Economics

Advancing public and private policymakers’ understanding of the complex interactions between climate change and the economy is critical to taking the most cost-effective action to reduce greenhouse gas emissions. Read More
 

Press Release: New Report: Climate Change Poses Challenges for U.S. Forestry

For Immediate Release: 
February 26, 2003

Contact:  Katie Mandes
(703) 516-0606

NEW REPORT: Climate Change Poses Challenges for U.S. Forestry


Washington, DC - One-third of U.S. lands are covered by forests, making forest ecosystems one of the nation's most prominent natural resources. In addition to their contribution to biodiversity, water quality, and recreation, forests also play a significant role in the U.S. economy, and forestry or forestry-related enterprises are the dominant industries in many U.S. communities. According to a new study by the Pew Center on Global Climate Change, the U.S. forestry sector will face a number of challenges in the next century due to the impacts of climate change.

The Pew Center report, Forests and Global Climate Change: Potential Impacts on U.S. Forest Resources, explores the challenges climate change will pose to forest ecosystems and related economic enterprises over the next century.

"Changes in forest productivity, the migration of tree species, and potential increases in wildfires and disease could cause substantial changes to U.S. forests," said Eileen Claussen, President of the Pew Center on Global Climate Change. "Moreover, these ecological impacts will have direct implications for our economy. The timber industry in the southern United States is particularly vulnerable."

The key conclusions of the report include:


Forest location, composition, and productivity will be altered by changes in temperature and precipitation. Climate change is virtually certain to drive the migration of tree species, resulting in changes in the geographic distribution of forest types and new combinations of species within forests. In addition, climate change is likely to alter forest productivity depending upon location, tree species, water availability, and the effects of carbon dioxide (CO2) fertilization.


Changes in forest disturbance regimes, such as fire or disease, could further affect the future of U.S. forests and the market for forest products. Increased temperatures could increase fire risk in areas that experience increased aridity, and climate change could promote the proliferation of diseases and pests that attack tree species.


U.S. economic impacts will vary regionally. Overall, economic studies indicate that the net impacts of climate change on the forestry sector will be small, ranging from slightly negative to positive impacts; however, gains and losses will not be distributed evenly throughout the United States. The Southeast, which is currently a dominant region for forestry, is likely to experience net losses, as tree species migrate northward and tree productivity declines. Meanwhile, the North is likely to benefit from tree migration and longer growing seasons.


As a managed resource, the implications of climate change for the forestry sector are largely dependent upon the actions taken to adapt to climate change. The United States currently has vast forest resources, and more timber grows within the United States than is consumed each year. If professional foresters take proactive measures, the sector may minimize the negative economic consequences of climate change.


A number of challenges currently limit our understanding of the effects of climate change on forestry. Existing projections for future changes in temperature and precipitation span a broad range making it difficult to predict the future climate that forests will experience, particularly at the regional level. Thus, current projections could fail to accurately predict the actual long-term impacts of climate change for the forestry sector.

Part of "Impacts" Series

Forests and Global Climate Change: Potential Impacts on U.S. Forest Resources, was prepared for the Pew Center by Herman Shugart (University of Virginia), Roger Sedjo (Resources for the Future), and Brent Sohngen (The Ohio State University). It is the ninth in a series of Pew Center reports examining the potential impacts of climate change on the U.S. environment. Other Pew Center reports focus on domestic and international policy issues, climate change solutions, and the economics of climate change.

Click here for a complete copy of this report and previous Pew Center reports.

Multi-Gas Contributors to Global Climate Change

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Multi-Gas Contributors to Global Climate Change: Climate Impacts and Mitigation Costs of Non-CO2 Gases

Prepared for the Pew Center on Global Climate Change
February 2003

By:
John M. Reilly, Henry D. Jacoby, and Ronald G. Prinn
Massachusetts Institute of Technology

Press Release

Download Entire Report (pdf)

 

Foreword

Eileen Claussen, President, Pew Center on Global Climate Change

In the effort to understand and address global climate change, most analysis has focused on rapidly rising emissions of carbon dioxide (CO2) and options for reducing them. Indeed, carbon dioxide, a byproduct of fossil fuel combustion, is the principal greenhouse gas contributing to global warming. However, other greenhouse gases including methane, nitrous oxide, and a number of industrial-process gases also are important contributors to climate change. From both an environmental and an economic standpoint, effective climate strategies should address both carbon dioxide and these other greenhouse gases.

Non-CO2 gases account for 17 percent of total greenhouse gas emissions in the United States and a much larger percentage in developing countries such as India and Brazil. In addition, a host of local and regional air pollutant emissions interact in the atmosphere’s complex chemistry to produce either additional warming or cooling effects. Understanding how these gases interact—and how to craft policies that address a range of environmental impacts—is vital to addressing both local and global environmental concerns.

In this report, authors John Reilly, Henry Jacoby, and Ronald Prinn of M.I.T. unravel some of the complexities associated with analyzing the impacts of these multiple gases and opportunities for reducing them. Emissions originate from a wide range of sectors and practices. Accurate calculation of emissions and emission reductions is easier for some sources than for others. For policy purposes, various greenhouse gases are compared on the basis of “global warming potentials,” which are based on the atmospheric lifetime of each gas and its ability to trap heat. However, these do not yet accurately capture the climatic effects of all the substances contributing to climate change and so must be used with some caution. While scientists have recognized the various roles of non-CO2 gases and other substances that contribute to climate change for some time, only recently have the various pieces of the puzzle been fit together to provide a more complete picture of the critical role these gases can play in a cost-effective strategy to address climate change.

Using M.I.T.’s general equilibrium model, the authors demonstrate that including all greenhouse gases in a moderate emissions reduction strategy not only increases the overall amount of emissions reductions, but also reduces the overall cost of mitigation: a win-win strategy. In fact, due to the high potency of the non-CO2 gases and the current lack of economic incentives, this analysis concludes that control of these gases is especially important and cost-effective in the near term. The policy implications are clear: any attempt to curb warming should include efforts to reduce both CO2 and non-CO2 greenhouse gases.

The Center and the authors are grateful to James Hansen, Keith Paustian, Ev Ehrlich, Francisco Delachesnaye, and Dina Kruger for their helpful comments on previous drafts of this report. The authors also acknowledge support, through the M.I.T. Joint Program on the Science and Policy of Global Climate Change, and the research assistance provided by Marcus Sarofim.

Executive Summary

 

Most discussions of the climate change issue have focused almost entirely on the human contribution to increasing atmospheric concentrations of carbon dioxide (CO2) and on strategies to limit its emissions from fossil fuel use. Among the various long-lived greenhouse gases (GHGs) emitted by human activities, CO2 is so far the largest contributor to climate change, and, if anything, its relative role is expected to increase in the future. An emphasis on CO2 is therefore justified, but the near-exclusive attention to this single contributor to global warming has had the unintended consequence of directing attention away from the other GHGs, where some of the most cost-effective abatement options exist. The non-CO2 GHGs emitted directly by human activities include methane (CH4) and nitrous oxide (N2O), and a group of industrial gases including perfluorocarbons (PFCs), hydrofluorocarbons (HFCs), and sulfur hexafluoride (SF6). When taken together with the already banned chlorofluorocarbons (CFCs), their climate significance over the past century is roughly equivalent to that of CO2. Looking to likely emissions over the next half-century, it is also the case that feasible reductions in emissions of methane and other non-CO2 gases can make a contribution to slowing global warming that is as large as or even larger than similar reductions in CO2 emissions. To effectively limit climate change, and to do so in a cost-effective manner, thus requires that climate policies deal with CO2 and non-CO2 gases alike.

There are several reasons why attention has been focused so heavily on CO2 even though the full list of GHGs has been targeted for control under international climate agreements. Emissions of CO2 from fossil sources can be readily estimated from market data on fuel use, whereas the other gases present measurement difficulties. Also, the analysis of abatement options for fossil emissions benefits from decades of research on energy markets, energy efficiency, and alternative energy supply technologies—work that was spurred by concerns about the security of supply and prices of fossil fuels. The analytical capability developed to study energy markets was then readily applied to the climate issue. Now that the capability to measure and assess the non-CO2 GHGs has improved, it is clear that their control is also an essential part of a cost-effective climate policy.

In addition to the main non-CO2 GHGs identified above, there are other emissions from human activities that are not included in existing climate policy agreements but that nonetheless retard or enhance the greenhouse effect. Tropospheric ozone (O3) is a natural greenhouse constituent of the atmosphere. Emissions of carbon monoxide (CO), nitrogen oxides (NOX), aerosols, non-methane volatile organic compounds (NMVOCs), and ammonia (NH3) all affect the chemistry of tropospheric ozone and methane. Black carbon or soot, though not well-understood, is thought to contribute to warming as well. Other human emissions have the opposite of a greenhouse effect. Sulfur dioxide (SO2) and nitrogen oxides (NOx), mainly from fossil fuel combustion, are converted by chemical processes in the atmosphere into cooling aerosols. These various gases and aerosols are related to one another by their common generation in industry and agriculture as well as by their interaction in the chemistry of urban areas, the lower atmosphere, and the stratosphere. Thus, policies that reduce CO2 also may affect emissions of SO2, NOx, and CO, as well as the non-CO2 greenhouse gases.

Designing a cost-effective approach for control of these multiple substances requires some way of accounting for the independent effects of each on climate. The current method for doing so is a set of indices or weights known as global warming potentials (GWPs). These have been developed for the main GHGs, but not for SO2 and other local and regional air pollutants. By design, the GWP for CO2 is 1.0 and the values for other GHGs are expressed in relation to it. These indices attempt to capture the main differences among the gases in terms of their instantaneous ability to trap heat and their varying lifetimes in the atmosphere. By this measure, for example, methane is ton for ton more than 20 times as potent as CO2, while N2O is about 300 times as potent, and the industrial gases are thousands of times as potent when taking into account the atmospheric effects of these gases over the next 100 years.

The relative value of controlling non-CO2 gases, as expressed by these GWPs, is one key reason that inclusion of the non-CO2 gases in policies to address climate change can be so effective in lowering implementation costs, particularly in the early years. Given the high carbon-equivalent values of the non-CO2 gases, even a small carbon-equivalent price on these gases would create a huge incentive to reduce emissions. Another reason is that, historically, economic instruments (i.e., prices, taxes, and fees) have not been used to discourage or reduce emissions of non-CO2 gases, whereas price signals via energy costs exist to curb CO2 emissions from fossil fuels.

If, for example, the total GHG emissions reduction required to meet a target were on the order of 10 or 15 percent, as would be the case if total GHG emissions in the United States were held at year 2000 levels through 2010, nearly all of the cost-effective reductions would come from the non-CO2 greenhouse gases. Compared to a particular reduction achieved by CO2 cuts alone, inclusion of the non-CO2 abatement options available could reduce the carbon-equivalent price of such a policy by two-thirds. This large contribution of the non-CO2 gases, and their potential effect on lowering the cost of a climate policy, is particularly surprising because it is disproportionate to their roughly 20 percent contribution to total U.S. GHG emissions. In developing countries like India and Brazil, non-CO2 gases currently account for well over one-half of GHG emissions. Any cost-effective effort to engage developing countries in climate mitigation will, therefore, need to give even greater attention to the non-CO2 gases.

Of course, these gases are only part of an effective response to the climate threat. Even if they were largely controlled, we would still be left with substantial CO2 emissions from energy use and land-use change. Over the longer term, and as larger cuts in GHGs are required, the control of CO2 will increase in its importance as an essential component of climate policy.

There remain a number of uncertainties in calculating the climatic effects of non-CO2 gases, and one is the accuracy of global warming potentials. Analysis has shown that the GWPs currently in use significantly underestimate the role of methane, and any correction of this bias would amplify the importance of the non-CO2 greenhouse gases. This error is due in part to omitted interactions, such as the role of methane in tropospheric ozone formation. The GWPs also fail to adequately portray the timing of the climate effects of abatement efforts. Because of its relatively short lifetime in the atmosphere, abatement efforts directed at methane have benefits in slowing climate change that take effect over the next few decades, whereas the benefits of CO2 abatement are spread out over a century or more. To the extent one is concerned about slowing climate change over the next 50 years, therefore, the control of methane and HFCs—the gases that last a decade or so—has an importance that is obscured when 100-year GWPs are used to compare the contributions of the various gases. Economic formulations of the GWP indices have been proposed that would address these concerns, but calculations using these economic-based formulae are bedeviled by a variety of deeper uncertainties, such as how to monetize the damages associated with climate change.

A still more difficult issue is whether and how to compare efforts to control other substances that affect the radiative balance of the atmosphere, such as tropospheric ozone precursors, black carbon, and cooling aerosols. The main issue with these substances is that, even though their climatic effects are important, a more immediate concern is that they cause local and regional air pollution that affects human health, crop productivity, and ecosystems. Moreover, their climatic effects are mainly regional, or even local, and this feature creates difficulties for the use of a single index to represent their effects across the globe. In the end, it is essential to consider these substances as part of climate policy, but more research and analysis is needed to quantitatively establish their climate influence and to design policies that take account of their local and regional pollution effects.

Putting aside the local and regional air pollutants, the quantitative importance of the other non-CO2 greenhouse gases has now been relatively well-established. One of the major remaining concerns in including them in a control regime is whether their emissions can be measured and monitored accurately so that, whatever set of policies are in place, compliance can be assured. In fact, the ability to monitor and measure has less to do with the type of greenhouse gas than with the nature of its source. It is far easier to measure and monitor emissions from large point sources, such as electric power plants, than from widely dispersed non-point sources, such as automobile and truck tailpipes or farmers’ fields. Methane released from large landfills can be easily measured, and is in the United States. But, it is impractical to directly measure the methane emitted from each head of livestock, or the N2O from every farmer’s field. The difficulty of monitoring and measuring emissions implies that a different regulatory approach may be desirable for different sources, at least initially.

Scientists have long recognized the various roles of non-CO2 greenhouse gases and other substances that contribute to climate change. It is only in the past few years, however, that the various pieces of this complex puzzle have been fit together to provide a more complete picture of just how critical the control of these gases can be in a cost-effective strategy to slow climate change. Control of non-CO2 greenhouse gases is a critical component of a cost-effective climate policy, and particularly in the near term these reductions can complement early efforts to control carbon dioxide.

Henry D. Jacoby
John M. Reilly
Ronald G. Prinn
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Press Release: New Report Examines Climate Impacts and Mitigation Costs of Non-CO2 Gases

For Immediate Release: 
February 11, 2003

Contact:  Press, 703-516-4146
 

CLIMATE CHANGE AND THE OTHER GASES
New Report Examines Climate Impacts and Mitigation Costs of Non-CO2 Gases


Washington, DC - To effectively limit climate change, and to do so in a cost-effective manner, climate policies must address emissions of both carbon dioxide (CO2) and the other greenhouse gases, according to a new report from the Pew Center on Global Climate Change. Although CO2 is the principal greenhouse gas contributing to global warming, other gases-including methane, nitrous oxide, and a number of manmade, industrial-process gases (such as hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride)-are also important contributors to climate change.

"The non-CO2 gases contribute a great deal to climate change, yet there is currently little or no incentive to control these emissions," explained Eileen Claussen, President of the Pew Center on Global Climate Change. "Curbing emissions of these greenhouse gases is both environmentally important and cost-effective."

Multi-Gas Contributors to Global Climate Change: Climate Impacts and Mitigation Costs of Non-CO2 Gases discusses the sources and amounts of these emissions, the atmospheric interactions of the various gases, and the relative costs of reducing them. Report authors John Reilly, Henry Jacoby, and Ronald Prinn of Massachusetts Institute of Technology use a general equilibrium modeling framework to analyze the costs and climate impacts of controlling various greenhouse gas emissions. The report discusses opportunities and difficulties associated with incorporating non-CO2 greenhouse gases into a climate policy framework.

The authors demonstrate that including all greenhouse gases in a moderate emissions reduction strategy not only increases the overall amount of emissions reductions, but also reduces the overall cost of mitigation: a win-win strategy. If, for example, total greenhouse gas emissions in the United States were held at year 2000 levels through 2010, many cost-effective reduction opportunities would come from the non-CO2 greenhouse gases.

In developing countries like India and Brazil, non-CO2 gases currently account for more than half of total greenhouse gas emissions. Thus, any cost-effective effort to engage developing countries in climate change mitigation should also include these other gases.

"The reduction of non-CO2 greenhouse gas emissions is a critical component of a cost-effective climate policy, so any efforts to reduce emissions of carbon dioxide should proceed hand-in-hand with reductions of the other gases," said Claussen.

Click here for a complete copy of this report and previous Pew Center reports.

Press Release: New Report Examines Patterns of Capital Equipment Investment and Retirement

For Immediate Release:  
November 18, 2002

Contact: Katie Mandes, 703-516-4146

New Report Examines Patterns of Capital Equipment Investment and Retirement

Washington, DC - Patterns of capital investment by businesses can have a major impact on the success and cost-effectiveness of climate change policies, according to a new report from the Pew Center on Global Climate Change. Capital equipment, such as electricity generation plants, factories, and transportation infrastructure, is a major source of greenhouse gas emissions. "Due to the high cost of new capital, firms often are reluctant to retire old, less efficient facilities and equipment," explained Eileen Claussen, President of the Pew Center on Global Climate Change. "Replacing existing capital stock with more efficient technologies will take time, but that process can be encouraged by certain policies."

Capital Cycles and the Timing of Climate Change Policy examines patterns of capital investment and retirement, or "capital cycles," and discusses implications for climate change policy. Report authors Robert Lempert, Steven Popper, and Susan Resetar of RAND, with Stuart Hart of the Kenan-Flagler Business School at UNC-Chapel Hill, combined analysis of the literature on investment patterns with in-depth interviews of top decision-makers in leading U.S. firms. Their work provides insights into the differing patterns of capital investment across firms and sectors.

The authors found that capital has no fixed cycle. Firms often invest in new capital to capture new markets. In the absence of policy or market incentives, expected equipment lifetimes and the availability of more efficient technologies are not significant drivers of capital stock decisions.

The report suggests certain policies that can stimulate more rapid turnover of existing capital stock. These include: (1) Putting in place early and consistent incentives that would assist in the retirement of old, inefficient capital stock; (2) Making certain that policies do not discourage capital retirement; and (3) Pursuing policies that shape long-term patterns of capital investment.

"It is crucial for policy-makers to understand the market factors and policies that drive capital investment patterns, and to start designing climate change policies accordingly," said Claussen.

A complete copy of this report -- and previous Pew Center reports -- is available on the Pew Center's web site, www.c2es.org.

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The Pew Center was established in May 1998 by The Pew Charitable Trusts, one of the United States' largest philanthropies and an influential voice in efforts to improve the quality of the environment. The Pew Center is an independent, nonprofit, and non-partisan organization dedicated to providing credible information, straight answers, and innovative solutions in the effort to address global climate change. The Pew Center is led by Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs.

Press Release: Report Shows Emerging Greenhouse Gas Market

For Immediate Release:
March 19, 2002

Contact: Katie Mandes
703-516-4146

Report Shows Emerging Greenhouse Gas Market

Washington, DC - Emissions trading has become the "policy of choice" for addressing climate change, according to a new report from the Pew Center on Global Climate Change that documents the emergence of a market for greenhouse gas emissions.

While the market remains fragmented, the report concludes that trading activity has increased around the world over the last five years. Among the forces bringing trading to the fore are progress in the international climate talks, new carbon trading systems in Europe, and private sector trading initiatives in the United States and elsewhere.

The Pew Center report, The Emerging International Greenhouse Gas Market, describes the characteristics of the market to date and key features of early trades. In the absence of a ratified international agreement, the report's authors conclude that the new market is evolving in a fragmented way. Regional, national, and subnational trading programs are operating under different rules, which could inhibit "market convergence" and increase the costs of trading.

"Despite the United States' inaction, it is abundantly clear that we are beginning to see the outlines of a genuine greenhouse gas market," said Eileen Claussen, President of the Pew Center on Global Climate Change. "Governments and businesses around the world understand that emissions trading is essential if we're going to address this issue in the most cost-effective way possible".

"The challenge now is to forge links between these emerging regimes in order to ensure that trading systems are compatible, " Claussen said. "We are already beginning to see interest in the U.S. Congress, and private sector efforts to build a trading system are even farther along. The need for certainty, consistency, and a level playing field will encourage a merging of trading regimes.

The report also evaluates the potential evolution of the greenhouse gas market, particularly in light of recent developments in climate change policy in the United States and internationally.

The report's conclusions are based on a review of greenhouse gas transactions to date, including case studies of two transactions between four utilities: TransAlta and HEW, and PG&E and Ontario Power Generation. According to the authors of the report, the experiences of these companies illustrate the benefits of trading, as well as the challenges of conducting trades in a nascent market that is lacking in clear rules.

Part of "Solutions" Series
The Emerging International Greenhouse Gas Market was authored by Richard Rosenzweig and Matthew Varilek of Natsource, LLC, and Josef Janssen of the University of St. Gallen in Switzerland. It is the latest report in the Pew Center's Solutions series, which is aimed at providing individuals and organizations with tools to evaluate and reduce their contributions to climate change. Other Pew Center series focus on domestic and international policy issues, environmental impacts, and the economics of climate change.

A complete copy of this report -- and previous Pew Center reports -- is available on the Pew Center's web site, www.c2es.org/projects.

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The Pew Center was established in May 1998 by the Pew Charitable Trusts, one of the United States' largest philanthropies and an influential voice in efforts to improve the quality of the environment. The Pew Center is conducting studies, launching public education efforts and working with businesses to develop market-oriented solutions to reduce greenhouse gases. The Pew Center is led by Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs. The Pew Center includes the Business Environmental Leadership Council, which is composed of 36 major, largely Fortune 500 corporations all working with the Pew Center to address issues related to climate change. The companies do not contribute financially to the Pew Center - it is solely supported by contributions from charitable foundations.

Implications for U.S. Companies of Kyoto's Entry into Force without the United States

This working paper examines some of the potential implications for U.S. business of the Kyoto Protocol's entry into force – in particular, the effects of the U.S. decision to stay out of the Protocol.

The Bonn and Marrakech meetings adopted generally sound rules regarding the Kyoto mechanisms. However, the implications for U.S. business will depend as much or more on the domestic policies and measures of Annex B parties1 as on the Kyoto rules themselves. The Kyoto rules merely establish the general framework within which national implementation will take place. Although bad Kyoto rules might have precluded efficient implementation of the Protocol, the Bonn and Marrakech rules do not ensure efficiency, since this will depend on the extent to which governments choose to utilize the Kyoto mechanisms to achieve their targets.

The implications of Kyoto for U.S. business will also depend significantly on whether the United States decides as a matter of domestic policy to undertake emission reduction requirements, and the stringency of any such requirements. This paper generally assumes a scenario in which the U.S. does not take significant domestic action to control emissions. In the final section, it considers an alternative scenario involving adoption of strong U.S. domestic measures to reduce emissions.

Download the PDF

by: Daniel Bodansky, University of Washington

Daniel Bodansky
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Press Release: New Report on Discounting the Benefits of Future Climate Change Mitigation

For Immediate Release:  
December 20, 2001

Contact: Katie Mandes
703-516-4146

New Report on Discounting the Benefits of Future Climate Change Mitigation

Washington, DC - How do we compare the costs of greenhouse gas reduction measures taken today with the future benefits of these actions? How do we calculate the value of investments when benefits will continue to accrue over centuries? These are important questions, because the way we value the benefits of greenhouse gas emission reductions will guide the development of cost-effective solutions to the threat of global climate change. A report released today by the Pew Center on Global Climate Change addresses these crucial questions.

The report, Discounting the Benefits of Future Climate Change Mitigation: How Much Do Uncertain Rates Increase Valuations?, by Richard Newell and William Pizer of the independent nonprofit research institute Resources for the Future, highlights an important variable that often goes unexamined in current climate change models-uncertainty in future interest rates. Climate models incorporate discount rates to compare costs and benefits over time-in essence, they tell us how high future benefits need to be to justify spending a dollar today. Most climate models choose one rate and hold it constant over the time horizon of the model.

This study questions that conventional approach, arguing that future rates are uncertain. The authors demonstrate that acknowledging uncertainty about future interest rates leads to a higher valuation of the future benefits of reducing greenhouse gas emissions today - regardless of the initial rate one chooses. The authors conclude that, by ignoring uncertainty, current approaches used in economic modelling may be consistently undervaluing the future benefits of current climate change mitigation efforts. The report shows that including the effect of interest rate uncertainty in climate models could raise valuations of mitigation efforts by as much as 95 percent relative to conventional discounting at a constant rate.

"This report indicates that immediate action to address global climate change could yield significantly greater benefits in the long-run than conventional economic models have estimated," said Eileen Claussen, President of the Pew Center. "This information will be especially useful for policymakers as they seek to balance near-term mitigation costs with long-term economic and environmental benefits."

This report is the first to be published as a technical report in the Pew Center's economics series. The results of this work - and additional ongoing Pew Center analyses - will be incorporated into a dynamic general equilibrium model in order to better capture the full complexity of the climate change issue.

A complete copy of this report and other Pew Center reports can be accessed from the Pew Center's web site, www.c2es.org.

The full text of this report is accessible on the Internet:
Discounting the Benefits of Future Climate Change Mitigation: How Much Do Uncertain Rates Increase Valuations? Report.

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The Pew Center was established in May 1998 by the Pew Charitable Trusts, one of the United States' largest philanthropies and an influential voice in efforts to improve the quality of the environment. The Pew Center is conducting studies, launching public education efforts and working with businesses to develop market-oriented solutions to reduce greenhouse gases. The Pew Center is led by Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs. The Pew Center includes the Business Environmental Leadership Council, which is composed of 37 major, largely Fortune 500 corporations all working with the Pew Center to address issues related to climate change. The companies do not contribute financially to the Pew Center - it is solely supported by contributions from charitable foundations.

Discounting the Benefits of Climate Change Mitigation: How Much Do Uncertain Rates Increase Valuations?

Download Report

Discounting the Benefits of Climate Change Mitigation: How Much Do Uncertain Rates Increase Valuations?

Prepared for the Pew Center on Global Climate Change
December 2001

By:
Richard Newell and William Pizer, Resources for the Future

Press Release

Download Entire Report (pdf)

Foreword

Eileen Claussen, President, Pew Center on Global Climate Change

How do we compare the costs of greenhouse gas mitigation measures taken today with the benefits produced by these actions in the future? How do we calculate the value of an investment when benefits will continue to accrue over centuries? These are important questions, because the way we value the benefits of mitigation measures will guide us in developing cost-effective solutions to the threat of climate change. This report highlights one important variable in this determination that is often left unexamined in current climate change models-uncertainty in future interest rates.

Underlying existing climate change models is a specific set of assumptions regarding emissions levels, economic growth and flexibility, technological innovation, climate change policies, and the magnitude of climate change damages. Though this set of assumptions varies from model to model, each includes a discount rate, which is used to compare costs and benefits over time. The discount rate tells us how high future benefits need to be to justify spending a dollar today. While there is considerable debate regarding the appropriate discount rate to apply to any cost-benefit analysis conducted across generations, most climate models choose one rate (2-7 percent is a common range) and hold it constant over the time horizon of the model.

This study questions that conventional approach. Rather than assuming that interest rates remain fixed over hundreds of years, authors William Pizer and Richard Newell argue that future rates are uncertain. Using an integrated assessment model of climate change, they demonstrate that acknowledging uncertainty about future rates will lead to a higher valuation of future benefits-regardless of the initial rate one chooses. This is a significant finding, because it reveals that including the effect of interest rate uncertainty could raise valuations by as much as 95 percent relative to conventional discounting at a constant rate. In other words, changing the approach to discounting in this manner results in significantly higher projected benefits of addressing climate change.

This report is the first to be published as a technical report in the Pew Center's economics series. The results of this and other ongoing Pew Center analyses will be incorporated into a dynamic general equilibrium model in order to produce a set of model estimates that better capture the full complexity of the climate change issue.

The Pew Center and authors would like to thank William Cline, Ev Ehrlich, and Randy Lyon for commenting on previous drafts of this report. The authors would also like to recognize Michael Batz for research assistance and Andrew Metrick and participants in seminars at the 2000 NBER Summer Institute and 2000 American Economic Association meetings for helpful comments on previous versions of this paper. Greater technical detail on the approach and results described in this paper are given in Newell and Pizer (2000).

Executive Summary

Most environmental policies involve a trade-off between short-term costs and longer-term benefits. Investments in cleaner technologies and abatement equipment, for example, require up front expenditures that produce environmental improvements over time. In cases where a pollutant decays within a few years, the time horizon for analyzing costs and benefits depends on the lifespan of the investment-perhaps as long as 50 or 100 years. By contrast, the benefits of climate change mitigation measures are linked not only to the lifespan of physical capital but also to the lifespan of greenhouse gases (GHGs), which may remain in the atmosphere for centuries. For this reason, climate change presents specific challenges for determining the proper balance between future benefits and present-day costs.

This paper explores some of the analytic difficulties of applying conventional discounting techniques to long-term problems such as global climate change. In particular, the paper focuses on the influence of uncertainty in the discount rate on the valuation of future climate damages, finding that this uncertainty has a large effect on valuations at horizons of 100 years or more in the future. Relative to the standard approach that ignores this uncertainty, the paper finds that the valuation today of benefits 300 years or more in the future rises by a factor of many thousand solely due to this uncertainty in discount rates. The paper also finds that the debate over which is the "right" rate to use is rendered less important once uncertainty in that rate is taken into account.

How do we compare costs and benefits that are separated by many decades or even centuries, thereby involving intergenerational comparisons? Individual experience typically involves trade-offs of at most 20-30 years, as one invests in a new house or saves for retirement. Businesses face decisions with similar horizons as they choose to invest in research and new equipment. In each of these cases, the market interest rate plays a central role: it allows us to convert costs and benefits at different points in time into comparable costs and benefits at a single point in time. This procedure is known as discounting.

Discounting is used as a tool for modeling optimal solutions for many long-term problems, including climate change. For example, an integrated assessment model of climate change can be used to estimate the time-profile of benefits associated with the reduction of one ton of carbon emissions in the year 2000. In order to use this information to conduct a policy analysis, the standard approach would be to choose a single interest rate, convert this path of values into equivalent discounted values in 2000 based on the chosen interest rate, and add them up.

Several practical issues complicate the application of this straightforward concept. Current tax policy creates a distinction between the rate of return to corporate investments (10 percent) and the rate of return that is available to individual investors after corporate taxes (7 percent). Focusing on the rate available to individuals, there is also a difference between the rate of return to equity (7 percent), the return to bonds (4 percent), and the return to each of these remaining after personal income taxes. While no consensus exists on the appropriate rate to use for discounting, there is a tendency to focus on the return to bonds (4 percent) for evaluating longer-term policies.

There is concern, however, among economists and non-economists about using conventional discounting techniques to value public benefits over hundreds of years, where trade-offs are evaluated across multiple generations. On the basis of equity, some argue that lower discount rates should be used to compare the value of costs and benefits between generations. Such an argument is common regarding the use of discount rates in the context of climate change modeling, which involves complex projections centuries into the future.

Here we focus on uncertainty in market interest rates, and evaluate the potential consequences for long-term discounting. Few markets exist for assets with maturities exceeding 30 years, making the interest rate beyond that horizon even more uncertain than the ambiguity among pre- and post-tax returns to bonds and equity. By focusing on the impact of this uncertainty, this study shows, perhaps surprisingly, that uncertainty about future changes in interest rates can have important consequences for the valuation of benefits over distant horizons.

To best understand how future interest rates are likely to change, we examine the behavior of long-term government bond rates in the United States. These rates reveal persistent changes, including a secular decline from near 6 percent in 1800 to 3 percent at the end of the 20th century along with five noticeable shifts of at least 1 percent lasting ten years or more. This leads us to believe that it should not be surprising if persistent changes in interest rates occur in the future, i.e., future rates are uncertain.

We use these data on long-term government bond rates to estimate the uncertainty surrounding interest rates in the past, to simulate uncertain rates in the future, and to compute the appropriate discount factors for various time horizons and alternative base rates. Starting with the assumption that the initial rate should equal the average rate of return to government bonds (4 percent), but that future rates follow an uncertain random trajectory (estimated based on historical data), we find that the discount factor after 400 years is over 40,000 times higher than if we instead assume that the rate remains fixed at 4 percent forever.

When we construct similar measures of the uncertainty effect for alternative initial rates of 2 percent and 7 percent, we find that the effect of uncertainty is larger for higher interest rates-this makes sense because higher rates have a larger opportunity to decline with uncertainty and thereby raise valuations. Comparing the discount factors directly, we find that the valuation of benefits occurring in the future is less sensitive to the choice of the initial discount rate when the effect of uncertainty is taken into account. That is, not only do valuations rise when one considers uncertainty, but they become less sensitive to whether the analysis is based on the after-tax return on bonds or the pre-tax return on equities.

Applied to one estimate of the consequences of climate change, the effect of uncertainty is large. Using the government bond rate of 4 percent, the expected present value of consequences from current carbon dioxide (CO2) emissions increases by over 80 percent when we incorporate the effect of future interest rate uncertainty. An initial rate of 7 percent yields a 95 percent increase in the value of carbon mitigation, while an initial rate of 2 percent yields an increase of about 55 percent.

The results of this study show that the conventional application of constant discount rates undervalues the benefits of GHG abatement measures. Moreover, they suggest that the concern expressed by those who argue for low discount rates is at least partially addressed-without abandoning conventional economic theory-by viewing future interest rates as uncertain. While this will not yield the same dramatic effects as the decision to arbitrarily apply a lower discount rate, uncertainty does have a large effect on valuations at horizons of 100 years or more in the future.

About the Authors

Richard Newell

Richard Newell is a fellow in the Energy and Natural Resources division at Resources for the Future (RFF). His current research focuses on the economic analysis of policy design and performance, with a particular interest in incentive-based policy and technological change. His research applications encompass a range of environmental and natural resource issues, including discounting, energy-efficiency, climate change, air pollution, and fisheries management. His methodological approaches include econometric analysis, modeling, simulation, and cost-benefit analysis.

On the research staff since 1997, Newell received his Ph.D. in public policy from Harvard University, where he specialized in environmental and natural resource economics. He also holds a master's degree in public policy and urban planning from Princeton's Woodrow Wilson School of Public and International Affairs, and undergraduate degrees in engineering and philosophy.

Newell is a member of the American Economic Association (AEA) and the Association of Environmental and Resource Economists (AERE). He has served as a consultant to state and federal agencies, environmental groups, international organizations, business organizations, and private firms.

William Pizer

William (Billy) Pizer is a Fellow in the Quality of the Environment Division at Resources for the Future (RFF). His current research focuses on the design and efficiency of environmental regulation under different circumstances, including uncertainty, endogenous technical change, and firm and household heterogeneity. He is particularly interested in the design of policies to address the risk of climate change due to manmade emissions of greenhouse gases.

He has worked at RFF since receiving his Ph.D. in economics at Harvard University in 1996. Specializing in econometrics and public finance, his dissertation considered the importance of uncertainty in the design of efficient climate change mitigation policies. He also holds a master's degree in economics and an undergraduate degree in physics. He is currently on leave as a Senior Economist at the President's Council of Economic Advisers.

 
Richard Newell
William Pizer
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Worker Transition & Global Climate Change

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Worker Transition & Global Climate Change

Prepared for the Pew Center on Global Climate Change
December 2001

By:
Jim Barrett, Economic Policy Institute

Press Release

Download Entire Report (pdf)

Foreword

Eileen Claussen, President, Pew Center on Global Climate Change

A Pew Center report series on the economics of climate change has identified ways in which economic modeling can more reliably project the costs of greenhouse gas reduction policies. These studies show that better model design — for instance, more realistically portraying technological progress and flexibility in the economy — can yield substantially lower projections for the costs of addressing climate change. They provide strong evidence that a rational climate policy that sets realistic short-, medium-, and long-term goals can achieve significant environmental gains while minimizing economic costs.

At the same time, it is important to recognize that the costs of addressing climate change are likely to fall disproportionately on certain industries, communities, and workers, and to explore ways to minimize these adverse impacts. This report draws from past worker transition efforts to recommend ways the government can best assist workers who may suffer economic dislocation as a result of climate change policies. A Pew Center report released simultaneously examines potential impacts on U.S. communities, and a future Pew Center report will evaluate competitiveness issues.

In the case of worker transition, the government has considerable experience assisting workers adversely affected by policy choices and market forces. Author Jim Barrett draws lessons from these government programs and outlines the building blocks of a worker transition program that could assist workers adversely affected by climate change policies. The report recommends that such a program include:

  • Substantial retraining and/or education for laid-off workers;
  • Substantial income support for program participants;
  • A bridge to retirement for workers nearing retirement age that maintains their standards of living and retirement benefit levels;
  • Maintenance of laid-off workers’ health and pension benefits until they find suitable employment;
  • Rapid response programs to ensure prompt service provision, and avoidance of detailed eligibility requirements;
  • Advance notice of layoffs when possible;
  • Work with unions to inform workers about program availability and to administer services;
  • Performance standards that avoid the unintended consequences of the overly simplistic standards used in the past; and
  • Requirements and funding for assessments of the program’s effectiveness by comparing outcomes for participants and non-participants, and allowing for mid-course corrections.

Clearly, some steps recommended in these reports will require funding. As policies to address climate change are developed, revenue streams from related fees (e.g., permit fees or auction revenues) could be used to assist with these programs. Addressing climate change through sound policy will make it possible to achieve our environmental objectives while shielding workers and communities from potential economic harm. Pew Center and the author wish to thank Susan Teegarden, Andrew Hoerner, Robert Ginsburg, Ev Ehrlich, Yolanda Kodryzycki, and Les Leopold, who offered helpful comments on previous drafts of this report. The author also would like to thank Brigit O’Brien and Terrel Hale for their research assistance.

Executive Summary

With most scientists and politicians agreeing that human-induced climate change is a potentially serious problem, the question of how nations respond to it, if at all, now seems to hinge on the perceived costs of action and inaction. Several attempts have been made to estimate the cost to the U.S. economy of reducing carbon and other greenhouse gas emissions. While there remains substantial debate over the net costs (or benefits) of various policy alternatives, there is little debate over the fact that reducing emissions will have potentially negative impacts for certain sectors of the economy and their workers. Any major reduction in carbon emissions in the United States will almost certainly require a decline in demand for fossil fuels, and, therefore, will result in employment losses in the coal, petroleum, and electricity industries, and possibly other sectors as well.

The question often arises: What policy options are available to address the needs of impacted workers?

The United States has substantial experience with programs aimed at helping workers dislocated both by policy choices, such as trade agreements and environmental regulations, and by market forces, such as the ongoing shift away from manufacturing and toward a service-based economy. The Trade Adjustment Assistance (TAA) program established in the 1960s was designed to aid workers displaced by the effects of international trade, while the Job Training Partnership Act (JTPA) was aimed at workers displaced for any reason. The experiences of these programs can provide valuable guidance for the design of policies aimed at dealing with workers displaced by climate change policies. In 2000, both programs were subsumed by the Workforce Investment Act (WIA), which would serve workers dislocated by climate policies if they were to be laid off today.

Examinations of TAA and JTPA raised important questions about the effectiveness of their training components. Studies have found that the majority of participants who subsequently found jobs were employed in occupations unrelated to their training programs. A closer look at the evidence shows that there can be sizable gains from retraining displaced workers, with some studies finding significant benefits through higher wages at reemployment. The evidence also appears to indicate that the quality of training may be as important as the quantity.

In addition to training and education, another important aspect of worker displacement programs has been income support for participants. Both TAA and JTPA are meant to provide support for their participants, although many, including the vast majority of JTPA participants, received little or no support. Aside from the obvious hardships this can impose on workers and their families, it also had substantial impacts on the ability of the programs to move workers successfully into new jobs. A study of one JTPA program found that over the first year following layoff, program participants earned about 20 percent less than displaced workers who did not join a program. While participants’ earnings recovered substantially over time, the cost of participating in the program, in terms of lost earnings over the first year, represents a substantial barrier to participation.

While some workers likely opted out of programs due to lack of income support or other reasons, some may have been discouraged from participating. The use of performance-based contracts, which pay service providers based on reemployment and wage replacement rates, can give providers the incentive to filter out the workers who are more difficult to place and who might bring averages and compensation down. TAA had substantial problems in serving its intended population as well. One audit found that the eligibility determination process arrived at an incorrect conclusion in over 60 percent of cases.

There are a wide range of lessons that can be drawn from previous programs to help inform the design and administration of a successful program to assist workers affected by climate change policies. A critical, if broad, lesson is that numerous tradeoffs exist that can make designing an effective program difficult. At the same time, some tradeoffs that are assumed to exist may not. Continuing to assume that they do can be equally limiting.

Both TAA and JTPA have tried to strike a balance between providing compensation to workers and providing incentives to leave programs as quickly as possible. For JTPA, those incentives appear to have been too strong. A large majority of eligible workers (as many as 93 percent) never entered programs in the first place. Under JTPA and now WIA, the goal of compensation has been sacrificed in the name of efficiency. However, income compensation and training appear to be complementary, so that increasing compensation can enhance training outcomes and program success. With limited resources, unfortunately, training and compensation appear to be substitutes at least in the budgetary sense.

While providing for substantial retraining is an essential element of a successful transition program, it is no guarantee of success. Despite the relatively long training programs in TAA projects, reemployment outcomes have been disappointing, due largely to inadequate job search and placement services and to mismatches between training programs and labor market demand. Careful design of training programs and the provision of job search and placement services will be critical to the success of a climate change transition program, particularly given the long tenure and deteriorated labor market skills likely to characterize many of the program’s participants.

In addition to some of the larger issues like income support, there are numerous factors in the administration of transition programs that can help determine their success or failure. Some of these issues have already been addressed in WIA. The continuous operation of WIA offices and rapid response teams can help keep the lag time between layoff and program entry low. Addressing layoffs at the earliest possible stage can increase the legitimacy of the program and help workers face the reality of permanent separation from their jobs. This approach increases participation rates and reduces the lag time between layoff and program entry.

To ensure that these workers have access to training options, two conditions must exist. First, training programs must be offered that can serve their needs. Second, training providers must have a limited ability to exclude or discourage clients who are difficult to place. If these conditions are met, it may be possible to employ performance-based standards successfully. To ensure that programs suitable for the hard to place are available, a successful program needs to offer sufficient incentive to trainers to offer such programs. One approach is to offer higher payments for placements of the difficult to place. Rather than offer payment based on the number of people placed, a system could offer payment based on the expected intensity of training required. This approach would offer increased incentives for training providers to design programs for workers who need the most help.

A more fundamental issue is the appropriateness of a program explicitly designed to serve one type of worker and not another. To a laid-off worker, and possibly to society as a whole, it may seem arbitrary to deny or approve benefits based on whether it can be proven that climate change policies contributed to the layoff. Climate change policies may be only one of a combination of causes leading to a layoff, particularly for industries already in decline. Any eligibility restriction based on climate change policies will thus be difficult to implement.

The following elements appear critical to the success of a transition program aimed at helping workers dislocated by climate change policies or other causes:

  • Substantial retraining and/or education should be available for laid-off workers.
  • The program should provide substantial income support for program participants.
  • For those workers nearing retirement age, the program should provide a bridge to retirement that maintains their standard of living as well as their retirement benefit levels.
  • The program should maintain health and pension benefits of laid-off workers until they find suitable reemployment.
  • To help ensure that services can be provided as quickly as possible, rapid response programs should continue to be employed, and detailed eligibility requirements should be avoided whenever possible.
  • The program should encourage advance notice of layoffs when possible.
  • The program should work with unions to inform workers about the availability of programs and to administer services.
  • The program should establish performance standards that avoid the unintended consequences of the overly simplistic performance standards used in the past.
  • The program should require, and provide funding for, assessments of the program’s effectiveness by comparing outcomes for participants and non-participants, and allow for mid-course corrections.
Jim Barrett
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Press Release: Easing the Burden: Two New Reports Identify Steps for Reducing the Economic Impacts of Climate Action

For Immediate Release:  
December 5, 2001

Contact: Katie Mandes
703-516-4146

Easing the Burden: Two New Reports Identify Steps for Reducing the Economic Impacts of Climate Action on Affected Communities and Workers

Washington, DC - Policymakers can do a great deal to ease the economic burden of addressing climate change by taking specific steps to assist affected workers and communities. This according to two new reports released today by the Pew Center on Global Climate Change.

"Responding to climate change means reducing greenhouse gas emissions, and that means making a shift from the current carbon-intensive economy to an economy that relies less on fossil fuels," said Pew Center President Eileen Claussen. "This shift is in everybody's interest, but it will not affect everybody equally. As a result, we need to be thinking now about how to assist those workers and communities that will be affected by the policy choices we make. Rather than leave them behind in our quest for a new economy, we must give them the tools and the resources they need to play their rightful role in our future success."

Focusing on the workers and communities that are likely to be most affected by efforts to address climate change, the Pew Center reports recommend worker retraining programs, economic adjustment initiatives for affected communities, and other steps. According to Claussen, the cost of these and other initiatives would amount to a small fraction of the overall bill for dealing with climate change. She added that permit fees and other revenues related to the implementation of new climate policies could provide an important source of funding for the transition efforts.

Worker Transition & Global Climate Change

Any major reduction in greenhouse gas emissions in the United States will almost certainly cause a decline in demand for fossil fuels. The result could be employment losses in the coal, petroleum, and electricity industries, and possibly in other sectors as well.

Worker Transition & Global Climate Change is a Pew Center report written by Jim Barrett of the Economic Policy Institute. The report draws lessons from the government's experience assisting workers who were adversely affected by policy choices and market forces in the past. The author also outlines the building blocks of a worker transition program that could assist workers adversely affected by government efforts to address climate change.

This report recommends that a worker transition program include:

  • Substantial retraining and/or education for laid-off workers, as well as income support for program participants;
  • A bridge to retirement for workers nearing retirement age that maintains their standards of living and retirement benefit levels;
  • Maintenance of laid-off workers' health and pension benefits until they find suitable employment; and
  • Advance notice of layoffs whenever possible.

Community Adjustment to Climate Change Policy

Efforts to avert global climate change are also likely to place certain communities at risk of economic dislocation. Affected communities could include those with large numbers of jobs in energy production, such as coal mining communities in Wyoming or oil producing areas of Louisiana. Also affected could be communities with energy-intensive industries-for example, parts of Pennsylvania with steel manufacturing operations.

Community Adjustment to Climate Change Policy was authored by Judith M. Greenwald of the Pew Center on Global Climate Change, Brandon Roberts of Brandon Roberts & Associates, and Andrew D. Reamer of Andrew Reamer & Associates. Based on a survey of how policymakers in the United States and elsewhere have responded to similar challenges in the past, the report suggests that appropriately designed programs can lessen the pain of economic adjustment considerably.

The report recommends a new federal adjustment program for communities as part of global climate change policy, and calls on U.S. policymakers to take the following steps:

  • Designate and fund the Economic Development Administration (EDA) of the U.S. Department of Commerce to design and implement an economic adjustment program for communities;
  • Identify and assist communities that are particularly dependent on energy-producing and energy-intensive sectors before dislocations occur;
  • Leverage and integrate additional resources by involving multiple federal agencies and state and local governments through regional task forces; and
  • Support the development and implementation of locally determined, comprehensive adjustment strategies.

A future Pew Center report will address the issue of competitiveness for those industries affected by climate change policy.

The full text of both reports is accessible on the Internet:

Community Adjustment to Climate Change Policy  Report.

Worker Transition & Global Climate Change Report.

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The Pew Center was established in May 1998 by the Pew Charitable Trusts, one of the United States' largest philanthropies and an influential voice in efforts to improve the quality of the environment. The Pew Center is conducting studies, launching public education efforts and working with businesses to develop market-oriented solutions to reduce greenhouse gases. The Pew Center is led by Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs. The Pew Center includes the Business Environmental Leadership Council, which is composed of 36 major, largely Fortune 500 corporations all working with the Pew Center to address issues related to climate change. The companies do not contribute financially to the Pew Center - it is solely supported by contributions from charitable foundations.

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