Adjustment costs for investments in the abatement of climate change under uncertainty

Abstract

This paper studies optimal abatement of CO2 emissions, when investments in abatement measures are subject to adjustment costs. Decisions are made under uncertainty about the damages of climate change. Optimal abatement is determined in a Ramsey model for economic growth in which the damages of climate change affect productivity. A numerical approximation of the solution of the dynamic programming model in continuous time is developed. The results indicate that uncertainty leads to a significant reduction in the level of abatement, but there is also a strong tendency to postpone action when the uncertainties are large, compared with decisions made under full certainty. The adjustment costs may be decisive for the question of when emission ought to be reduced, but have less impact on the level of abatement. The model also allows for an analysis of the irreversibility of investments in climate measures. The results indicate that abatement is little affected by the fact that investments in climate measures may be irreversible.