship between energy growth and GDP and between global emissions and GDP is not one that is immutable.

One experience and one statistic made this point more powerfully to me but it is documented in any number of studies. I always believed as an economist that firms naturally are efficient and they do things in the least cost way and that is how it works. I discovered as President of Harvard, and I do not believe Harvard is at all unique in this respect, that we as a university engaged extensively in constructing buildings and we held those who were involved in the construction of buildings closely responsible for the cost of the building. We asked how much our laboratory can cost compared to MIT’s laboratory or compared to the budget that we set. We made no effort in assessing the cost of the buildings to build in the lifecycle costs of the buildings, whatever it cost to heat them in the winter or whatever it cost to cool them.

So what happened? People built the buildings in ways that invested as little as possible in insulation so that they could succeed and quite consciously chose to forego opportunities to invest in energy saving that would pay itself back in three or four years when we were able to change that focus by providing special loans and such we produced a somewhat better outcome. It is clear from those who know that such opportunities are ubiquitous, that we do not have in most energy users accounting systems that succeed in giving credit for even the highest return investments that promote efficiency.

A different way of making the point on what is dramatically possible is just to say this: In the United States, carbon emissions per person from the State of California are 55% of the national average. Why? A set of local environmental policies, a set of policies directed at electricity, a number of other regulatory measures to be sure the comparison is not entire fair because California’s climate is more mild. But it is increasing clear that energy efficiency at the same level of GDP is possible. So the good news is that there is a broad sense of political commitment and it is clear that there is an enormous amount that is possible.

The less good news, I will suggest to you, is this: it is far from clear that so far Kyoto is delivering in ways other than highlighting and driving this tremendous concern about the problem. First, in the way that Hamlet is not a very good play without the prince, global warming treaties in which the United States does not participate are limited in the efficacy that they can have. I should say, and have to say, that while I have my many differences with the current administration, the decision not to participate in the Kyoto treaty was made by a 97 to 0 vote of the United States Senate, including members of both political parties.

In other industrial countries, and I think here principally of Europe, it is far from clear that Kyoto is as yet driving changes in the environment that other wise would not have taken place. One way to make this point is to observe that on the market where carbon allowances can be traded, they are currently selling for one Euro – a de minimus price suggesting that the constraints are not yet heavily binding on business. Another is to look within Europe and to observe that while a number of countries have achieved very substantial reductions – for example the UK, Germany or several countries in central Europe – they are primarily countries that, for other reasons independent of global warming, were moving radically away from coal during the 1990s. If one looks at other countries, Italy and Spain for example, one can observe more than a 20% increase in their emissions since 1990.

Nor, and this is the critical point, has Kyoto meaningfully engaged the developing world. There are no targets that the countries in the developing world have accepted, nor did they appear to be on an imminent path to accepting targets. There was the hope that the so-called clean development mechanism would provide for meaningful interactions and meaningful financing from the industrial world to the developing world. The reality to date has been at best sobering. More than half of clean development projects have involved industrial gases. The industrial gases that have been affected are very difficult to measure relative to any alternative baseline and it has indeed calculated that the emitters of those industrial gases who have converted them as a consequence of clean development projects are now earning more money from the clean development mechanism than they are from selling their underlying project.

This invites the suspicion that there may well be those who are going into business, and who are going into the activity of expanding businesses, not so as to make profits in the market but so as to make profits by them abating their global gas emissions. All of this suggests that the incremental achievement of the Kyoto treaty in reducing developing country emissions separately from any contribution to industrial emissions is at yet quite small.

It also seems to me that we have learned from other international experience in recent years the difficulty of what Bill Nordhaus has called the Westphalian dilemma: under the realities and the principles that have governed international law for three centuries now, nations are not able to coerce other nations, agreements can only be entered into voluntarily, and the difficulties of enforcement are profound. The European experience with the Maastricht Treaty – an agreement entered into universally and with great conviction – is very educational in this regard. It referred to a policy instrument that was within governments’ control – budget and deficits – which could be relatively easily adjusted with spending or tax policy changes. There was an explicit agreement on an enforcement mechanism. At the first instance when it appeared that a free country would not meet its goals, the enforcement mechanism was abandoned. A certain amount of experience with international pledging conferences such as the ones that are now in effect with respect to the Millennium Development Goals also makes one aware that it is much easier to enter into collective national commitments than it is to honor those commitments.

What is the way forward? I think this is a fair question, and there are two dominant views in the debate. There is agreement that yes, it needs to be worked on; yes, there should be some pilot projects; yes, there should be some research; yes, it is very valuable to have a dialogue. But we gush we cannot do anything transformative because the current problems we have to face are just too urgent and too important and this will some how take care of itself down the road. That view might be juxtaposed with its polar opposite which I might label the alarmist or immediate action view of the kind that is exemplified in the Stern Report. The Stern Report comes close to suggesting the fate of the planet will be determined in the next 15 years by whether the right steps are or are not taken.

There is a cost for a mechanism in which nations would commit themselves absolutely or subject to large monitoring payments to promise the world that come what may to the price of energy, come what may to their economic growth, they would not emit more than a certain quantity of greenhouse gases a decade hence. And though this approach has eminent appeal, the question is whether it is at all realistic in terms of nations, and to be sure for the reasons raised earlier, and whether developing nations are going to be prepared to take on such commitments. And if they do to take on such commitments, can they live by those commitments. I am not sure that either of these perspectives can fully point us forward, though the second one contains important elements of truth. And so I would suggest three requisite principles and then a number of elements that may be part of an ultimately successful package.

First, thought leadership must come from the developing world. The central actions that need to be taken and the central compensation that needs to be received will take place in the developing world, and the largest player by far will be China. It will be followed by India, and others in the developing world, simply as a matter of scale, will trail far behind. The stakes are very large, the changes very important, and the magnitude of the support that can be expected and should be expected is very large.

How this can best be done? I am going to suggest some answers in a few moments. But fundamentally it is as much or more for the developing world to prescribe as it is for the industrial world and I worry about any approaches in which the effort is to bring along the developing world rather than a strategy in which the developing world is central from the start. Second, any successful strategy must recognize the twin realities that the industrial countries are responsible and the developing countries are at the centre of the solution. That means major actions must be taken in the developing countries but they can reasonably expect, perhaps even demand, that they not bear the burden of taking those actions but be compensated and supported in taking actions that are in the interests of all.

At the same time, and I think this is the third principle, there needs to be a shared recognition that the development of those who are emerging cannot be a recapitulation of the growth experience of the industrial countries. There is no projection on which it is reasonable to believe that the kinds of energy use per person that are common in the United States or Western Europe today can be enjoyed by 9 billion people. Fortunately there is every reason to suppose that economic growth can and will take place at much higher levels of energy efficiency.

After all, if one takes a very different sphere, the levels of life expectancy or literacy that have been achieved in Asia are far, far greater than the levels of life expectancy or literacy that has been achieved in the industrial world at times when they enjoyed comparable levels of income to those that are enjoyed in Asia today. And so this is not in any way to suggest that it would be more feasible or appropriate to suggest that the growth in standards of living of the citizens of developing countries should be held back by this concern with global warming.

I suggested that thought leadership will need to come from the developing world and so I am hesitant to prescribe too much but I can hardly stop without offering some prescriptions that seek to instantiate this principle that of industrial country responsibility and developing country action. I would suggest four major areas where action is necessary. First, there needs to be an expectation for a set of policy commitments in the industrial world. The United States has no basis for expecting others to act without having taken more actions than it has today. An international mechanism needs to be established for measuring the extent of policy actions that countries have taken that move beyond their base lot. The approach of simply measuring emissions is one that rewards those who have recessions, rewards periods in which the price of energy rises for other reasons, penalizes those who grow their economy and provides no basis for the measurement of national effort. An international mechanism such as takes place in the trade area through the WTO, or in the subsidies area through the OECD, needs to be established for measuring, monitoring, reporting and making transparent the efforts of each country. Inevitably, the calculations will involve subjectivity; inevitably, there would be room for debate, but making policy commitments transparent is a first key and expecting that every major industrial country make significant policy commitments is the first element of any solution.

The second element is a far greater commitment than has been made to date towards the funding of research in every area that can contribute to the reduction of greenhouse gases, a present commitment to avoiding the mistakes with respect to intellectual property that were made in the pharmaceutical sphere, and assuring that technologies that are developed will be made practically and fully available in the developing world. There are to be sure a wide variety of research efforts underway, they are not commensurate to the scale of the problem and in many cases they are not directed at the issues that press most in the developing world.

Third, reconceptualization of the development banks as banks for development and environment. Let it be said clearly the traditional role of the developing banks in major middle income and rapidly growing countries is not there when the net flow of capital is very substantially from developing counties to industrial countries. The traditional function of lending to support development has much less meaning when major countries have 200 billion or a trillion dollars in reserves. So quite apart from the environmental question there are a major set of institutions whose role with respect to middle income countries needs to be reconceptualized.

That is perhaps fortunate because their central purpose, which was to intermediate the flow of resources from the industrial world to the developing world, does need to be resurrected, but not as loans for development. Rather, it should be resurrected as support through grants and through enhanced credits for global environmental objectives. There is very substantial potential economic value that lies in the credit guarantees that the funders of the development banks make to them. How best to harness that value for energy and the environment is an open question but one that I believe of urgent importance if ways are to be found of transferring significant resources as is appropriate to developing world and if these institutions are to fulfill their potential in the next century.

Fourth, a global commitment should be entered into soon to end all energy subsidies by the year 2025. The definition of ending all energy subsidies will prove to be a not totally intellectually interesting but vastly consuming task for economists, the question of whether if you have an energy tax and you have somewhere else an energy subsidy that constitutes zero energy subsidy will have to be debated. But at a time when the world is concerned about the excessive use of energy it is hard to believe that moving to eliminate nearly $250 billion that the Stern report estimates is being spent on energy subsidy should not be other than a first step. This can be done through the standard mechanisms for enforcing unfair trade practices which surely subsidized energy can be.

This has another very important benefit. If, as I suspect will ultimately be necessary, the world will have to not just ban energy subsidies but will have to agree collectively on a common higher price of energy. The effort to eliminate energy subsidies will require doing the necessary intellectual and institutional work. I believe that if in the next several years the principle can come to be clearly established, as I believe it is not today in the industrial and the developing world, that the large actions will be in the developing world and that large amounts of support will be necessary to reflect the responsibility of the industrial world, if that principle can come to be established, and steps of this kind can be undertaken the world will be in a much better place to address this formidable challenge come what may.

There will be those who regard this program as manifestly insufficient because it does not involve the clear establishment of a binding commitment on a target as to how much gas will be emitted – whether 5 years, 10 years, or 20, or 25 years from now – and to those who are able to establish such mechanisms, I would suggest more power to you. But just in case that does not prove possible, I hope that in these and perhaps other or even better ways your country and others in the developing world will show us the way and make suggestions that will enable us collectively to address what I believe is a central global economic challenge and for those of us in the financial area will be the central challenge of official global finance in the years ahead. Thank you very much.