Stern Review on Climate Change is Bad Economics

Stern Review on Climate Change is Bad Economics

The review of the economics of climate change under British civil servant Sir Nicholas Stern, released on 30 October, has created headlines around the world.

The government appealed to its findings in putting forward a battery of proposals related to its Kyoto commitments before Christmas. But how reliable are these findings?

The Review calls for urgent and drastic action on climate change, claiming that acting now might cost ‘only’ 1 percent of world GDP whereas doing nothing might devastate economies, cutting between 5 and 20 percent off global GDP.

The Review’s estimates of possible damage are far higher than those of other climate economists, while its projections of the costs of reducing emissions are lower. Why?

Essentially there are two reasons.

First, the damage numbers rest on extreme assumptions and worst case scenarios.

The Review takes as its starting point the proposition that the scientific evidence on climate change is now overwhelming, and that new evidence has yielded new grounds for alarm.

No amount of repetition of this mantra will make it true. Media reports suggest that next year’s IPCC report, which comes only 5 years after the last one, will reduce overall estimates of global warming by 25 percent and halve (from 34 inches to 17 inches) the predictions for sea-level rise by 2100.

Such swings in the space of 5 years, coupled with the fact that atmospheric methane levels appear to be declining, contrary to IPCC assumptions, and that there has been no global warming since 1998, hardly suggest settled science.

The Review presents estimates of increased damage from hurricanes and flooding if nothing is done. But critics such as sceptical environmentalist Bjorn Lomborg have pointed out that these risks can be mitigated far more cheaply by simple initiatives such as measures to strengthen buildings and control flooding than by taking costly action to cut carbon emissions.

Lomborg also points out that Stern appears to accept the estimate of Yale University’s William Nordhaus, a leading climate economist, that perhaps 3 percent (around a year’s growth) will be cut from global GDP over the coming century if nothing is done.

But he inflates this estimate by assuming carbon emissions will continue at high rates into the following century and by exaggerating the possible impacts of warming.

A second aspect of the Review that has attracted much criticism is the assumed discount rate – the rate used to compare the well-being of future generations with the well-being of those alive today.

Stern uses a very low discount rate factor that gives almost as much weight to the interests of future generations as to those living today. Thus the benefits far into the future of measures to reduce global warming are made to exceed current abatement costs.

This procedure accords neither with the reality of how people vote nor with their individual decisions. Eminent Cambridge economist Partha Dasgupta has pointed out that it implies that British citizens should be saving 97.5 percent of GDP (compared with the current UK saving rate of 15 percent), independently of global warming. As he says, this is an absurd figure: it implies the current generation should impoverish itself for all that follow.

The choice of a low discount rate has radical and nonsensical implications.

If consistently applied, it would call into question any income redistribution policies such as Working for Families since these reduce economic growth and hence the income levels of the relatively poor in generations to come.

Similarly we should scrap taxes on capital because of their growth-reducing effects.

As Nordhaus has written, “If we were to substitute more conventional discount rates used in other global-warming analyses, by governments, by consumers, or by businesses, the Review’s dramatic results would disappear.”

Even action to curb carbon emissions costing about 1 percent of global GDP would involve large sums.

For New Zealand, it would mean an annual cost of over $1000 a household.

It is little wonder that, given the minimal effect such action by a limited number of countries would have on global temperatures, governments are unwilling to impose such costs and are violating their Kyoto obligations.

The risks of climate change cannot be dismissed. They should be evaluated through sober analysis, not political alarmism or lobbying by self-interested parties, including businesses and consultants. Policy should be calibrated to reflect assessments of the net benefits of ‘insurance’ against possible future economic and environmental harm.

The Review offers a kind of cost benefit analysis, albeit a flawed one. None has been produced in a New Zealand context. The government’s latest proposals still lack any assessment of the kind that is supposed to accompany regulatory proposals.

The Stern Review is far from being an authoritative guide to the economics of climate change. Like the infamous ‘hockey stick’ analysis used in the IPCC’s last report, it is likely to end up discredited.

Roger Kerr is the executive director of the New Zealand Business Roundtable.

ENDS

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