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Stern Review: How Climate Change is Revolutionizing Economics
Alan AtKisson, 31 Oct 06
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"The benefits of strong, early action on climate change outweigh the costs."




The sentence appears as a paragraph by itself, in bold, in the Executive Summary of the now-released, much-anticipated Stern Review on the Economics of Climate Change.

The numbers underscore the point: addressing the problem now will cost about 1% of GDP per year. Doing nothing, say the economic models, will cost the world the loss of 5% GDP per year -- "now and forever" says the report, evoking an almost religious tone. That 5% figure is actually the best case scenario for doing nothing: if all the risk factors are taken into account, and they all hit home (an appropriate phrase in this case, since our homes are what they will hit), then the figure could be as high as 20%.

This conclusion, and these figures, are what will be most remembered about this report -- that, and the media/policy splash it's making. We'll get into the details (there are 700 pages of them, so we certainly won't get into too many) later in this article. Let's first consider the frame and context.

Essentially, Stern's team took the output from climate models, and fed them into economic models. The models are intended to number-crunch a great many factors including rates of innovation, capital investment, discounting and the like, and to produce a result. Often that result is radically simplified (at least for political consumption) in the form of changes in GDP over time. The Stern Review takes broader economic-and-social approach, but it's the GDP numbers that, as usual, make the news.

As always, the results of such a study are only as good as the models and the data fed into them. But the climate models are getting darned good (we have enough historical data now on observed recent climate change to do continuous model validation and improvement), and economic modelers also have a pretty good track record at summing up a nation's development plusses and minuses. The Stern Review is based on the best of both kinds of models -- by best, I mean ethically best as well as methodologically best -- so our capacity for environmental and economic mathematical prophesy doesn't get any "better" than this.

But I cannot go farther before I air a critique about the use of that tricky word, "cost". In the Stern Review's "address it now" scenario, many of those "costs" are probably better framed as investments. They involve changes in energy consumption and technology, new fuels, new materials, reductions in traffic, etc. A great deal of that economic action will save money and/or earn it. The Stern Review itself points to a likely half-trillion dollar market in low-energy products by 2050, and Gordon Brown, the Chancellor of the Exchequer (equivalent of Treasury Secretary), also noted in a speech today that 100,000 new British jobs could be expected from many of the "costs" mentioned by the Stern review. It's unclear, at least in the summaries of this report and from scanning as many pages as I had time for, whether the net effect of this costs-cum-investments will be a real reduction in GDP ... or an increase. GDP is notorious, in fact, for registering lots of socially and environmentally negative "costs" as positive economic activity, and for not registering positives when they are not part of the monetized economy. But in any case, "cost" is not the right word here, in my view.

On the other hand, the "costs" of the "business-as-usual" (BAU) scenario are mostly real costs -- such as the cost of providing food to people whose land can no longer grow food, or the cost of dealing with climate refugees. Scrambling to meet these costs, at the expense of other economically productive activity, is what lead's Stern's review to warn that BAU, also known as "doing nothing", will result in a great depression, the likes of which has not been seen since the Great Depression.

Which leads us to lead-author Stern himself. Nicholas Stern is not just any economist; he was Chief Economist of the World Bank from 2000-2003. That by-line, and the gravitas and credibility that it evokes in nearly every corner of the globe, is a huge piece of the reason this report is getting such attention. Stern is now a UK civil servant and government advisor holding the rank of "second permanent secretary at the Treasury," but this title does not play as well in Peoria, or Pretoria, or Porto Alegre.

The other reason the report is news is because the UK wants it to be news. In case you had not noticed, the United Kingdom is very busy "profiling itself" as we say here in Sweden (and as was said today on our own national radio with a slight undertone of envy) as the world leader in the area of climate change policy. This report is another salvo in a massive national public relations campaign, which appears driven by a combination of save-the-world missionary zeal and political scuffling for center stage, all supported on a deep bedrock of UK-based science and activism on climate going back over two decades. Gordon Brown's announcement that he had engaged Al Gore to advise him on climate policy is substance plus symbolism in the same vein. David Cameron, the Tory leader, is competing on climate not with traditional conservative skepticism, but with charges of weak Labor leadership on the issue and attempts to set the policy bar even higher. In the UK, climate is cool.

Now into some of the details of the Stern Review. The ones that will get the most attention have to do with predicted economic impacts of predicted physical -- that is, environmental, ecological, climatic -- events. These impacts are of course based on science, and there is a lot of science summarized in this report. In fact, the Swedish economic commentators (I listened to Swedish radio while doing errands in my ethanol car) were at least a little surprised and even alarmed about how much climate science was in this presumably economic study. That anyone is surprised that an economic look at climate change would include a review of the science is what I find surprising; but economics is notorious for banishing references to the real world from its considerations. "Economists try to prove that what works in practice is also possible in theory," goes the old joke.

So the extensive and thoughtful scientific review is quite a credibility booster -- and that makes it all the more sobering to hear a former World Bank Chief Economist noting that:

- "[S]tabilisation [of greenhouse gases] -- at whatever level -- requires that annual emissions be brought down to more than 80% below current levels."

- "The power sector around the world would need to be at least 60% decarbonised by 2050"

- "Climate change threatens the basic elements of life for people around the world ..."

- "Ecosystems will be particularly vulnerable to climate change, with around 15 - 40% of species potentially facing extinction after only 2°C of warming."

... and so on.

The Stern Review will especially be noted for its characterization and quantification of the economic costs and benefits of climate change, in both the developed and the developing world. Chapters with titles like "Understanding the Costs of Mitigation" and "Opportunities and Wider Benefits from Climate Policies" will probably be the most read.

But I believe the most important contribution of the Stern Review is not in the conclusions that it draws, and in its methods ... but its ethics.

It may seem odd to insert that word "ethics" in an article about an economic report on climate change. But any careful reading of the Stern Review reveals that ethics is central to the project. A long review of climate change's ethical dimensions -- ranging from impacts on rights and freedoms to inter-generational equity -- appears as Chapter 2, together with a highly technical (and fascinating) annex immediately following. Why is this ethical dimension so important? Because assessing the economics of climate change requires, absolutely, making departures from traditional ethical assumptions embedded within economics.

For example, "traditional" neo-classical economics uses something called "pure time discounting," which basically says that the future and everything in it, from people to resources to species, is worth less than the present, simply because it's in the future and therefore inaccessible to us. What builds my confidence most in the Stern Review is that it builds inter-generational ethics -- which acknowledges (duh!) that the future has value to the people who will actually live in the future -- explicitly and transparently into its models. You have to speak economic math fluently to follow all this in detail, and I speak only a pigeon variety. But I sometimes lead people on expeditions to that difficult country (see Introducing Inclusive Wealth: A New Economic Measure of Sustainability); and I like what understand in the Stern Review.

Actually, it's important to underscore that the ethics in this report are mostly not arcane -- even though those arcane aspects reflect, I think, a tectonic shift in economics that the Stern Review is helping to solidify. Climate change is forcing economists to think differently. In fact, I think climate change will one day be credited with having knocked some sense into the discipline of economics.

The Stern Review itself says that it takes a "multi-dimensional view of economic and social goals, rather than a narrowly monetary one," and assesses climate change impacts against the United Nation's Millennium Development Goals. This is already a hugely important ethical decision, and quite different from, for example, the by-comparison-ridiculous "Copenhagen Consensus" process run by Danish statistician Bjorn Lomborg. That process also involved a cost/benefit analysis of climate change ... but it considered the issue in purely monetary terms, and in isolation from the other problems (like AIDS or water) it was supposedly "competing" with for artificially "scarce" global investment dollars. Lomborg's framing of issue revealed a profound lack of understanding about how the world actually works -- that problems are systemically connected, for one thing, and that money isn't the only thing available to invest. The Stern Review crushes the flimsy intellectual scaffolding of such over-exposed work with 700-page, equation-and-data-braced, systems-thinking-fueled "ka-thunk".

In short ... it does not do justice to this report to report on it in short. I predict the Stern Review will inevitably be used largely as a political prop and target, for better or worse but mostly for better, and that it will be read in its surprisingly lucid entirety by relatively few. But I also predict the Stern Review will go down as a landmark of how clear, thorough thinking can emerge into policy -- a landmark not just in climate change, or the economics of climate change, but in economics in general.

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Comments

The Economist actually ran a rather good summary of the environment a few months or perhaps week back. Could have swore I sent it to you. Basically, they made the same points as Stern (in fact it might have been written by him). Ok found it September 9th to 15th 2006 on page 10 of the survey they discuss the cost benefit analysis. "The range of estimates of the cost of mitigating climate change is not quite as large as that of estimates of the damage casued by climate change, but big enough to make it hard to decide between action and inaction. Britian's House of Lords report on the economics of climate change came up with a range of 0.2-3.2% of global output a year for the cost mitigation, but pointed out that unless developing countries start doing their bit, rich countries will end up spending more."

The Economist's report is also fascinating in that it gets into the loop holes in the European climate exchanges which are significant (they found one in the british exchange that essentially meant that kyoto was in actuality subsidizing power plants) and also the problems with the spending of Kyoto dollars. Sengal proposed two projects and received no funding while China proposed 200 projects and received 60% of all Kyoto dollars which is problematic becuase China in turn taxes Kyoto contributions hence 60% of all Kyoto money actually goes to the Chinese government's sustianability fund and not to the intended NGO.


Posted by: andrew jones on 31 Oct 06

This--

"BAU, also known as "doing nothing", will result in a great depression, the likes of which has not been seen since the Great Depression."

ought now to be the leading idea of every climate action campaign.

Great post, Alan.


Posted by: Alex Steffen on 31 Oct 06

This--

"BAU, also known as "doing nothing", will result in a great depression, the likes of which has not been seen since the Great Depression."

ought now to be the leading idea of every climate action campaign.

Great post, Alan.


Posted by: Alex Steffen on 31 Oct 06

p.s. also the economist survey is based of Bjorn Lumborg's calculations and not Stern's. But even so they do make it clear that mitigation is about the only road to prevent a steady down fall in global trade over the next century or so.

-
A


Posted by: andrew jones on 31 Oct 06

Thanks for providing us laypeople with a clear, concise introduction to the Stern Review.

I have a question about your critique of the word "costs". Is the "investment" dimension of these costs (i.e. changes in energy consumption and technology, new fuels, new materials, reductions in traffic, etc.) already calculated into the GDP impact projections? If not, then this seems like a major flaw in the calculations. Perhaps economists have a good reason for not building in such projections.


Posted by: Ira Gooding on 31 Oct 06

If the economic models being used are typical of their class, then the calculated costs and impacts are very likely understated. Econometric models are good at short-term predictions from extrapolating recent trends or through statistical regression analysis. They aren't good at anticipating runaway feedback loops or abrupt nonlinearities - both of which are probable, even likely, in a "business-as-usual" world. I think we could "get better than this" in the economic analysis by using models that can easily and explicitly incorporate feedback loops, nonlinearities and systemic delays.


Posted by: David Foley on 31 Oct 06

This deserves wide dissemination. I doubt we will come across such a succinct, incisive comment making such valuable points.
It's also worth noting, for those who don't know, that Alan is International Director of the Earth Charter Initiative www.earthcharterinaction.org


Posted by: Jeffrey Newman on 31 Oct 06

Hi Alan,

Good writing - thanks for keeping me posted about whats going on in the metropol. Here in Nuuk, it's all too hot for the season in the Arctic! No winter yet - although it should have started late-september, october.

Henriette Rasmussen


Posted by: Henriette Rasmussen on 1 Nov 06

George Monbiot did a good response to the Stern report in the Guardian , with practical actions that could be taken to address climate change in the UK.
http://environment.guardian.co.uk/climatechange/story/0,,1935560,00.html
The advantage of the Monbiot article is that you can grasp the ideas in 30 seconds, while the Stern report is a tad on the turgid side. So thanks Alan for reading it on my behalf.

Like you Alan, I am sceptical about the motivation of the (my) UK government to take the lead as an ethical protector of the environment. But at least it opens up opportunities for activists to hold them to account. The Report adds leverage to environmental campaigns; it's already been used to put pressure on the UK Government to release aditional funds for home-owners to insulate their houses.
(http://environment.guardian.co.uk/energy/story/0,,1934925,00.html


Posted by: winkie williamson on 1 Nov 06

I would doubt very much that the Stern Review will revolutionize anything. The economics profession is likely to ignore it, or perhaps use it in class as an example of how not to do policy analysis.

The Stern Review is interesting in that it is the highest bid ever on the alarmist side of climate change. No one has ever claimed such high impacts of climate change before.

Needless to say, estimates in the peer-reviewed literature are substantially lower. Stern is an outlier. And as the report has not been assessed by independent experts, but is rather written by a civil servant of a politician in trouble, a suspect outlier at that.

The most interesting part of the Stern Review are the conclusions. The Stern Review argues that greenhouse gas concentrations should be stabilised around 550 ppm CO2 equivalent. This has been the target of the UK government for a while. The Stern Review claims to put new, stronger evidence to the fore -- and then argues that the political target is unchanged. Twisted logic.

The Stern Review itself is low quality. The reading of the literature is so selective that it would make even Lomborg blush. Basic economic concepts are misinterpreted or abused.

The Stern Review is best forgotten.


Posted by: Richard Tol on 1 Nov 06

Dear Richard Tol. Rather than just complain at the low quality, why don't you tell us what we should be reading instead? With links please or titles of books. I am curious. Best regards


Posted by: Thomas Bjelkeman-Pettersson on 1 Nov 06

You should have also pointed out that global warming will increase gender inequality (chapter 4 pg. 23). We have pretended the global warming and gender inequality aren't connected for too long and we are now paying a high cost that will only increase.


Posted by: Bill James on 1 Nov 06

Richard Tol is well known as a dyed-in-the-wool disbeliever in (human caused) climate change - he refuses to consider the science and rejects the need to do anything


Posted by: Flannel Flower on 2 Nov 06

Alan -- heroic post, kudos to you and David Foley especially for talking about the systems issues. I actually don't doubt that there is a lot that can be questioned about Stern's modelling assumptions. But Lomborg's critique is meaningless, and the Stern Discount Rate is indeed a good result for the intergenerational collective! :-)


Posted by: jesseblack on 2 Nov 06

here is Richard Tol's homepage
He actually teaches classes on economics and the enviornment.
His response to the Stern report is available here

Tol aside, there are many critiques of the Stern report:
"The Stern Report’s selective fishing out of a convenient statement from one of the background papers prepared for our workshop is a classic example of cherry picking a result from a diversity of perspectives, rather than focusing on the consensus of the entire spectrum of experts that participated in our meeting. The Stern Report even cherry picks from within the Muir-Wood et al. paper." - R. Peilke amongst others. The comments sections of prometheus is full of corrections to the Stern report.

The summary from this week's Economist actually ends on a positive note though: "Sir Nicholas may well err on the gloomy side, And it is certainly impossible to predict precisely what effect climate change will have had on the world economy in a entury's time. But neither point invalidates Sir Nicholas's central perception-that governments should act not on the basis of the likeliest outcome from climate change but on the risk of something really catastrophic." and here is another summary of the Stern report in that issue.

Additionally, these economic anaylsises don't look at the environment in terms of risk mitigation, they assume that predicted forecasts are actually accurate, hence were you to look at climate change in terms of mitigating risk it might look like a better proposition taken the high amount of unknown information about the actual effects of climate change etc.

p.s. found a pretty cool podcast from Antartica today.


Posted by: andrew jones on 5 Nov 06

p.s. Richard Tol's homepage also has links to his own estimates of the costs of climate change and also take into account uncertianty over climate change too.
Some papers of note:
http://www.uni-hamburg.de/Wiss/FB/15/Sustainability/espmargcost.pdf
http://www.uni-hamburg.de/Wiss/FB/15/Sustainability/eredamage1.pdf
http://www.uni-hamburg.de/Wiss/FB/15/Sustainability/eredamage2.pdf

there's actually quite a few. I haven't read them yet though.


Posted by: andrew jones on 5 Nov 06

ok one last thing
this from one of Tol's papers on climate change:
"We ?nd that using a declining schedule of discount rates increases the social cost of carbon estimate by as little as 10% or by as much as a factor of 40, depending upon the scenario selected. Although the range of plausible estimates is large, using declining discounting schemes in FUND 2.8 in most cases does not yield values at the £70/tC level suggested by UK DEFRA [Clarkson, R., Deyes, K., 2002. Estimating the social cost of carbon emissions. Government Economic Service Working Paper. HM Treasury, London]. Indeed, only at the higher end of the values of social cost of carbon found here would many climate change related policies – such as the Kyoto Protocol – pass a cost-bene?t analysis. This conclusion, however, does not necessarily undermine the ethical and political economic reasons for supporting international collective action on climate change."

Tol's main point is simply that he does not believe cost benefit anaylsis justifies action against global warming. He simply thinks people should mitigate carbon for ethical or politlcal reasons and not due to economic ones. A point that Alan Atkisson and others have already made time and again. Actually reading Tol's papers is quite different than the gist one draws from simply reading his comments on Nicholas Stern, here is another qoute:

"The widely publicized ‘Copenhagen Consensus’ used a cost-benefit analysis framework to examine solutions to 10 pressing global problems, including climate change, and subsequently promoted the (arguably misleading) headline conclusion that climate control is a ‘bad’ global investment."

That said some of Tol's arguements against Stern require adapatation i.e. the number of people and technologies that will be developed to deal with a hotter climate:
"Let us first examine the Stern Review conclusion that climate change will cause economic disruption now and forever. The “now and forever? is preposterous.1 The world economy is growing briskly; immediate threats to economic growth are imbalances in the US, overheating in China, and lack of reform in the EU. But the “forever? part is also problematic. It assumes that society will never get used to higher temperatures, changed rainfall patterns, or higher sea levels. This is a rather dim view of human ingenuity. It contradicts what we know about technological progress, adaptation, and evolution."
Basically there's a chance we might get used to global warming (think Code 46). That said many of Tol's points actually push the Stern report further (for instance Stern's models predict continued economic growth in Africa where as Tol predicts faminine). Read 'm. It's worth it.

That said, how much effort would be required to let Tol, Lomborg, and Stern duke it out in a debate or present their reports in simple English with out economic syntaxes required?


Posted by: andrew jones on 7 Nov 06

I've just posted on the ethics of the report as well. What worries me is where we stop. Surely any action we do today that will have benefit to our grandkids should be at the Stern cost-benefit discount rate --so, any technology research, sanitation program, etc... are we going to end up investing more in our kiddies' futures than we have to consume using this discount rate?


Posted by: Adamsmithee on 13 Nov 06

Me? A "dyed-in-the-wool disbeliever in (human caused) climate change"? If Flannel Flower had done some research, (s)he would have found that Aart de Vos and I published one of the first papers (in 1993) that showed that warming was likely caused by greenhouse gas emissions.

Elsewhere, I have consistently argued that there is a solid economic case for emission reduction -- and a stronger moral case.

The Stern Review does not contribute to this cause. It is so badly researched and argued, and so full of hyperbole, that it is bound to backfire.


Posted by: Richard Tol on 17 Nov 06

As I understand them (not too well, to be honest) climate models make assumptions of a largely business as usual future, so there's potential for some interesting feedback. In theory.

But my gut feeling is that business as usual is pretty likely, since it's hard to imagine that any amount of scaremongering is likely to turn a noticeable proportion of the major C02 producing families into bicycling, alloment gardening, eco types. So the mitigation investment through taxation of two car, two holiday a year, gadget owning, fast food eating types seems certain.


Posted by: Michael Saunby on 17 Nov 06



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