Stern Review

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The Stern Review on the Economics of Climate Change is a 700-page report released on October 30, 2006 by economist Lord Stern of Brentford for the British government, which discusses the effect of climate change and global warming on the world economy. Although not the first economic report on global warming, it is significant as the largest and most widely known and discussed report of its kind.^[1]

Its main conclusions are that one percent of global gross domestic product (GDP) per annum is required to be invested in order to avoid the worst effects of climate change, and that failure to do so could risk global GDP being up to twenty percent lower than it otherwise might be. Stern’s report^[2] suggests that climate change threatens to be the greatest and widest-ranging market failure ever seen, and it provides prescriptions including environmental taxes to minimize the economic and social disruptions. He states, "our actions over the coming few decades could create risks of major disruption to economic and social activity, later in this century and in the next, on a scale similar to those associated with the great wars and the economic depression of the first half of the 20th century."^[3][4] In June 2008 Stern increased the estimate to 2% of GDP to account for faster than expected climate change.^[5]

The Stern Review has been criticized by some economists, saying that Stern used an incorrect discount rate in his calculations, and that stopping or significantly slowing climate change will require deep emission cuts everywhere.^[6][7] Other economists have supported Stern's approach,^[8][9] or argued that Stern's conclusions are reasonable, even if the method by which he reached them is incorrect.^[10] At the climate congress, Lord Stern stated that the current data on climate sensitivity to greenhouse gases and the severity of the effects of global warming predict earlier and more severe impacts than in the original report.^{[citation needed]}

The draft report of the Garnaut Climate Change Review, a similar study conducted in Australia in 2008 by Ross Garnaut broadly endorsed the approach undertaken by Stern, but concluded, in the light of new information, that Stern had underestimated the severity of the problem and the extent of the cuts in emissions that were required to avoid dangerous climate change.

[edit] Background

On 19 July 2005 the Chancellor of the Exchequer, Gordon Brown announced that he had asked Sir Nicholas Stern to lead a major review of the economics of climate change, to understand more comprehensively the nature of the economic challenges and how they can be met, in the UK and globally.^[11].

[edit] Previous debate in the UK

In 2004, along with six others, former UK Chancellor of the Exchequer Nigel Lawson wrote a letter to The Times criticising the consensus on climate change between the two major UK political parties ^[12]. In 2005, the House of Lords Economics Affairs Select Committee, of which Nigel Lawson was a member, undertook an inquiry into the economics of climate change ^[13]. The committee's report, The Economics of Climate Change, recommended the UK Government make greater efforts to assess the costs and benefits of climate change mitigation and adaptation, and was also critical of the Kyoto Protocol and the IPCC.

Writing in Prospect magazine, Michael Grubb, Chief Economist of the Carbon Trust, said that Kyoto's sequential targets helped to achieve many of the things the House of Lords report wanted ^[14]. David Pearce, who had earlier served the IPCC as a convening lead author, was the senior advisor to the House of Lords committee. Professor Grubb felt that there could be a link between the House of Lords report's criticism of the IPCC and David Pearce's earlier involvement with the IPCC. Professor Pearce had been the only IPCC convening lead author to have officially dissented on the government-negotiated "summary" of the chapter for which he was responsible. Pearce had also thrashed an earlier report by HM Treasury on the economics of climate change.^[15]

Lord Lawson responded to Grubb's article, describing it as an example of the 'intellectual bankruptcy of the ...climate change establishment'. Lawson also said that Kyoto's approach was 'wrong-headed' and called on the IPCC to be 'shut down' ^[16]. The House of Lords report was much milder in tone, pointing at the mismatch between the costs and benefits of climate policy as estimated by independent academics and as assumed by politicians. The House of Lords report also lamented the lack of input of economists in climate policy making, and recommended that HM Treasury take a more active role.

The Stern Review was prepared by a team of economists at HM Treasury; independent academics were involved as consultants only. The Stern Review emphasised the need for urgent action to be taken to mitigate climate change. In its assessment, the Review used one of the emission scenarios produced by the IPCC, some of which had been criticised in the House of Lords Economics report. A critique of the Stern Review was published in the World Economics journal, which described the Stern Review as being 'deeply flawed' ^[17] . This critique included contributions from two members of the Economic Affairs Select Committee, Robert Skidelsky and Nigel Lawson. Some witnesses who presented evidence to the Select Committee have been critical of the Stern Review ^[18].

[edit] Positive critical response

The Stern Review attracted positive attention from several sectors. Pia Hansen, a European Commission Spokeswoman, said doing nothing is not an option, "we must act now".^[19] Simon Retallack of the UK think tank IPPR said "This [Review] removes the last refuge of the 'do-nothing' approach on climate change, particularly in the US."^[19] Tom Delay of The Carbon Trust said "The Review offers a huge business opportunity."^[19] Richard Lambert, Director General of the Confederation of British Industry, said that a global system of carbon trading is "urgently needed".^[19] Charlie Kronick of Greenpeace said "Now the government must act and, among other things, invest in efficient decentralised power stations and tackle the growth of aviation."^[19]

Miles Templeman, Director-General of the Institute of Directors, said: "Without countries like the US, China or India, making decisive commitments, UK competitiveness will undoubtedly suffer if we act alone. This would be bad for business, bad for the economy and ultimately bad for our climate."^[20]

Asset managers F&C look to the business opportunities and say "this is an unprecedented opportunity to generate real value for our clients".^[21]

Brendan Barber, General Secretary of the Trades Union Congress, was optimistic about the opportunities for industry to meet demands created by investment in technology to combat climate change.^[22]

The Prince of Wales’ Corporate Leaders Group on Climate Change, formed by 14 of UK’s leading companies shared this hope. Chairman of Shell UK, James Smith, expressed the hope of the group that business and Government would discuss how Britain could obtain “first mover advantage" in what he described as "massive new global market".^[20]

On November 1, 2006, Australian Prime Minister, John Howard, responded by announcing that AU$60 million would be allotted to projects to help cut greenhouse gas emissions ^[23] while reiterating that Australia would not ratify the Kyoto Protocol. Much of this funding is directed at the non-renewable coal industry.

British Prime Minister, Tony Blair, stated that the Review demonstrated that scientific evidence of global warming was "overwhelming" and its consequences "disastrous" if the world failed to act.^[24]

The UK Treasury, which commissioned the report, simultaneously published a set of favourable comments from prominent economists and other leading figures:

• "If the world is waiting for a calm, reasonable, carefully argued approach to climate change, Nick Stern and his team have produced one. They outline a feasible adjustment policy at tolerable cost beginning now. Sooner is much better." Robert M. Solow, Nobel Prize economist 1987^[25]
• "The Stern report shows us, with utmost clarity, while allowing fully for all the uncertainties, what global warming is going to mean; and what can and should be done to reduce it. It provides numbers for the economic impact, and for the necessary economic policies. It deserves the widest circulation. I wish it the greatest possible impact. Governments have a clear and immediate duty to accept the challenge it represents." James Mirrlees, Nobel Prize economist 1996^[25]
• “The stark prospects of climate change and its mounting economic and human costs are clearly brought out in this searching investigation. What is particularly striking is the identification of ways and means of sharply minimizing these penalties through acting right now, rather than waiting for our lives to be overrun by rapidly advancing adversities. The world would be foolish to neglect this strong but strictly time-bound practical message.” Amartya Sen, Nobel Prize economist 1998^[25]
• "The Stern Review of the Economics of Climate Change provides the most thorough and rigorous analysis to date of the costs and risks of climate change, and the costs and risks of reducing emissions. It makes clear that the question is not whether we can afford to act, but whether we can afford not to act. To be sure, there are uncertainties, but what it makes clear is that the downside uncertainties—aggravated by the complex dynamics of long delays, complex interactions, and strong non-linearities—make a compelling case for action. And it provides a comprehensive agenda—one which is economically and politically feasible—behind which the entire world can unite in addressing this most important threat to our future well being." Joseph Stiglitz, Nobel Prize economist 2001^[25]
• "The Bank is committed to addressing the dangers of climate change and has made substantial progress in developing an Investment Framework for Clean Energy And Development. I very much welcome the Stern Review which provides a much needed critical economic analysis of the issues associated with climate change, and complements the recent IEA technology assessment and the World Bank's Clean Energy Investment Framework paper. The Bank is today working closely with its clients and partners to turn our analysis into practice, and will seek to substantially increase its own investment flows and those of the private sector. A crucial next step is to involve the private sector in the EIF. I am therefore pleased to support a partnership between the World Bank and the World Economic Forum and the World Business Council on Sustainable Development to stimulate private sector investment through the Energy Investment Framework. Chancellor Gordon Brown and I will co-host a conference early next year to launch the partnership." Paul Wolfowitz, former President of the World Bank^[25]
• "The Stern Review of the Economics of Climate Change is a vital step forward in securing an effective global policy on climate change. Led by one of the world's top economists, the Stern Review shows convincingly that the benefits of early global action to mitigate climate change will be far greater than the costs. The report establishes realistic guidelines for action (based on long-term stabilization ceilings for greenhouse gases), core elements of an effective global policy (carbon pricing, technology policy, and removing barriers to change), and a framework for international cooperation that must include all regions of the world, both developed and developing. The Stern Review will play an important role in helping the world to agree on a sensible post-Kyoto policy." Prof. Jeffrey D. Sachs, Director of the Earth Institute at Columbia University and Special Advisor to UN Secretary General Kofi Annan^[25]
• "The Economics of Climate Change sends a very important and timely message: that the benefits of strong, early action on climate change outweigh the costs. That conclusion is one that the International Energy Agency fully endorses - notably in its World Energy Outlook 2006 to be published next week. Congratulations to Sir Nick Stern and his team for producing a landmark review which I have no doubt will strengthen the political will to change of governments around the world." Claude Mandil, Executive Director of the International Energy Agency^[25]
• "Climate change can impose enormous costs on mankind and particularly on the innocent poor people. The uncertainty that is used as an excuse not to act works both ways. If the impact is larger than expected it could be catastrophic. Sir Nick Sterns report is valuable as it shows the need to act now and that the costs of action are modest. One hopes it will spur to action those who are responsible for creating this threat." Kirit Parikh, Member, Planning Commission, Government of India^[25]
• "The scientific evidence of global warming is overwhelming but some commentators and lobby groups have continued to oppose offsetting actions on economic and competitiveness grounds. This comprehensive and authoritative report demolishes their arguments, explaining clearly the complex economics of climate change. It makes plain that we can cut emissions radically at a cost to the economy far less than the economic and human welfare costs which climate change could impose" Adair Turner, Former Director of UK Confederation of British Industry and Economic Advisor to Sustainable Development Commission^[25]
• "When the history of the world's response to climate change is written, the Stern Review will be recognized as a turning point. Sir Nicholas and his team have provided important intellectual leadership as humanity engages with its greatest challenge. While the details will be debated, the main thrust of the report is clear and compelling — the expected benefits of tackling climate change far outweigh the expected costs." Cameron Hepburn, Oxford University^[25]
• "I support the Stern Review's conclusion that there is a strong economic case for taking early, effective action to reduce greenhouse gas emissions. This clearly has important implications for transport policy, which my own study is taking into account - sustainable economic growth cannot be achieved in any sector without tackling the effects of our actions on the environment". Sir Rod Eddington, Adviser to the UK Government on the long term links between transport and economic growth, and former Chief Executive of British Airways^[25]

Some of these comments appeared at the same time as the Stern Review itself, even though the Stern Review was not reviewed by outsiders before publication.

[edit] Unfavorable critical response

The Stern review received numerous critical responses. Some critics, particularly economists, argued that Stern had overestimated the present value of the costs of climate change, and underestimated the costs of emission reduction. Others, particularly associated with business, argued that the economic cost of the proposals put forward by Stern would be severe, or that the scientific consensus view on global warming, on which Stern relied, was incorrect. By contrast, a number of critics, particularly natural scientists, criticised Stern from the opposite direction, arguing that he had underestimated the costs of damage to natural environments from climate change, and that more aggressive action to stabilise climate was needed.

[edit] Stern's modelling choices overstate damages

William Nordhaus, an economist at Yale University who has done several studies on the economics of global warming, criticised the Review for its use of a very low pure rate of time preference of 0.1%.^[26]:

The Review’s unambiguous conclusions about the need for extreme immediate action will not survive the substitution of discounting assumptions that are consistent with today’s market place. So the central questions about global-warming policy — how much, how fast, and how costly — remain open. The Review informs but does not answer these fundamental questions.

Yale economist Robert Mendelsohn made similar criticisms in a BBC radio programme The Investigation. A number of other economists and scientists on the programme argued that the review's assumptions were far more pessimistic than those of most experts in the field, and that while claiming to be a review of current academic thinking the Stern review's conclusions were in fact at odds with the mainstream view.^[27]

The Stern review differs strongly from other estimates of climate change costs which adopt a different approach to discounting future costs and benefits ^[28]

Cambridge economist Partha Dasgupta calls Stern's combination of pure rate of time preference and rate of risk aversion "patently absurd" as this would imply a savings rate of 97.5% while the observed rate is around 15%.^[29] Berkeley economist Hal Varian shares Dasgupta's critique.^[30]

Richard Tol, an environmental economist at the Economic and Social Research Institute and lead author (amongst a total of over 450 lead authors) for the Intergovernmental Panel on Climate Change (IPCC), said that "If a student of mine were to hand in this report as a Masters thesis, perhaps if I were in a good mood I would give him a 'D' for diligence; but more likely I would give him an 'F' for fail. There is a whole range of very basic economics mistakes that somebody who claims to be a Professor of Economics simply should not make. (...) Stern consistently picks the most pessimistic for every choice that one can make. He overestimates through cherry-picking, he double counts particularly the risks and he underestimates what development and adaptation will do to impacts." ^[31] Tol also showed that the Stern Review's estimate of the social cost of carbon is an outlier in the literature.^[32] Tol further referred to the Stern Review as populist science.^[33] Harvard economist Martin Weitzman writes^[34] that "the Stern Review consistently leans towards ... assumptions and formulations that emphasize optimistically-low expected costs of mitigation and pessimistically-high expected damages from greenhouse warming", that the documentation in the report is "elusive, frustrating, and ultimately unsatisfactory" and that "the key assumption that drives its strong conclusions is the mundane fact that a very low interest rate is postulated". Weitzman writes that "concerning the rate of pure time preference, Stern follows a decidedly-minority paternalistic view", and that "in a similar spirit of choosing extreme taste parameters, Stern selects as its base-case coefficient of relative risk aversion ... that is the lowest lower bound of just about any economist’'s best-guess range." Weitzman continues to argue that the Stern Review underestimated the risk of climate change and that, therefore, the Stern Review is "right for the wrong reasons", a conclusion shared by Yohe and Tol.^[35] Australian economists Paul Jensen and Elizabeth Webster also criticize the paternalism in the Stern Review, and link this to Britain's imperial past.^[36]

In an official letter, Joan Ruddock dismissed the criticisms of Dasgupta, Mendelsohn, Nordhaus, Tol, Weitzman and Yohe as these economists suffer from "a fundamental misunderstanding of the role of formal, highly aggregated economic modelling in evaluating a policy issue".

Environmental writer Bjørn Lomborg criticised the Stern Review in OpinionJournal^[37]:

Mr. Stern's core argument that the price of inaction would be extraordinary and the cost of action modest [...] falls apart when one actually reads the 700-page tome. Despite using many good references, the Stern Review on the Economics of Climate Change is selective and its conclusion flawed. Its fear-mongering arguments have been sensationalized, which is ultimately only likely to make the world worse off.

[edit] Stern underestimates costs of mitigation

Professor Emeritus of Economics at Pepperdine University George Reisman said that "Any serious consideration of the proposals made in the Stern Review for radically reducing carbon technology and the accompanying calls for immediacy in enacting them makes clear in a further way how utterly impractical the environmentalist program for controlling global warming actually is. The fundamental impracticality of the program, of course, lies in its utterly destructive character." ^[38]

Reason magazine's science correspondent Ronald Bailey also emphasized on the Stern proposals' 'destructive character', saying that "Surely it is reasonable to argue that if one wants to help future generations deal with climate change, the best policies would be those that encouraged economic growth. This would endow future generations with the wealth and superior technologies that could be used to handle whatever comes at them including climate change. (...) So hurrying the process of switching from carbon-based fuels along by boosting energy costs means that humanity will have to delay buying other good things such as clean water, better sanitation, more and better food, and more education." ^[39]

The Confederation of British Industries, the British Chambers of Commerce pointed out the dangers to business of additional taxation.^[40]

The Business, a British magazine, reported on November 2, 2006 that, according to a leaked United Nations report obtained by the magazine, mitigating climate change could cost up to 5% of global gross domestic product ^[41]. Journalist Fraser Nelson argues that “if the Intergovernmental Panel on Climate Change figures [undermining Stern’s economic rationale] are right, they open up the possibility that the British proposals would cost as much as they save, making them redundant.”

Jerry Taylor of the Cato Institute, an American libertarian think-tank and climate sceptic organisation, criticized Stern's conclusion, taking a calculation by himself ^[42]:

Stern’s investment advice makes sense only if you think that warming will hammer GDP by 10% a year. You don’t gain much at all from emission cuts, however, if you think GDP will only drop by 5% a year if we do nothing. And if you think warming will only cost the global economy 2% of GDP every year, [...] then Stern’s investment advice is [sheer] lunacy.

[edit] Scientific consensus is incorrect or does not exist

Martin Livermore, of the Scientific Alliance, said that "climate is not driven primarily by human use of fossil fuels" and that the money to be spent is unlikely to have much effect: it would be better spent on the world's poor.^[43]

Ruth Lea, Director of the Centre for Policy Studies, questions if there is scientific consensus about global warming. She alleges that "authorities on climate science say that the climate system is far too complex for modest reductions in one of the thousands of factors involved in climate change (i.e., carbon emissions) to have a predictable effect in magnitude, or even direction." About economic models, upon which Stern relied for his projections, her experience was that forecasting just two or three years ahead was usually wrong. She described the problem of drawing conclusions from combining scientific and economic models as ‘monumentally complex’. She doubted whether international cooperation was really possible. She concluded that she thought that this Review was designed to cloak the motives of a government that wanted some moral justification for increasing taxation on fuels.^[44]

Two days after publication of the Stern Review, Nigel Lawson gave a lecture at the Centre for Policy Studies, warning of what he called “eco-fundamentalism” ^[45]

Nigel Farage, leader of the UK Independence Party, disagreed there was scientific consensus on global warming. At best, he said, there is uncertainty and politicians world-wide are jumping on the ‘green’ bandwagon, but, if they want popular support, they’d better be sure that this is not simply the ‘new witchcraft’. ^[46].

[edit] Stern underestimates damage to natural environments

Professor Bill McGuire of Benfield UCL Hazard Research Centre said that Stern may have greatly underestimated the effects of global warming. ^[19]

David Brown and Leo Peskett of the Overseas Development Institute, a UK think-tank on international development, argued that the key proposals in relation to how to use forests to tackle climate change may prove difficult to implement ^[47]:

Radical ideas are needed not only at the level of understandings but also of forward strategies. The Stern Review is much stronger on the former than the latter, and leaves a lot of questions unanswered on implementation, particularly the downstream practicalities of bringing avoided deforestation into climate mitigation efforts.

[edit] Other responses

Some economists endorsed the main findings of the Review, while noting that some of the assumptions in the Review's analysis were open to debate. Nobel prize winner Kenneth Arrow wrote ^[48]

Critics of the Stern Review don’t think serious action to limit CO2 emissions is justified, because there remains substantial uncertainty about the extent of the costs of global climate change, and because these costs will be incurred far in the future. However, I believe that Stern’s fundamental conclusion is justified: we are much better off reducing CO2 emissions substantially than risking the consequences of failing to act, even if, unlike Stern, one heavily discounts uncertainty and the future.

In the Economist's Voice,^[49] this is summarised as

Kenneth J. Arrow explains why something must be done to limit global warming even if the Stern Report inadequately discounted future costs.

[edit] Discounting

The central issue in economic debate over the Stern Review concerned the discounting procedure used to evaluate flows of costs and benefits occurring in the future. There are four main reasons commonly proposed for placing a lower value on consumption occurring in the future rather than in the present.^[50]

• future consumption should be discounted simply because it takes place in the future and people generally prefer the present to the future (inherent discounting)
• consumption levels will be higher in the future, so the marginal utility of additional consumption will be lower
• future consumption levels are uncertain
• improved technology of the future will make it easier to address global warming concerns

[edit] Inherent discounting

Debate over the Stern Review initially focused on the first of these points. Previous studies by William Nordhaus and others had adopted inherent discount rates of up to 3 per cent, implying that (other things being equal) an environmental cost or benefit occurring 25 years in the future is worth about half as much as the same benefit today.^[51] Stern argued that inherent discounting is ethically inappropriate. His view was endorsed by a number of economists including Brad DeLong who, echoing Frank P. Ramsey and Tjalling Koopmans, wrote “My view--which I admit may well be wrong--of this knotty problem is that we are impatient in the sense of valuing the present and near-future much more than we value the distant future, but that we shouldn't do so.” ^[52] and criticised by others including Hal Varian and Richard Tol who argue that in a democratic society, the preferences of the majority of people are more important than the arguments of philosophers.

The difference between Stern’s estimates and those of Nordhaus can largely (though not entirely^[53]) be explained by the difference in approach regarding inherent discounting.

[edit] Treatment of uncertainty

Uncertainty about future consumption may be addressed either through adjustments to the discount rate or by replacing uncertain flows of consumption with certainty equivalent flows. Stern adopted the latter approach, but was criticised by Tol and Yohe (2006) for double counting, a claim rejected by Stern (Dietz et al 2007).

While critical of Stern's approach to discounting, Martin Weitzman has presented arguments to suggest that standard discounting procedures are inherently incapable of dealing with extreme, low-probability events, such as the risk of catastrophic climate change. Thus, Weitzman argues, Stern's conclusions are "right for the wrong reasons"

[edit] Future consumption will be higher

With increasing average consumption in future, the marginal utility of consumption will decline. The elasticity of the marginal utility of consumption may be interpreted as a measure of aversion to inequality. Partha Dasgupta^[54] has criticised the Stern Review for parametric choices that, he argues, are inadequately sensitive to inequality. In subsequent debate, Stern has conceded the case for a higher elasticity, while noting that it would support much more extensive redistribution of income within the current generation (Dietz et al 2007).

[edit] Improved technology

As far as discounting is concerned, the effects of improved technology work through increased consumption and do not need to be treated separately. However, specification of an optimal response to climate change will depend on assumptions about improvements in technology and the extent to which such improvements will be induced by policies that increase the cost of emissions.

[edit] Market rates

Both supporters and opponents of Stern's approach have used comparisons with market rates of return on capital to justify their position.^[55] The rate chosen by Stern is close to the real interest rate for government bonds. The higher rates preferred by Stern's critics are closer to the weighted average cost of capital for private investment; see the extensive review by Frederick et al.^[56]. The difference between the two is determined by the equity premium. There is no generally accepted theory accounting for the observed magnitude of the equity premium and hence no easy way of determining which, if either, approach should be regarded as the appropriate market comparator.^[57]

[edit] Stern's later comments

In April 2008 Stern said that the severity of his findings were vindicated by the 2007 IPCC report (which gives stronger warnings than their 2001 report) and admitted that in the Stern Review: “We underestimated the risks ... we underestimated the damage associated with temperature increases ... and we underestimated the probabilities of temperature increases”.^[58][59]

In June 2008 Stern said that because global warming is happening faster than predicted the cost to reduce carbon would be even sharper, or about 2% of GDP instead of the 1% in the original report. ^[5]

[edit] References

[edit] See also

Energy portal

• Economics of global warming
• Politics of global warming
• Global warming controversy
• World Energy Outlook
• Avoiding Dangerous Climate Change
• Garnaut Climate Change Review

[edit] External links

• Full text of the Stern Review, from HM Treasury
• The UK Government's Treasury web pages about the Stern review
• The Economics of Climate Change - The Stern Review
• Economist.zoom: How to value a grandchild, Dec 4th 2006
• Summary of key findings from the report
• "The Stern gang", linked index of resources.
• The RIBA Trust Annual Lecture: Lord Stern (part of the International Dialogues: Architecture and Climate Change talks series) (video)

[edit] In the media

• Nov 2, 2006, The Economist: Stern warning
• Nov 6, 2006, Der Spiegel: The Day the Climate Changed
• Jan 10, 2007, BBC: Chrysler Boss says Stern Report is based on dubious economics
• Jan 26, 2007, BBC: Running the rule over Stern's numbers