Sir Nicholas Stern released in October 2006 the Stern Review: The Economics of Climate Change, the first major government-sponsored benefit-cost analysis of climate change. This report concludes that “the benefits of strong, early action on climate change outweigh the costs” – unmitigated climate change would impose damages equivalent to 5–20% of global per capita income, but stabilizing atmospheric greenhouse gas concentrations at 550 parts per million carbon equivalent would only cost the world about 1% of global GDP annually.
The Stern Review has received substantial attention in policy and academic circles. Stern testified before the U.S. Senate, and Resources for the Future and
1. Do you care more about your grandchildren or your siblings?
In modeling the damages from climate change, Stern employed a very low social discount rate by assuming a near-zero rate of time preference (0.1%) and a modest benefit from a small increase in consumption. These two assumptions (recently defended by Stern) drive the conclusion that today’s generation should invest substantially in climate change mitigation for the future’s wealthier generations. Several economists have critiqued these assumptions, including Bill Nordhaus of Yale, Partha Dasgupta of C
2. Is it possible to be simultaneously optimistic and pessimistic about technology?
The Stern Review employs a so-called “bottom up” analysis of the costs of technology adoption through 2050 to generate its estimate that a 550 ppm stabilization goal would cost 1% of global GDP. Such analyses are valuable as a catalogue of the various feasible technologies for limiting emissions, but they do not adequately characterize economic behavior by firms and individuals. By failing to model the economy, these analyses do not account for interactions across markets that can also exacerbate costs, thereby yielding optimistically low costs. Such analyses are also pessimistic – they do not account for the economic incentives of higher prices (e.g., through an emissions trading program) that can induce innovation. Reducing greenhouse emissions will require substantial resources, but smart climate policies can also unleash the creativity to develop new technologies beyond the scope of current imagination.
3. Will governments implement the “smart” policies envisioned in the analysis?
One of the strengths of the Stern Review is its emphasis on policies that can achieve the greatest possible emissions abatement for a given cost. The least-cost policies require an efficient economy-wide emissions trading program or carbon tax. Auctioning emissions permits can further reduce the costs of climate policy by allowing governments to lower labor and income taxes. In contrast, the world’s largest greenhouse gas emissions trading program, the EU’s Emission Trading Scheme, covers only half of all EU sources and severely limits permit auctions – in phase one, only one-tenth of one percent of all permits were auctioned.
4. Can governments implement the “smart” policies envisioned in the analysis?
Is a global emissions trading program feasible? Is a harmonized global carbon tax feasible? With national sovereignty, how can countries develop multilateral agreements that would provide the proper incentives for participation and compliance? Can “small” trading programs – the EU ETS, the Regional Greenhouse Gas Initiative, the California law, Congressional proposals – evolve into a global regime that could deliver the substantial emissions abatement necessary to stabilize the global climate? The critical challenge lies in designing the international policy architecture to move the world to a more climate-friendly path of economic growth.