The Stern Review on MER/PPP
One of the issues that’s been debated at length here is the choice of exchange rates to use in converting different currencies for projections of future economic growth and energy demand. The scenarios developed by the IPCC have used market exchange rates (MER) Ian Castles has argued, in very strong terms, that it’s crucial to use exchange rates adjusted so as to exhibit Purchasing Power Parity (PPP). In my submission, I made a couple of points. First, that there is no uniquely satisfactory method of obtaining PPP exchange rates. Second, and more importantly, the choice doesn’t make much difference to projections of energy use or CO2 emissions, as long as the same values are used consistently. A method like MER, which tends to overstate income differences between poor and rich countries relative to PPP will yield a lower income elasticity of demand for energy. And since MER data have been, until recently more readily available for more countries, there are some practical arguments in favour of using them.
That said, there are a couple of reasons to favour a move to PPP-based scenarios. First, since these are now becoming the norm, continued use of MER numbers is likely to cause confusion. Second, while the crucial numbers regarding emissions aren’t much affected (and any error may be either up or down) other variables, particularly those used in calculations of economic welfare, might be significantly affected.
In this context, it’s unfortunate that the debate has been seized upon by denialists as a basis for attacking the whole IPCC process. The energy that’s gone into pointless disputes could have better been used in a constructive attempt to improve things.
Where does the Stern report come out on all this? Pretty much right in my view. Key quote
efforts are under way to improve the provision of PPP data. The International Comparison Programme (ICP), launched by the World Bank when Nicholas Stern was Chief Economist, is the worldâ€™s largest statistical initiative, involving 107 countries and collaboration with the OECD, Eurostat and National Statistical Offices. It produces internationally comparable price levels, economic aggregates in real terms, and Purchasing Power Parity (PPP) estimates that inform users about the relative sizes of markets, the size and structure of economies, and the relative purchasing power of currencies.
In the IPCC SRES scenarios that use MER conversions, it is not clear that the use of MERs biases upwards the projected rates of emissions growth, as the SRES calibration of the past relationship between emissions per head and GDP per head also used GDPs converted at MERs as the metric for economic activity (Holtsmark and Alfsen (2003)). Hence the scenarios are based on a lower estimate of the elasticity of emissions growth per head with respect to (the incorrectly measured) GDP growth per head. As Nakicenovic et al (2003) have argued, the use of MERs in many of the IPCC SRES scenarios is unlikely to have distorted the emissions trajectories much.
I should point out that the World Bank ICP is a successor to the earlier ICP work of Heston and Summers who initiated the idea of systematic PPP comparisons and produced the well-known Penn World Tables. Still, as the quote makes clear, Stern can speak with authority on this topic.