Last year we saw one dismal weather record broken after the next. The seriousness of the climate problem was further underlined when the Stern Review on the Economics of Climate Change was published in October 2006. Economist Nicholas Stern believes that climate change will cost far more than previously thought.
The report was commissioned by British prime minister Tony Blair, and is called by the name of its lead author, Nicholas Stern. Stern is a very highly recognized British economist with experience from such distinguished institutes as the London School of Economics, the Massachusetts Institute of Technology, and Oxford University, as well as acting as chief economist at the World Bank.
The Stern report claims that the costs of climate change are far greater than previously believed. Unless we do something drastic soon, the loss of welfare by year 2100 can reach up to 20 percent of the gross domestic product (GDP) compared to a future without climate change. Previous estimates projected a welfare loss of only 0.5–1.5 percent. (check!) It will cost 1–2 percent of the GDP to reduce emissions so that some of these changes can be prevented. In other words, while previous economic analyses only support a moderate investment to reduce emissions, the Stern report argues for truly drastic measures.
Three reasons for higher costs
Stern gives three reasons for why climate change will cost more than what other economists have estimated. First, it seems as though the changes in climate will be greater than previously supposed – both because the global mean temperature will increase more and because ecosystems appear to be more sensitive than previously thought. Second, many previous estimates have overlooked the substantial welfare losses connected to changes in so-called non-economic variables, such as environment and health. Third, the world’s poor will be harder hit than the rich, and it is argued – convincingly – that these losses should be given greater weight than is the case when we only look at average values.
Like other reports of its kind, the Stern report emphasizes that the numbers are highly uncertain. Nevertheless, the results differ so much from what others have done that if they are true, then it is a very serious blow to traditional economic analyses. The question is really who is in the right ballpark: Stern or everyone else.
Criticism of Stern
Many economists assert that is Stern who is off base. Richard Tol, a highly cited economist, has pointed out that even though it is not easy to pinpoint specific errors in the report, it can nevertheless be criticized for drawing selectively from the literature. He finds examples where damage cost estimates are calculated without using available estimates of adaptation measures that can reduce the costs significantly. In other cases, findings show the strongest impacts and pick out the highest costs.
When it comes to the consequences of climate change, the estimates in many cases also seem to build more on intuition than logic. The report concludes that northern countries can expect to benefit from moderate climate change because the conditions for agriculture will improve, without taking into account that agriculture is particularly expensive in these countries and constitutes only a miniscule part of the economy. Adaptation problems for poor countries remain equally large – despite the fact that high economic growth is expected in some of these countries, they will still be poor. This is, however, not a serious criticism, because knowledge about the impacts of climate change is incomplete.
What’s worse is that the report more or less consistently uses average costs to evaluate emissions reductions. However, it is well known that marginal costs determine which measures should be implemented, and they can deviate considerably from average costs. In this area, our knowledge is far more complete.
Emphasizes the next generation
The most important reason for the major differences is, however, that the Stern report, in contrast to other studies, assumes that costs and revenue mean almost the same thing for welfare, regardless of when they are accrued. This is justified by saying that it is ethically indefensible to give greater weight to our own generation’s welfare than to the welfare of future generations, as is typical in economic analyses. It is easy to agree with this, but the truth is that this assumption is not about how to weight the welfare of the various generations. Rather, it is an expression of how long we can stand delaying consumption so that we can instead invest and consume more at a later time. When we, as in the Stern report, more or less choose to ignore impatience, it means then that it does not matter whether consumption takes place now, in 100 years, or in 200 years.
This is a radical departure from observed behavior. Another well-known economist, Partha Dasgupta, points out that if we take seriously the Stern report’s assumption that the benefit of consumption is discounted by only 0.1 percent per year, then it will pay off to save 97.5 percent of our income if the return on capital is four percent, which is about what it is in many countries today. Then most of us would starve to death. The observed savings rate is between about 10 and 20 percent in most Western countries. But the Stern report is silent about this.
Another expert in the field, Bill Nordhaus, points out that other economic analyses do not claim that significant cuts in emissions are unprofitable, but because we can invest and achieve a greater return after a short period of time, it is smart to wait a little before implementing them. We thus still have time to adapt to climate change in a rational way, even though we must live with a changing climate. It is far from certain that the Stern report and other economic analyses will have such different answers about where we will be in 100 or 200 years. The differences lie primarily in what we should do in the next few years.
Not written for economists
In the light of this criticism, we have to ask why Nicholas Stern would jeopardize his good name and reputation by overlooking some very basic economic precepts. The answer is probably that the Stern report is not written for economists. It is meant to be a basis for a political manifesto that will be to Tony Blair what the moon landing was to John F. Kennedy: namely, a call to action that the world must start acting now to solve the climate problem. In this respect, the document has done what it was supposed to do, and more. With the exception of climate skeptics and economists, reader response has been overwhelmingly positive.
In the light of the skepticism that economic analyses of the climate problem generally face, one can just as well ask whether the problem is that we economists have a problem with communicating our message. It does not help if scholarly objections hold water if nobody cares about them. So why are we not able to reach people, and what exactly is our message?
One reason is that economic analyses are hard to use as justification to undertake drastic emissions reductions today. They are often interpreted as a defense for not doing anything. The message, however, is that it will pay off to take drastic measures in the relatively near future, that is, in about 20 to 30 years. This is a relatively short period of time when we think about what has to happen to achieve a common understanding of the problem in all countries, so that also developing countries with burgeoning economies also contribute with significant reductions. Second, it requires that technologies will be developed that will enable a low-emissions future. It can very well pay off to undertake this development today. In other words, it is high time to get prepared, but we can still survive an increase in emissions for a few more years.
Not much new
The other problem is that it sounds so unreasonable to give the consumption of our own generation greater weight than the consumption of future generations. But this is not meant as a principle of intergenerational income distribution. Had this been the case, we could also ask why the Stern report allows future generations to be so much richer than our own generation, which after all includes an enormous number of poor people. In addition, there are very few of us who believe that our grandparents should have saved more, so that we could be even richer. The point of discounting the value of future consumption is that we do not want to wait indefinitely until an investment – whether it be in manufacturing, health, or climate measures – pays off. All in all, there is thus little new in the Stern report – apart from the fact that those who care about the climate problem have actually listened to what an economist has to say.
Denne artikkelen ble opprinnelig publisert i Magasinet CICERONE nummer 1, 2007